Uganda's current account deficit grew by $1.42 billion to $2.762 billion at the end of February, raising the possibility of a weaker currency, higher imported inflation, increased cost of living and lower foreign reserves in coming months.
The current account measures the value of imports and exports registered in a country and offers clues on self-reliance levels. A deficit implies that higher expenditure was incurred on imports compared with revenues earned from exports, putting pressure on the country's financial account and foreign reserves required to clear the excess import bill. A rising import bill usually triggers higher demand for foreign currency among importers and a decline in the local shilling.
The widening current account deficit was mainly driven by a surge in the trade deficit, which rose by $802 million between February 2018 and February 2019, according to latest Bank of Uganda data.
Whereas BoU economists blame this deficit on high imports of machinery by investors setting up new factories and expanding old manufacturing plants, new electricity generation projects recently approved by the industry regulator could add more pressure to the current account deficit over the next 12 months.
More than five new factories have been launched in Uganda in the past year.
"Higher economic growth of more than the seven per cent projected by government could help cut the current account deficit by around $200 million in six months' time, along with the renewed export momentum in South Sudan. So far, the widening current account deficit has triggered higher fuel prices both for motorists and power producers and this will eventually feed into the business value chain," said Paul Corti Lakuma, a research fellow at the Economic Policy Research Centre based at Makerere University.
Faced with a rising current account deficit, the local currency is expected to suffer more pressure amid higher prices levied on imported products and increasing core inflation. Price increases on imported items will mean higher costs of living for consumers.
Core inflation -- a measure of price changes in imported goods -- rose from 3.7 per cent in February to 4.6 per cent in March. It is projected to reach 6.4 per cent during the first three months of 2021, before easing to less than five per cent, according to BoU figures.
"The expanding current account deficit is likely to keep the dollar rate above Ush3,700 in the near future as BoU struggles to contain it below Ush3,800. But in case it exceeds Ush3,800, BoU will probably let go because it cannot afford to intervene heavily for too long. The central bank has spent a lot of money intervening in the currency market since the start of the year, and has also disbursed funds intended to support infrastructure projects. This means less cash is available for forex market operations. The government's plans to make additional payments for the two new planes ordered by Uganda Airlines from the Bombardier Company could complicate matters in the currency market," said Fred Muhumuza, an independent economist.
"The current account deficit and its fallout for the import bill have already affected prices of drugs meant to treat long term diseases. For example, some drugs required for treatment of delicate conditions like cancer, liver disease, kidney and heart problems have seen their prices rise from Ush7,000 ($1.85) per tablet to Ush10,000 ($2.66), and local pharmacies claim it is the exchange rate to blame. Certain monthly doses of life-saving medicines cost as much as Ush1,000,000 ($266).
"Core inflation may rise slightly above the official target of five per cent after six months, due to growing import price pressures," Mr Muhumuza added.
The country's foreign reserves fell slightly from $3,414.4 million in December 2018 to $3,341.47 million at the end of March, equivalent to 4.5 months of import cover.
"There are fears of drought this year, and fuel prices are also going up. Due to pressures caused by the rising import bill, we have adopted a cost-plus strategy that allows us to price our products with a small mark-up for unexpected cost fluctuations linked to external factors. We have also adopted short term client contracts that run for one month to enable us to review our prices early enough and protect our revenue margins under difficult circumstances.
"The effects of imported inflation have not been fully felt in the market because some importers enjoy high profit margins of around 50 per cent of the selling price, and are yet to pass on the higher import costs experienced in their supply chain," said Oscar Ofumbi, a business owner in the transport and education sectors.
The Uganda shilling fell by 1.3 per cent against the dollar between March 2018 and March 2019, BoU data shows. The local currency declined by 0.9 per cent against the dollar between February and March 2019, under pressure from commercial banks accumulating dollars in preparation for this year's dividend repatriation season among big corporates in the telecommunications, energy and beverages sectors.