Inflation has been contained, but experts are still wary of country's economic outlook in short-medium term
With inflation at its lowest level in 12 months and the Central Bank Rate at just 12.5% - lower than the level at which it started rising in July 2011, expectations should have been high over the outlook for the Uganda's economy. But if the sentiments expressed at a presentation by the International Monetary Fund (IMF) on Nov.5 are anything to go by, inflation might be going down but laying the groundwork for a robust recovery of economic growth could pose an insurmountable challenge in the short term.
Coupled with exogenous challenges, internal economic bottlenecks could cause a recurrence of the inflationary pressures of the past one and half years if priority sectors are not dealt with urgently.
Emmanuel Tumusiime Mutebile, the Central bank governor, told journalists at a press briefing on Nov.1 that although real GDP growth is projected to rise to 5.0% in 2012/13, from 3.4% in the previous fiscal year, it would still be below the economy's potential of 6.5-7% per year. But despite, the gloomy picture, Mutebile could be forgiven for making a rare grin, as he announced a reduction of the CBR to 12.5% in November down from 13%, a month earlier. Prior to this reduction, the bank had reduced the rate by 10 percentage points from a high of 23%. Mutebile explained that the reduction in the CBR was as a result of a sharp reduction in inflationary pressures, which had topped a high of 30.4% in October last year - the highest since 1993.
The Uganda Bureau of Statics (Ubos) reported that the October inflation fell partly because of decreases in the prices of food stuffs in most centers across the country. It said food price inflation fell 2.5% year-on-year compared to a 2.8% increase in September. The core rate of inflation, which excludes food crops, fuel, electricity and metered water, dropped to 4.0% from a revised 4.9% in September.
In a relatively jovial mood, Mutebile said the CBR was approaching the level that is consistent with the medium-term inflation target of 5.0%. "The reductions in inflation have re-enforced the BoU's confidence that core inflation will stabilise at around the medium term target of 5.0% through to the middle of next year," he said. "The main constraints to a faster recovery in the short term are the weak domestic demand and the risks and uncertainties in the global economy."
Additionally, thanks to the reductions in the CBR so far, Mutebile said there were indications that commercial banks' lending to the private sector is beginning to pick up, albeit at a slow pace.
According to BoU statistics, commercial bank weighted average rates jumped from 21.7% in July, last year to the highs of over 27% at the beginning of 2012 before slowing to around 25.6% in September. This is still very high for most borrowers - high enough to bother the BoU bosses.
"I note with concern that the interest rate spreads have recently increased," Mutebile said adding, "nonetheless, I want to thank those banks that have responded and encourage all banks to implement bolder reductions in their lending rates."
However, economic experts say it is not yet time for Ugandans to celebrate. They say that in a bid to overcome the past experiences of a volatile economic environment characterised by high inflationary pressures and a volatile exchange rate, the government has to do one main thing - balance the monetary policy with the fiscal policy to have the economy growing at the desired level of over 6% per year. Now, that is not a walk in the park.
The experts made the remarks during a presentation on the economic outlook of the world, the Sub-Saharan African region and Uganda at the Economic Policy Research Centre (EPRC) at Makerere University on Nov.5.
Ana Lucia Coronel, the International Monetary Fund (IMF) resident representative in Uganda, said the high inflationary pressures in the country had negatively affected the population since the Central bank had tighten monetary policy to make borrowing by the private sector very expensive in a bid to control inflation.
However, she said the policy tightening stance came with several drawbacks - it limited private sector opportunities for investment and job creation and thus led to slow economic growth rates. This, according to Coronel, could have been avoided.
"The government has to ensure there is high growth alongside lower inflationary pressures," she said, adding that means balancing the fiscal and the monetary policies. On the fiscal side, she said government needs to invest more in the sectors of agriculture, tourism, mining, electricity, water, roads and railways among others. She however, added the Central bank had no option but to fulfill its mandate to maintain a tight monetary policy to ensure inflation is under control for economic growth to happen. Coronel however, said despite the fact that Uganda's economy had the potential to grow because of its natural resources, limitations on strong and reputable institutions - which would help to attract more foreign investors - made the benefits of the lower inflationary pressures minimal.
One of the main consequences of the Central bank's action was an escalation of interest rates, which sent the private sector scampering out of commercial banks. Consequently, Uganda's economy grew at the rate of 3.2% in the year 2010/2011 down from 6.7% in 2009/2010 because of the high cost of doing business.
The industrial sector grew at 1.1% down from 7.9%; while the services sector grew 3.1% from 8.4% in the same period.
This, according to Coronel, presented a dilemma for the government because the fiscal side was left unattended to. "Low economic growth hurts and so is the high inflation. But it is possible to lower inflation without increasing interest rates which can be done once the fiscal and the monetary policies are well coordinated," she said.
Lawrence Bategeka, the acting principal at the EPRC, argued that for any economy to grow in the world, commercial banks must lend to the investors and entrepreneurs who in the end turn the borrowed funds into potential investment that would in the end contribute to job creation and revenue earnings to the government and spur production.
Bategeka shared Coronel's view, saying government needed to diversify the economy by examining policies in different sectors of the economy to ensure that they achieve positives "especially the agriculture sector," which would prevent the food price shocks that have been a major contributor to the high inflationary pressures since last year. He said tightening monetary policy by the Central bank was good in the short term - because it would fight inflation - but at a cost to the economy. He said "growing the sectors" of the economy would ensure a better economy even in the long term but fiscal indiscipline would only take the whole process backwards.
"We want an economy that is growing but also with low levels of inflation," he said, adding that maintaining fiscal discipline would see the economy attain this. "The authorities should at all times inspect, monitor or supervise the money allocated to different sectors of the economy to ensure it does the real activities instead of it being stolen by corrupt officials," Bategeka added.
Razia Khan, the Standard Chartered Bank regional head of research, said while BoU's reduction in the CBR to 12.5% was timely, Uganda's economy continues to perform below potential, which necessitated that banks reduce their lending rates further in order to boost economic growth.
Apart from inflation, economic management in Uganda has faced major challenges -some internal others external - in the last two years. These have included exogenous shocks (Eurozone crisis and high oil prices), as well as the electoral cycle and security concerns, which have led to massive off budgetary and supplementary expenditures to the utter chagrin of the country's development partners. Coupled with colossal corruption scandals, the general feeling is that the country's economic recovery prospects don't look good at all. While inflation has been brought down to single digits thanks to the tight monetary policy stance, the challenge of tightening the budget, the wide current account deficit and the need to maintain flexible exchange rate regime could negate the achievements realized so far.
This is because the ongoing Euro crisis presents several risks for countries such as Uganda - lower export volumes, tourism revenues, reduced capital flows (including foreign direct investment), remittances, and official development assistance - all of which could put massive pressure on the local currency in the short term as import demand for foreign exchange outstrips supply. To make matters once, several donors several major donors have announced suspension of aid to Uganda over the OPM corruption scandal. So far, Ireland, Denmark, Norway and UK have announced suspensions of aid. This according to observers would put the Central bank under renewed pressure to strengthen its position to intervene in the foreign exchange markets so as to take care of speculative attacks on the Shilling. These worries required immediate re-assurance from the Central bank.
Mutebile told journalists at his monthly press briefing on Nov. 1 that the Central bank would support the gradual adjustment of the real exchange rate, which is necessary to reduce the current account deficit of $2 billion to sustainable levels. According to BoU's monetary policy report for November, the exchange rate depreciated by 2.5% (month-on-month) but appreciated by 8.1% (year-on-year) to an average of Shs 2, 579 to the dollar. The report says the depreciation was due to the pickup in demand from offshore players, the oil and manufacturing sectors.
The other pertinent issue that came out strongly in the discussions at the EPRC discussions was the challenge of the low tax revenue to GDP ratio. The experts argued that the government through the Uganda Revenue Authority needed to grow the tax to GDP ratio from the current 12.5% - which has been flat for years - so as to compete with the average 27% for the Sub-Saharan African region.
Bategeka argued that collecting more revenue would help government invest more in different productive sectors, which would see the economy grow. Even more worrying is the fact that URA is struggling to maintain its current rate of 12.5% of GDP - the lowest in the region. In its latest report, the tax body registered a Shs 40.96bn deficit in September after failing to hit its target of Shs 556.32bn. On a cumulative basis, the tax authority said that net revenue collections for the first quarter of 2012 registered a deficit of Shs 55.5bn. Uganda's low revenue collections have been mainly attributed to the narrow tax base and the massive tax incentives and exemptions that are secretly offered to selected investors. These massive incentives are at variance with what studies by the IMF, World Bank, and others organisations around the world have found out - that what investors really want in order to invest in a particular country are not tax incentives, but proper infrastructure - roads, railway and energy - and a healthy and well-educated workforce.
In the medium term, the economic prospects might be good especially when oil revenues start flowing. Racheal Sebudde, a senior economist at the World Bank, was positive that once the country starts oil exportation, the economy would benefit but warned that it would only happen if the oil resources are spent on productive sectors to further support economic growth.
Indeed, the consensus was that boosting productivity in agriculture and industry, fixing persistent energy deficits, increasing productivity, and dealing with the inefficient transport systems were top priorities if the economy is to rebound.