Uganda’s balance of payments position is looking increasingly unsustainable. The currency is likely to weaken and domestic demand is set to slow. We think that GDP growth will be a lot weaker than most currently expect over the coming years.
- Uganda’s balance of payments position is looking increasingly unsustainable. The currency is likely to weaken and domestic demand is set to slow. We think that GDP growth will be a lot weaker than most currently expect over the coming years.
- Uganda’s current account deficit has more than doubled over the past 18 months, from 4.0% of GDP in Q3 2017 to 10.4% in Q1. This is one of the largest deficits in the emerging world. (See Chart 1.) The current account position deteriorated largely due to a steep rise in imports – mainly machinery and equipment intended for large public infrastructure projects and the development of the country’s nascent oil industry.
- Despite the worsening external position, the shilling has not depreciated. The currency actually bucked the regional trend and is up against the US dollar so far this year. (See Chart 2.) This has helped to ease price pressures – core inflation now sits below the central bank’s target.
- The risks posed by the current account deficit are mitigated by the fact that it is funded in part by large direct investment inflows. (See Chart 3.) However, it is also financed by more volatile portfolio and banking flows, leaving the currency vulnerable to a bout of investor risk aversion. The falls in the prices of Uganda’s key commodity exports (gold and coffee) that we expect, combined with the threat of political uncertainty ahead of the elections due in 2021, could trigger the shilling to come under pressure. We expect that the currency will drop by 15% against the US dollar by end-2020.
- The good news is that such a currency fall is unlikely to trigger severe strains in the country’s balance sheets. Although a relatively large share of Uganda’s public debt is external, the debt-to-GDP ratio stood at a relatively modest 42% in 2018. And almost 60% of loans owed to external creditors are highly concessional, carry low interest rates, and should be easy to roll over.
- However, rising import prices will push up inflation. This will put pressure on policymakers at the Bank of Uganda to tighten monetary policy – we have pencilled in a total of 300bp of hikes in the policy rate next year, from the current 10.00%. Tighter monetary conditions in turn will weigh on domestic demand and the economy as a whole. Our GDP growth forecast of 5.0% for 2020 and 4.5% for 2021 lie well below the consensus which expects growth of more than 6.0%. (See Chart 4.)
Chart 1: Current Account Balance (Latest, % of GDP)
Chart 2: Exchange Rate vs. US Dollar (% YTD)
Chart 3: Net FDI Inflows (% of GDP)
Chart 4: GDP (% y/y)
Sources: BoU, UBOS, IMF, Refinitiv, Bloomberg, Capital Economics
Virág Fórizs, Emerging Markets Economist, +44 20 7808 4079, firstname.lastname@example.org