The Bank of Uganda cut its benchmark interest rate by a percentage point, joining forces with other central banks around the world that have eased monetary policy in the wake of the coronavirus outbreak.
The Bank on Monday dropped its policy rate to 8% from 9%, the lowest level since it started its inflation targeting monetary policy in July 2011. It said the decision follows a deterioration in macroeconomic conditions and is intended to ensure adequate access to credit and the normal functioning of financial markets.
Bank of Uganda also expanded measures to support the financial institutions it supervises, including a moratorium on dividends and bonus payments for at least 90 days, liquidity assistance to banks in distress, a plan to purchase government securities held by microfinance deposit-taking institutions and credit institutions to ease their liquidity distress, and expanded repurchase operations.
The measures were first announced last month.
In addition, the Bank granted “exceptional permission” to financial institutions to restructure loans of customers that have been affected by the pandemic, including a suspension of loan repayments. These will be applied “on a case by case basis at the discretion of the SFIs [supervised financial institutions] for up to 12 months, effective 1 April 2020.”
The Bank said it “will continue to monitor the evolving financial market and macroeconomic conditions and calibrate its operations to meet the need for any additional liquidity support, as may be warranted.”
The central bank said it now expected GDP growth in the 2019/2020 fiscal year — which ends in June — to fall to 3 to 4%, down from its February forecast of between 5.5 and 6%. It added that the balance of risks to its growth outlook is on the downside, particularly in the short term, because economic activity is expected to remain soft until the pandemic is contained globally.
“Although GDP growth is projected to gradually recover in the second half of 2020/2021, the emerging output gap is projected to persist until 2022. However, there is significant uncertainty over the depth and duration of the current slowdown,” said the Bank.
The rediscount rate and the bank rate were both reduced by 1% to 12% and 13%, respectively.
BoU said the Covid-19 coronavirus pandemic has led to a “severe contraction” in economic activity following disruptions in global supply chain disruptions, travel restrictions, social distancing measures, and a sudden decline in demand.
“Consumer-facing sectors have been severely affected by social distancing measures and heightened uncertainty, while the manufacturing sector has declined on account of disruptions to the inflow of raw materials,” read a policy statement explaining the Bank’s decision.
“Economic activity in the trade sector has also been weighed down by the decline in external demand and supply chain disruptions, while service sectors such as finance, insurance, and information and communications are affected by the general stall in business activity and investment.”
Another effect of the pandemic is volatility in the domestic foreign exchange market. Between February and March 2020, the Uganda shilling depreciated against the US dollar by 2.2%, the Bank said. It is set to depreciate further, reflecting capital outflows and declines in tourism arrivals, remittances, foreign direct investment, and bank lending.
The finance ministry said in March, before the coronavirus entered Uganda, that it expects the current account balance to widen by 12.7%, or $363.1m, in 2019/20 due to the shilling’s depreciation. As a result, foreign exchange reserves will fall from 4.2 future months of imports to 3.5 months.
However, the ministry’s “worst case scenario,” in which the coronavirus “enters Uganda and spreads rapidly,” leading to strict restrictions would lead to an even more significant deterioration in the current account.
The usually hawkish central bank says it is also faced with the dilemma of falling prices, caused by the ‘feeble’ economy. The slowdown in economic activity has led to a fall in the demand for goods and services, adding another risk to growth.
Core consumer inflation, which is targeted by the Bank, fell 2.5% year on year in March from 3.1% the previous month, while the headline inflation rate fell 3% from 3.4%. BoU said it expects core inflation to remain below its historical average, and below its 5% target, over the next one year due to low demand and a fall in international crude oil prices.
Last month, Matia Kasaija, the finance minister, said that the government “will seek support from the International Monetary Fund to support the central bank in ensuring that international reserve buffers remain strong and that the exchange rate remains stable.”