By Musa Mayanja Lwanga

After overcoming the political uncertainties that characterized much of 2017, Uganda’s economic outlook for 2018 is positive. I envisage that the economy is poised to grow at a faster rate than observed last year. This projection is anchored on strong macroeconomic fundamentals and the expected political calm following the signing of the constitutional amendments.

Monetary Essentials

On the monetary policy side, inflation is expected to stay low ranging between 4 to 6 percent, having ended the year at 3.3 percent, far below the Central Bank target of 5 percent and below the 5.7 percent registered at the end of 2016.

This is based on the assumption that the favourable weather conditions witnessed in 2017 continue boosting agriculture production as well as keep food prices low, a major driver of overall inflation. Given the low inflation expectations, the central bank is expected to continue loosening monetary policy by further lowering its benchmark rate - the Central Bank Rate (CBR). This would lead to a drop in commercial bank lending rates and increased private sector borrowing.

The expansionary monetary policy is expected to spur economic growth through increased private investment resulting from the reduction in the cost of credit; improved employment creation; higher incomes and increased consumption. However, for this to bear fruit commercial bank lending rates must respond more strongly to movements in the CBR than in the past.

Although Bank of Uganda has steadily been lowering the CBR, by over 700 basis points, from 17 percent in March 2016 to 9.5 percent in November, 2017, commercial bank lending rates have only declined marginally from 24.7 percent to 21.4 percent over the same period. This has led to the widening of the spread between the CBR and lending rates (see figure 1).

Figure 1: Interest Rate Movements and Private Sector Credit

Interest Rate Movements and Private Sector Credit

Source: Bank of Uganda, 2018

A wide spread between the CBR and lending rates theoretically signals two things;

  • One, a weak interest rate transmission mechanism (meaning that the policy rates have little or no effect on commercial banks’ decisions).
  • Two, that commercial banks are either being cautious (mindful of the prevailing market conditions and future economic expectations) or are liquidity constrained (which is highly unlikely in this case given the movements in other interest rates including the time deposit rate which has dropped from 12.1 percent in December 2016 to 8.6 percent in November 2017).

The former might explain the rigidity of lending interest rates in responding to the CBR movements in Uganda. The highly charged political atmosphere in 2017 may have contributed to uncertainty and dampened economic expectations. This coupled with the fact that the banking sector was just recovering from its poor performance and the economic slowdown following the last presidential and parliamentary election, partly explain the slowdown in credit growth especially in the first half of 2017 (see figure 1 above).

Another factor that possibly contributed to the slow growth of credit to the private sector was the increase in domestic borrowing by the government from 2,258.6 billion shillings in December 2016 to 3,089.4 billion in November 2017. This had a crowding out effect forcing a slowdown in private sector credit growth. Commercial banks are willing to lend to government despite the steady drop in yields on government securities. For example, yields for the 91 and the 364 days Treasury Bills have dropped from 14.1 percent and 15.9 percent in December 2016 to 8.4 percent and 9 percent December 2017 respectively.

Despite the slow movement in the commercial bank lending rates, there is increased optimism and positive expectations regarding the health of the economy. Real sector indicators like the Business Tendency Indicator and Composite Index of Economic Activity collected by Bank of Uganda have generally been improving over time. For example, the Business Tendency Indicator has moved up to 58.8 in December 2017 from 54.4 registered a year ago while the Composite Index of Economic Activity has inched up from 195.8 to 206.7 during the same period.

Fiscal Essentials

From the fiscal side, the planned public investments in infrastructure and other services are expected to boost economic activity and incomes especially if the Buy Uganda Build Uganda (BUBU) policy, that is expected to boost demand for locally produced goods and services, is properly implemented. Success of the public spending in boosting economic activity will however, depend on government’s efforts and ability to mobilize resources to finance these activities.

With the global economy forecasted to growth faster in 2018 than in 2017 on the account of high growth in the USA, China and Europe; Uganda should expect increased inflows in terms of remittances from increased labour exports especially to the Middle East and Europe.

In addition to this, increased inflows of Foreign Direct Investment (FDI) especially in the Oil and Gas sector (with the start of the oil pipeline construction) and increased export earnings are expected to boost foreign exchange receipts.

This positive outlook however, is still subject to a number of risks, which include:

  • Weather shocks (in the form of drought and floods);
  • Pests and disease that could affect agricultural production (like was the case with army worm last year);
  • Shortfalls in revenue collection;
  • Political unease following the constitutional amendment, which could deter investors and disrupt business; corruption and delays in public project implementation.
  • In addition, external factors such as the war in South Sudan and other disruptions in the region (e.g. Burundi and Somalia) could negatively affect this outlook.

Required Actions

Efforts should be put in place to minimize the effects of the above risks, if they do eventually occur. For the projected economic growth to be realised, government and other development partners need to improve complementary services that support the agriculture sector that employs most Ugandans. This could be attained through increasing the coverage of the agriculture insurance scheme, as well as investment in the water for production in agriculture.

Similarly, improvement in domestic revenue mobilization, a reduction in domestic government borrowing, fighting corruption and improving project implementation will improve the effect of public spending on the economy.

The Writer is a Research Analyst at Economic Policy Research Centre

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