The Monetary Policy Statement highlights that the rapid exchange rate depreciation in the last one month is driven by sentiments and speculation as opposed to market fundamentals. Two perfect candidates driving expectations are the recent intensification of election related events and the approval of the perceived expansionary budget for financial year 2015/16 of UGX 24 trillion down from UGX 15 trillion in the previous financial year. It should however be noted that the budget expected to be spent in 2015/16 is UGX 18.5 trillion and the rest largely relates to Domestic Debt Repayment which will be financed through a rollover but as required by the new 2015 Public Finance Management Act, it had to be appropriated in the budget and approved by Parliament. Even then the budget remains expansionary and 47% of the overall budget is recurrent in nature.
Overall the MPS re-emphasizes the heightened risks to inflation, growth and financial conditions. This is consistent with the present year economic developments. With the CBR at 14.5%, it implies that the bank rate (rate at which commercial banks borrow from central bank) is 18%, implying that base lending rates will increase further to range of 25% and above given most agencies value credit risk risk between 4-5%. As of 14 July 2015, the overnight interbank borrowing was at 22%. These lending rates by and large are eventually distortive; they will slow private sector credit, crowd out private investments and could potentially heighten the prospects of non-performing loans. In the extreme case, there will be a recurrence of a 2011 situation where some banks stopped lending in Uganda shillings at the cost of the shrinking of the overall economic activity. In 2011/12, economic growth dropped to lowest in two decades owing to the contractionary monetary policy – the CBR was increased from 11% (July 2011) to 23% (Nov 2011 to Jan 2012) in response to the tehn evolving economic conditions.
An exploratory review of previous election cycles indicates that they have been economically costly to Uganda. In the election years, three possible shocks are experienced: the laxity to collect taxes, the pressure to increase overall expenditure and the amplified need to increase recurrent nature expenditure. The most recent elections in 2011 were marred with exceptional spending on fighter jets. This led to a retrospective approval of supplementary budgets to a tune of 33% of the approved budget. The 2005/06 budget year also had a supplementary budget of nearly 10% of the approved budget and these supplementary budgets are largely recurrent in nature. In addition, perceived corruption and, on the overall, money supply tends to increase during these times.
Also traceable in 2011 was rapid depreciation of the shilling encountered in part on account of dwindling foreign direct investments, and the election related speculation related to increased monetary expansion. As aforementioned, the Uganda shilling trend has worsened this year, reaching three record lows against the dollar; at UGX 3000 shillings in March, UGX 3300 in June and UGX 3600 in July. This has come at a cost of foreign exchange reserves, as was noted in previous election cycles, in particular 2011. Uganda's reserves have reduced from 6 months of import value enjoyed in the mid to late 2000s to an average of 4 months of imports in recent couple of years.
Inflation tends to increase during these cycles, and as noted in the monetary statement, inflation is expected to increase to 8-10% over the next year, a rate higher than national target of 5%. In 2011, inflation reached the highest at 30% in 20 years. Theoretically higher inflation tends to increase the misery index (inflation plus unemployment rate), which constrains growth and increases poverty levels.
The associated economic effects are often accompanied by corrective contractionary policies, often times the monetary policy side trying to mop out the excess liquidity largely created by the fiscal side. The lagged effects tend to last longer, as demonstrated by subdued private sector credit growth and below potential growth rates since 2011. The recent UBOS statistics show that Uganda grew at 5% of GDP in 2014/15 compared to 4.6% in 2013/14. These rates are in fact below our regional counterparts and way below the last 2 decades average of 6-7%.
In conclusion, election cycles in Uganda have tended to come at the cost of macro-economic stability. And, therefore, the performance of our economy in the next few years has all to do with national politics as it does with exogenous factors like the strengthening dollar.
By Enock Nyorekwa Twinoburyo-Economist
PhD Research Fellow - University of South Africa.