Bank of Uganda raises CBR to 10%

by Christopher Kiiza
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As inflation rates surge and the value of the Ugandan shilling declines, the Bank of Uganda has taken decisive action by raising the Central Bank Rate (CBR) from 9.5% to 10%. 

This was done during a special Monetary Policy Committee (MPC) meeting on Wednesday.

“The MPC raised the CBR by 50 basis points to 10%. The bands on the CBR remain at +/-2 percentage points and the margins on the CBR for rediscount and bank rates at 3 and 4 percentage points, respectively. As a result, the rediscount and bank rates will rise to 13% and 14%, respectively. Going forward, there are prospects for a higher CBR to bring inflation down and anchor inflation expectations or a lower CBR if the risks do not materialize,” reads the Central Bank statement.

The Bank of Uganda Deputy Governor, Michael Atingi-Ego said the unfolding of some of the risks mentioned in the monetary policy statement of February 2024, which includes the depreciation of the shilling exchange rate, has triggered the need for monetary policy to be tightened.

The depreciation of the Ugandan shilling against the U.S. dollar persists, as evidenced by its performance in the trading session on Wednesday, March 6, 2024. Once more, the shilling concluded the day at a diminished level, with buying and selling rates recorded at Shs3,910 and Shs3,920, respectively.

This signifies another notable decline of the Ugandan shilling in comparison to its performance in 2020, when it reached similar levels, dropping to lows of 3,945 against the dollar.

The continued fragility of the Uganda shilling seems unavoidable, as the Central Bank’s capacity for effective intervention is hampered by inadequate reserves to steady the swiftly depreciating domestic currency.

Central Banks raise interest rates to reduce the amount of money in circulation, making borrowing more expensive and saving more attractive. This decrease in spending helps to cool down demand and reduce inflationary pressures.

The inflation outturns in February 2024 indicate that both headline and core inflation rose to 3.4% from 2.8% and 2.4% in January 2024, respectively.

Bank of Uganda said that whereas the main contributors to the rise in inflation are services and Energy Fuel and Utilities, this combined with the shilling depreciation could spill over into a generalized price increase if not contained.

Central Banks often increase the CBR to strengthen a country’s currency by attracting foreign investors seeking higher returns on their investments. A higher CBR can attract foreign investors seeking higher returns on their investments. The increased demand for the domestic currency boosts its value in the foreign exchange market.

Increasing the CBR can help stabilize exchange rates by reducing speculation and volatility in the foreign exchange market. Higher interest rates make it more expensive to borrow in foreign currencies, which can discourage speculation against the domestic currency.

According to Bank of Uganda, the exchange rate depreciation since November 2023, with sharp depreciation in February 2024, was in part caused by the outflow of some offshore investor funds from the domestic market pursuing more attractive yields available in other markets, strong domestic demand partly as a hedging mechanism against further depreciation, and seasonal factors.

The Central Bank has warned that further exchange rate depreciation could drive inflation above the medium-term target of 5% by the second half of 2024. 

“The inflation trajectory, going forward, would be shaped by the outlook of the shilling and the other goods inflation. The inflation forecasts have been revised upwards in the short term (12- month horizon) in light of the exchange rate depreciation. Inflation is projected to rise above the medium-term target of 5% by quarter 1 of FY 2024/25 and stay above 5% throughout 2025 unless monetary policy is tightened,” the Bank of Uganda statement reads in part.

“Risks to the inflation outlook remain highly dependent on the global and domestic environment. Specifically, higher global commodity prices partly due to geopolitical tensions and an increase in shipping costs resulting from the Middle East conflict as well as tighter global financial market conditions could result in higher domestic inflation, MPC assessed the risks and the uncertainties of the outlook as being broadly on the upside.”

Economic growth for FY 2023/24 is projected to remain unchanged with growth of 6%.

However, economic growth in the outer years is projected in the range of 5.5% to 6.5% compared to an earlier projection of 6.5% to 7.0%.

“The downward revision of growth in the outer years largely reflects the likely impact of tighter monetary policy, which is required to stabilize inflation around the medium term. In addition, the rise in inflation could depress household real incomes, reducing consumer spending while investment expenditure could be dampened by high raw materials import costs.”

Moreover, tax revenue underperformance could increase domestic financing which would crowd out private sector credit growth and dampen economic activity.

Furthermore, a sluggish recovery in external demand could reduce Uganda’s exports. 

However, Bank of Uganda says strengthening activity in the oil sector and the Financial Action Task Force’s (FATF) removal of Uganda from the Grey List, on February 23, 2024, could unlock additional FDI inflows and somewhat mitigate the negative effects above. 

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