Persistent Current Account Deficits are costly in the Long run ( published in newvision october 2014)

When you visit most of the super markets chains in town, you notice the dominance of non-Ugandan products from the small items on the shelves such as toothpicks, honey, rice and mopping rugs to the big items such as furniture and other house accesories. When you enter other stores such as boutiques, hardware and carports, they are dominated by foreign goods too.  

To probably put this into perspective, the main sectors contributing to our national cake (in this case GDP) are services and manufacturing. Arguably, foreign players dominate these sectors.  This in part explains the increased foreign deposits as share of total deposits, reported by bank of Uganda at over 30 percent.   This is manifested in the persistent current account deficit, meaning more imports more than exports (Trade deficit) –although the current account also includes net income (such as interest and dividends) and transfers from abroad (such as foreign aid), which are usually a small fraction of the total.  The current account deficit also implies that Uganda’s national savings are less than national investments. As such, Uganda’s investments are largely financed by borrowed foreign capital.

In spite of the current account deficits, Uganda is one of the fastest growing economies in Africa. This is mainly because Uganda’s current account deficits are financed by foreign direct investments. As of 2012, Uganda enjoys the highest FDI by volume in the East African region at 1.72bn dollars and are projected to increase in the next few years in preparation for the oil sector. A positive inflow of foreign direct investment is a major source of technology transfer and a boost for economic growth and development in many developing countries.This implies that current account deficits are not always bad.  For example, the United States of America (USA), the world’s biggest economy, has persistently operated current account deficits. 

 

While some trade theorists argue that, there is no reason why one should not import today (run a deficit) and export tomorrow, the increased magnitude of Uganda’s current account deficit at over 2.4 billion dollars( over 11% of GDP) could prove to be harmful in the long run. When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by foreign inflows or capital. In Uganda’s case, the Foreign Direct Investments that largely facilitate the current account deficits are mainly skewed towards the services, manufacturing sector, and not the agricultural sector. The linkages with the agricultural sector remain very weak, prompting the growing sectors to import some of the basic agricultural products.  The perseverance of weak linkages implies that the possibility of reversal of the trade deficits will remain a toll order.

 

 

 Also, a current account deficit exposes the exchange rate to volatility, inevitably weakening the Uganda Shilling against the dollar. For instance, the current account deficit from 5.5 percent of GDP in 2007 to over 12 percent in 2013 and this coincides with depreciation of the Uganda Shilling from 1710 UGX per 1 USD in January 2008 to over 2500 UGX per 1 USD in 2014. Furthermore, the volatility of the exchange rate complicates the conduct of monetary policy because it is untenable for central bank in the short run, to simultaneously maintain an open current account, target the exchange rate and maintain an independent monetary policy.

 

A country with current account surplus stands a better chance to weather economic shocks. For example, the world’s second biggest economy China has become a financial and trade power, in part, by keeping a current account surplus by maintaining its trade surplus artificially high. The same goes for Germany, Norway and Netherlands. While those with deficit such as Portugal, Ireland, Greece and Spain have suffered the consequences of imprudence.  As such, Uganda’s current account deficit signals to undesirable costs in long run. A careful examination of the composition of Uganda’s imports will reveal that some of the products imported should be manufactured domestically. East Africa Community (EAC) provides a market for consumption of Uganda’s manufactures. For example, Kenya is a net importer of Maize from outside EAC. Therefore, Agro processing in Uganda needs more attention than ever before. Some research studies recommend careful introduction of capital controls in awake of increased cross border capital movements.