By Enock Nyorekwa Twinoburyo
His recent statements are same as swearing never to drink again on a hangover morning
In recent days, the public has been awash with the recent Bank of Uganda (BoU) Governor’s public statement on being misled in 2011 election spending, subsequently leading for a record high inflation (30% in October 2011), the highest in the last 2 decades. The Governor has subsequently clarified alluding to the fact that the net amount lent to government in 2011 was Shs94 billion which is less than one quarter of 1% of GDP thus having limited impact on the money supply and this inflation.
Against the backdrop of inflation spiral in 2011, BoU adopted an inflation targeting lite framework where it uses the Central Bank Rate (CBR) to guide the interest rates and ultimately the public expectations. This regime is associated with the trinity characteristics of maintaining price stability, independence, and accountability of the central bank. The key fundamentals with this framework are transparency and communication.
Under the policy, investors know what BoU considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices. In 2011, the CBR was changed from 11% (July 2011) to 23% (Nov 2011 to Jan 2012) to the current 11% in response to evolving economic conditions. This successfully reduced inflation to lower than the BoU target of 5%.
The global and domestic causes of inflation withstanding, 2010/11 was peculiarly also associated with a spike in money supply attributed largely to election spending supplementary budgets, the US$740 million purchase of fighter jets, and the awarding of Haba Group of companies with Shs142.7 billion (US$53m) in compensation for purported lost business in cancelled market tenders.
Apparent in all this is the lack of exclusive operational independence of the central bank as mandated by the Bank of Uganda Act. One of the fundamental threats to monetary policy is the fiscal policy pressures. Persistent fiscal imprudence exhibited by the rising fiscal deficits funded through domestic markets insubordinates the monetary policy to fiscal policy, and the expectations of economic growth and inflation are likely to hinge on fiscal policy.
While the governor’s statement served to reinstate confidence of the public that the 2011 occurrence would not reoccur in 2016, it has been met with a lot of public scepticism. To most, it can be equated to a hangover morning when one swears never to drink again. It is only a matter of time before one goes to the bars again.
Just last financial year, the government intended to borrow Shs1 trillion domestically (through issuance of treasury bills and bonds). This money was, in part, to fund the budget, which budget already had a high interest bill of almost the same amount.
To me, it seems like the famous Ponzi game, borrowing to just clear the interest bill. The ultimate borrowing that financial year was Shs1.7trillion.
This financial year, the government intends to borrow Shs1.4 trillion from domestic markets and, your guess is as good as mine, the outturn is likely to be higher.
In addition, the government will also draw down part of its savings in BoU by Shs1.1 trillion. As of 2013/14, domestic debt had risen to 40% of the total debt of US$7 billion.
Expansionary fiscal policies also tend to crowd out the monetary autonomy. This imperils the Central Bank’s credibility. At the extreme, it forces the Central Bank to abandon the price stability, and to adopt the role of keeping the interest rates low. In such a case, the markets tend to perceive an outlook with bulging fiscal problems, huge capital outflows, and the associated inflation. Fiscal deficits tend to impact negatively on the economy’s growth via the interest rate channel, as higher interest rates crowd out domestic investments.
Domestic debt is short term and high cost, which has led to the interest bill as share of the budget rising to about 8% of the current budget. Also in the recent couple of years, the private sector growth has remained subdued subsequently constraining aggregate demand and the economic growth. In addition, with inflation lower than 5%, BoU would be expected to reduce interest rates further to boost private sector growth. But this, arguably, has been hampered by fiscal policy. As result, over the last few years, monetary-policy costs have grown to account for 30% of the central bank’s total operating expenditure. This trend will probably lead to an erosion of the BoU’s capital and to the risk of its independence being compromised.
The challenges of fiscal dominance over monetary policy will likely heighten in the coming years due to the planned infrastructural investments of over USD 25bn (Uganda Current GDP) in next five years. This alone will heighten the inflationary pressures that the central bank has to contain. But it is also likely to be associated with exchange rate challenges as well as financing pressure from domestic markets.
Because BoU has dejure independence but not the defacto operational independence, it may in long run dent the effectiveness of monetary policy. To avoid that, its operational independence needs to enhanced
Enock Nyorekwa Twinoburyo is an economist and PhD Research Fellow at the University of South Africa.