The Brexit vote, from a macroeconomic perspective, implies a substantial increase in uncertainty in the short-and medium to long run. In the short-run, the uncertainty was mirrored by volatility in the global financial markets, with stock market declines, rallies in bond prices and wide swings in major currencies.
State of the Economy Report for September 2016
In the medium to long run, the economic consequences of the Brexit become less about financial market disruptions, but more about real economic activity. It will take at least two (2) years for the UK to negotiate the exit, leading to more uncertainty, which will hold back investment and economic activity. Indeed, global growth prospects for 2016 have continued to weaken, following the BREXIT vote. This has led to a further downward revision of global growth projections in July 2016 by the IMF.
In terms of the implications on Uganda, The Brexit will continue to pose uncertainty, holding back investment and consumption in the UK and EU with negative impact on Uganda’s export earnings given that the EU is one of Uganda’s major trade partners. In addition, remittances and foreign direct investment (FDI) inflows from the EU and UK could decline.
Crude oil prices have been on a decline since mid-2014, in part reflecting supply-side developments and lower growth in global demand. While this could support global activity through keeping domestic inflation in check in oil-importing economies, it could destabilize the outlook for oil-exporting countries, leading to a fall in exports earnings. Uganda, being an oil-importer, benefits from this scenario through the reduction in oil imports bill. On the other hand, the persistently low oil prices could depress oil related FDI inflows to Uganda. This is bound to adversely affect Uganda’s already weak balance of payment position. In addition, the renewed volatility in the global financial markets because of the BREXIT vote could cause volatility in the domestic foreign exchange market with implications for the exchange rate.
In August 2016, Bank of Uganda (BoU) eased monetary policy further, reducing the Central Bank Rate (CBR) by 1.0 PP to 14.0 per cent from 15 per cent in June 2016. This was warranted by the softer than expected inflation outlook, which was forecast to converge around the BoU’s medium term target of 5.0 per cent in Q4-2016, earlier than earlier projected on account of relative exchange rate stability and subdued domestic demand.
Despite the structural liquidity overhang in the banking sector, the interbank money market rates evolved in line with the monetary policy stance. However, lending rates remained elevated, in part reflecting provisioning for bad debt, the lagged impact of the tight monetary policy stance and structural rigidities in the financial sector, including the high cost of doing business. Indeed, Non-Performing Loans (NPLs) as a ratio of gross loans increased from 6.9 per cent in Q1-2016 to 7.4 per cent in Q2- 2016, while overhead costs continued to contributed a significant proportion—about 7 percent—to the lending spreads. Further increases in NPLs could heighten the risk aversion of commercial banks, further constraining the growth in credit to the private sector.
Growth in credit to the private sector, a leading indicator of the financial sector’s contribution to economic activity, continued to slow down in Q2-2016. The slowdown in growth in PSC was driven largely by provisioning for bad loans, which has heightened risk aversion in banks, and relatively weak economic activity.
Preliminary fiscal data for FY 2015/16 indicate that the fiscal deficit amounted to Shs. 4,019.3 billion, which was lower than programmed by Shs. 1,362.7. The deficit was financed majorly from external sources (Shs. 2,458.5 billion), while domestic financing amounted to Shs. 2,078.7 billion. The fiscal stance for FY 2016/17 focused on the need to address infrastructural constraints to increase efficiency and reduce the costs of doing business. The budget deficit is projected at 6.2 per cent of GDP, largely funded by external sources as domestic borrowing by Government securities is projected to reduce to Shs. 612 billion down from Shs. 1,384 billion in FY 2015/16.
The balance of payments recorded a surplus balance of USD 80.2 million in FY 2015/16, an improvement from a deficit of USD 352.8 million recorded in FY 2014/15. The external current account deficit improved, largely driven by a decline in private sector import bill, reflecting a combination of low global crude oil prices and subdued domestic demand. In terms of the outlook, the balance of payments is likely to remain weak in the short- to medium-term because of subdued exports, a pickup in imports by government as well as the private sector.
In July 2016, the Shilling was relatively stable, depreciating slightly by 0.3 per cent m-o-m and by 0.6 per cent y-o-y to an average mid-rate of Shs. 3,375.6 per USD. The relative stability was largely because of subdued demand for imports and stronger inflows from offshore players. In the near-term, the Shilling is expected to weaken on account of sustained dollar demand for infrastructure projects, a correction of overshooting, weak current account position, and strife in South Sudan, which is likely to hold back export growth.
The Ugandan economy has continued to grow, but at a moderate pace. Preliminary data for FY 2015/16 show that GDP expanded by 4.6 per cent in real terms and by 11.6 per cent in nominal terms. The moderation in growth is largely attributed to uncertainty related to the recent electioneering, harsh international economic environment, including sluggish growth in our major trading partners and the crisis in South Sudan, and persistently soft commodity prices, which have affected exports.
The Consumer Price Index (CPI) data for July 2016 indicates that domestic cost pressures remain relatively subdued, with all components of inflation, save for food crops, declined in July 2016. Annual headline and core inflation declined to 5.1 and 5.7 per cent from 5.9 and 6.8 per cent, respectively in June 2016.
Compared to the June forecasts, the revised medium term outlook for headline and core inflation is softer. Both headline and core inflation are projected to decline to about 5.0 per cent by Q4-2016, premised on economic growth, which remains below potential. Although the exchange rate was expected to depreciate in the near term, its impact on domestic inflation is expected to be offset by the negative output gap.
The inflation outlook is highly contingent on the movements of the exchange rate, inflation expectations and the impact of weather-related risks on domestic food production. The external economic environment remains volatile, with substantial upside risks to the exchange rate. Domestically, forex demand, particularly for public infrastructure projects continues to grow and this may pose downward pressures on the exchange rate. The impact of weather related risks on domestic food production and prices is real; there has been prolonged drought in major food producing parts of the country. Food crops inflation already reversed trend in June 2016, but the full impact of the dry spell is yet to materialise.
