Why the Uganda shilling is struggling

Monday July 11, 2011

THE shilling fell to historic lows last week on a rumour that Central Bank boss Tumusiime Mutebile had handed in his resignation. This came hot on the heels of Mutebile’s published reservations on the management of the economy.

Since then importers; Kampala City Traders Association, have been up in arms, promising more strike action if the Government does not do something about the shilling. It was even suggested that the Government should hold the shilling at a certain price.

The President has since penned his opinion on this current “crisis.” Given his first-hand experience with the economy over the last 25 years, he is understandably dismissive of suggestions that this is a crisis and has counselled that we need to stay the course, make the long-term beneficial decisions and steer clear of short-term populist measures whose repercussions could unwind years of economic gain.

Whether we keep a long-term view or succumb to pressures for short-term remedies will be determined by our politics. Let us wait and see.

There are several reasons the shilling-dollar relationship has not been in our favour in recent months. A slowdown in inflows -- investment and tourists, ahead of the February polls, lower export earnings from traditional sources – the main coffee season is over, and election-related overspending. Internationally, the dollar has been strengthening on growing uncertainty about the viability of the Eurozone, a hint of recovery in the US economy and rising oil prices.

As a country, we can influence our level of fiscal discipline or lack of thereof and to some extent, the rate of inflows into the country. We have little if no say about what happens on the international currency markets.

The shilling’s decline is a symptom of structural deficiencies in our economy. At a fundamental level, our currency will appreciate or depreciate depending on external demand for it. Are we producing; can we produce stuff that will be in demand externally and therefore increase demand for our shilling, therefore causing appreciation?

As it is, we are still exporting raw coffee, tea, fish and labour. We are a commodity exporting country. The problem with commodities is that it does not take much science to replicate them and therefore they are not very expensive.

For instance, 15 years ago, Vietnam was not a coffee exporter of any reckoning, but have since boosted production to come second only to Brazil in Robusta coffee exports, affecting Uganda’s major forex earner.As I see it, we have two options. Either we grow more coffee so we can export more raw beans at lower and lower prices per kg or we start processing our own coffee and export it as a higher value product.

The more sustainable solution is the latter, but this will take a lot of government support in low cost financing, funding of research and development and marketing abroad; a solution we should have started on yesterday and will take another generation before sustainable results are realised.

Uganda is also vulnerable to currency movements because many of our manufacturing inputs are imported.

In fact, only a few days ago, Ugandan manufacturers got another extension for some semi processed imports to continue being classified as raw material imports into the EAC so they suffer less tax.

In the long-term, we have to re-examine the structure of our manufacturing sector before the unforgiving hand of the market lays down the law.

Many of our manufacturers are assemblers and packagers of finished goods. They continue to “manufacture” goods they have no competitive advantage being involved in.

This is critical because as it is now, China is fast becoming the factory of the world – there are very few things that can be manufactured cheaper than in China because of their economies of scale and cheap labour.

Our manufacturing needs should be angled more towards agriculture where we have a competitive advantage. To reengineer our manufacturing sector in that direction cannot be done overnight. In short, there is no real short-term relief to our currency woes. Politics can dictate that we put a plaster on a broken economy, but it will be a short-term solution that will give the false impression of relief, but in the long-term come back to haunt us.

As for those suggesting the Government should hold the shilling exchange, they need to think again. Trader-turned philanthropist George Soros cemented his reputation in the 1990s when he bet against the pound, judging rightly that UK’s economic fundamentals could not hold the pound to a certain level.

The Bank of England pumped in billions to support the pound, but eventually had to give up and allow the pound to find its market determined level.

It is said Soros made at least a billion dollars on that trade. He did it again during the Asian crisis in 1997.

Rest assured the moment the Bank of Uganda attempts to defend the shilling, speculators – not Soros, Uganda is too small for him, will beat a path to our shores.

And when we invariably fail to defend our shilling, 4,000 to the dollar will not be a far off fantasy.

By Paul Busharizi: The New Vision Newspaper