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Why the Ugandan Shilling is rapidly depreciating?
Economists warn that the demand for the US Dollar is expected to outstrip its supply further impacting the exchange rate. PHOTO/FILE
What you need to know:
- This increased demand, in turn, led to unprecedented levels of inflation in global markets. To combat this, central banks responded with aggressive monetary policies, using central bank policy rates to ease inflation.
The rapid decline of the Ugandan shilling against the US dollar may come as a surprise to many Ugandans. However, it is essential to note that this is not a sudden event but rather a result of various global economic factors that are taking place. To throw more light on this, after the pandemic, there was an increase in aggregate demand stemming from heightened household expenditure, which led to a higher demand for US dollars to import goods and services.
This increased demand, in turn, led to unprecedented levels of inflation in global markets. To combat this, central banks responded with aggressive monetary policies, using central bank policy rates to ease inflation. As a result, many countries have experienced the highest interest rates. In the US, the interest rates were raised to levels not witnessed in decades.
This policy stance has caused pressure on the US dollar in the global markets. The probable effect is dampening foreign reserves at the Bank of Uganda. This has been further worsened by the increasing trend in the import bill as opposed to exports. This simply means that Ugandan’s demand for the US dollar has been high to be able to purchase goods and services from foreign markets. Similarly, this phenomenon is being experienced in neighbouring Kenya, where after rebasing the economy, economists realised that its exchange rate was not reflecting the actual outlook of the economy. In other words, the economy was worse off. However, a highly depreciating currency might not necessarily be such a bad thing.
A depreciating currency props up your exports by the competitive nature of low-cost goods and services in the global market. It gives your country a competitive edge over the others. However, while this could have been a good thing for Kenya, its high inflation has kept diminishing the value of its currency, adding pressure to it. In Uganda’s case, inflation has been declining since mid-last year, and current data outputs it as 2.8 percent as of January 2024 for headline inflation. It is vital to use headline inflation as a metric for it accounts for volatile items like food and energy, which largely form the drivers of Uganda’s inflation or in any country. Hence, inflation has not added pressure to the Ugandan Shilling like in Kenya’s case.
The dwindling external financing sources to Uganda can also explain the reduction in foreign reserves, weakening the currency against the US dollar. This has been exemplified by a reduction in our resource envelope.
Also, net external financing is poised to drop from Shs5,313 billion to Shs3,305 billion, respectively. Uganda’s public terrain remains fragile because of the constrained finances to support the budget. While the government of Uganda has struggled to tilt the side, external budget support still plays a critical role in our public finances. Therefore, it is important to note that external financing brings colossal sums of US dollars into the economy through financing projects. This, in turn, also acts as a buffer for any exchange rate shock for the macroeconomy. In conclusion, it is crucial to understand that the Ugandan shilling’s rapid decline against the US dollar is not an isolated event, but it is a result of various global economic factors. Thus, the government of Uganda’s commitment to sound macroeconomic policies will stabilise the currency and eventually restore confidence in the financial markets.
Ronald Ochen, Economist at the Civil Society Budget Advocacy Group [email protected]
