BoU Governor’s REGRET Statement: The HANGOVER EQUIVALENT

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.

 

GDP rebasing: It is ripe for Uganda( published in observer and newvision)

A long-standing measure of economic activity in any country is the Gross Domestic Product (GDP), which by definition is the total monetary value of goods and services produced with in the country over a period- mostly a year. It is often measured by the total sum of expenditure by key economic agents (firms, households/individuals and government) and net receipts from abroad (exports minus imports). However, it can also be measured by two other methods: by adding up all the value added in a given year or by adding up all the money earned (Income) each year. Theoretically all the three methods: expenditure, value added and income should be equal.  Governments use a combination of the three methods and rely on the GDP figure to shape their economic policies including the budget policies. Uganda uses all the three methods.

 

In the last couple of years, some African countries have rebased their GDP figure thrusting them into middle-income status. GDP rebasing is the changing from old base year price structure to a recent base year in compiling composition of GDP. It requires the national statistical offices to carry out a survey of businesses in different sectors and allocate weights to each sector based on the importance to the economy in the base year. Infact, most developed countries rebase their GDP and sector weights every five years in order to reflect the current structure of the economy in terms of consumption and production patterns. 

  

In 2010, Ghana revalued its economy from 1993 base to 2006, increasing its overall GDP by over 60%.  In April this year, Nigeria’s GDP rebased its GDP from 1990 base year to 2010 base year, increasing its GDP by 89% to $ 510 billion suddenly becoming Africa’s largest economy surpassing South Africa. Kenya in September this year revalued its base year from 2002 to 2009, which increased its GDP  by 25 per cent to $53.4 billion in 2013. Tanzania is also expected to rebase its economy from 2001 base year to 2007 and that should provide higher estimates than its current GDP.  

 

Uganda uses a base year of 2002 and since then the structure of the economy has vividly and substantially changed. The discovery of oil in 2006 is already changing the economic landscape, public investments have drastically increased since 2008, mobile money has since been introduced and grown exponentially, more banks and telecommunication players have entered the market, and there has been a heightened increase of foreign direct investments mainly to extractives, manufacturing and services sector. Supermarkets have replaced the omnipresent informal shops in urban areas, and the real estate has grown rapidly underpinned by the rapid growth in private sector. On the overall, over the last decade, Agriculture sector dominance in GDP composition has since dwindled over, while services and industry sector have picked up. As such, there is need to revalue the GDP base year to capture the economic developments in the national accounts.   

 

As of end June 2014, Uganda’s nominal GDP stood at $ 24.5 billion. By safely assuming that Uganda’s GDP would change by same rate (25%) as Kenya, the figure would increase to $ 30 billion implying a GDP per capita of $ 860 for the estimated 35 million Ugandans. This should still be short of the Middle-income threshold of $ 1000, which implies Uganda would still qualify for the concessionary loans. The higher GDP would also heighten investors’ expectations, at the plus of attracting more investments: both domestic and foreign

The rebasing will have implications on the other metrics that are often referenced to GDP. For example with in the EAC, Uganda has committed to  the performance criteria which requires  a fiscal deficit, including grants as a percentage of GDP of 3%, present value of public debt as a percent of GDP of an utmost 50% as well as the revenue to GDP ratio of about 24%.  Rebasing would mean a reduction in these ratios. For example, the already low revenue to GDP of 13% would reduce further but at same time, the lower debt to GDP ratio would mean more room for debt.

Lessons from other countries show that data matters more than methods in the revision exercise. Complete and meaningful revisions can take place only when data availability is improved. Uganda has a good foundation in the recently concluded Census and other household surveys. It is also important, it is done in an open and transparent manner, to minimise the risk of politicians hijacking the process for election purposes given that 2016 is in sight. Rebasing would also provide more accurate information to guide the next phase of GDP. Uganda we can- For God and my country.

The oil price slump trend not good news for Uganda (published in african

Published in africanexecutive magazine- http://www.africanexecutive.com/modules/magazine/articles.php?article=8096&magazine=518#  
In recent months, international oil prices have been dropping and there is a sense that it’s not a short-term drop. As of week beginning 6^th October 2014, crude oil was less than $95/barrel. What is interesting is that the drop in the oil price is against the backdrop of on-going conflict in the Middle East; issues with Libya supply; conflict in South Sudan and even the Ebola outbreak in West Africa.  However, the growth in North American crude oil production attributed to shale boom in the US has offset fears of supply disruptions. The U.S. has become the world's largest producer of liquid petroleum and has in recent months, increased daily production relative to the top two oil giants Russia and Saudi Arabia. The plunge in oil prices is manifested in ample inventories, slackening demand and a U.S. dollar trading at multiyear highs.

 

Oil prices like many economic variables tend to be random walks meaning that they are unpredictable in the short run but some international factors provide some meaning guide on the trajectory. The prices are predicted to decline to lows of 80-85USD per barrel by end of year. Global demand is expected to remain subdued because of weaker-than-anticipated growth in China and Europe. The recent action by Saudi Arabia to cut prices is likely to trigger a price war.  Iran and Libya are expected to bring in more stable volumes to world market and in recent past, new drilling techniques such as hydrofracking should shove up production.

 

The fall in prices has short-term and long-term implications for Uganda.  In the shorterm, the consumers should be smiling all the way to pumps but at the same time lead to loss of government revenue. Sadly, though, the pump prices are yet to ease. Limited players in the fuel industry, as well structural, regulatory and institutional weakness, in part explain that.   In the long term, however it is not good news for Uganda. The  potential recoverable estimates are about 1.4billion barrels, and different estimates at a price of crude at 100 USD per barrel reveal potential annual oil revenues of up to 3bn dollars at peak production.

 

Like many oil rich developing economies, oil revenues will be increasingly an important financing source for public investment. Any potential shortfall in all revenues will definitely have macro-economic shocks on the economy. For example, during the oil price boom of 2003-06, Angola saved about 60 percent of the incremental increase in oil revenue, but as Oil prices stayed up, leading to the belief that they were permanent, spending increased sharply. From 2006 to 2008, Angola spent 140 percent of its additional oil revenue, more than most other low- and middle-income oil producers. By 2009, Angola faced growing macroeconomic instability against a backdrop of a significant oil price decline. In the Ugandan context, in recent past, there has been heightened fiscal (national budget) expansion increasingly funded by the expensive short-term domestic debt and market price external loans. For example, a single project the standard railway gauge is expected to cost Ugandans 8 billion dollars, 25% more than the current national budget of about 6billion dollars.  Arguably, this trend is driven by the expected windfall of oil revenues. Taking the spend-as-you-go approach forward could destabilize the economy and lead to the types of boom-bust cycles that many oil-dependent economies have suffered.

 

Needless to mention is the need to reinforce both the institutional and regulatory capacity in preparation of the windfall. The current legal framework provides for the allocation of future oil revenues to the national budget to be left to the discretion of parliament. The likely risk with this is paramount given the recent trend on the usage of supplementary budgets. In addition, the proposed law does not provide the set-up of the stabilisation fund, which should aim at setting up a mechanism by a government to insulate the domestic economy from large influxes of revenue, as from commodities such as oil. The fund is however envisaged in the regulations of the law.

 

The aforementioned estimates of oil revenues will not be large enough to be transformative; therefore, it calls for continued efforts to enhance the non-oil tax revenues. Sadly again, Uganda along with Burundi have the lowest tax revenue to GDP in the East African region. This will require innovative measures to enforce compliance with in the large and formal sectors (real estate, business services, hotels and restaurants, education) as well as the informal sector that pay little tax. Oil is often associated with windfall of capital flows, so Leakages from aggressive cross-border ‘profit shifting’ will need to be addressed.

 

 

 

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. 

 

Monetary Policy in Uganda may be sound but risks futility.

 

Since independence, Uganda has recorded at least as many shifts in policy as, there have been regime changes including the shift from direct controls (on interest rates and credit) pre 1993, to indirect monetary policy control as part of the financial sector liberalization process undertaken under the IMF Structural Adjustment Programmes. Prudent macroeconomic management helped by economic reforms, particularly better monetary policies, have contributed to an improvement in macroeconomic performance in Uganda since the early 1990s, manifested in higher real GDP growth rates and lower inflation.

In 1993, when BOU assumed its primary responsibility as the formulation and implementation of monetary policy, the Bank adopted the Reserve Money Programme (RMP) as the operating framework to facilitate indirect monetary control. This RMP remained the guiding framework until June 2011 and was premised on monetarism school of economic thought, which maintains that the money supply (the total amount of money in an economy) is the chief determinant of current GDP in the short run and the price level over longer periods. 

 

In July 2011, the base money targeting was replaced by “inflation targeting lite”. The most important consequence of the change in monetary policy regime is that the operating instrument for monetary policy became an interest rate dubbed the central bank rate (CBR), rather than the monetary base. Under the new regime, the CBR is the operating target of monetary policy, which is set monthly and announced through published monthly monetary policy statements.

 

Monetary policy is typically the first line of defence against a number of internal and external shocks that a country faces or is exposed to, so it is important to get it right. While inflation targeting has been successful at reducing inflation from double to single digit(s), the designing of monetary policy frameworks in a bid to achieve its objectives of low inflation and full employment output as well maintain that financial stability faces a number of challenges.

 

First, there is fear of the growing disharmony between the fiscal (budget) policy and the monetary policy. While the monetary policy CBR would be set lower than the current  11.5% for the last six months to boost private sector credit, the increased government presence on the domestic debt would defeat this objective as the associated yields on the government risk free paper(e.g. Treasury bills) would make attract banks to invest in government securities rather than lend to private sector a phenomenon known as crowding out effect. The Bank of Uganda Governor in his speech at the annual dinner of Uganda’s Bankers’ Association indicated that the primary auctions of government securities are now used to fund the government domestic borrowing requirement and to refinance the existing stock of securities as they mature rather than as instrument of monetary policy . As matter of fact, between 2007 and 2012, Uganda’s domestic debt stock picked up from 9% to 13.1% of GDP and it is by no surprise that the interest payments on debt as share of the budget accounts for over 8% of the budget (more than twice the agricultural budget).

 

A common institutional constraint in most developing countries is the lack of central bank independence. Over the last few years, monetary policy costs have grown to account for 30% of bank’s total operating expenditure. Some of the monetary costs relate to the fiscal policy operations. If domestic interest rates do not come down given the still low returns on BoU reserves,  BoU’s capital is at risk of  getting eroded away which undermines the credibility of monetary policy.

 

Second, the attainment multiple objectives:, with concerns about the path and volatility of the exchange rate still playing a dominant role amongst private actors, is a challenges for Monetary policy. With an open capital account, it is not possible to have independent monetary policy when the central bank is also trying to manage the exchange rate a phenomenon known as “the impossible trinity”. This is because the central bank lose control over money supply.  On price and output objectives, the governor too has been on record saying that in the circumstances when the economy is faced with supply shock as was the case in 2011, there was an unavoidable conflict between achieving both inflation and output targets. In that particular circumstance, the inflation target takes precedence even at cost of private sector growth, an issue which private actors need to comprehend.

 

There are a number of other factors that constrain the conduct of monetary policy in Uganda including but not limited to; the low levels of financial development for example limited access to formal financial services (thanks to the growing level of financial innovation e.g. mobile money), and low levels of trading on the secondary securities markets all of which constrain monetary transmission mechanism, global exogenous shocks ( including fuel and food prices) and the transition to the East African Monetary Union. In addition, the greater dollarization (ratio of foreign currency deposits to the total deposits at 33.8% of total deposits as at december 2013) of the economy, limits the scope there is for an independent monetary policy.

 

Without addressing the challenges head on, especially institutional reforms at BoU to strengthen its independence, the transition to a modern monetary policy may be futile.