We need to overhaul our monetary system that has been ravaged by mounting foreign debt, and fiscal indiscipline!
If China is at the epicentre of a financial earthquake, Uganda is the headquarters of currency free-fall. The Ugandan Shilling has lost a quarter of its value in the last six months.
Six months ago, a dollar was purchasing Ushs.2,800. Currently, the exchange rate is Ushs.3,560 per U.S. dollar.
We are a net importing country, meaning that most of the items that we use on daily basis are imported from other countries.
To import them we need dollars since their prices are quoted in dollars. Yet the price of the dollar keeps on increasing despite the occasional interventions by Bank of Uganda to smooth the depreciation. This has left the Shilling in a very bad shape. The cost of living of an average Ugandan has become quite expensive. The prices of general merchandise we buy have gone up.
Inflation, although reported low, the prices are realistically higher than they were in 1993 when we liberalised the economy.
Low inflation does not necessarily mean low prices. It just means that the (already high) prices are rising at a relatively slower pace than previously. What matters in this case is the baseline at which you start to measure the inflation.
Although UBOS reports that the current headline inflation is 5.4%, this does not mean that prices of goods and services are low. The prices have typically kept high since the past inflationary spikes, only that they are currently rising at slower pace.
This new economic reality is contrary to what economic theorists have been telling Ugandans in the past.
When the Shilling started depreciating, following the floating of the currency, economists at Bank of Uganda and Ministry of Finance promised us that this was good for the economy. They posited that the depreciation would make our exports competitive, sell more, earn more dollars and boost our balance of payments.
This is not the reality we are facing today. Instead, the rapid depreciation of the Shilling has not only made life more expensive, has also worsened our balance of payments. Exports have not been boosted as promised; instead the depreciation has made the imports more expensive. Yet these items we import seem to have inelastic demand (we simply cannot do without them).
It worked in 1987
The general feeling among economists and other analysts is that we need to work on our exports such that we are able to earn more dollars. Others are suggesting that we substitute some of the imports that we may produce locally in order to save the foreign exchange we spend on them.
In my view, although these are plausible interventions, they are medium- to long-term interventions. Secondly, it would be a very tall order for us to correct the kinds of imbalances our economy is experiencing today by simply embarking on structural change. As a beginning, we may need another currency reform.
In May 1987, the fledgling NRM government announced three key reforms that would improve the value of the Shilling. Firstly, new currency notes were introduced. To convert the ‘old’ currency into the ‘new’ one, two zeros were knocked off, that is to say, one new Shilling was equivalent to 100 old Shillings. This measure helped to reduce excessive liquidity in the economy and restore the value of the Shilling that had been badly battered by the numerous economic distortions of 1970s and ’80s.
Secondly, a currency conversion tax at a rate of 30% was imposed. This tax helped to further reduce the supply of money and also availed government some quick revenue to finance its budget deficits that had expanded as rapidly as they are doing today.
The two above mentioned measures were accompanied by a 77% devaluation of the Shilling, that is, from 14 to 60 Shillings per U.S. dollar, intended to address the imbalances in the external sector by promoting exports.
Economy has been dollarised
As a result of these measures, there was an immediate drop in average inflation from 360.7% in May 1987 to about 200% in June, and later inflation was fully arrested back into single digits beginning in early 1990s.
Someone may ask why we are in this shape if the currency reforms worked. Well, currency reform is necessary but not sufficient. After the reforms, we failed to put in place an industrial policy to raise productivity both for export and import substitution.
We devalued at a time when we had nothing to export. Consequently, we made it difficult for local producers since they had to import raw materials at higher prices. This left the economy unable to produce tradable goods. We had to rely on imports. It will take us a great deal of effort and patience to get out of the current position.
But I strongly believe we have now learnt a few lessons. Let us get a fresh beginning. Another currency reform will be successful. In any case Ugandans are both naïve and not homogeneous in their understanding of monetary issues. If we knocked a zero off the Shilling, it will create what economists call an endowment effect in it. The endowment effect refers to the fact that people often demand much more to give up an object than they would be willing to pay to acquire it. In other words, people place a higher value on objects (in this case money) they own relative to objects they do not own.
After the reform, a Ugandan buyer will think about the transactions in terms of the new currency while the seller will be thinking in terms of the old currency. This will create a “money illusion” — a kind of false impression of increase of the value of the Shilling.
In any case the rate at which the economy is getting dollarised is quite scary. This habit among established businessmen to transact in dollars is grounded in their concerns about exchange rate risk. Nearly on a daily basis the Shilling loses value. To shield their incomes and wealth against this loss, businessmen opted for the dollar.
Therefore, in the face of these challenges I believe it is prudent to overhaul our monetary system that has been ravaged by increasing foreign debt, very low productivity, and of course a long list of NRM’s unfulfilled promises. These and other factors, particularly the campaign money, are going to worsen the already very bad record of the Shilling. The solution lies in having another currency reform. Let’s knock a zero off our Shilling and restore its value.