The Bank of Uganda (BoU) has reduced its benchmark Central Bank Rate (CBR) by 0.25% to 9.75%, marking the second rate cut this year. This decision reflects a broader trend of central banks adopting more accommodative monetary policies amid declining inflationary pressures. The move is in line with recent developments seen across global financial markets, notably in the U.S. and the European Union, as central banks seek to stimulate economic growth.

This latest rate cut comes on the back of data showing significant declines in Uganda’s inflation metrics, with annual headline inflation dropping from 3.5% in August to 3% in September. Additionally, core inflation—a measure excluding volatile food and energy prices—fell slightly from 3.9% to 3.7% during the same period. A particular highlight was the decline in services inflation, which dropped from 6.2% in August to 5.8% in September, while inflation for other goods remained stable at 2.1%.

Inflation Trends and Key Drivers

The downward trend in inflation is largely attributed to the decline in fuel and food prices over recent months, which has helped ease cost-of-living pressures for many Ugandans. Lower fuel prices are in part due to stabilizing global oil markets, while improved agricultural output following favorable weather conditions in parts of Uganda has contributed to reduced food prices. Nonetheless, there remain significant risks to inflation, especially linked to climate change and unpredictable weather patterns, which could affect agricultural production in the future.

Climate change is increasingly influencing inflation in Uganda, with erratic weather patterns threatening to disrupt agricultural cycles, which in turn impacts food prices. The agricultural sector remains a key component of Uganda’s economy, and any fluctuation in output can have ripple effects on inflation levels. Severe droughts or floods, for instance, can reduce crop yields, pushing prices higher. As such, the BoU’s rate decisions are being made with careful consideration of these external factors.

Impact of Rate Cuts on Uganda’s Economy

Despite inflation appearing under control, the BoU’s decision to reduce the CBR raises questions about its potential impact on economic growth. Uganda’s economy is projected to grow by 6% to 6.5% for the fiscal year 2024/25, but analysts are concerned about the medium-term growth trajectory, especially given ongoing challenges such as high unemployment and low private sector investment.

According to Dr. Adam Mugume, Executive Director for Research at the BoU, the rate cut was designed to provide a boost to economic activity. “Whenever we cut the CBR, we consider both inflation and economic growth. With the CBR at 9.75%, we expect average interbank rates to fall to around 11.75%, down from 12% in September. This should encourage commercial banks to lower their lending rates, expand their loan books, and ultimately stimulate economic growth.”

The BoU’s decision to lower rates follows an earlier rate cut in August, which saw the CBR fall from 10% to 9.75%. This aligns with the global trend of monetary easing, particularly following recent rate cuts by the U.S. Federal Reserve and the European Central Bank. The U.S. Federal Reserve cut its benchmark rate for the first time in more than a year, reflecting concerns about slowing global growth, while the European Central Bank (ECB) has also reduced rates twice this year to spur economic activity.

Spillover Effects from Global Monetary Easing

Uganda is not isolated from global economic trends. The easing of monetary policy in major economies like the U.S. and Europe has influenced the BoU’s decision to lower rates, as external factors such as foreign investment inflows, exchange rates, and global demand for Uganda’s exports affect the country’s economic landscape. Lower rates in advanced economies often lead to capital flows into emerging markets, including Uganda, as investors seek higher returns.

However, despite the potential benefits of increased foreign investment, the BoU has opted for a cautious approach by not adjusting the Cash Reserve Ratio (CRR), a tool used to control liquidity in the banking system. Uganda’s CRR, currently set at 10%, remains unchanged. In 2022, the BoU raised the CRR from 8% to 10% to curb rising inflation, and while there have been discussions about lowering it, central bank officials have been hesitant due to concerns about inflationary pressures in the longer term.

Challenges with Private Sector Credit Growth

The reduction in the CBR is expected to make credit more affordable for businesses and consumers, but the exact impact on private sector credit growth remains unclear. According to Benoni Okwenje, General Manager for Treasury Operations at Centenary Bank, while lower interest rates should stimulate demand for loans, banks remain cautious about expanding their loan portfolios, especially in a challenging economic environment.

“Banks are still assessing the overall business climate. While the CBR cut is likely to reduce prime lending rates, we need to be mindful of risks such as loan defaults and business closures, which have risen since the Covid-19 pandemic,” Okwenje stated. The private sector, particularly small and medium-sized enterprises (SMEs), continues to face liquidity constraints, and access to affordable credit is seen as key to driving economic recovery. However, some businesses remain reluctant to borrow due to uncertainty about the future, particularly in sectors heavily reliant on consumer spending and tourism.

Uganda’s Economic Outlook

Despite the mixed reactions to the BoU’s rate cut, the outlook for Uganda’s economy remains cautiously optimistic. With the global economy showing signs of recovery, Uganda is likely to benefit from improved trade and investment flows. The East African region is also seeing greater economic integration, with initiatives such as the African Continental Free Trade Area (AfCFTA) offering opportunities for Ugandan businesses to expand into new markets.

At the same time, the government’s infrastructure projects, such as investments in energy and transport, are expected to provide a further boost to growth. However, there are challenges ahead, including high public debt levels and the need for structural reforms to enhance competitiveness and attract more foreign direct investment (FDI).

Conclusion

The BoU’s decision to cut the CBR to 9.75% signals a commitment to supporting economic growth while ensuring inflation remains within target. However, the central bank faces a delicate balancing act as it navigates both domestic and international economic pressures. While lower rates may encourage credit growth and boost demand, concerns over the private sector’s ability to absorb more loans and sustain growth will need to be addressed.

Looking ahead, much will depend on the evolution of global economic conditions, particularly in key trading partners like the U.S., China, and Europe. The potential for further monetary easing, both domestically and internationally, remains on the table, but it will require careful management to avoid triggering inflationary pressures down the road.

In the near term, the BoU’s rate cuts are expected to provide relief to businesses and consumers, particularly in the wake of declining inflation. However, the success of these policies in stimulating long-term growth will depend on continued efforts to address underlying challenges such as low productivity, climate risks, and the need for further financial sector reforms.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

9th October, 2024