Comment — Even as humanity collectively embarks on the painstaking journey of recovery from the COVID-19 pandemic, businesses in Uganda, Sub-Saharan Africa and the world over are currently reeling from rising inflation, the effects of the war between Russia and Ukraine and a potential economic slowdown in the two biggest economies - China and the USA.
This has once again rekindled the conversation around how both exporting and importing businesses in Uganda can and should embrace risk management interventions to hedge against the increasingly volatile world we are currently operating within.
The immediate impact of aggressive rate hikes in the USA has led to a significantly strong dollar, leading to the progressive weakness of sub-Saharan African currencies among others.
According to the Uganda Bureau of Statistics' External Trade Statistics Bulletin for April 2022, Uganda's total exports amounted to US$ 289.8 million in February 2022, while total import flows in February 2022 stood at US$ 798.3 million. With Uganda importing more than it exports, and most businesses relying on foreign currency to pay for their imports, the Uganda shilling has also suffered some weakness against the dollar.
And for local companies with dollar-denominated debt at floating interest rates, both their interest rate and the cost of servicing such debt are higher.
For example, businesses in manufacturing that import inputs require foreign currency to pay for them, and while some have foreign exchange received from export sales which helps them pay for their imports, the bulk of companies in Uganda have zero or minimal foreign exchange inflows.
As such, they would need to use the Uganda shillings they collect from their local sales to buy US Dollars, Euros, GB Pounds, Kenya Shillings, SA Rand, Japanese Yen, Chinese Yuan etc., which creates a foreign exchange risk for them.
Their key risk arises from the fact that if the Uganda shilling depreciates, it will be more costly to buy a single dollar. As such, they use more of their sales-generated cashflows to buy foreign exchange, reducing the business' profit.
Just as the COVID-19 pandemic improved risk awareness amongst the public and enterprises of all sizes towards embracing insurance, so should the current global environment emphasise the need for Risk Management Products.
These generally fall within the scope of Foreign Exchange instruments, Interest Rate risk instruments or Commodity instruments - with the first two categories being the most common within our markets. Two examples come to mind to best explain these alternatives, as follows:
Company X - a coffee exporter - normally exported their crop and received foreign exchange periodically for their export. This foreign exchange - usually US dollars - is then converted to Uganda shillings to cater for different operating costs.
After the COVID-19 pandemic and the resulting business disruptions, the US dollar strengthened against the Uganda shilling - a situation that resulted in higher exchange rates - and the company was able to exchange their foreign currency at higher rates, thus getting more Uganda Shilling per dollar for about 2 months.
However, having assumed that these elevated rates would prevail for a prolonged period, they projected their financial outcome with the expectation of higher exchange rates.
Unfortunately, thereafter, the market conditions reversed and the Uganda shilling started appreciating, resulting in lower rates, under which conversions the company's anticipated profit margins were wiped out - negatively affecting their performance.
The company could have considered utilizing FX Forwards to lock in FX Forward rates to be used for their foreign exchange conversions, thereby creating certainty on their future cash flows as well as minimizing FX volatility.
Company Y, on the other hand, is a real estate company that borrowed US dollars over 7 years against the 3-month USD Libor rate to invest in their business.
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At the time of their borrowing, the USD 3-month Libor rate was 0.2% and they opted to get a financial instrument that helped them fix their interest rate at 1%.
In the last 6 months, interest rates have moved to about 4% but despite this movement, this company is still paying 1% where they fixed their rate, a decision that has helped reduce their costs significantly - especially as the current conditions indicate that market interest rates are likely to be elevated for a while as different Central Banks try to manage inflation.
With a more competitive landscape across most business sectors, companies are going to have to be more prudent in the way they minimise costs and handle risks within their business to remain profitable, and that entails embracing alternatives that are designed to help create certainty amid the global volatility we face.
