Sylvia Juuko
28 October 2008
Kampala — THE shilling that has breached the 2,000 mark against the dollar in recent weeks will remain weak despite the central bank's assurance that the trend is short-lived, market players have warned.
The local unit traded slightly below 2,000 last week as the global financial market turmoil began to be felt closer home. Dealers said the last time the shilling traded at these rates was in May-August 2003.
On Monday, it was trading at 2,000/2,020 to the dollar in the inter-bank market compared to 1,795/1,810 the previous week.
Central bank governor, Emmanuel Tumusiime Mutebile, last week said the depreciation trend, occasioned by the exiting of offshore investors in the government securities market, was short-lived.
"Over the last three-four days, the exchange rate of the shilling to the dollar has depreciated at a faster rate. This has been caused largely by offshore investors from Europe and America in government Treasury bills and bonds who decided to sell, get dollars and take them back."
"This is the only impact we have seen from the crisis from advanced countries. We believe it is temporary and should not cause alarm," he stressed.
The central bank said the shilling has been depreciating at a rate of 13.4% per day during the month of October.
"I'm not losing sleep over the fact that the exchange rate has moved. The depreciation of the exchange rate will not impact on the economy as long as the macro-economic targets are not affected," Mutebile stressed.
But market players said the outlook is for a weak local unit in the next three months with a risk of inflation.
"I see the current rates holding for some time. There is demand piling up from the corporates. Importers also need dollars at this time of the year to bring in goods for the festive season," Denis Mushabe Mashanyu, a dealer at Standard Chartered Bank, explained.
He said the offshore investors who sell dollars to buy Treasury securities decided not to roll over their investments beginning late July and August, pushing the local unit to slightly below 2,000 from 1,640.
Mashanyu noted that despite the plunge in global oil prices to $61.72 per barrel, the weak shilling resulted into an upward movement in pump prices to sh2,750 from sh2,490.
"Oil firms are taking a hit because fuel products are imported using a strong dollar. This cost has to be passed on to consumers and since fuel affects transport, it will play into increased prices, fuelling inflation," Mashanyu said.
Mashanyu said the central bank was cautious regarding intervention with a market tight in shilling liquidity.
He predicted that the traditional end-month inflows would be more than outmatched by the piling demand for dollars.
"The dollar is resurgent. People are taking long dollar positions." The dollar has generally strengthened against other currencies due to adjustments in the global economy as a result of various rescue operations of financial institutions in America and Europe.
Economists, however, say the Ugandan shilling has been overvalued in recent times and the current trend was a market correction.
"When you look at the nominal exchange rate curve and the real effective rate, the two were tracking each other until 2004. Over time, while the nominal exchange rate has been appreciating, we have had a divergence with depreciation in the real effective exchange rate," explained the economist.
"This growing divergence has resulted into a market correction and the central bank intervenes to smoothen volatility," said the economist.
The nominal exchange rate is the price of one unit of foreign currency in local currency terms. The real effective exchange rate is an index of the economy's nominal exchange rate versus its major trading partners adjusted by the economy's inflation and that of the trading partners.
The economist said the divergence was a result of central bank's action of resorting to the forex market for sterilisation, which distorted the foreign exchange market at the expense of the money market.
The market has also been characterised by speculative tendencies, which the central bank governor re-affirmed he would stamp out.
Going forward, economists predict tougher times for individuals as a weak the shilling is coming against the backdrop of global financial market turmoil that will impact on remittances, exports and donor flows in the second half of this financial year.
"The cost of inputs is expected to rise. This cost will be transferred to consumers. If the exchange rate movements become inflationary, income will take a hit and people will have less disposable income."
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