Ugandan Shilling (UGX) - October 2016

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The UK’s shock Brexit vote in June and a relatively weak US labour report in August has now ensured we’re unlikely to see multiple interest rate increases in the US in 2016. We now expect just one hike from the Federal Reserve in December followed by further increases on a quarterly basis thereafter. Meanwhile, almost every other G10 central bank remains overwhelmingly in easing mode.

In the UK, the Bank of England cut interest rates for the first time in nine years in August, with the European Central Bank looking likely to expand its quantitative easing measures later in 2016. Further, the Bank of Japan announced a modest expansion of its monetary stimulus program, while the Japanese Government will significantly expand stimulus spending.

We think that the backdrop of extraordinarily stimulative policy from the main central banks, with the notable exception of the Federal Reserve, and a clear shift towards more accommodative policies in the laggard economies (e.g. Japan) is generally positive for risk assets and emerging market currencies in particular.

The Ugandan Shilling (UGX) has recovered well so far this year having suffered from a torrid 2015 that saw the currency plunge by over 20% in value in the year to October in line with a strong US Dollar and general sell-off among emerging market currencies (Figure 1).

Figure 1: Historical Evolution of USD/UGX (2011 - 2016)

Source: Thomson Reuters Datastream Date: 26/10/2016

The stabilisation in the Shilling at the back end of last year followed a series of interest rate hikes by the Bank of Uganda (BoU) which raised its benchmark rate to a two year high 17% in October 2015. However, with pressure on the currency abating and inflationary pressures slowing the central bank has had room to ease monetary policy this year, lowering rates by a further 100 basis points to 13% in October following similar cuts in both June and August. The BoU has hinted there remains scope to continue easing monetary policy as inflation begins to slow, and we now expect the central bank to cut rates by a further 100 basis points at its December meeting in a bid to support economic growth in Uganda.

Headline inflation has slowed sharply to 4.2% in September, while core inflation, the main measure watched by the BoU when deciding on its monetary policy, declined to its lowest level in a year-and-a-half from around 7% earlier in the year to a far more manageable 4.1%. This was due largely to weak consumer demand and a relatively stable exchange rate. Policymakers in Uganda are anticipating core inflation to remain around the central bank’s 5% medium term target throughout the remainder of the year.

The still lofty interest rate and declining inflation in Uganda means that real interest rates are currently very high at around 10% (Figure 2). This is still one of the highest real rates in the world, which should continue to provide solid support for the Shilling.

Figure 2: Uganda Interest Rate vs. Inflation (2012 - 2016)

Source: Thomson Reuters Datastream Date: 26/10/2016

We think slowing inflation will allow the Bank of Uganda to conduct a further interest rate cut this year, especially given economic growth continues to disappoint. The Ugandan economy grew by just 3.9% on an annualised basis in the second quarter of the year, well below the 5-6% growth rates the country has been accustomed to. Unseasonably bad weather has led to a very poor performance in the country’s dominant agriculture sector, which accounts for around a quarter of overall GDP. A gradual recovery in private sector credit should support consumer spending, with the BoU now forecasting the economy to grow by 5.0% in the financial year 2016-17.

In an effort to stem the depreciation of the Shilling, the Bank of Uganda also intervened relatively heavily in the currency market during last year. Foreign exchange reserves in Uganda fell in absolute terms, although have recovered of late and remain sufficient at the equivalent of around 6-7 months’ worth of import cover (Figure 3). This should allow the central bank to continue to conduct modest intervention in the FX market if required in order to stabilise the Shilling.

Figure 3: Uganda Foreign Exchange Reserves (2000 - 2016)

Source: Thomson Reuters Datastream Date: 26/10/2016

Uganda’s current account is relatively large at just over 9% of GDP, although foreign direct investment into the country should be sufficient in order to fund the deficit. The country’s balance of trade has also improved sharply so far this year, with Uganda’s characteristic as a net importer of oil beneficial for its terms of trade.

Relatively solid levels of economic growth, ample levels of foreign exchange reserves and among the highest real rates in Africa should provide good support for UGX and, in our view, cause the currency to suffer no more than a modest depreciation against the US Dollar amid gradually increasing interest rates by the Federal Reserve.

By contrast, we think that the large scale easing measures launched by the European Central Bank in the Eurozone should ensure a gradual long term appreciation of the Shilling against the Euro.































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