Where next for the Ugandan shilling? - African Business Magazine
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Where next for the Ugandan shilling?

Where next for the Ugandan shilling?

Ugandans will have to brace themselves for hard economic times ahead. The elections this month are exacerbating the fragility of the economy, which is suffering from the effects of the continuing decline in the value of the Uganda shilling.

The shilling, according to the Bank of Uganda, has had its value fall by 16% in the past 12 months. The Bank of Uganda’s assistant director of communications, Kelvin Kiyingi, said the exchange rate at the end of December 2015 for the shilling was 3,380 per dollar, down from USh3,000 six months earlier. The bank has warned that the decline will not end soon because the country’s exports are on the slump.

They have been falling since the beginning of the year. Exports to South Sudan, the destination of almost 25% of Uganda’s exports, have hit rock bottom as the war, which broke out in December 2013, has cut off most of the country from Ugandan supplies.

The Bank of Uganda has also blamed the fall in the value of the shilling on the global economic downturn, which has led to a decline in the demand for Ugandan exports.

The Bank of Uganda Governor Tumusiime Mutebile has said because of the decline in exports there is a growing threat to the country’s $3bn foreign reserves. The value of imports has continued to rise while that of exports has continued to decline. Kiyingi said the trade deficit in the period up to October 2015 was $1,771m.

It is projected that another deficit of $1,037m will be posted in the six months to April 2016. This trend is forecast to continue as the country’s export sector is not expected to recover in the short run to counter the increasing demand for imports.

The situation is made worse by the decline in foreign direct investment. Bank of Uganda statistics quoted by Kiyingi indicate a decline in FDI from $960m in 2014 to $830m in 2015.

Although the decline in FDI may not be blamed entirely on the coming elections, Kiyingi says there is no doubt that there is general apprehension about the country’s economic situation after the elections. He says the economic decline in the home countries of foreign investors may also be partly to blame for decline in FDI inflows.

In addition, he says, the rise in interest rates by the US Federal Reserve Board will affect the investment decisions of foreign direct investors to Uganda, who will borrow investment funds at higher interest rates than before. At the moment, Kiyingi says, there is no direct link between the decline in FDI and the shilling exchange rate to the hike in interest rates by the Federal Reserve.

While FDI inflows are declining, the situation is being aggravated by the increase in remittances out of the country by foreign workers in Uganda from $703m in 2014 to $850m in 2015. By remitting more savings and capital than before, they are reducing the dollar supply in the local foreign exchange market and raising its exchange rate as more shillings chase fewer dollars.

If the current trend continues, the figure is expected to rise further in February when the elections will be held. Some local and foreign entrepreneurs fear that a change in economic policy may result from the coming polls. For a country which has a history of political violence, some investors consider it safer to keep their money out of the country until after the elections. Forex bureaux operators say there has been increasing demand for dollars and other convertible currencies as elections come nearer.

Both local and foreign entrepreneurs say they are turning their savings and capital into convertible currency to avoid a possible erosion of value resulting from the continuing decline in the value of the shilling.

Foreign exchange bureau operators say the demand for the dollar and other convertible currencies has been steadily rising in the run-up to the general elections. Statistics from the Bank of Uganda predict a steady rise in the exchange rate from Sh3,000 to Sh3,500 per US dollar. Speculators in the money market are buying dollars and re-selling at a premium. This has put more pressure on the shilling. The Christmas season drove the demand for dollars higher as importers stocked luxury items.

The Bank of Uganda has intervened 11 times in the past 18 months to try to save the shilling’s value from falling further. But as the decline continued, Tumusiime Mutebile has admitted that propping up the shilling through money market interventions is not sustainable. He told the media in September that the country’s foreign reserves of  $3bn could be eroded if the bank continued to prop up the shilling.

The central bank usually rescues the decline of the shilling by selling dollars to the foreign exchange market when demand is running wild. Mutebile said the only sustainable way to strengthen the value of the shilling was to increase exports and to attract foreign investment.

The high dollar rate has led to higher taxes, which are calculated as a percentage of the total export or import value.

Traders have been protesting against rising taxes. They argue that they buy dollars expensively to import goods but are taxed heavily, and when they put the goods on to the market with a mark-up to reflect the rising cost of the dollar, they are unable to sell because customeras’ purchasing power is low.

After fruitless appeals for tax cuts, Kampala traders went on strike at the beginning of December. The Uganda Revenue Authority, the tax body, said it could not lower taxes. Some investors claim high taxes have made business unprofitable and are considering relocating elsewhere. They are buying dollars to do that.

While traders were protesting the high taxes, manufacturers were up in arms against Umeme, the electricity distributor, over the high cost of electricity. Every time the cost of the dollar rises against the shilling, Umeme increases consumer rates to reflect the rising cost of the dollar. This has driven up manufacturing costs.

Despite its huge potential, Uganda currently produces only about 810 MW of electricity from its three hydropower stations on the River Nile. More power is generated by two thermal plants and several others owned by sugar factories, which use bagasse.

However, according to the Electricity Regulatory Authority website, a government regulator, the demand for electricity is growing by 23% a year, which far outstrips the less than 10% growth rate of the sector. The country’s energy demand is likely to continue to outstrip its supply.

The increasing power deficit and its high cost is affecting investor confidence and making Ugandan products uncompetitive in the regional East African common market.

Available data shows that Uganda has the highest electricity charges  in the East African region. Ironically even countries such as Kenya and Rwanda, which import some of their power from Uganda, have lower electricity consumer rates than Uganda. This reflects the high consumer tax burden Uganda consumers face.

The decline in the value of the shilling will continue to trouble the economy long after the elections.

Epajjar Ojulu

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Written by African Business Magazine

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