Thursday, 20 August 2015

Dollarisation an Economic time bomb( published in the independent, Newvision and Monitor)

In recent times, the media has been awash with digital migration, a term that has cascaded into politics, digital and analogue presidential candidates. Kampala waved good bye to analogue signal in June and since there have been massive adverts for digital migration. As a recent recruit to DSTV in recent months, I have noticed that the pricing for the different packages has been on an upward swing largely pegged on the exchange rate. Another classic example of business pegged to the foreign currency is the Electricity Regulatory Authority pricing of electricity units, which has stifled debate among economic practitioners regarding the use of exchange rate as variable for adjusting electricity tariffs when it is already captured in the core inflation computation. Pegging of business pricing to exchange rate is essentially used by investors to cover the exchange rate risk, often time known as covered interest rate arbitrage.
In the extreme case, a country with perpetually weak currencies will face a situation where the citizens of a country officially or unofficially use a foreign country’s currency as legal tender for conducting transactions. Increasingly the major shopping malls around Kampala charge rental space in the US dollars and so are many other business entities like hotels, schools and land. The corruption cases surface in dollar terms because understandably those who offer bribe use the dollar. The statistics also indicate that there has been growing trend of foreign deposits as share of the total deposits, also referred to as dollarization. This by June 2015 stood at 43%. This makes Uganda one of the most dollarized economies in the world. Increasingly also the commercial banks hold significant assets in particular loans in foreign currency; foreign currency loans account for 45% of the total loans. The trend has been growing, like cockroaches, you never only seen one. The private sector expectations have been triggered with the trend likely to continue to grow, as foreign currency is seen as currency for the future. Dollarization in part reflects growing inflationary and volatile outlook, in particular with investors holding non-monetary assets priced in foreign currency rather than investing abroad. Zimbabwe is one recent example, as a result of hyperinflation and associated depreciated currency value of ZW$10 billion to 0.33 US$ in July 2008, was forced to adopt the use foreign currencies (USD, EURO and Rand) as official currencies. This is what is regarded as official dollarization. In African History, 24 other African economies have practiced official dollarisation, some as a result of colonisation while others as result of economic, social and political disturbances. Uganda's previous dollarization was between 1906 and 1920, when the East African Rupee was used
Uganda today grapples with de facto dollarization, where there has been a gradual adoption of the dollar by the general public without deliberate support from government legislation. If the trend is not reversed, it could have far reaching effects on economy through various transmission mechanisms. The most obvious and direct channel being compromising effectiveness of the bank of Uganda monetary policy conduct. The increased dollarization literally means strength of the dollar against the shilling, implying it would first and foremost keep the central bank at its toes in trying to ensure stability of the exchange rate, in the extreme at peril of drawdown of its reserves. The reserves have since 2008 deteriorated from 6 months of import value to the current 4 months of import, in part owing to the stabilisation efforts of the exchange rate by Bank of Uganda as well as fiscal slippages. In addition, the exchange rate depreciation exacerbates inflation expectations, as highlighted in the July monetary policy statement; it is expected to be between 8-10% over the next year. Management of the rapid depreciation of the exchange rate and the associated upward swings in inflation presents any central bank a nightmare bearing in mind the other supplementary objectives of creating a favourable environment for investment and growth as well as ensuring financial stability.  In the end, the central bank independence may be compromised.

By definition, broad money supply encompasses currency in circulation, local currency deposits (demand and savings) and the foreign currency deposits. With the latter growing sizeably implies the central bank's control of the money supply will be compromised as most of its instruments are tailored to controlling currency in circulation and the local currency deposits. The commercial banks, the main holders of the foreign currency deposits face a heightened foreign exchange risk exposure, mainly due to fact that foreign exchange deposits are responsive to the interest rate differentials (difference between local interest rates and regional or international rates).  

In a nutshell, dollarization is a response to economic instability including persistent depreciation of the local currency and high inflation, as investors diversify their asset portfolios. In the long run, the store of value, unit of value and the medium of exchange functions of the Uganda shilling will be compromised. Against this backdrop, the solutions should be tailored to addressing economic instability and this will require a concerted effort to address institutional, regulatory and structural bottlenecks to Uganda's competiveness. In absence of the addressing these, de-dollarisation direct measures are essential. Nigeria for example has put an embargo on importation of foreign currencies as well as the acceptance of foreign currency deposits by commercial banks into the country to stem the dollarisation of the economy.

Corruption is an economic evil in the longrun.

Corruption is an economic evil( published in monitor on the 20th august 2015)
On the 11th August 2015, while Andrew Mwenda was on NTV news night, he intimated that there is no evidence that corruption is an impediment economic development anywhere in the World. This statement is quite fallacious and ill-informed of the existing empirical evidence.  Mwenda's arguments were premised on largely correlation to argue causality.  Correlation however doesn't mean causality. Secondly, while economic growth and economic development are interchangeably used, they don’t mean the same. Economic development encompasses economic growth plus social economic transformation like poverty reduction, income inequality and improved human development indicators. A simplistic (however, contentious) measure of economic development is GDP per capita with countries that have a GDP per capita of USD 1045 are considered as low Income countries.

 In Mwenda's recent facebook post he argues that estimated corruption of about 10% of the annual budget is not the cause of bad services. He also points to the fact that recent efforts by Ministry of Finance cleanup of the register to remove ghost workers saved 230 billion in a wage bill of 3 trillion. That is about 7%.  While, poor service delivery is a manifestation of many factors including corruption, both are indicative of institutional and regulatory weakness. These arguably are very costly to a nation. To start with, 10% of the 2015/16 budget is UGX 1.85 trillion shillings and only 3 sectors of works and transport, energy and education have more. This amount compares favorably amount of interest payments by government for its debts and more than the amount government intends to borrow from the domestic market of UGX 1.4 trillion. The latter at current interest rates will attract interest payments above UGX 200 billion (50% of the agriculture budget). In short, if 10% of the budget is lost annually, a full year of the budget is lost every 10 years.

Common in literature and Mwenda's citation is the high-growth countries in East Asia exhibiting corruption tendencies inter alia of - bribery, patrimonialism, cronyism, and rent-seeking. What however, is often missed the primary growth drivers; inter alia the institutional strength and factor productivity reforms that were encountered in these economies. A recent study compares the Sub-Saharan Africa which includes many countries that are stagnating in the category of low-income countries; the same characteristics that were in many East Asian economies in the 1960s before exhibiting spectacular growth performances onwards. This study shows that East Asia has been characterised by growth-oriented governments and strong states, which have had the capacity to contain corruption and prevent threshold effects and the fall into lower equilibria. In East Asia, corruption exists but is controlled, channelled, and submitted to growth objectives because states have the capacity to achieve this.Forexample successful anticorruption campaigns in both Singapore and Hong Kong, China were implemented when they were both still relatively poor.  In contrast, in Sub- Saharan Africa, vicious circles and endogenous causalities may have created poverty traps, where weak states, predatory political regimes, generalised corruption, commodity-based market structures and windfall gains reinforce each other.

Corruption however is often intrinsically difficult to define and measure, so institutional and regulatory capacity can be used as proxy for corruption. Another commonly used is the Transparency International corruption Index which examines over 175 countries. In the top 21 countries, only 5 countries (New Zealand, Luxemburg, Iceland, Uruguay and Barbados) have a GDP of less than USD 200 billion. Of the 21 most corrupt countries, 19 of them have an annual GDP of less than $100 billion. The other two of Venezuela and Iraq each have GDP of above USD 200 billion.  The majority of low income countries, also associated with low Human Development Indicator scores, are associated with high corruption perception and this negative correlation provides prima facie evidence of the negative impact corruption has on value creation.
The corruption and economic growth consensus however remains mixed, with a few studies indicating corruption can actually spur economic growth at least in the short run. Essentially corruption (public) spurs private sector creation-as exhibited by the growing private infrastructure and businesses but at the cost of public infrastructure which is too is a fundamental driver of growth. Corruption breeds ironies for example officials of ministry of education taking their kids to private schools.  

In a literal lenses( captioned from discussion with a few colleagues), I'll illustrate with a few crude examples Police accepts bribes for issuance of driving permits or let off a reckless driver – Now quantify the cost of lives lost (include impact on dependants) and serious injuries due road carnage which flourishes because of corruption has allowed untrained drivers/riders on the road; Medical equipments are stolen, monies for repairs of equipments swindled, drugs diverted to private clinics, medical doctors abscond from work, fake HiV results, Global fund swindled etc – how many lives lost due to these malaise (infant mortality, maternal mortality etc)? What are the social and economic costs? Substandard roads works, axle load control disregarded, narrower roads, roads without signs etc – how much damage to the economy that this cause? At what cost? Teachers abscond, shoddy or incomplete classrooms constructed or money swindled altogether hence the future of children, especially belong to the poor is left in ruin. In economic terms, how much are the total cost of these children's future. Pensioners are defrauded, ghosts earn more than real people, real people are paid peanuts, not paid for months etc

Corruption may have considerable adverse effects on economic growth, largely by reducing private investment, and perhaps by worsening the composition of public expenditure and revenue, thereby undermining public trust in the government. This diminishes its ability to fulfil its core task of providing adequate public services and a conducive environment for private sector development. In the long run, corruption associated growth may dwindle and wealth distribution challenges may entail the delegitimization of the state, leading to severe political and economic instability. Corruption in Uganda has to be dealt with head on, small or big fish, and the quick wins start with addressing the inefficiencies in public entities that are rated highest in receiving bribes. Welfare audits may also come handy. Removing the Institutional and regulatory impediments to growth is better than circumventing them by corruption. 

Monday, 27 July 2015

Election cycles an Economic cost to Uganda

In various economic reports this year, one imminent risk to macro-economic stability is the 2016 election. This is in part encapsulated in the July Monetary Policy Statement (MPS), where Bank of Uganda has increased its Central bank rate for the third time this year by even a higher rate of 1.5% to 14.5%, compared to previous increases of 1% in June and another 1% in April. Before that, the central bank rate was kept at 11% since June 2014. This illustrates the heightened election related risks as Uganda draws near the election cycle.
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 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.

Wednesday, 8 July 2015

Lessons Ugandan Banks can draw from the Euro Zone

Lessons Ugandan Banks can draw from the Euro Zone
By Enock N. Twinoburyo
At the start of 2015, the Eurozone expanded its membership to 19 members when Lithuania joined. At the helm of its banking industry is the European Central Bank (ECB), which administers monetary policy of the member states - one of the largest currency areas in the world. Listed in the Treaty on European Union (TEU), the ECB is one of the world's most important central banks. The capital stock of the bank is owned by the central banks of all 29 EU member states.
In January 2015, the Eurozone inflation continued to decelerate into negatives, a ramification of prevailing aggregate demand deficiency in the currency zone. This is largely due to the financial crisis of 2008, which culminated into the Euro zone debt crisis. Referred to as the PIIGS (Portugal, Ireland, Italy, Greece and Spain), these countries had debt to GDP ratio of over 100%.
Ireland and Greece have since sought bailouts, the latter’s bailout programme hangs in balance and so is its EU zone membership. The crisis deepened the bank’s need for support from national governments. The governments on the other hand already had weakened fiscal positions. The crisis also led a threat of widespread bank failures in EU countries and near collapse of their financial systems, characterised by weak bank balance sheets and less desire by banks to lend due to depressed business confidence.
As a result, the European Commission has since proposed 28 new rules with the aim of setting up a European banking Union to better regulate, supervise, and govern the financial sector.
This was done in order to put an end to the era of massive bailouts paid for by taxpayers. It is believed that this will help restore financial stability. The measures in place include the establishment of a Single Supervisory Mechanism (SSM) effective November 2014, Single Resolution Mechanism (SRM)- expected in 2016, the European banking Authority(EBA), set up in 2012 and a future banking Union.  With the SSM and SRM, the Banks will no longer be "European in life but national in death", as they are supervised by a European mechanism and any failure will be managed by a truly European mechanism. The ECB will be stretched in trying to ensure that its monetary policy and supervision roles do not conflict. For instance it has to ensure that it does not set low interest rates to save the weaker banks.

ECB and EBA carried a year-long
comprehensive exercise to assess the state of banks and through stress tests, 25 banks failed the asset quality review (AQR) conducted by the ECB on 130 of the largest banks in the Eurozone. In the stress tests performed by the European Banking Authority on 123 of the EU’s largest banks, 24 failed. They had capital shortfalls amounting to €24.6bn(0.09 per cent of assets worth €28tn) after comparing the projected solvency ratios under the adverse stress test scenario. This was against the threshold of 5.5% tier 1 capital relative risk weighted assets. Most of these 25 banks are concentrated in (use PIIGS) crisis economies in particular Greece, Portugal, Ireland, and Italy-, which is an indication that banks, are focused on deleveraging as opposed to lending due to the low business confidence.

AQR sets a foundation for the Single Supervisory Mechanism (SSM), with ECB having direct supervisory responsibility for most of these 130 banks. It is also indirectly responsible for the rest of the banks in countries that are members of the SSM. This sets a platform for confidence building and transparency but it remains no panacea for the Euro zone banks. The bank resolution remains a responsibility of the national governments until the SRM is in place, which will also remain hybrid resolution mechanism (national and SRM framework) and the full-fledged banking Union remains to be seen. (Beck, 2014).

In addition, there has been subdued financial performance of the euro area-banking sector observed since the onset of the financial crisis, with notable cross-country differences. In particular, the profitability of the euro area-banking sector which has been mainly challenged by the on-going deterioration in asset quality, with ensuing increases in impairment charges and provisions.  Deteriorating loan quality resulted in a steady and broad-based increase in non-performing loans (NPLs) in many countries from 2008 onwards, with pronounced further increase in some cases (ECB, 2014)

The EU banking lessons indicate the need for stringent bank supervision and resolution mechanism in a bid to sustain business confidence; first at national level especially when economies are in a boom (booms are fuelled by an underestimation of risks), as well as the hit by economic hardships.  In that respect, the EAC Central Banks that are moving towards establishment of a Monetary Union do carryout joint inspections of banks and have agreed to put in place a framework for cross-border bank resolution. - Secondly, the EU banking reforms are also guided by the Basel III regulatory reforms, which require higher capital charges for systemically important institutions and better internalisation of the risks their size poses to the financial system. Fourthly, the need to repair balance sheets and beef up capital to requisite capital threshold.

Uganda has a history of  bank failures in late 1990s, early 2000s and in 2014, when Bank of Uganda revoked Global Trust bank’s license. This was in accordance to the the framework of the Financial Institutions Act (FIA), 2004, which constitutes among other minimum capital requirements and liquidity requirements and restrictions on risk taking such as limits on large loan and foreign exchange exposures. This mandates the Central Bank to protect the deposits. Uganda has also embarked on the review of both the Foreign Exchange Act 2004 and the Foreign Exchange (Forex Bureaus and Money Remittance) Regulations 2006.The process is done in consultations with other EAC central banks.
Overall, Uganda’s financial system is sound while the risks to financial stability emanating from both international and domestic sources have eased. Information from the latest Financial Stability Report from Bank of Uganda indicates that the banking system is currently well capitalized and most banks would comfortably meet the Basel III capital requirements.   
On the regional front, the EAC Central Banks are to conduct self-assessments of their compliance with Basel Core Principles for Effective Banking Supervision (BCPs) annually and conduct peer reviews every two years. In addition the EAC have adopted a standardised approach for calculating a capital charge for operational risk. As well are to finalize the process of adopting the leverage ratio, following the Basel III approach, as a supplementary measure for the analysis of capital adequacy (Bank of Uganda, 2013).

In the recent past, 2-4 years, when the Ugandan economy has slowed or least grown at less than potential, there were increased risks on the banking sector, with heightened Non-performing loans, increased credit risk and dwindling profits as well as asset quality. (See table 1).

Table 1: Uganda Banking sector Indicators March 2012- September 2014

With the limited competition in Uganda banking industry, it is likely that the lower tier banks (with a high cost to income ratio) will increase risk-taking initiatives due to moral hazard. Lessons from the Euros zone indicate that the large banks- the too big to fail, may also increase their risk taking initiatives. It is also observed, that during the economic boom days, banks over expanded and subsequently are over leveraged (European Systemic Risk Board, 2014). Uganda outlook looks positive- with the expected oil activities likely to spur the level of economic activities (including bank activity) in the coming few years; which in itself calls for prudent monitoring of the bank’s asset quality and risks. According to IMF, 2014 – there is need to strengthen the macro-prudential framework to improve risk management in systemically important banks, introduce a capital conservation buffer, and introduce counter-cyclical financial regulation will help anticipate and deal with risks.
Indeed the Bank of Uganda has taken several measures to address these concerns including data collection on and monitoring loan to value ratios for property loans.  The Bank carries out quarterly stress testing to assess the resilience of banking sector to systemic risks.
In addition to that, BoU engages small and new banks as well as systemically important ones with a view of enhancing their loan quality and liquidity. Related to that, it has brought forward implementation of Basel III capital measures to January 2014 in a bid to strengthen bank resilience.
As such, there is need to insulate the banking system from the too big to fail, in part, by enforcing measures that will create more competitive business models, as well rebalance the financial activity away from banking industry. Continued supervision indeed is a necessary action.

The writer is a PhD fellow at University of South Africa

1.    Bank of Uganda (2014), “Annual Supervision report 2013”,June
2.    Beck, T. ( 2014), “After AQR and stress tests – where next for banking in the Eurozone?”,, 10 November
3.    European Systemic Risk Board (2014), “Is Europe Overbanked?”, Advisory Scientific Committee Report 4, June.
4.    IMF (2014), “Uganda Third Review Under Policy Support Instrument”,Country Report No. 14/344, 21 November
5.    Bank of Uganda (2014), “Financial Stability Report  2014 Issue No. 6” June