Uganda Inflation to drop 5 percent in 2013 - Central Bank

Friday, 30th September, 2011

Headline inflation increased to 21.4% in August from 18.7% in July, the highest level in 18 years. Paul Busharizi and Samuel Sanya spoke to Dr. Louis Kasekende, the deputy governor about the current economic health of country.

QUESTION: What are the main causes of the current high inflation rates?
The biggest cause is the higher food prices that have been brought about by supply shocks to harvests in Uganda and elsewhere in East Africa, and by higher global food prices.

Uganda?s annual food price inflation was 42.9% in August, whereas the Food and Agriculture Organisation?s world food price index rose by 26% in August.

There is also the danger of imported inflation and the depreciation of the exchange rate.
The shilling has depreciated by nearly 24%.
This has pushed up prices of imported goods.
The consumer price index food component has gone up by 40%.

What is the Bank of Uganda doing to reduce inflation?
We have tightened liquidity to reduce aggregate demand because it outweighs supply.
We use monetary policy for macro-economic management and to control inflation.

It is an effective tool to control inflation in the medium-term because it is related to aggregate demand.

However, it is not possible to control inflation in the short-term, when it has been caused by a supply side shocks.
A monetary policy cannot affect the supply of food to markets.

However, supply side shocks are cyclical, temporary phenomena and it is reasonable to expect harvests to improve and food prices to fall.
But we cannot assume that inflation will automatically cease to be a problem once the supply of food improves and food prices fall.

This is because there is a serious danger that the current high food prices, the higher prices of fuel and other imported goods, triggers a rise in inflation of prices throughout the economy.

This leads to a self-reinforcing cycle of wage and price increases with high inflation becoming entrenched.
There are some worrying signs that this has begun to occur.

Therefore, curbing the demand for goods and services will take the heat off inflationary pressures.
We are using the Central Bank Rate (CBR), which provides a signal for short-term interest rates.

We raised the CBR to 16% in September, from 13% in July to encourage commercial banks to raise interest rates on loans, which has already begun.
This will reduce the growth of their lending to the private sector, which has been buoyant.
Curtailing credit growth is unavoidable if we are to bring inflation down.

It is necessary to reduce the pace of private sector spending to dampen demand pressures on prices.

Higher interest rates will also encourage households to curb consumption and save.

They (interest rates) will also encourage larger firms to seek finance from external sources.

It is inevitable that annual inflation rates will rise further in September and October, because of the recent increases in the prices of charcoal, food stuffs and mobile phone call charges. But it should peak before the end of 2011 and begin to fall back.

It is difficult to forecast how quickly inflation will fall. We do not know what further shocks might affect prices in the future.

But we can pull annual inflation down to between 10 and 14% by this time next year and reach our 5% target by the first half of 2013.
We will be robust in raising interest rates and keeping them high until we are confident that inflation is falling back to the 5% target.
Firms should consider this when deciding to raise their prices.

If they think high inflation is here to stay and raise prices excessively, they will risk pricing themselves out because their customers will not have the money to pay.
Our assessment is that economic growth will fall to 5% from the original projection of 6.5%.
That is the price we pay for re-establishing stability in the market.

What is the Bank of Uganda doing about the exchange rate?
Our total exports are $2.5b and total imports are $4.5b. We have a trade deficit of $2b, which we have to close.
Components that can close this gap like the remittances have been weak because of the global crisis.
This is no longer a reliable source.

Even the grants have been weak. We have to reduce the demand for imports or increase capacity for exports.

Our policy is to allow exchange rate to be determined by market forces.
The economy is open to trade and capital flows.
This is subject to frequent external shocks.
It is difficult and counter-productive to control exchange rate.

But the Bank of Uganda intervenes in the market by buying and selling foreign currency if the movement in the exchange rate is too rapid because this is potentially disruptive for firms which use foreign exchange.

Our monetary policy also has indirect effects on the exchange rate because interest rates have influence on capital inflows and outflows.
Higher interest rates will normally serve to strengthen the exchange rate and vice-versa.

Have we ever been here before and dug ourselves out?
Uganda has experienced supply side shocks before. The recent was in 2008, when annual headline inflation rose to 15.9% due to food price inflation, which climbed to 33.6%.
As is the case today, 2008 was also a year of high global food price inflation.
The Bank of Uganda responded by tightening monetary policy.

This, with the return of better harvests in 2009 and 2010, brought headline inflation back to single digits by January 2010, while annual core inflation was brought down to the 5% target by May 2010.

The lesson draw from this experience is that, if policy-makers react with sufficient resolve, it is possible to bring inflation down after supply side shocks, but it does not happen quickly.

What do we need to take from this ?crisis? to make the economy resilient?
Policy-makers need to address underlying structural weaknesses, which beset our economy.

Uganda is a very fertile country, but is food insecure. We should regularly generate food surpluses to export to the region and hold sufficient stocks to prevent shortfalls on domestic markets during poor harvests.
To achieve this, it is imperative to modernise and commercialise agriculture, storage facilities, transportation and marketing of farm produce.

Secondly, the economy needs to be competitive on regional and world markets, generate more formal sector jobs to reduce unemployment and increase real wages.

The country?s competitiveness is affected by poor infrastructure, weaknesses in higher education and training, poor governance in the public sector and the heavy burden of diseases. These are deficiencies which have to be tackled urgently.

The New Vision Newspaper