Short-term risks to long-term growth

Jeffery Mbanga

Over the past 15 years, the Ugandan economy has set an enviable growth record, but a sharp hike in inflation rates is having a turbulent effect on economic activity as interest rates have soared.

Uganda’s economy has seen better days. Although the impact of the global slow­down of 2008 was not felt as deeply here as in some other African economies, and an­nual economic growth rates have remained close to the decade-long average of 6 per­cent, things are far from easy on the ground.

The main culprit has been a strong surge in inflation over the last 12 months, to which the central bank has responded with harsh monetary tightening. Resulting high interest rates – some as high as 30 percent – are hurting the economy and were severe enough to spark off a traders’ strike in Janu­ary. To guard against trouble in the bank­ing sector, the IMF has called on the central bank to “reinforce financial sector supervi­sion”, while the banks themselves have cut back on their lending.

All of this has effectively slowed down economic activity. Fears that more credi­tors could default on their loans have grown. Adam Mugume, the central bank’s research director, recently predicted that “there could be some problems within the real estate sec­tor – because that is where there was a boom”.

Senior finance ministry and central bank officials have held fast to their belief in a turnaround, and in February there were at least a few hopeful signs of recovery. For the first time in seven months, the central bank interest rate was eased by one percentage point to 22 percent, though this is still high by regional standards. There were also in­dications that electric power supplies might soon be able to meet demand as the newly built Bujagali dam began to come on stream.

Ssebagala Kigozi, executive director of the Uganda Manufacturers Association, said the commissioning of the 250MW of power from Bujagali could ease the burden of high opera­tional costs on his members. Although he said manufacturers were still not working at full capacity, he expected turnover to improve by the end of the year with steel and plastics in­dustries performing well, as the ongoing con­struction boom has pushed up steel prices. He also foresaw benefits from growing synergies between the East African Community market and its southern neighbours.

Despite these few positive signals, manu­facturers have been hit as hard as everyone else by the high interest rates and by the gov­ernment’s recent abolition of its subsidy to the power sector, forcing their costs to spiral upwards. Kigozi also added that those dependent on agricultural products for raw materials were in for a time of low production be­cause of recent drought conditions.

The central bank has forecast inflation falling back from its current 25.7 percent to single digits before the end of 2012. This scenario will, however, require a sharp de­cline in credit growth, a gradual apprecia­tion of the Ugandan shilling against major international currencies and a fall in global commodity prices.

Taming price increases within the local food market, in order to ease the inflation­ary pressures, remains one of the govern­ment’s biggest challenges. Food prices in Uganda have been driven by demand from the region. Uganda is widely perceived to be East Africa’s ‘breadbasket’, and poor neighbours like South Sudan depend heav­ily on Uganda’s food. “Even if you get everything right [about boosting food sup­ply] in Uganda, [food] prices in East Africa influence prices in Uganda,” said World Bank economist Rasit Pertev. The World Bank has placed agriculture among the pri­ority areas for intervention this year and a $127 million fund to help farmer groups set up processing facilities and other improve­ments is intended to boost the food supply.

Uganda’s exports to South Sudan shot up to $910 million in 2008 from $60 million in 2005, according to Standard Chartered Bank, and cross-border trade has continued to flourish since then. To assist the flow, the Uganda National Roads Authority has now started construction work on the road from Gulu to Atiak, which borders South Sudan.

Another current priority project is a new highway from Kampala to Entebbe, site of the country’s main airport. China decided to fast-track the project after the government softened its stand on a $2.9 billion oil deal in which the Chinese oil company CNOOC is involved.

The tourism industry has been taking a lead in pressuring the government for better infrastructure and for more substantial budget allocations to the sector. Tourism players staged an exhibition in parliament during the second week of February, with the aim of raising awareness among legislators about the importance of tourism. The participants said they were working on a detailed document with recommendations on how government can boost the tourism sector, which they in­tend to present to parliament later in the year.

The telecommunications sector, which has done much to transform Ugandan business in recent years, is continuing to produce im­portant innovations. Leading companies like MTN Uganda, Warid, Airtel and UTL have been placing more emphasis on the money transfer platform, where consumers can send and receive money over their mobile phone. Around 400,000 customers are currently us­ing the transfer platform, processing about UGX1.3 billion ($560,000) per day, accord­ing to Bank of Uganda figures. MTN Uganda is expected to launch a service which enables customers to send and receive money across borders.

Uganda’s financial sector is also promot­ing innovative products to help traders guard against market risks. “We have seen a grow­ing interest in foreign exchange, interest rate and commodity hedges this year, and expect this interest to continue in the long term,” said Philip Henry Ssali of Standard Char­tered Bank Uganda. “In an interconnected world, events elsewhere inevitably affect the market player in Uganda. The unresolved eurozone debt crisis, pending eurozone re­cession, potential unrest in the Middle East, changing global climate and regional elec­tions will have an effect on exchange rates, commodities prices and interest rates,” said Ssali. “If last year taught us any lessons, the need for businesses to hedge against volatil­ity and have a certain degree of certainty in their costs and expenses was a big one.”

For traders seeking cheaper interest, a bill to allow Islamic banking could be tabled in parliament this year, according to Adam Mugume, from the central bank. Another source of innovation could come with plans for the country to issue a diaspora bond, which would help Ugandans abroad to take a direct stake in the widely hoped-for eco­nomic recovery.

About the author:

Jeffery Mbanga is Director at Legend Consultancy, The Wordsmith, Business Editor at The Observer, Uganda


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