29 June 2012

Uganda: Bank of Uganda Is On the Right Course

When Bank of Uganda (BOU) introduced a new monetary policy framework in July last year, many thought it was doomed to fail.

At that time, inflation was rising rapidly, driven mainly by supply side shocks to food and fuel prices and the depreciation of the exchange rate.

After nearly 12 months of the new policy, we now have the opportunity to look back and see what has been achieved.

The new monetary policy introduced by BOU is called Inflation Targeting Lite (ITL). It is similar to the monetary policy framework used by many other central banks around the world.

The ITL framework employs short-term interest rates as the main operating tool of monetary policy. Every month, the BOU sets the policy interest rate, which is called the Central Bank Rate (CBR).

The CBR aims to guide short-term interest rates and, thereby, to influence other interest rates in the economy such as lending and deposit rates offered by commercial banks.

ITL replaced the previous monetary policy framework, which relied on monetary targets rather than interest rates to control spending and demand in the economy.

The reform of the monetary policy was prompted by three main reasons.

First, it was difficult to know the amount of money in circulation, given financial innovations like mobile money and the increasing use of the Uganda shilling in the region, especially in South Sudan and eastern Congo.

Second, it was difficult under the previous framework to use monetary policy as an indicator for anchoring inflation expectations of the financial markets and the general public. It was not a very transparent framework or one which the public could easily understand.

Third, base money (which loosely refers to, but not equivalent to, the amount of money in circulation) was becoming difficult to control.

The new policy entailed a strengthening of BOU's communication strategy.

The Governor issues the monthly monetary policy statement to the media every month, explaining the reasons for any change in the Central Bank Rate and how this is expected to influence future inflation. The monetary policy statement is posted on the Bank of Uganda website and placed in all leading newspapers.

In terms of communicating issues related to the exchange rate, BOU is the only African Central Bank website that posts exchange rate movements three times every day, on all working days.

All was not smooth-sailing. The tight monetary policy stance, which was necessary to control inflation, pushed up commercial banks lending rates and has reduced private sector credit growth and had temporary slowed economic output. However, the rise in inflation has been brought to halt and has now been reversed.

Core inflation, which excludes prices of food, fuel, electricity and utilities, peaked at 30.8% in October and has now fallen to 21.2% in May 2012.

I am confident, BOU will reduce core inflation to less than 10% by the end of this year.

The new monetary policy framework has had the desired effect.

The writer is the acting director of the communications department at Bank of Uganda

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