Sudan trade to excite shilling again, push up interest rates

By Edward Ojulu

September 27, 2007 (KAMPALA) — Bank of Uganda’s recent success in stopping the rapid appreciation of the shilling against the dollar may after all be short-lived. Financial analysts have predicted that pressure from the booming cross-border trade between Uganda and Southern Sudan to the north and the Democratic Republic of Congo to the west will result in a big demand for the shilling.

As a result, borrowers from Uganda’s financial market will have to contend with higher interest rates as demand for the local currency surpasses supply.

Also, borrowers will pay a higher price, in dollar terms for the money they borrowed cheaply after the value of the shilling appreciates. If this happened, the private sector, already crippled by shortage of credit finance, will face harder times.

Already, at the current average rate of 23% per annum, Uganda’s lending rates are the highest in the region compared to East Africa’s biggest economy, Kenya at 13.29%.

“The demand for Uganda shillings in the region will remain strong for the foreseeable future, and as interest rates inevitably rise in order to meet money supply targets…,” Razia Khan, the Standard Chartered Bank Regional Head of Research for Africa, said in the September 2007 analysis of Uganda’s economy.

Since mid August, the central bank has managed to maintain the local currency at above Shs 1,720 against the America dollar after injecting billions of shillings, canceling two consecutive fortnightly Treasury Bills auctions and threatening punitive action against “speculators.”

For nearly two months now, the result of this intervention has helped the dollar to hold on firmly. The shilling closed this week trading at an average rate of 1,755 a dollar, having slightly appreciated from 1,790 the previous week.

But the central bank governor, Emmanuel Tumusiime-Mutebile, and his technocrats should not pop champagne yet, because external factors outside BOU’s jurisdiction will soon influence further strengthening of the shilling.

A senior banker has told this writer that high consumption of Ugandan goods in two different economies (south Sudan and eastern DRC) using the Uganda shilling as the preferred medium of exchange will certainly pose challenges that may not be brought under control by BOU’s interventions such as cancellation of TB auctions.

“There is a lot of consumption going on in Southern Sudan and there is virtually no production taking place there. So, millions of dollars from that country enter Uganda through easy conversion of the shilling due to increased trade,” he said.

Khan agrees: “the use of the Uganda shilling banknotes as the currency of choice in Southern Sudan prior to the introduction of its own notes is one factor that is thought to have contributed to pressure on the Uganda shilling to appreciate.”

Southern Sudan recently introduced its own currency, but the Uganda shilling remains the most preferred currency by the predominantly Ugandan traders. About Shs 40 billion is circulating in Southern Sudan, according to a central bank official.

Khan said that it was unlikely that the Bank of Uganda would sell shillings to sterilise domestic money supply. And even if it did, it would not be enough to match the flow of dollars from Sudan whose first phase of reconstruction is now at its peak.

Southern Sudan has attracted billions of dollars for the on-going reconstruction effort; most of it converted into Uganda shilling to facilitate commerce.

That means that local Sudanese, most of whom are paid in dollars, must convert them into Ugandan shillings to buy goods and service from the mainly Ugandan traders who are comfortable being paid in the currency they understand best.

“You do not expect some of these traders who do not understand exchange rates and have no capacity to detect fake dollars to sell their goods in any currency other that the shilling. That is why the shilling remains dominant in Southern Sudan and has resulted in almost two exchange rates; one for Southern Sudan and northern Uganda, and the other for Kampala,” he said.

This, he said had created more complications in the money market.
“In fact, the dollar is cheaper in northern Uganda compared to Kampala because of the Southern Sudan influence,” he added.
Donors have pledged millions of dollars to rehabilitee Southern Sudan following the signing of the comprehensive Peace Agreement in January 2005, ending Africa’s longest and bloodiest civil war between the Khartoum government and the Sudanese People’s Liberation Army (SPLA) rebels in the South.

A donor conference in Oslo in April 2005, saw countries pledge $4.5 billion for humanitarian and reconstruction needs for 2005-2007.
The European Union pledged $ 756 million, Britain $545 million, Norway $250 million, Italy and Denmark $90 million each. Germany pledged $40 million and Ireland $20 million. Disbursement of this money may already be at its climax as 2007 is about to end.

At the same time, South Sudan is a vast area endowed with natural resources like oil and timber that have attracted multinational companies from China, the United States of America and Canada to prospect for and exploit oil as well as build supporting infrastructure, such as roads and airports. All these activities have and continue to exert pressure on the shilling, appreciating from 1,860 in September 2006 to 1,590 in June 2007.

The rapid appreciation forced the central bank to swing into action, cancelling two consecutive Shs 65billion each TB auctions. Commercial banks are major investors in this.

Banks hurt

This decision to suspend TB auctions in a bid to keep more shillings on the market has however not gone down well with the commercial banks—the major investors in government financial instruments such as TBs.

Unable to lend government, commercial banks have had no option but to increase investments in “risky lending” to the private sector, a leading banker who is not authorised to speak on behalf of his institution said on condition of anonymity.

With the central bank not about to relax this restriction, as the shilling is expected to come under even more appreciation pressure with millions of dollars flowing in during the Commonwealth Heads of Government Meeting (CHOGM) in November, banks were likely to have a very challenging last quarter of the year.

Investment in TBs has been the biggest source of profits for commercial banks because they are 100% risk-free.
This is the second time banks have lost out on lucrative government business.

Two years ago, the government moved all accounts of donor-funded projects from commercial banks to BOU, cutting off access to free money that the banks used to earn ironically by lending to the government through TBs and government bonds.

Instead of paying the government for using project money, the banks, especially multinationals, invested that money in risk-free instruments such as government bonds and TBs and made huge profits.
The loss of that business saw an emergency of stiff competition for small borrowers (retail banking and SME banking) originally dominated by small local banks and microfinance institutions.

(Weekly Observer)