13 April 2014

Uganda: BoU Maintains CBR At 11.5 Percent

The Bank of Uganda has for the 5th month running maintained the CBR at 11.5%. After annual headline inflation for March 2014 surged to 7.1 % from 6.8% in February, expectations were rife that the key rate would be adjusted upwards.

However, the BoU probably didn't deem it fit to do so at this time - and more so as core inflation reduced to 3.7% from 3.9% in February over the same period. The CBR is the rate at which commercial banks borrow from the Central Bank and it provides a benchmark to price other instruments in the banking system. All other money market rates hover around the CBR. Central Bank Governor Tumusiime Mutebile said that given the outlook for the macro economy over the next 12-18 months, they believe that a "neutral monetary policy stance is warranted in April."

According to the Uganda National Bureau of Statistics (UBOS), high food prices hiked inflation as a result of the Jan/ Feb dry spell. To make matters even worse, the exchange rate was not favourable to the local currency causing it to lose some value.

Fred Muhumuza, an advisor to the Ministry of Finance, suggested that he was not surprised by BoU's action. "I expected the governor to hold the CRB at the same level for at least another month and wait for May. The economy is already not doing well and he cannot make it worse by raising the CBR," he said.

Mutebile said growth of commercial bank credit to the private sector picked up slightly in February 2014 but remains sluggish with year on year growth of 6.8%, which was below the BoU projections at the beginning of 2013/14. Average bank lending rates for shilling-denominated loans fell to 20.8% in February 2014, the lowest level since mid 2011. "Never the less, a faster recovery in credit growth may be impeded as banks focus on improving credit quality," he said.

On the effectiveness of the CBR, Muhumuza said inflation in Uganda is more of a structural problem (restricted supply amidst growing demand especially of food) and hence the medium to long-term solution of increasing right investments and production would be appropriate. This would call for lower interest rates but in a selective manner to avoid triggering the wrong demand and investment, he added.

The tightening of the Monetary Policy (when the CBR was introduced) began during 2011/12, aimed at reigning in the runaway inflation that touched 20% driven by what was described as "excess liquidity." Though it was painful to banks and borrowers, the policy eventually brought about the required stability.

However, Muhumuza suggested that while the CBR is a good tool, it had severe limitations because it is reactionary rather than proactive. For example, it is announced after inflation figures come out and yet it is supposed to be used for controlling inflation. He described it as "outright carpet bombing" that kills all forms of money demand and investments through high interest rates.

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