Tuesday, March 17, 2015

SHILLING COLLAPSE IS OUR FAULT NOT THE DOLLAR’S

Last week the US dollar burst through historical highs against the shilling raising inflationary fears and more stress for local businessmen.

The dollar traded above sh3,000 on Tuesday and held there by the time of publication. This is the highest the dollar has been against the shilling.

There was very little we could do about it.

During the financial crisis in 2008 the US decided that to jump start the economy they would risk the threat of inflation and pump more and more dollars into the economy. They called it Quantitative Easing.

This and other interventions got the economy back on its feet and last year the US Federal Reserve – the central bank, announced it would start mopping up the excess dollars as the economy was on a steady growth path. The effect of this announcement and subsequent actions have strengthened the dollar.

However the other major economies – Europe and Japan, held back on their own Quantitative Easing programs hoping their economies would just recover organically. They did not. So at the end of last year Japan kicked off its own program and Europe started in March.

So while the dollar is strengthening the other major currencies are weakening against it.

Locally, the drought has affected coffee exports, which have been down almost a fifth in the first months of the season, which begun in September, compared to the same period last year. In addition, while donor funding has returned the taps have not been fully opened. While our supply of dollars is not as healthy as it was a year or two ago, our demand for imported goods and fuel continues to grow unabated.

The usual suspects -- the importers, are jumping up and down calling for government and the central bank to do something about the galloping dollar.

"The best the Bank of Uganda can do – and they know it, is to moderate the movement of the shilling either upward or downward, so there are no dramatic jumps in the value of the shilling either way. To try and hold the shilling to certain rate would be a fool’s errand....

To hold the shilling to say sh2000 to the dollar would require that the central bank flood the market with dollars, which they would have bought using shillings. The artificial supply – supported by no production, would only last for a while before either the central bank gives up or runs out of reserves to sustain the defence of the shilling. At that point the shilling would suffer a spectacular collapse, possibly shoot past sh3,000 and who knows even touch sh4000 before the forces of supply and demand return it to a more sustainable level.

In 2011 the Swiss National Bank (SNB) declared it would hold the Franc from appreciating against the Euro, whose economy was in throes of depression following the global financial crisis.
At the end of last year, four years and $400b later, the Swiss gave up their defence and the Franc gained 30 percent in one day against the Euro. Imagine if the Uganda shilling jumped from sh3,000 to sh3,900 in one day against the dollar? Mayhem!

Central bank interventions are often the equivalent of treating a deep wound with a plaster. One would only be treating the symptom and not the real cause.

There are no short cuts.

To shield ourselves from the vagaries of the market two things must happen.

One, we have to produce more. And we are not talking about incremental improvements in production, but exponential leaps.

Secondly, with increased production agro-processing will become a more viable proposition. We need to process these products in order to have better control of the market prices. When the world price of coffee drops, like it did in the late 1990s from $4.00 to $0.40 a kilo, we did not see a corresponding drop in the price of instant coffee, if anything it has continued to rise ever since.

"The way our economy is structured, based on huge donor inflows and exportation of raw materials, we can expect that we will every so often suffer these fluctuations against international currencies. The antidote of course is to reduce donor dependency and add value to our exports...

Restructuring the economy is a long term project that will involve reforming the land tenure system, the resuscitation of the cooperative movement, the reskilling of our manpower and the rejigging of the financial system.


Of course in the short term it is much less painful to seat on our hands just allow things to take their own course. It really is too hard and potentially politically expensive to do what needs to be done, but we put off the necessary to our own detriment.

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