The Bank of Uganda, on Wednesday last week announced that its Monetary Policy Committee (MPC) reduced the Central Bank Rate (CBR) by 25 basis points to 10%.
This is the first time the Central Bank has reduced the lending rate in four months.
The CBR had been raised to 10.25% by the Central Bank in April 2024 to among others; tackle inflation and stabilize the Uganda shilling, which had not stabilized against the U.S. dollar for several months.
The value of the Uganda shilling against the U.S. dollar had continued to decline. For example, during the March 6, 2024 trading session, a month before the Bank of Uganda raised the Central Bank Rate, the shilling closed at a low point, with buying and selling rates at Shs. 3,910 and Shs. 3,920, respectively.
This marked yet another significant drop of Uganda shilling compared to its performance in 2020 when it reached similar levels, hitting lows of 3,945 against the dollar.
The shilling’s vulnerability seemed unavoidable, as the Central Bank lacked sufficient reserves to effectively counter the rapid depreciation of the local currency.
The Bank of Uganda’s decision to slash the Central Bank Rate has barely made an impact in the foreign exchange market. The Uganda Shilling has remained stable against the US dollar.
The official exchange rate at the Bank of Uganda on Thursday, August 15, showed the shilling trading at Shs 3719.41 per US dollar buying and Shs3729.41 selling per US dollar.
According to Bank of Uganda Deputy Governor, Michael Atingi-Ego, the relative stability of the shilling against the US dollar has benefited from the recent CBR increases and inflows from coffee exports owing to favourable international coffee prices
Central Banks also raise the Central Bank Rate to combat inflation by making borrowing more costly. This discourages consumer spending and investment, helping to slow down economic activity. The goal is to stabilize prices and manage inflationary pressures.
In the twelve months to July 2024, domestic inflation continued to moderate, with annual headline and core inflation averaging 3.2% and 3.0%, respectively, below the medium-term policy target of 5%.
This, according to the Central Bank, is due to the fading impacts of global shocks like the war in Ukraine and COVID-19, the tightening of monetary policy early this year and the exchange rate that has stabilised with a bias towards appreciation since March 2024.
Nonetheless, both annual headline and core inflation edged up slightly to 4.0% in July 2024 from 3.9% and 3.8% in June 2024, respectively.
The increase in inflation was largely driven by services inflation which increased to 6.5% in July 2024 from 6.1% in June 2024, due to the increases in passenger transport, accommodation, recreation, sports, and culture services’ inflation.
“Looking forward, the Bank of Uganda expects inflation to be below the 5% target in FY 2024/25, broadly reflecting stable demand conditions, lower imported inflation and exchange rate stability,” said Atingi-Ego.
The inflation projection has been revised slightly downwards relative to the June 2024 forecast round, largely due to a lesser depreciated shilling exchange rate.
“However, we expect inflation to continue rising moderately in the next four months due to seasonal factors but stabilise around the target of 5% by the first quarter of 2025. There are, however, persistent uncertainties around the inflation projection, including the effects of a possible escalation of the ongoing geopolitical tensions in the Middle East, potential energy price hikes, unfavourable weather patterns affecting food production, and a stronger-than-expected path for domestic demand,” the Deputy Governor said.
“In addition, the signs of lingering inflation in other parts of the world and heightened volatility in both capital flows and the exchange rate could result in stronger depreciation of the shilling exchange rate and, therefore, higher inflation than currently assumed. Conversely, the continued unwinding of the past shocks to energy and other imported goods prices may moderate Inflation. The risks around the projection for inflation are judged to be balanced,” he added.
Economic Growth
Economic growth has recovered from the recent slowdown which had been occasioned by several external shocks.
“GDP growth picked up in the last two quarters of FY 2023/24, with an average growth of 6.7% year-on-year compared to a growth of 5.3% in the first two quarters of the financial year. The pickup in growth was broad-based across all sectors. There are signs that the continued recovery in real incomes and rising confidence are beginning to pass through to stronger consumption despite the tight monetary policy,” said Atingi-Ego.
Economic growth for FY 2024/25 is projected between 6.0% and 6.5%. Over the medium term, economic growth is projected to be above 7%, supported by stronger private sector investment and government intervention, especially in agriculture and global economic growth recovery.
However, there are vulnerabilities to the growth outlook. Internationally, there remains the continuing risk of higher commodity prices and disruption to trade flows associated with developments in the Middle East and other significant geopolitical uncertainties, which could lead to weaker global economic activity and stronger inflationary pressures.
Additionally, the Central Bank expressed worry that the re-emergence of protectionist policies could add pressure on the international trading system and weigh on domestic growth through lower exports of goods and services.
“Economic growth could also be lower if the growth in private sector credit slows further due to higher costs of borrowing and higher domestic borrowing by the Government. Additionally, a stronger shilling depreciation could weigh down on domestic demand since capital and other intermediate goods account for about 75% of imports.”
On a positive note, more favourable weather conditions leading to good food crop harvests, higher government and private sector investment in the extractive industry, and effective government intervention programs could boost economic activity.
If the world economy grows more strongly than currently projected, rising net exports, would boost domestic growth than expected.
