Bank of Uganda Tightens Monetary Policy with CBR Increase. What does it mean for Ugandans?

The Bank of Uganda (BoU) has recently declared an upsurge in the Central Bank Rate (CBR), incrementing it from 10% to 10.25%. This represents a 0.25 percentage point rise and is the second consecutive monthly elevation of the CBR—a testament to the central bank's proactive stance in Uganda's against the depreciating Ugandan Shilling and the inflation in the country.

This decision by the BoU seeks to address multiple economic objectives. The modest yet strategic increase in the CBR is a deliberate move to manage the country's monetary policy amidst the current inflationary pressures and the ongoing devaluation of the Ugandan shilling against international currencies like the U.S. dollar that we saw in early February and March of 2024 when the Ugandan shillings depreciated against the Dollar to the extent of reaching 3,930 for a dollar, the highest depreciation rate the country has ever experienced.?

To discern the implications of the central bank's move, we must delve into how monetary policy serves as a governmental tool. The Bank of Uganda, by adjusting the CBR, executes control over the nation's monetary system. This control is vital in influencing spending patterns and investment activities that shape the broader macroeconomic landscape. The CBR is one of the tools the Bank of Uganda has on it’s disposal to impact financial assets in the economy like the Loans and investment products like Treasury bills and bonds.

At its core, this increase in the CBR is an inducement for the economy and its people to change their financial behavior (This is to either promote investment and control consumptive expenditure, or to promote spending and limit investments). By increasing the CBR, the Bank of Uganda automatically is signaling an increase in the cost of borrowing (standard bank loans), the central bank aims to control consumer spending (which automatically controls and reduces effective demand in the economy as people can’t easily access cheap money) and encourage greater investment activities (as those with money will want to spend less and invest more given that the CBR will automatically see an upside increase in the yields of financial investment products like Money markets, treasury bills and treasury bonds. This shift can serve to mitigate inflation, as an increase in savings and investments often correlates with a reduction in consumer expenditure which will have an impact on the price of goods and services to reduce if fewer people are buying or demanding for them.

With a hike in the CBR, lending rates offered by commercial banks are likely to rise. This consequential effect makes borrowing more expensive, leading to a contraction in the amount of money circulating amongst consumers. This decrease in liquidity then directly impacts purchasing power, often leading to a subdued demand for goods and services.

?From a macroeconomic perspective, the implications of reduced purchasing power cannot be overstated. As demand declines, it can put downward pressure on the prices of goods and services. This deflationary consequence is essential for managing inflation rates within an economy like Uganda's economy and this is what sometimes Bank of Uganda is targeting, to control the prices of Goods and services..

As an import-reliant nation, Uganda's economy is especially vulnerable to shifts in foreign exchange rates. A weakened shilling results in higher costs for importing goods, leading to 'imported inflation.' When the foreign exchange rate suffers, the domestic prices of imported goods tend to escalate, putting an additional strain on consumer wallets.

For example, Let’s assume the cost of an Item in China is $1,000 and standard, in December when 1 USD cost UGX 3, 750, the importer spent only 3,750,000 to buy the item, and in February when the 1 USD cost reached UGX 3,920, the importer then spent only UGX 3,920,000 an increase of? UGX 170,000 for the same item and this creates imported inflation into the country caused by the depreciating local currency to the major currency like the USD.

The Bank of Uganda leverages its monetary policy instruments, such as the CBR, to negate these downward currency trends and stabilize the exchange rate. A resilient shilling against other significant currencies—like the U.S. dollar, British pound, Kenyan shilling, and Chinese yuan—helps maintain market equilibrium and control imported inflation into the country.

By raising the CBR when currency depreciation looms, the BoU influences lending rates. This spillover effect extends to short-term investment returns in money markets. A higher CBR discourages extensive borrowing, especially for non-essential and imported goods, which can exacerbate inflation and weaken the national currency.

The resultant higher yields on investment vehicles, such as treasury bonds and bills, create an attractive environment for foreign investments. This attractiveness helps retain and even attract capital, offering an element of protection and appreciation to the domestic currency in the face of foreign exchange volatility (if fewer investors are moving their money out of the country and more are bringing more USD into the country, it reduces the pressures on the local currency and strengthens it against the Dollar).

The manipulation of the CBR is a significant component of the BoU's strategy to influence the economy. This influence extends to both the cost of local investments and the borrowing expenses, effectively functioning as a remote to move between encouraging spending and curbing consumption.

In the wider context of an ordinary citizen's day-to-day life, the BoU’s policy decisions translate into a direct impact on incomes, the cost of living, and the availability of credit. Increased CBR rates can mean tighter budgets and more conservative spending habits for the general population, as borrowing costs rise and loans become harder to secure.

On the other hand, when the BoU decides to lower the CBR, it is typically signaling stability and confidence in the economy. Lower borrowing costs can stimulate spending and, if well-managed, help improve economic growth.