Bank of

Monetary Policy Report

December 2020

1 | P a g e

Table of Contents List of Figures ...... 3 List of Tables ...... 3 Acronyms and Abbreviations ...... 4 Executive Summary ...... 5 1. Reflections of in the Previous Period ...... 7 1.1 Monetary Policy Stance...... 7 1.2 Monetary Policy Implementation ...... 8 2. Money and Financial Markets Developments ...... 8 2.1 Global Financial Markets ...... 8 2.2 Domestic Financial Markets ...... 9 2.2.1 Interbank Money Market ...... 9 2.2.2 Primary Market for Treasury Securities ...... 9 2.2.3 Secondary Market for Treasury Securities ...... 10 2.2.4 Lending and deposit interest rates ...... 10 2.2.5 Private Sector Credit ...... 11 2.2.6 Credit Demand and Supply ...... 12 2.2.7 Asset quality ...... 13 2.2.8 Money Supply...... 14 3. Economic Activity ...... 15 3.1 Global Economic Activity ...... 15 3.2 Domestic Economic Activity ...... 16 4. Fiscal Policy and Developments ...... 18 4.1 Government Expenditure and Revenue ...... 18 4.2 Public Debt Stock ...... 19 5. Balance of Payments and Exchange rate Developments ...... 20 5.1 Balance of Payments ...... 20 5.2 Exchange Rate Developments ...... 22 6. Inflation ...... 23 6.1 Global Inflation and International Commodity Prices ...... 24 6.1.1 Global Inflation ...... 24 6.1.2 International Commodity Prices ...... 24 6.2 Domestic Consumer Price Inflation ...... 25 7. Economic and Inflation Outlook and Risks ...... 26 7.1 Economic Outlook ...... 26 7.2 Inflation Outlook and Risks ...... 27 8. Conclusion ...... 27

2 | P a g e

List of Figures

FIGURE 1: 7-DAY INTERBANK RATE AND THE RATE (CBR) ...... 9 FIGURE 2: SECONDARY MARKET YIELDS ON T-BILLS AND T-BONDS ...... 10 FIGURE 3: LENDING INTEREST RATES BY SECTOR ...... 11 FIGURE 4: ANNUAL PRIVATE SECTOR CREDIT GROWTH...... 11 FIGURE 5: ANNUAL GROWTH IN PRIVATE SECTOR CREDIT BY SECTOR (SECTORAL SHARES AS AT OCTOBER 2020 IN BRACKETS) ...... 12 FIGURE 6: PROXIES FOR DEMAND AND SUPPLY OF BANK CREDIT PER SECTOR ...... 13 FIGURE 7: CONTRIBUTIONS TO M3 GROWTH ...... 15 FIGURE 8: CONSTANT GDP GROWTH (%) ...... 17 FIGURE 9: MONTHLY CHANGES IN THE CIEA AND PMI ...... 18 FIGURE 10: DEVELOPMENTS IN OVERALL BALANCE OF PAYMENTS AND MAIN COMPONENTS ...... 21 FIGURE 11: CHANGES IN THE NER, INFLATION DIFFERENTIAL AND REER (Y-O-Y)...... 22 FIGURE 12:SELECTED EAC PARTNER STATES’ EXCHANGE RATES (YOY, PER CENT CHANGE) ...... 23 FIGURE 13: INFLATION RATES IN SELECTED COUNTRIES ...... 24 FIGURE 14:GLOBAL COMMODITY PRICE DEVELOPMENTS ...... 25 FIGURE 15: DEVELOPMENTS IN DOMESTIC INFLATION ...... 25 FIGURE 16: INFLATION OUTLOOK ...... 27

List of Tables

TABLE 1: NON PERFORMING LOANS BY SECTOR ...... 14 TABLE 2: GLOBAL ECONOMIC GROWTH FORECASTS IN SELECTED COUNTRIES ...... 16 TABLE 3: FISCAL OPERATIONS (SHS. BILLION)...... 19

3 | P a g e

Acronyms and Abbreviations AEs Advanced Economies BoP Balance of Payments BoU Bank of Uganda CA Current Account CAD Current Account deficit CBR Central Bank Rate CPI Consumer Price Index EU European Union EFU Energy, Fuel and Utilities EMDEs Emerging Market and Developing Economies FDI Foreign Direct Investment GDP Gross Domestic Product IFEM Interbank Foreign Exchange Market IMF International Monetary Fund M-o-M Month-on-Month NEER Nominal Effective Exchange Rate NPL Non- Performing Loans OPEC Organization of Petroleum Exporting Countries PDMF Public Debt Management Framework PPs Percentage Points PSC Private Sector Credit PSI Policy Support Instrument q-o-q Quarter on Quarter REER Real Effective Exchange Rate REPOs Repurchase Agreements SMEs Small and Medium Enterprises SSA Sub- Saharan Africa T-Bills Treasury bills T-Bonds Treasury bonds UK United Kingdom US United States US$ United States Dollar WAI Weighted Average WALR Weighted Average Lending Rate WEO World Economic Outlook Y-o-Y Year-on-Year

4 | P a g e

Executive Summary

1) In October 2020, the Bank of Uganda (BoU) maintained the eased monetary policy stance holding the Central Bank Rate (CBR) at 7 percent, and continuing to offer liquidity support to supervised financial institutions (SFIs). The band on the CBR remained at +/-2 percentage points, while the margin on the rediscount rate and bank rate were also unchanged at 3 and 4 percentage points on the CBR respectively. Consequently, the rediscount rate and the bank rate stood at 10 percent and 11 percent, respectively.

2) Short-term money market rates trended in line with the Central Bank Rate (CBR). The weighted average 7-day interbank money market rate averaged 7.3 percent in the quarter to November 2020, compared to 7.4 percent in the quarter to August.

3) Yields on Government securities declined at the short end but increased at the longer end of the spectrum in the quarter to November 2020 reflecting increased fiscal financing requirements by government. Commercial bank lending interest rates were relatively stable, averaging 19.7 percent in the quarters to July and October 2020. However, lending interest rates on foreign currency denominated loans recorded an increase to an average of 6.0 percent from 5.0 percent over the same period.

4) Growth in private sector credit (PSC) remained subdued in the quarter to October 2020 on account of relatively low economic activity. The average year-on-year growth in PSC averaged 7.6 percent in the quarter to October 2020, down from 8.9 percent in the quarter to July 2020.

5) The Uganda Bureau of Statistics (UBOS) revised estimates for economic growth to 2.9 percent from an earlier approximation of 3.1 percent in FY2019/20. The low growth is occasioned by the mitigation measures taken globally and domestically to curb the COVID- 19 pandemic. The high frequency indicators of economic activity point to continued recovery in economic activity in the quarter to October 2020. The Composite Index of Economic Activity (CIEA) and Stanbic Purchaser Manager’s Index (PMI) grew by 0.7 percent and 35 percent respectively lower than 5.7 percent and 37.7 percent respectively in the quarter to July 2020. Economic growth is projected to increase to 3.5-4.5 percent in FY2020/21, and further to 5.5- 6.5 percent in FY 2021/22.

6) Fiscal operations in financial year (FY) 2020/21 has been supported by a surplus in domestic revenue albeit hindered by lower-than-target financing (domestic & external) as well as slow execution of infrastructural projects. Total Government revenue (including grants) in the first four months of FY 2020/21, amounted to Shs. 5,856.3 billion which was Shs. 437.9 billion higher than the amount in the approved budget largely due to an over performance in domestic revenue partly reflecting tax administration reforms, higher import duty, and spill overs from FY2019/20.

5 | P a g e

7) Total public debt increased by 21.7 percent in FY2019/20. External debt increased from US$ 8.35 to US$ 10.45 billion, while domestic debt increased from Shs 16.2 trillion to Shs 19.1 trillion. As a percentage of GDP, nominal public debt increased from 35.3 percent in June 2019 to 41.0 percent in June 2020.

8) The external sector strengthened in the twelve months to October 2020 reflecting improvements in the financial account. Indeed, the overall balance of payments recorded a surplus of US$690.2 million, up from the deficit of US$45.8 million recorded in the same period in 2019. The current account deficit widened by 14.6 percent to US$2,748.4 million, in the twelve months to October 2020 largely due to the widening of the services account deficit impacted by lower travel receipts due to COVID-19 containment measures including closure of borders and lower government services imports.

9) The Uganda Shilling has remained relatively stable partly reflecting subdued aggregate demand in addition to a weaker USD against other international currencies. In November 2020, the Shilling appreciated slightly against the US dollar by 0.2 percent on a month-on- month basis but depreciated by 0.4 percent year-on-year to an average mid-rate of Shs. 3,710.7 per US dollar.

10) Inflation remains well anchored. Headline inflation declined to 3.7 percent in November 2020 from 4.5 percent in October 2020. Core inflation also declined to 5.8 percent from 6.3 percent on account of a fall in Services inflation to 11.1 percent from 11.8 percent mainly due to lower transport fares. Other measures of inflation also declined in November 2020. The inflation outlook has been revised downwards compared to the October 2020 forecast round. Inflation is now projected in the range of 5-6.5 percent in 2020 before converging to its medium-term target of 5 percent.

11) Given the uncertainty surrounding the inflation outlook and taking into consideration the weak state of the economy the MPC decided to keep CBR rate unchanged at 7 percent and maintain liquidity support to supervised financial institutions. The band on the CBR has also been maintained at +/-2 percentage points, while the margin on the rediscount rate and bank rate is unchanged at 3 and 4 percentage points on the CBR, respectively. Consequently, the rediscount rate and the bank rate have been maintained at 10 percent and 11 percent, respectively.

6 | P a g e

1. Reflections of Monetary Policy in the Previous Period

1.1 Monetary Policy Stance

In October 2020, the Bank of Uganda (BoU) maintained the eased monetary policy stance holding the Central Bank Rate (CBR) at 7 percent, and continuing to offer liquidity support to supervised financial institutions (SFIs). The band on the CBR remained at +/-2 percentage points, while the margin on the rediscount rate and bank rate were also unchanged at 3 and 4 percentage points on the CBR respectively. Consequently, the rediscount rate and the bank rate stood at 10 percent and 11 percent, respectively.

GDP growth momentum in 12 to 24 months ahead was expected to be modest against sluggish external demand, subdued consumer expenditure, the weak performance of the service sector, commercial banks’ cautious lending, and uncertain economic outlook. Moreover, downside risks to the economic growth projection included the possibility of an increase in new infections and a longer period to get the virus under control, periodic spouts of global financial volatility that could led to capital outflows from Uganda, as well as increasing protectionism. Further, Private Sector Credit (PSC) was likely to remain subdued due to commercial banks facing increasing non-performing Loans (NPLs), high lending interest rates, and an increase in domestic financing of the fiscal deficit. Economic growth would however, recover swiftly than projected if the threat from COVID-19 faded more quickly than envisaged and global economic growth strengthened.

Core inflation remained higher than target since June 2020 although the MPC noted that the gradual recovery in economy would bring inflation back to around target in the medium term. Cost push pressures emanating from higher taxes on imported consumer and intermediate products and social distancing measures were expected to cause inflation to edge up further. In addition, price pressures were likely to increase, due to the further easing of lockdown measures as households increased spending on items that they had been forced to defer, for example expenditure on school fees. Price pressures were also expected to increase due to higher production costs from persistent supply disruptions. Overall, inflation was expected to be well contained over the medium-term, on the premise that both global and domestic risks did not materialize.

7 | P a g e

1.2 Monetary Policy Implementation

BoU used Repurchase Agreements (REPOs), reverse REPOs, and deposit auctions to align liquidity conditions with the desired monetary policy stance.

2. Money and Financial Markets Developments

A well-functioning financial market contributes to market efficiency and discipline, financial stability and enhances financing conditions in the economy. It also plays an important part in information aggregation, price discoveries, and facilitates monetary policy transmission. A comprehensive assessment of the performance of the financial market is therefore vital for macroeconomic policy formulation.

2.1 Global Financial Markets

Global Financial market conditions remained stable in the quarter to November 2020 reflecting the support by central banks and fiscal authorities at the onset of the pandemic. However, Global financial market sentiment improved in November 2020 as news of the COVID-19 vaccine improved investor sentiments. Equity prices have rebounded however long-term government bonds yields remain low in developed economies due to massive monetary policy easing, flight to safety and subdued economic outlook. Notably currencies in advanced and emerging economies have bounced against the US dollar, reflecting an improvement in global risk sentiment and concerns of worsening of the COVID-19 crisis in the US. Although immediate liquidity pressures have disappeared, large fiscal deficits and debt levels in 2020 and the likelihood of tightening financial conditions are expected to lead to debt distress, especially for Emerging Markets and Developing Economies (EMDEs).

The outlook is for anxiety in the global financial markets, with intermittent episodes of volatility, throughout 2020. Global financial conditions are however expected to improve in 2021, with the more positive prospects for 2022. Central Banks are expected to continue pursuing an accommodative monetary policy to alleviate the evolving risks. Indeed, the US Feds new long- run policy objectives are expected to keep the Fed funds rate around 0 percent until the end of 2023. Continued weakness in global financial market sentiments is likely to sustain subdued remittances and capital flows to EMDEs. This coupled with wider current account deficit may exert Shilling depreciation pressures

8 | P a g e

2.2 Domestic Financial Markets

2.2.1 Interbank Money Market

Short-term money market rates continue to trend in line with the Central Bank Rate (CBR). The weighted average 7-day interbank money market rate averaged 7.3 percent in the quarter to November 2020, compared to 7.4 percent in the quarter to August. Similarly, the weighted average overnight and overall rates averaged 6.7 and 7.0 percent compared to 6.8 percent and 7.0 percent, respectively, in the same period. The developments in the money market interest rates were consistent with the Central Bank Rate (CBR) as shown in Figure 1.

Figure 1: 7-day Interbank Rate and the Central Bank Rate (CBR)

14.0 13.0 12.0

11.0 10.0 9.0

8.0 Rates (%) Rates 7.0 6.0 5.0

4.0

Feb-20

Aug-20

May-20

Nov-20 Nov-19

CBR Lower Bound Upper Bound 7- day rate Source: Bank of Uganda

2.2.2 Primary Market for Treasury Securities

Generally, while yields on Government securities declined at the short end, increases were noted at the longer end of the spectrum in the quarter to November 2020 compared to the previous quarter.

The decline in yields at the shorter end was partly due to increased liquidity, subdued loan demand by the private sector, and increased appetite for safe and liquid assets linked to the negative sentiments caused by the pandemic. The 91-day, 182-day and 364-day Treasury bill rates declined to 7.7 percent, 9.6 percent and 12.4 percent, respectively in the three months to November 2020 from 8.7 percent, 10.3 percent and 12.2 percent in the three months to August 2020.

9 | P a g e

At the longer end, yields on the 2-year, 10-year and 15-year Treasury bonds on average recorded an increase of 0.7, 0.9 and 0.4 percentage points, respectively, to 14.3 percent, 15.7 percent and 15.2 percent in the quarter to November 2020. Volatility in the financial markets although moderated, could be exacerbated by lingering concerns of a second wave of the pandemic that could weigh on risk sentiments and increase the costs of borrowing going forward.

2.2.3 Secondary Market for Treasury Securities

The movement in the yields in the secondary market for government securities mostly reflected the developments in the primary market as shown in Figure 2.

Figure 2: Secondary Market Yields on T-bills and T-bonds

Source: Bank of Uganda

2.2.4 Lending and deposit interest rates

Commercial bank lending to households and businesses remains an important channel through which monetary policy affects the economy. Commercial bank lending interest rates have been relatively stable, averaging 19.7 percent in the quarters to July and October 2020. However, lending rates on foreign currency denominated loans recorded an increase to an average of 6.0 percent from 5.0 percent over the same period. During the quarter to October 2020, an increase in lending rates was mostly noted in the Transport and Communication sector, which averaged 22.0 from 17.9 percent in the quarter to July 2020. The sectoral decomposition of lending interest rates is illustrated in Figure 3.

10 | P a g e

Figure 3: Lending Interest Rates by Sector

26.0

22.0 20.93 19.84 19.91 18.84 19.30 19.30 18.0 17.78 17.73

14.0 Percent (%) Percent 10.0

6.0 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Personal and Household Loans Agriculture Transport and Communication. Manufacturing Trade Industry average Source: Bank of Uganda

2.2.5 Private Sector Credit

Growth in private sector credit (PSC) remained subdued in the quarter to October 2020 on account of relatively low economic activity. The average year-on-year growth in PSC averaged at 7.6 percent in the quarter to October 2020, down from 8.9 percent in the quarter to July 2020. Year-on year growth in shilling and foreign currency denominated loans slackened in the three months to October 2020 to 9.8 percent and 3.4 percent, respectively, compared to 10.9 percent and 5.1 percent in the preceding quarter. Net of exchange rate valuation changes, annual PSC grew by 7.8 percent year-on-year in the quarter to October 2020, down from 8.9 percent growth recorded in the quarter to July 2020. PSC growth is likely to remain subdued in the short-term due to weak economic growth and increased risk aversion by lenders. In the long-run, credit growth remains dependent on recovery in the level of economic activity. Figure 4 depicts the annual private sector credit growth.

Figure 4: Annual Private Sector Credit Growth

16 Contributions to PSC Growth by Currency 14 12 10 8

6 4 2 - Percent (2)

(4)

Jun-19 Jun-18 Jun-20

Oct-17 Feb-18 Oct-18 Feb-19 Oct-19 Feb-20 Oct-20

Apr-18 Apr-19 Apr-20

Dec-17 Dec-18 Dec-19

Aug-19 Aug-18 Aug-20 PSC Forex PSC Shs. Total PSC PSC (Net Revaluation) Source: Bank of Uganda 11 | P a g e

New net lending in the quarter to October 2020 comprised capitalized interest of Shs. 658.0 billion up from Shs. 429.2 billion in the quarter to July 2020, reflective of an increase in the uptake of credit relief measures in response to the COVID-19 pandemic. Excluding capitalized interest, the year-on-year growth in PSC growth averaged 6.9 percent in the quarter to October 2020, down from an average growth of 8.6 percent in the preceding quarter. As at the end of October 2020, the restructured loans under BOU’s COVID-19 credit relief measures amounted to Shs. 5.2 trillion, equivalent to about 31 percent of the loan portfolio.

A sectoral decomposition of credit as shown in Figure 5 reveals a further slackening in growth in lending to major sectors of the economy during the quarter to October 2020. Average annual credit growth to the agriculture, manufacturing, trade, personal & household and Building, mortgage, construction and real estate sectors grew by 4.1 percent, minus 0.4 percent, 0.7 percent, 7.0 percent and 9.6 percent in the three months to October 2020 from respective growth rates of 9.0 percent, 0.6 percent, 3.4 percent, 5.8 percent and 12.7 percent in the previous quarter. A slowdown in lending to the major economic sectors poses challenges for private investment and consumption and may further constrain economic growth prospects.

Figure 5: Annual Growth in Private Sector Credit by sector (Sectoral Shares as at October 2020 in Brackets) 25 Annual Growth in PSC per Sector (Sectoral Shares as at Oct 2020 in brackets) 20

15

10

5

0 Percent (%) Percent

-5

Jul-20 Jul-20

Jan-20 Jan-20

Jun-20 Jun-20 Jun-20

Oct-19 Oct-20 Oct-19 Oct-20 Oct-19 Oct-20

Sep-20 Sep-20

Feb-20 Feb-20 Feb-20

Dec-19 Dec-19 Dec-19

Apr-20 Apr-20 Apr-20

Aug-20 Aug-20 Aug-20

Nov-19 Nov-19

Mar-20 Mar-20

May-20 May-20 Personal Loans and Agriculture (13%) Trade (18%) Building, Mortgage, Manufacturing Household Loans Construction and (12%) (17%) Real Estate (20%)

Source: Bank of Uganda

2.2.6 Credit Demand and Supply

Credit demand proxied by value of loan applications and approvals increased in the quarter to October 2020. The value of loan applications increased to an average of Shs 1.5 trillion per month compared to Shs 1.2 trillion in the quarter to July 2020 while the average loan approvals averaged Shs 992 billion compared to an average of Shs 690.3 billion in the quarter to July 2020

12 | P a g e

(Figure 6). Lower approvals than applications partly reflect commercial banks’ continued risk aversion as a result of the impact of COVID-19.

Figure 6: Proxies for Demand and Supply of Bank Credit per Sector

Bank of Uganda

In the short-run, credit is likely to remain subdued due to uncertainty about borrowers’ ability to service their loans at the end of the moratorium. Indeed, some borrowers in the Services sector particularly, Education and Tourism remain distressed as they are yet to resume full operations. This may result in higher non-performing loans (NPLs) thereby increasing the risk aversion of commercial banks. In the medium term however, a boost in credit growth is projected, in line with anticipated improvement in economic activity.

2.2.7 Asset quality Asset quality of loans extended by commercial banks improved in September 2020, reflected in a decline in the share of NPLs to total loans to 5.1 percent in September 2020 from 6.0 percent and 5.4 percent, respectively in June and March 2020. The lower NPLs were observed in the sectors of Agriculture, Trade, Building, Construction & Real Estate, and Personal & Household loans sectors as shown in Table 1. The improvement in the ratio of NPLs is in line with the gradual recovery in economic activity following the opening up of the economy post lockdown.

Going forward, asset quality could deteriorate as loan moratoriums mature amidst subdued economic activity especially in the consumer facing service sector such as education and tourism. NPLs should improve as the negative effect of the COVID-19 pandemic on the general business environment wanes. The worsening in asset quality continues to be largely moderated by the credit relief measures instituted by BOU.

13 | P a g e

Table 1: Non Performing Loans by sector NPL RATIO (%) Sep-18 Dec-18 Mar-19 Jun-19 Sep-19 Dec-19 Mar-20 Jun-20 Sep-20 AGRICULTURE 9.8 7.9 9.7 9.1 8.4 8.8 9.8 9.4 8.5 MINING & QUARRYING 4.7 0.4 0.3 0.8 0.3 0.3 0.1 5.6 5.7 MANUFACTURING 1.9 2.3 2.9 2.7 2.0 2.4 2.4 2.2 2.2 TRADE & COMMERCE 6.3 4.0 3.6 3.2 5.0 7.5 7.4 8.9 7.6 TRANSPORT & COMMUNICATION 4.3 2.6 1.5 3.4 3.8 2.9 2.1 2.1 2.1 BUILDING, CONSTRUCTION & REAL ESTATE 3.9 2.2 2.5 3.0 4.4 4.5 4.4 6.5 4.7 ELECTICITY & WATER 0.1 0.0 0.1 0.3 0.1 0.1 30.9 21.6 17.9 BUSINESS SERVICES 3.7 2.7 3.1 2.8 2.7 2.7 2.9 3.5 3.1 COMMUNITY, SOCIAL AND OTHER SERVICES 3.8 3.0 8.0 7.6 5.7 5.4 2.2 2.1 1.2 PERSONAL AND HOUSEHOLD LOANS 3.3 2.6 2.8 2.6 2.7 2.8 4.0 5.0 4.6 OTHER ACTIVITIES 21.8 8.6 6.7 4.0 17.0 5.0 6.8 6.7 6.6 OVERALL NPL RATIO 4.7 3.4 3.8 3.8 4.4 4.9 5.4 6.0 5.1 Source: Bank of Uganda

2.2.8 Money Supply

Growth in monetary aggregates slowed in the quarter to October 2020 largely due to a drop in deposits. On an annual basis, M3 grew on average by 20.4 percent in the quarter to October 2020, lower than the 22.1 percent growth recorded in the quarter to July 2020. Shilling deposits grew on average by 22.9 percent compared to a 23.0 percent growth in the preceding quarter, while foreign currency deposits also decelerated to 16.4 percent compared to the 19.9 percent growth recorded in the same period.

There was a drop in the contribution of Net Domestic Assets (NDA) to growth in M3 during the quarter. NDA contributed 9.0 percentage points in the three months to October 2020, lower than the 13.4 percentage point contribution registered in the preceding quarter. The decline in the contribution of NDA to growth in M3 superseded the rise in the contribution of Net Foreign Assets (NFA) to growth in M3, which stood at 11.4 percentage points compared to the 8.7 percentage point contribution in the period under review.

Contributions of Net Claims on the Government (NCG) and PSC to growth in M3 declined in the quarter to October 2020, to 8.5 percentage points and 3.8 percentage points, respectively, compared to 10.7 and 5.9 percentage points in the quarter to July 2020. Figure 7 depicts the contribution of M3 on the liability and asset side.

14 | P a g e

Figure 7: Contributions to M3 growth Contributions to Annual Growth Contributions to Annual M3 in M3-Liability Side 30 25 growth - Asset Side 25 20 20

15 15

10 10 5

%change 5 0 0 -5change %

-10

Jul-19

Jul-20

Jan-19

Jun-19 Jan-20

Sep-18 Sep-19

Jun-20 Apr-19

Oct-18 Oct-19

Sep-20

Apr-20

Feb-19

Oct-20

Feb-20

Dec-18 Dec-19

Mar-19

Aug-18 Aug-19

Mar-20

Aug-20 Nov-18 Nov-19

May-19

May-20 Jul-19

Shillings deposits Jul-20

Jan-19

Jan-20 Jun-19

Sep-18 Sep-19

Apr-19 Jun-20

Oct-19 Oct-18

Sep-20

Apr-20

Feb-19

Oct-20

Feb-20

Dec-19 Dec-18

Mar-19

Aug-18 Aug-19

Mar-20

Nov-19 Nov-18 Aug-20 May-19 Foreign deposits May-20 CIC M3 NFA PSC NCG M3

Source: Bank of Uganda

3. Economic Activity

Although monetary policy has lived under many guises, it generally boils down to adjusting the supply of money in the economy to achieve non-inflationary growth. It is generally agreed that in the long run, output is fixed and any changes in money supply only leads to increases in prices. Nonetheless because prices and wages are sticky in the short run, changes in money supply affect the actual production of goods and services and aggregate demand in the economy.

3.1 Global Economic Activity

Global economic growth remains weak albeit prospects for recovery have improved with positive news on covid-19 vaccine development. Nonetheless, recent projections from the Organisation for Economic Co-operation and Development (OECD) and the IMF World Economic Outlook indicate a Global economic contraction of between 4.2 percent and 4.4 percent in 2020, less severe than earlier projected. The upward revision is partly informed by better-than anticipated pick-up in economic activity in the second quarter of 2020, following a scale back in the lockdowns especially in the advanced economies, China and the Euro Area. The pick-up in economic activity was however, not uniform across economies, particularly in EMDEs such as India and Mexico where activity was weaker than anticipated due to a contraction in consumption and investment on account of continued spread in the pandemic. Moreover, renewed virus outbreaks in many economies, and the containment measures being 15 | P a g e

implemented, have checked the pace of the global rebound from the output collapse in the first half of 2020 and could result in further near-term output declines, particularly in many European economies.

The OECD economic outlook for December 2020, projects a rebound to Global growth of 4.2 percent in 2021, lower than 5.0 percent projected in September (Table 2), reflecting the more moderate downturn projected for 2020 and consistent with expectations of persistent social distancing following renewed virus outbreaks which could persist given the significant development and logistical challenges in deploying a vaccine widely around the world. The balance of risks to the global outlook remains skewed to the downside due to the continued spread of the pandemic in some parts of the world. The increased spread of the pandemic and responses of more lockdowns is likely to disrupt economic activity, reduce investment, tourism and remittances flows. In addition, uncertainty surrounding the persistence of the pandemic shock, the public health response, and the associated economic activity disruptions may contribute to a further contraction in global growth. On the other hand, a faster production and distribution of the Covid-19 vaccines and an extension of fiscal countermeasures into 2021 present a positive picture to the outlook.

Table 2: Global Economic growth forecasts in selected Countries

OECD Economic Outlook Forecasts - September/December 2020 Outturn Sep-2020 Projs Dec-2020 Projs Difference 2019 2020 2021 2020 2021 2022 2020 2021 World 2.7 -4.5 5.0 -4.2 4.2 3.7 0.3 -0.8 G20 2.9 -4.1 5.7 -3.8 4.7 3.7 0.3 -1.0 US 2.2 -3.8 4.0 -3.7 3.2 3.5 0.1 -0.8 Euro Area 1.3 -7.9 5.1 -7.5 3.6 3.3 0.4 -1.5 Japan 0.7 -5.8 1.5 -5.3 2.3 1.5 0.5 0.8 UK 1.3 -10.1 7.6 -11.2 4.2 4.1 -1.1 -3.4 Brazil 1.1 -6.5 3.6 -6.0 2.6 2.2 0.5 -1.0 China 6.1 1.8 8.0 1.8 8.0 4.9 0.0 0.0 India 4.2 -10.2 10.7 -9.9 7.9 4.8 0.3 -2.8 South Africa 0.2 -11.5 1.4 -8.1 3.1 2.5 3.4 1.7

Source: OECD, December 2020

3.2 Domestic Economic Activity

Economic growth slowed in FY2019/20. Indeed, the most recent data from UBOS depicts that the economy only grew by 2.9 percent in FY2019/20 from 6.8 percent in FY2018/19 (Figure 8). The slowdown in economic growth was largely on account of the mitigation measures taken

16 | P a g e

to curb the COVID-19 pandemic. The most affected sectors were the industry and services sectors that each grew by 2.2 percent and 2.9 percent respectively, lower than 10.1 percent and 5.7 percent in FY2018/19.

Figure 8: Constant GDP Growth (%)

Source: UBOS, October 2020

A recovery in economic activity is underway across the country, but is proceeding at an uneven pace. Some industries remain constrained by mandated and voluntary social distancing, particularly in hospitality and tourism, while some other industries are feeling the effects of the broader economic downturn. The high frequency indicators of economic activity point to continued recovery in economic activity in the quarter to October 2020. The Composite Index of Economic Activity (CIEA) and Stanbic Purchaser Manager’s Index (PMI) grew by 0.7 percent and 35 percent respectively lower than 5.7 percent and 37.7 percent respectively in the quarter to July 2020 (Figure 9). On annual basis, the growth in the CIEA rose to 3.3 percent higher than 2.0 percent in the quarter to September 2020 and a sharp contraction of 6 percent in the quarter to June 2020. The increase in activity is supported by the accommodative monetary policy stance and the fiscal stimulus social services to support the recovery. The levelling off of growth in economic activity could increase social distancing and slow recovery in global demand.

17 | P a g e

Figure 9: Monthly Changes in the CIEA and PMI 120 8 100 6 80 60 4 40 2 20

0 0

%age Growth PMIin %age change in CIEA -20 -2 -40 -60 -4 PMI CIEA

Source: BoU, Stanbic PMI

4. Fiscal Policy and Developments

Fiscal policy plays a significant role, both as a stabilization tool and in influencing the short- and long-term growth prospects of an economy. In the short term, counter-cyclical fiscal expansion can help support aggregate demand and growth during downturns. Conversely, fiscal contraction can help cool down an economy that is growing at an unsustainable pace and could face the risk of overheating. Effective coordination of a country’s fiscal policy with its monetary policy, rather than a subservience of the latter to the former, plays an important role in the overall macroeconomic management and achievement of the long-term growth target.

4.1 Government Expenditure and Revenue

Fiscal operations have been supported by a surplus in domestic revenue albeit hindered by lower-than-target financing (domestic & external) and slow execution of infrastructural projects. Total Government revenue (including grants) in the first four months of financial year(FY) 2020/21, amounted to Shs. 5,856.3 billion which was Shs. 437.9 billion higher than the amount in the approved budget largely due to an over performance in domestic revenue partly reflecting tax administration reforms, higher import duty, and spill overs from FY2019/20. Moreover, higher taxes were recorded in international trade taxes on account of improved collections of VAT on imports, import duty and petroleum duty as well as direct and indirect taxes.

As shown in Table 3, total government expenditure in the first four months of financial year FY 2020/21 amounted to Shs. 11,704.1 billion, Shs. 3,528.4 billion lower than the programmed expenditure. This was mainly due to an under performance of Shs. 2,838.2 billion in development expenditure. The shortfall in development expenditure is attributable to slow 18 | P a g e

absorption by some government projects. Current expenditure and net lending repayment were also lower than programmed by Shs. 715.8 billion.

Expenditure pressures especially related to combating the effects of COVID-19 and the upcoming election coupled with projected shortfall in revenue have raised the financing gap by almost Shs. 6 trillion shillings in FY2020/21. The fiscal deficit is thus projected at 10.4 percent of GDP. In that regard, the parliament approved a supplementary budget and related financing amount of Shs. 3.258 billion from domestic sources and US$ 600 million from external sources.

Table 3: Fiscal Operations (Shs. Billion) Jul’20 - Prel. Prog. Jul’19 - Oct’19 Variation Oct'20 Jul’20-Oct’20 Revenue & Grants 5,986.4 5,856.3 5,418.4 437.9 Revenue 5,484.3 5,482.7 4,722.3 760.3 Grants 502.1 373.7 696.1 -322.5 Expenditure & Lending 10,519.5 11,704.1 15,232.4 -3,528.4 Current Expenditure 5,325.0 6,595.0 7,310.8 -715.8 Development Expenditure 4,729.7 4,176.2 7,014.4 -2,838.2 Net lending/repayments 239.5 554.4 729.1 -174.7 Domestic arrears repayment 225.3 378.4 178.1 200.4 Deficit(excluding grants) -5,035.2 -6,221.4 -10,510.1 4,288.7 Deficit(including grants) -4,533.1 -5,847.7 -9,814.0 3,966.2 Financing (net) 4,533.1 5,847.7 9,814.0 -3,966.2 External Financing (net) 654.5 2,335.8 2,563.4 -227.6 Domestic Financing (net) 2,777.8 2,427.8 7,252.4 -4,824.6 Errors & Omissions 1,100.8 1,084.2 -1.8 Source: Ministry of Finance, Planning and Economic Development (MOFPED)

4.2 Public Debt Stock

Total public debt increased by 21.7 percent in FY2019/20. External debt increased from US$ 8.35 to US$ 10.45 billion, while domestic debt increased from Shs 16.2 trillion to Shs 19.1 trillion. As a percentage of GDP, nominal public debt increased from 35.3 percent in June 2019 to 41.0 percent in June 2020. In Present Value terms, public debt to GDP increased from 27.0 percent to 31.8 percent. The provisional total public debt stock as at end October 2020 stood at Shs. 63,352.8 billion, corresponding to an increase of 13.8 percent from June 2020 compared to an increase of 3.9 percent over the same period the previous year. Public external debt continued to maintain the dominant share of 67.5 percent of the total public debt.

19 | P a g e

5. Balance of Payments and Exchange rate Developments

5.1 Balance of Payments

A large current account (CA) deficit usually implies an external imbalance in the economy, which in a flexible exchange rate regime might be corrected by depreciation of the exchange rate. Persistent CA deficits may, however, require structural changes in the economy to enhance productivity and economic growth and consequently minimize the persistent CA deficit.

The external sector continued to strengthen in the twelve months to October 2020 reflecting improvements in the financial account. Indeed, over the same period, preliminary data indicates that the overall balance of payments recorded a surplus of US$690.2 million, up from the deficit of US$45.8 million recorded in the twelve months to October 2019.

The current account deficit widened by 14.6 percent (or US$351.0 million) to US$2,748.4 million, up from a deficit of US$2,397.4 million in the twelve months to September 2019 and this was largely due to the widening of the services account deficit. The services deficit widened by US$1001.4 million to US$ 1,549.1million, which more than offset improvements on the trade, primary income and secondary income deficits by US$ 429.1 million, US$ 183.4 million and US$ 37.5 million, respectively. The services account was largely impacted by lower travel receipts due to COVID-19 containment measures including closure of borders and a lower government services imports. The trade deficit however improved by 15.2 percent to US$2,404.2 million in the twelve months to October 2020, reflecting subdued economic activity over the same period. The financial account surplus widened year-on-year by 26.6 percent (or US$537.9 million) to US$2,553.0 million from US$2,015.1 million respectively, driven by increased budget support loan disbursements during the year.

On quarterly basis, the overall balance of payments recording a deficit of US$193.1 million in the quarter to October 2020 compared to the a surplus of US$890.9 million recorded in the previous quarter, ended July 2020. Preliminary data indicates that, the current account deficit widened by US$322.0 million to US$998.3 million in the quarter to October 2020, primarily due to deterioration of the goods and services deficits in the quarter under review, relative to the previous quarter. The trade balance worsened by US$190.9 million to US$726.8 million in the quarter to October 2020, largely driven by a higher import bill. Similarly, the services account

20 | P a g e

deficit worsened, widening by 62.4 percent (or US$222.5 million), to a deficit of US$579.6 million over the same period. Developments in the BOP are presented in Figure 10.

Figure 10: Developments in Overall Balance of Payments and Main Components 1500 1000 500 0 -500 -1000 -1500 -2000

Curent account Financial account Overal balance

Source: Bank of Uganda

The capital account balance increased by US$22.4 million to US$35.6 million for the quarter to October 2020, relative to US$13.1 million recorded in the previous quarter. The financial account surplus reduced by US$973.9 million to US$428.7 million in the quarter to October 2020 from US$1,402.7 million recorded in the previous quarter. The decrease was on account of a 78.1 percent reduction in capital inflows observed through Other Investment, specifically, budget support loans totalling US$215.4 million disbursed to the government sector for the quarter to October 2020, down from US$1,277.9 million in the previous quarter. During the quarter under review, the capital inflows received were insufficient to finance the widened current account deficit; leading to a draw-down in reserve assets of US$193.1 million. The stock of reserves as at the end of October 2020 was estimated at US$3,852.1 million (including valuation changes) which is equivalent to 4.9 months of future imports of goods and services.

In the short run, the current account deficit is likely to deteriorate further on account of a rise in the import bill linked to the festive season. However, this may be moderated by a rise in remittances receipts often associated with the same period and a slight pick-up in travel receipts expected following the opening of the airport. On the financing side, FDI inflows are likely to remain subdued in the wake of the 2021 elections coupled with weak global economy, but the country could attract additional donor inflows related to the COVID-19 pandemic as well as disbursements from existing project loans.

21 | P a g e

5.2 Exchange Rate Developments

The Uganda Shilling has remained relatively stable partly reflecting subdued aggregate demand. The shilling strengthened slightly in November 2020 compared to previous month appreciating by 0.2 percent month-on-month to an average mid-rate of Shs. 3,710.68/USD. Activity in the interbank foreign exchange market (IFEM) was subdued with demand from telecom, energy and manufacturing sectors being matched to supply from offshores, NGOs, remittances, forex bureau and coffee export receipts.

On a trade-weighted basis, in November 2020 the exchange rate (Nominal Effective Exchange Rate - NEER) depreciated by 0.2 percent month-on-month and appreciated by 0.5 per cent year- on-year. In real terms, in October 2020, the Real Effective Exchange rate (REER) depreciated by 0.9 percent month-on-month and appreciated by 2.4 percent year-on-year, largely due to a widening inflation differential as depicted in Figure 11.

Figure 11: Changes in the NER, Inflation Differential and REER (Y-o-Y)

Source: Bank of Uganda

Movements in EAC Partner State currencies relative to the US Dollar were mixed in the quarter to November 2020. The Tanzania Shilling was stable appreciating by only 0.13 percent year-on- year to an average rate of TZS 2,297.7 per US$. However, on an annual basis, the Kenya Shilling and Rwanda Franc depreciated 5.3 percent each to aver average rates KES 108.8 and RWF 960.0 per US $ in the three months to November 2020 as depicted in Figure 12.

22 | P a g e

Figure 12:Selected EAC Partner States’ Exchange Rates (YoY, per cent Change) Exchange rates of EAC Currencies 8% 6% 4% 2% 0% -2%

-4%

Annual Percentage Changes Percentage Annual

2019 M04 2019 M11 2019 M06 2020 2019 M02 2019 M03 2019 M05 2019 M06 2019 M07 2019 M08 2019 M09 2019 M10 2019 M12 2019 M01 2020 M02 2020 M03 2020 M04 2020 M05 2020 M07 2020 M08 2020 M09 2020 M10 2020 M11 2020 UGX/USD KES/USD RWF/USD TZShs/USD

Source: Source: Bank of Uganda

Going forward, the exchange rate is likely to remain stable on account of matched corporate activity; with a bias towards an appreciation due to inflows expected over the festive season. In 2021 and beyond, the shilling could benefit from a projected USD depreciation against other reserve currencies. Moreover, the outlook for a post-pandemic rebound in global growth and trade in 2021 and the reduced odds of unpredictable trade wars should lead to a reduction in exchange rate volatility. In terms of purchases for reserve build-up BoU purchased USD 37.7 million for reserve build-up from interbank foreign exchange market (IFEM) in the quarter ended November 2020 bringing the total purchases for the FY 2020/21 so far to US$ 85.1 million.

6. Inflation

Domestic inflation is contingent on both domestic and external economic factors. The importance of the external economic environment in determining domestic inflation dynamics depends on the economic linkages between the domestic and global economy. A careful assessment of the evolution and outlook of both domestic and external factors is therefore critical in the design of an effective monetary policy stance, which in Uganda is formulated to deliver a medium term core inflation target of 5 percent and to ensure that output is not only as close to potential as possible, but also consistent with the inflation objective.

23 | P a g e

6.1 Global Inflation and International Commodity Prices

6.1.1 Global Inflation

Global inflation slightly picked up in October 2020, although it remains subdued, owing largely to COVID-19 related weakening of global demand. Although, inflation increased marginally in the UK to 0.9 percent in October 2020 from 0.7 percent in September 2020, it remained broadly subdued in the US and the Euro Area. In the US, Inflation declined to 1.2 percent from 1.4 percent; and it remained unchanged in the Euro Area at 0.3 percent, during the same period. Notably, these rates are significantly below the inflation targets of 2 percent. In the Emerging Economies, inflation increased to the central bank target of 4.0 percent in Russia from 3.7 percent in September 2020 partly on account of currency depreciation. Inflation in South Africa also increased to 3.3 percent from 2.9 percent during the same period. Inflation developments in selected countries are shown in Figure 13.

Figure 13: Inflation Rates in Selected Countries

Source: OECD Statistics

6.1.2 International Commodity Prices

International commodity prices continued to recover in November 2020 from the record lows of April 2020 which were occasioned by the COVID-19 containment measures and their impact on global demand. However, commodities prices remain below the pre COVID-19 outbreak levels. In November 2020, average crude oil prices rose by 85.2 percent to US$42.3 per barrel, from US$23.3 per barrel in April 2020. The pickup in crude oil prices is attributed to improvement in oil market conditions on account of better prospects of oil demand in the second half of 2020 and reduction in the largely oversupplied position of the oil market. On an annual basis, the decline in average crude oil prices decelerated to 31.1 percent in November 2020. Developments in global commodity prices are presented in Figure 14.

24 | P a g e

Figure 14:Global Commodity Price Developments

Source: World Bank & FAO

6.2 Domestic Consumer Price Inflation

Inflation remains benign. Indeed, Headline inflation declined to 3.7 percent in November 2020 from 4.5 percent in October 2020. Core inflation also declined to 5.8 percent from 6.3 percent on account of the lower Services inflation to 11.1 percent from 11.8 percent mainly due to lower transport fares. Other goods inflation also declined to 2.2 percent from 2.6 percent. Food crops and Energy Fuel & Utilities inflation also declined to -7.3 percent and -1.4percent, respectively from -6.1 percent and -1.3 percent. The decline in EFU was largely driven by a fall in prices of solid fuels and cooking gas. These developments are shown in Figure 15.

Figure 15: Developments in Domestic Inflation

Source: Uganda Bureau of Statistics (UBOS)

25 | P a g e

7. Economic and Inflation Outlook and Risks

Monetary policy impacts on inflation and real economic activity with a lag. A critical assessment of the future trajectory of inflation is therefore crucial in the design of a forward-looking monetary policy framework. This requires a thorough understanding of the outlook and risks to the external and domestic economic environment.

7.1 Economic Outlook

Economic growth is projected to increase to 3.5-4.5 percent in FY2020/21, further to 5.0-6.0 percent in FY 2021/22 and to between 6.5-7.5 percent beyond. Monetary and fiscal policy stimuli as well as rebound in both foreign and domestic demand will support growth albeit could weighed down by, reduced consumption due to voluntary social distancing in response to rising COVID-19 infections, increased precautionary savings and the weak performance of the tourism sector. In addition, pro-cyclical private sector credit growth, increasing non-performing loans, high lending interest rates, increasing trade protectionism, volatile international financial markets and the subdued global demand still pose challenges to domestic growth. This coupled by the increasing fiscal financing pressures could pose significant downside risks to the growth outlook. However, the recent developments surrounding the Covid-19 vaccines present a positive picture to the outlook.

The outlook for Uganda’s economy is uncertain and depends on a wide range of developments. GDP is expected to recover gradually over coming years. However, the pandemic will have long lasting effects on the economy. Economic Growth is projected to recover to pre-Covid levels in FY2022/23. Many businesses in the service sectors, such as transport, entertainment and leisure, could become insolvent if demand does not recover, triggering large-scale job losses. Rising unemployment is also likely to worsen the risk of poverty and deprivation for millions of informal workers, particularly.

Overall, risks to the economic outlook in the near term have brightened with the progress on the Covid-19 vaccines, signs of recovery in private demand and the additional boost to growth expected from fiscal policy. Nevertheless, the medium-term outlook remains highly uncertain and there are a number of risks.

26 | P a g e

7.2 Inflation Outlook and Risks

The inflation outlook as shown in Figure 16 has been revised downwards compared to the October 2020 forecast round. Inflation is now projected in the range of 5-6.5 percent in 2020 before converging to its medium-term target of 5 percent. There are however risks to these forecasts. On the upside, a more depreciated exchange rate; increase in food prices due to a shorter rainy season, and a faster than anticipated global economic recovery due to the discovery of Covid-19 vaccines could put upward pressure on domestic inflation. On the other hand, lower than anticipated fiscal spending and sustained global and domestic economic weakness will lead to downward pressure in domestic inflation.

Figure 16: Inflation Outlook

Source: Bank of Uganda 8. Conclusion

The Bank of Uganda’s Composite index for Economic Activity (CIEA) points to a continued moderate recovery of economic activity with estimated annual growth of 3.3 percent in the quarter to October 2020, higher than 2.0 percent in the quarter to September 2020 and the sharp contraction of 6 percent in the quarter to June 2020. The simultaneous fiscal, monetary, and financial stimuli and have been effective in avoiding the most negative economic consequences of the COVID-19 shock. The easing of the lockdown also contributed to the recovery in economic activity.

Economic growth is projected in the range of 3.5-4.5 percent in FY2020/21 and 5.0-6.0 percent in FY 2021/22 supported by fiscal and monetary stimuli and. The economic outlook is extremely uncertain, due to the unpredictable course of the virus, election related factors, continued weakness in global economic activity, weather-related natural disasters and escalation of geopolitical tensions, trade policy uncertainty and technology fractions. The downside risks to

27 | P a g e

the economic growth projection include the possibility of an increase in new infections and a longer period to get the virus under control, periodic spouts of global financial market volatility, and increasing protectionism by trading partners. In addition, the private sector credit extensions could remain subdued due to increasing Non-Performing Loans (NPLs), high lending interest rates in the face of weak economic activity and increase in domestic financing of the fiscal deficit. On the upside, however, economic growth could recover swiftly if global economic growth strengthens, private sector credit recovery is sustained, and the vaccine is widely distributed.

Inflation declined in November 2020, however Core inflation remains above the target of 5 percent. The inflation outlook has been revised downwards compared to the October 2020 forecast round. Inflation is now projected in the range of 5-6.5 percent in 2020 before converging to its medium-term target of 5 percent. There are however risks to these forecasts. On the upside, a more depreciated exchange rate, increase in food prices due to unpredictable weather patterns, global commodity prices rebound, and a faster than anticipated global economic recovery due to the discovery of Covid-19 vaccines could put upward pressure on domestic inflation. On the other hand, lower than anticipated fiscal spending and sustained global and domestic economic weakness will lead to downward pressure in domestic inflation.

Overall financial conditions remain appropriately accommodative, with the real policy rate averaging 2.6 percent in the four months to November 2020, lower than the neutral real rate of 4 percent. Given the uncertainty surrounding the inflation outlook and taking into consideration the weak state of the economy the MPC decided to keep CBR rate unchanged at 7 percent and maintain liquidity support to supervised financial institutions. The band on the CBR has also been maintained at +/-2 percentage points, while the margin on the rediscount rate and bank rate is unchanged at 3 and 4 percentage points on the CBR, respectively. Consequently, the rediscount rate and the bank rate have been maintained at 10 percent and 11 percent, respectively.

28 | P a g e