In recent days, the public has been awash with the recent Bank of Uganda (BoU) Governor’s public statement on being misled in 2011 election spending, subsequently leading for a record high inflation (30% in October 2011), the highest in the last 2 decades. The Governor has subsequently clarified alluding to the fact that the net amount lent to government in 2011 was UGX 94bn which is less than one quarter of 1% of GDP thus having limited impact on the money supply and this inflation.
Against the backdrop of inflation spiral in 2011, BoU adopted an inflation targeting lite framework where it uses the central bank rate (CBR) to guide the interest rates and ultimately the public expectations .This regime is associated with the trinity characteristics of: maintaining price stability, independence and accountability of the central bank. Thekey fundamentals with this framework is transparency and communication.Under the policy, investors know what BoU considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices. In 2011, the CBR was changed from 11% (July 2011) to 23% (Nov 2011 to Jan 2012) to the current 11% in response to evolving economic conditions. This successfully reduced inflation to lower than the BoU target of 5%.
The global and domestic causes of inflation withstanding; 2010/11 was peculiarly also associated with a spike in money supply attributed largely to election spending, USD 740 million purchase of fighter jets and awarding of Haba group of companies with Shs 142.7billion (USD 53m) in compensation over the alleged lost business in cancelled market.
Apparent in all this is the lack of exclusive independence ( operational) as mandated by the Bank of Uganda Act. In part, it is manifested in the appointing authority of the governor. One of the fundamental threats to monetary policy is the fiscal policy pressure. Persistent fiscal imprudence exhibited by the rising fiscal deficits funded through domestic markets insubordinates the monetary policy to fiscal policy; and the expectations of economic growth and inflation are likely to hinge on fiscal policy.
While the governor’s statement served to reinstate confidence of the public that 2011 reoccurrence would not reoccur in 2016, it has been met with a lot of public scepticism and to most; it can be equated to a hangover morning when one swears never to drink again. Only in a matter of time, that one goes the bars again. Just last financial year, the government intended to borrow UGX 1 trillion domestically (through issuance of treasury bills and bonds) to in part fund the budget, which budget already consisted a high interest bill of almost the same amount. To me, it seems like the famous Ponzi game, borrowing to just clear the interest bill. The ultimate borrowing that financial year was UGX 1.7trillion. This financial year, the government intends to borrow UGX 1.4trillion from domestic markets and your guess is as good as mine- the outturn is likely to be higher. In addition, the government will also draw down part of its savings by 1.1 trillion in BoU. As of 2013/14, domestic debt had risen to 40% of the total debt of USD 7bn. All these complicate the operations of monetary policy.
Domestic debt is short term and high cost, which has led to the interest bill as share of the budget rising to about 8% of the current budget. Also in the recent couple of years, the private sector growth has remained subdued subsequently constraining aggregate demand and the economic growth. In addition, with inflation lower than 5%, BoU would be expected to reduce interest rates further to boost private sector growth but this arguably has been hampered by fiscal policy. As result, over the last few years, monetary-policy costs have grown to account for 30% of the central bank’s total operating expenditure, leading BoU to make operational losses in the last couple of years. This trend will probably lead to an erosion of the BoU’s capital and to the risk of its independence being compromised.
The challenges of fiscal dominance over the monetary policy will likely heighten in the coming years due the planned infrastructural investments of over USD 25bn (Uganda Current GDP) in next five years. This alone will heighten the inflationary pressures that central bank has to contain, but it is also likely to associated with exchange rate challenges as well as financing pressure from domestic markets.
Inflation target achievement will be contingent upon credibility of BoU, so without legal, operational and institutional independence, its policy will get into limbo. BoU has however, despite the precarious environment delivered astounding results over the last two decades.