The Bank of Uganda cut its lending rates on Tuesday, the first adjustment since October 2022, responding to recent economic indicators highlighting the risk of a slowdown in GDP growth, and using the latitude given by decreasing consumer price inflation.
The central bank said it has reduced its central bank rate to 9.5 per cent, “aiming to stimulate economic activity while maintaining inflation around the target.” The rate was last adjusted in October, when it was raised to 10 per cent from the 9 per cent.
In a statement explaining its decision, the Bank’s monetary policy committee said it believes risks to economic growth are likely to cause a sharp decline in GDP growth which could exert downward pressure on inflation if sustained over the next two years.
Recent economic data suggests that activity has slowed, largely due to weak domestic demand. The average quarter on quarter GDP growth rate for the last two quarters of 2022 fell 6.5 per cent, BoU said, with activity in all three sectors declining; agriculture experienced the most pronounced reduction of 21.6 per cent.
Bank lending to the private sector has also remained muted, with growth stuck in single digits since September. The latest figures show that commercial bank credit rose 2.7 per cent year on year in June, the lowest rate of growth since October 2016. According to BoU, in its monetary report for June, weak growth in bank loans is a result of high interest rates and tighter lending terms.
In addition, the Bank said its high-frequency economic indicators point to weaker growth in the quarter to the end of June. It cut its forecast for economic growth in the 2023/2024 fiscal year to between 5 per cent and 6 per cent, down from 6 to 6.5 per cent.
At their previous sitting in June, policymakers said the economy “remains resilient,” but also noted that the risks to growth outweighed the factors on which they had based their outlook. That reading was anchored on preliminary estimates from the Uganda Bureau of Statistics showing a rise in growth of 5.3 per cent for 2022/2023, up from 4.6 per cent the previous financial year.
On Tuesday, the committee reiterated its assertion that “the economy has demonstrated resilience and has been recovering well,” but highlighted the warnings from recent data.
Similar to June, the BoU noted a higher likelihood of growth decline, based on the data at hand. The risks to a rebound include slow global growth, weaker demand for exports, supply chain distortions caused by geopolitical factors, tighter fiscal policy, and a decline in domestic demand.
The central bank’s rate reduction aims to prompt financial institutions to lower interest rates on loans and credit offerings. This may encourage individuals and businesses seeking loans, fostering consumer spending and investment, and potentially boosting overall economic sentiment.
However, credit growth depends on both interest rates and bank lending standards. Assuming lower lending rates lead to increased loan demand, banks must balance meeting this demand while upholding robust credit standards. This ensures the resilience of loan portfolios against potential risks.
The BoU signalled that inflation is under control after declining steadily since peaking at 10.7 per cent in October 2022, and coming in below its target of 5 cent for two consecutive months. The latest figures show headline inflation and core prices at 3.9 per cent and 3.8 per cent respectively, down from 4.9 per cent and 4.8 per cent in June.
It attributed the year on year decline in consumer prices to “tighter monetary and fiscal policies, strengthening of the shilling exchange rate, lower energy and food prices, improved global supply chains, and reduced domestic demand.” Furthermore, current prices are lower than they were at the same time in the previous year.
This downward trend in consumer prices is expected to “continue in the coming months due to lower international food and fuel prices, better agricultural supply, and decreasing inflation expectations.”
The central bank kept the bands on the CBR at plus or minus two percentage points, while the rediscount rate is now 12.5 per cent and the bank rate has been set 13.5 per cent. BoU also decreased the cash reserve requirement by 50 basis points to 9.5 per cent.
