Monday, October 10, 2011


The Bank of Uganda stepped up its fight to bring inflation under control, raising the central bank rate (CBR) for the fourth consecutive time to 20%.

The CBR was introduced this year as an indicator for banks setting their lending rates.

In addition the Bank of Uganda raised by four percentage points its bank rate – the cost it lends money to banks, to 26%.

The above decisions were a direct consequence of annual inflation – the general change in prices, jumping to 28% in September from 21% the previous month. This is the highest inflation has been since January 1993, almost 19 years ago.

A coincidence of elements have come into play that have triggered this historical rise in inflation – poor harvests and rising food demand regionally, imported inflation due to the falling shilling and campaign spending earlier this year.

The central bank, whose brief among other things is keep to prices stable, has a limited number of instruments with which to mop up excess money in circulation, which drives inflation.

They have already pushed up the amounts they offer in their treasury bill and bond auctions this year, with the result being that in last week’s auction the 91-day treasury bill rate was up to 21.4% the highest it has been in almost a decade(?).

In direct response to these actions commercial banks have been pushing up their lending rates with average base lending rates – the interest rate banks offer to their best clients, climbing to 23% from 18% at the beginning of the year.

Higher lending rates should lead to less borrowing. This has far reaching repercussions for the economy. Lower borrowing will put the brakes on economic growth, as businessmen will have to cut back on investment plans, lowering their capacity to grow production and increase jobs.

This is a situation the central bank is well aware of. The cost of reining in inflation is lower economic growth. The alternative, with runaway inflation eroding the value of people’s earnings, is too dire to contemplate and could reverse the economic gains of the last three decades.

The Bank of Uganda’s aggressive attempts to wrestle down inflation is a double edged sword and puts them in the clichéd position of damned if they do (take the steps they are taking now) and damned if they don’t.

But the Bank’s leeway to bring down inflation is short term at best. The economy’s planners need to think more strategically.

If this “crisis” has shown something it is how fragile and shallow this economy is. For instance how can Uganda with its rich soils and benign climate, in the middle of a region stressed by conflict and drought fail to rise to the occasion and supply food, so much so that the external demand for our food drives up our own prices to historic levels?

In a comment issued last week by Makerere University’s Economic Research Policy Center they warned that the current tightening of monetary policy if carried on for a long time could send the economy into recession, especially if the productive sectors – agriculture and manufacturing, are not supported.

They counseled that coupling tight monetary policy with “prioritization of expenditure in support of the productive sectors should succeed in controlling inflation as well as spurring growth of the Ugandan economy, which seems to be operating below full employment. This would entail cutting consumptive expenditure, especially budgets for state house, defense and public administration.”

In personal financial terms this is like the wannabe who “looks” rich because he rents an expensive house, drives a flashy car and is dressed to the nines, even to bed, but has not invested in any assets to make him really rich and ensure the long term sustainability of his flashy lifestyle – his doom beckons.

To work this “crisis” out of our system there are no short term solutions.

What BOU is doing is firefighting and this has limited value before the water from their fire hoses drowns us in the debris of the Ugandan economy.

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