The decision by the Bank of Uganda to cut the lending rates by a half percentage point may bring some positives, even though market readers say it is shocking.
On Tuesday, Bank of Uganda (BoU) cut its policy rate to 9.5 percent for the month of August 2023 in a surprise move that caught analysts off guard. The move also highlighted strong worries among monetary policy makers surrounding tough economic conditions affecting several sectors.
Local analysts had been betting on a stable 10 percent Central Bank Rate (CBR) – a pricing level maintained by Bank of Uganda for almost 12 months, but a biting urge to stimulate economic recovery in spite of a battered shilling apparently motivated the rate cut, sources claim.
“I’m surprised by the rate cut,” said Benoni Okwenje, General Manager for Financial Markets Operations at Centenary Bank.
“I expected BoU to keep the CBR stable at 10 percent, but it believes the economy requires lots of growth momentum to recover at this time before it can hit the 5-6 percent growth mark in the short term,” he added.
Read: Uganda’s Central Bank raises policy rate to 8.5pc as inflation bites
Mr Okwenje forecasts that the 0.5 percent cut will certainly bring down lending rates in the near future, though yields on some treasury bonds went up last week following the World Bank announcement, and rates on government paper could go down in upcoming debt auctions.
Uganda experienced signs of economic recession in the first half of 2023 and a diminished private sector credit flows. BoU cited this in its sudden policy rate cut. Uganda has had a lower inflation influenced by shrinking food prices.
Some sectors posted negative growth rates during the first six months, yet headline inflation dropped from 4.9 percent in June 2023 to 3.9 percent last month as falling food crop prices, lower fuel pump prices and subdued consumer demand patterns combined.
But a recent suspension of development funding support by the World Bank following Uganda’s enactment of the Anti-Homosexuality Act of 2023 triggered panic among some foreign investors and spurred a selloff in the foreign exchange market last week.
As a result, the Uganda shilling fell to record lows against the US dollar and grossed Ush3,770 per USD before recovering some ground shortly after the latest BoU announcement – an indicator of cooling nerves within the investor community.
BoU’s intervention strategy, however, may fail to address bigger economic growth concerns.
“[The] economic growth seems to be slowing due to weak domestic demand,” the BoU Monetary Policy Statement said. According to the Uganda Bureau of Statistics data, quarter-on-quarter average economic growth was -6.5 percent in the second and third quarters of 2022/23.
“The agriculture, industry and services sectors posted -21.6 percent, -2.3 percent, and -1.3 percent growth in activity. Private sector credit growth was moderate amidst tightening bank lending standards…” it said.
Read: Museveni banks on oil, exports in economy forecast
Another 0.5 percent in the Cash Reserve Ratio (CRR) promises higher liquidity levels and lending activity in the country’s banking industry after several months of “dry” interbank market conditions.
The CRR was raised from eight percent to 10 percent last year in an effort to tame potential, massive speculation in the forex market by commercial banks less willing to indulge in significant lending business after the outbreak of the Russia Ukraine war.
Following this rate cut, the CRR was lowered to 9.5 percent effective August 15, 2023 – a decision that could unlock more than Ush100 billion ($26.7 million) in fresh cash flows available in the interbank market, according to banking industry executives.
The Uganda shilling opened at Ush3,730 against the US dollar on Wednesday morning and held steady towards lunchtime.
“The Central Bank believes the economy is stagnant and need some stimulation to recover. The 0.5 percent cut is a clear signal to banks that it is time to lend more money to government or the private sector going forward,” says Charles Katongole, Head of Financial Market Operations at Standard Chartered Bank Uganda.
He adds that government is also cautious about the cost of borrowing against its coffers while credit risk in the economy remains fairly high for commercial banks.
“The reduction in the CRR is another positive lending signal that will unlock about Ush160 billion ($42.6 million) in new cash flows within the banking industry but might be felt more by the big banks compared to the small ones,” Mr Katongole argues.
