Bank of Uganda to continue assessing evolving economic conditions and their implications

UGANDA - This report presents economic developments for the quarter to November 2022, where data is available. The objective of the report is to assess Uganda’s recent macroeconomic developments and the associated monetary policy decisions. The report is divided into two main parts. Part one of the report presents the external environment and implications for Uganda and Part 2 presents the domestic economic developments that are relevant to monetary policy.

2. The world economic outlook is complex, given the high persistence of global inflation and hawkish monetary policies by the main central banks. Global growth has lost momentum as monetary policy actions tighten financial conditions and as consumer confidence weakens with the rising cost of livelihood. Indeed, the October 2022 IMF projections indicate a sharp global output growth downgrade in 2023 as most economies undergo significant slowdowns. The October 2022 IMF world economic outlook significantly revised down the 2023 growth outlook in Advanced Economies, Emerging Markets and Developing Economies, and Sub-Saharan Africa. The downward revision is underpinned by; tighter global financial conditions, the gas crisis in Europe associated with the war in Ukraine, extended Covid-19 lockdowns in China, less favourable external conditions, lower trading partners’ growth, and a negative shift in the commodity terms of trade.

3. Inflation remains elevated and persistent across countries as they grapple with food and energy price shocks and shortages. More recently, however, there are some signs of moderation in price pressures, which have raised expectations of an easing in the pace of monetary tightening. Alongside easing in sovereign bond yields, the US dollar has come off its highs. Capital flows to emerging market economies (EMEs) remain volatile and global spillovers pose risks to growth prospects.

4. Global commodities prices though still at elevated levels, continue to ease after peaking between April and August 2022 owing to actual and expected easing in demand pressures and easing of supply constraints globally and specifically at the black sea. The slowdown in energy prices is driven by a pronounced easing in the average international crude oil price while the decline in non-energy prices relates to food and metal & minerals (fertilizers) is attributed to the easing supply disruptions at the black sea.

5. In the quarter to November 2022, the international financial market showed severe volatility, owing to changes in both expectations for the intensity of global monetary policy tightening and circumstances surrounding the UK market turmoil. Since late August, global interest rates had risen, stock prices had fallen, and the US dollar had further strengthened due to heightened risk aversion. The aversion came after concerns over further monetary policy tightening in major countries. This has raised the financing costs for emerging markets and developing economies, which are already generally facing real rates higher than those in advanced economies. However, the expected slowdown in the pace of tightening has prompted the easing of the US dollar in November 2022 and the edging down of yields on treasuries in advanced economies although they remain substantially higher compared to the period before the current Monetary policy tightening cycle.

6. In Uganda, BoU raised the Central Bank Rate (CBR) by one percentage point to 10 percent in October 2022 and maintained at this level in the December 2022 Monetary policy meeting as inflationary pressures had peaked in the last quarter of 2022 much earlier than previously anticipated. This CBR coupled with fiscal consolidation are expected to deliver the convergence of inflation to its mediumterm target of 5 percent by end of 2023. Consistent with the Monetary policy actions, interest rates have edged up while private sector credit extension has moderated.

7. As expected, the tightening monetary policy has resulted in rising interest rates. The weighted average 7-day interbank rate rose to 11.5 percent in the quarter to November 2022 from 9.5 percent in the quarter to August 2022. Banks more than doubled the uptake of the Standing Lending Facility to Shs v | P a g e 17.1 trillion from 7.5 trillion in the same period. Yields on Government securities have risen, with yields on 364-day treasury bills rising to an average of 15 percent in the quarter to November 2022 from 12.1 percent in the quarter to August 2022. Similarly, the weighted average lending interest rates rose to 18 percent in the quarter to October 2022 from 16.7 percent in the quarter to July 2022.

8. Preliminary data for the four months of FY22/23 indicates that fiscal operations were less expansionary than what was programmed. Government expenditure amounted to Shs.11,065 billion compared to the projected of Shs.12,663.4 billion. Current expenditure was higher than programmed by Shs.130.1 billion mainly due to the overrun in the domestic debt interest payments. Government revenue (including grants) amounted to Shs.7,658.1 billion, below the budget target by Shs.217.7 billion. With respect to the URA targets, total revenue collections in the same period amounted to Shs.7,182.1 billion, Shs.142.9 billion above their target largely due to overperformance in taxes on international trade.

9. Public debt in nominal value stood at Shs. 79,938.1 billion (appx. 49 % of GDP) in October 2022. Public debt remains sustainable. Public debt as a ratio to GDP is projected to rise further in the medium term and peak at about 53 percent before gradually easing and returning to the Government target of 50 percent by the end of FY2024/25. However, public debt servicing continues to exert pressure on domestic revenues. Total debt service (domestic & external) as a percentage of domestic revenues averaged 37 percent in the first four months of FY2022/23. Although most all debt risk indicators were within the 2018 PDMF thresholds, domestic debt interest payments continued to be in breach, reflecting liquidity pressures on the domestic revenues to finance the domestic debt liabilities at the expense of other priority budgetary items. Moreover, external debt serving which is projected to average US$ 1.3 billion per year between FY2022/23-2025/26 remains a major strain on international reserves.

10. Uganda’s external position weakened in the 12 months to October 2022, reflecting adverse spillover effects associated with the Russia-Ukraine conflict, especially on the commodities terms of trade which exerted pressure on the trade balance, keeping the current account on the weakening path. The financial account surplus recorded a steep contraction due to a surge in the outflow of short-term capital and shrinkage of loan disbursements to the government amid increased external debt service. The combination of a widening current account and reduced financing resulted in an overall BOP deficit to a tune of US$ 545.2 million in the year to October 2022 from BOP surpluses recorded for similar periods in the previous two years.

11. Similarly, on a quarterly basis, the current account deficit widened although marginally due to the widening of the services deficit on account of reduced inflows from tourists due to the Ebola epidemic. While the financial account surplus somewhat recovered on account of good performance of FDI and drawdown deposits assets abroad by banks during the quarter to October 2022, it remained insufficient to cover the current account deficit culminating in an overall BOP deficit of US$184.9. Consequently, gross reserves contracted to $3,610.8 million or equivalent to 3.5 months cover of imports of goods and services at end of October 2022, down from a stock of US$4,331.2 million equivalent to 4.8 months cover of future imports of goods and services as at end October 2021.

12. The Uganda shilling has been stronger than expected, strengthening by 1.6 percent month-on-month in November 2022. The shilling strengthening has been supported by the tightening of monetary policy, the recent easing of global transportation costs, decline in the global commodity prices such as crude oil which somewhat eased the pressure on the deteriorating terms of trade, increase in workers' remittances and foreign direct investment in the oil sector. The outlook on the exchange rate is dependent on global developments, particularly the pace of monetary tightening in advanced economies.

13. The domestic economy remains resilient to the current external shocks and is projected to grow in the range of 5.0-5.3 percent in Financial Year (FY) 2022/23 driven by improvement in agricultural productivity as a result of government interventions, investments in the oil sector, and a rebound in industrial activities. However, this is slightly lower than the October 2022 round of forecast of 5.0-5.5 percent. Indeed, the latest high-frequency indicators of economic activity show that economic activity weakened in the quarter to October 2022. Also, business sentiments fell in November 2022, reversing the upward trend recorded in the previous two months. The softening of growth is attributed to a combination of moderation of external demand following softening global growth, continued adjustments in US interest rates which have contributed to a persistently strong US dollar environment and, fiscal policy consolidation that is likely to weigh economic growth downwards though imperative for debt sustainability, and tighter financial conditions due to higher interest rates.

Economic growth is projected to strengthen in outer years but remains below its long-run trend until FY2025/26. The growth outlook remains subject to downside risks, which include weaker-than-expected global growth, higher risk aversion in global financial markets amid more aggressive monetary policy tightening in major economies, and further escalation of geopolitical conflicts that could spill over into constraining trade and disrupt global supply chain. Growth could be lower than projected should the Ebola epidemic worsen, implementation of oil-related projects be delayed, financial conditions and fiscal policy get much tighter or a global recession materializes.

14. Inflation remains persistently higher than the target although there are indications that it is losing momentum and peaking. Annual headline inflation decreased slightly from 10.7 percent in October 2022 to 10.6 percent in November 2022, while the annual core inflation declined from 8.9 percent in October 2022 to 8.8 percent in November 2022. The easing inflationary pressures is a reflection of the impact of previous monetary policy decisions, diminishing effects of the supply disturbances such as global supply chain disruptions and war-induced elevation of global energy and non-energy commodities prices responsible for the recent high inflation. Indeed, the annual electricity, fuel and utilities inflation, has continued to fall after peaking at 19.6 percent in August 2022 and has since declined to 12.2 percent in November 2022. However, the main factor backstopping the fall of inflation remain the lagged impact of the drought which is still putting upward pressure on food prices. However, the elevation of food prices is temporary and should dissipate with the full harvests of the current season coming on board.

15. In December 2022, the inflation outlook was assessed to be lower than predicted in October 2022 by 2 percentage points. Inflation is to peak in the last quarter of 2022 and will average between 6- 8 percent in 2023, converging back to the 5 percent medium-term target by the end 2023. The downward revision of the inflation outlook is due to the dissipating impact of the earlier upsurge in global energy and nonenergy prices, subdued domestic and external demand, lower exchange rate depreciation, current monetary policy stance, and expected decrease in global inflation and international commodity prices.

16. BoU will continue to assess evolving economic conditions and their implications on the overall outlook to domestic inflation and growth. With significant uncertainty surrounding the inflation outlook, the MPC decided to be cautious and will adjust monetary policy stance based on incoming data in a measured and gradual manner, ensuring that monetary policy delivers inflation to the medium-term target while remaining supportive of sustainable economic growth.

Global economic activity and outlook Faced with adverse consequences of the war in Ukraine, the global economy is experiencing a broadbased and a sharper-than-expected slowdown amid unusually high inflation. The outlook has progressively deteriorated as high inflation and hawkish central bank monetary policies are worsening the cost-of-living conditions and diminishing consumers’ purchasing power. The actual and expected contraction in global demand is worsening the outlook and is putting the global economy on a brink of a recession. The October 2022 IMF projections indicate a sharp global output growth slowdown to 3.2 percent in 2022 from 6.1 percent in 2021 as most economies undergo significant slowdowns. Relative to the July 2022 projection, the global growth forecast for 2023 has been further downgraded by 0.2 points to 2.7 percent.

In conclusion, Uganda’s post- pandemic recovery trajectory has been disrupted by several shocks. The economy continues to suffer from adverse spillovers from the Russia-Ukraine war induced high global commodity prices, tight global financial conditions, and adverse weather conditions. The effects of the decade long high inflation caused by these shocks and associated tight domestic financial conditions due to actions to prevent its escalation, are squeezing consumers into difficult living conditions and businesses into tight operating environment. The difficult situation is exerting damaging effects on business and consumer confidence, and aggregate demand. However, the domestic economy remains resilient and is projected to grow in the range of 5.0-5.3 percent in Financial Year (FY) 2022/23 higher than the 4.7 observed in FY2021/22. Growth will pick up momentum in the outer years but will remain below its long-run trend until FY2025/26.

The softening of growth outlook is attributed to moderation of external demand, weakening business and consumer optimism at the back of high inflation and interest rates squeezing real incomes and fiscal consolidation triggered by the need to keep public debt on a sustainable path which are depressing aggregate demand. The growth outlook remains subject to downside risks, which include weaker-than-expected global growth, higher risk aversion in global financial markets amid more aggressive monetary policy tightening in major economies, further escalation of geopolitical conflicts that could spill over into constraining trade and disrupt global supply chain.

The Bank of Uganda has revised inflation projection downwards. Inflation will continue to moderate, average between 6 to 8 percent in 2023 and stabilize around the medium-term target by the end of 2023. This forecast is 2 percentage points lower than what had been earlier projected. The forecast revision is due to the dissipating impact of the earlier increases in global commodity prices, subdued domestic demand, expected decrease in global inflation, and lower than anticipated exchange rate depreciation. However, the trajectory of inflation remains uncertain due to the ongoing evolution of supply shocks.

The upside risks include potential increase in international commodity prices beyond current forecasts due further in oil supply cuts by the OPEC+, higher shilling depreciation than currently being projected due to simultaneous tightening of monetary policies by major central banks, persistence of supply and logistical constraints to production and recurrence of bad weather in the coming year. The downside risks to the inflation outlook include: the materialization of a global recession which will affect Uganda through trade and financial channels and increased economic uncertainty impacting on confidence thereby increasing disinflation pressures, lower domestic demand as real incomes decline and as spending decisions are constrained by higher interest rates and lower food and other commodities prices.

The MPC assessed that signs were evident that higher inflation pressures were diminishing although there were many uncertainties surrounding the outlook that make the path of returning inflation to target while keeping the domestic economy on an even keel a narrow one. As such, the MPC maintained the CBR at 10 percent and maintained its band at +/- 2 percentage points. The rediscount and bank rates were also kept unchanged at 13 percent and 14 percent, respectively.