Currency Forecast - UGX: Monetary Tightening Will Not Stop The Slide - SEPT 2015


BMI Uganda Currency Forecast
Spot 2015 2016
Source: Bloomberg, BMI. Last updated August 12
UGX/USD, ave 3545 3,250 3,600
UGX/EUR, ave 3946 3,550 4,000
Policy rate, eop % 16.00 18.00 15.00

BMI View: A risk-off environment, weak balance of payments dynamics and loose fiscal policy will see the Ugandan shilling continue to slide over the coming months despite an aggressive monetary tightening cycle.

Short-Term Outlook (three-to-six months)

The Ugandan shilling is facing challenges on multiple fronts and there is little sign of imminent meaningful respite. It has been Sub-Saharan Africa (SSA)'s worst performing currency in 2015, depreciating nearly 22% against the dollar year-to-date, and we expect it to remain both weak and volatile over the coming months. Like many SSA currencies, the shilling has been a casualty of ongoing risk-off sentiment towards emerging market assets over the last six months. While the bulk of the USD bull-run has happened, there is still potential for further dollar strength and there is little in Uganda's domestic picture to suggest it can buck this trend.

Weak And Volatile
Uganda - Exchange Rate, UGX/USD
Source: Bloomberg, BMI

The Bank of Uganda (BoU) began an aggressive hiking cycle in April that has further to run, but, beyond bringing temporarily calmer conditions we doubt it will meaningfully stabilise market expectations ( see 'BoU To Remain Hawkish Well Into 2016', July 15). Neither does the BoU have the reserves - at USD2.9bn (just over four months' of imports) - or the inclination to prop up the currency through sustained interventionism. Moreover, we believe that the Ugandan monetary authorities' are effectively fighting with one hand tied behind their back. Markets have become increasingly concerned by the government's loose fiscal policy and these concerns will remain to the fore as the February 2016 election approaches ( see 'Expansionary Budget Speaks To Rising Fiscal Indiscipline', June 19). We expect the unit to average UGX3,600/USD through the end of 2015, significantly weaker than the UGX3,057/USD averaged year-to-date.

Deep In The Red
Uganda - Current Account, % of GDP (RHS) & Breakdown Of Component (LHS)
e/f=BMI estimate/forecast. Source: BoU, BMI

Long-Term Outlook (six-to-24 months)

Weak balance of payments dynamics will augur further shilling depreciation over the next couple of years. That said, we predict that the pace of depreciation will moderate from 2016 onwards, with Uganda's bright, investment-oriented macroeconomic outlook likely to provide some stability.

External imbalances arising from a dearth of domestic productive capacity are reflected in Uganda's gaping trade in goods deficit. We do not believe this will be plugged and will remain the key pressure point for the shilling over the medium term. We predict that the trade deficit will widen to 11.5% of GDP in 2015 and this will serve to keep the current account deep in deficit over the next few years.

Unfavourable Terms Of Trade
Uganda - Trade Deficit, USDmn (RHS) & Exports/Imports % yoy (LHS)
Source: Bank of Uganda, BMI

In addition to a weak manufacturing base, Ugandan exports are suffering a two-year long malaise that shows no sign of abating - recently published data revealed an anaemic 0.4% y-o-y expansion in Q115. The external sector is grappling with the effects of continued insecurity in South Sudan - a major export partner - and a weak price environment for key produce such as coffee and tea. With these conditions likely to persist over the coming quarters we do not expect a meaningful revival in exports and this in turn will weigh on hard currency inflows. Imports meanwhile are likely to accelerate over the coming quarters as the economy enters an upswing. While the BoU's recent tightening measures will curb demand to a degree, heavy government spending and a wave of major infrastructure projects will ensure growth in imported consumer and capital goods remain robust.

Direct Investment Underpins External Account Stability
Uganda - Financial Account Breakdown, USDmn
Source: Bank of Uganda, BMI

While these imbalances will see Uganda run a current account deficit of between 10% and 12.0% of GDP over the next few years, we do not view this in itself as cause for alarm, and the currency is unlikely to depreciate on its account in the long term. For the most part the deficit will continue to be matched by long-term FDI financing, particularly from China. Direct investment continues to make up the lion's share of financial account inflows and this will continue to underpin broad external account stability. Portfolio investment - predominantly into government debt - has increased steadily in recent years as high nominal yields and relative currency stability have enticed foreign investors into the market. Even so, hot money is still a small percentage of total financial account inflows and for this reason is unlikely to prove a source of macroeconomic instability.