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.
