Uganda turns to its thin foreign exchange reserves as the shilling slides, putting pressure on the country’s defences against currency turmoil - Business Insider Africa

The Ugandan shilling fell to its lowest level since 1993, showing severe pressure on the currency. In response, the central bank raised its benchmark interest rate by two percentage points, described as the world’s largest rate hike this year. The goal was to slow inflation and reduce pressure on the shilling.

The currency weakened because of strong demand for dollars, higher US bond yields, and foreign investors withdrawing money from emerging markets. A weaker shilling makes imported goods more expensive, while higher energy costs add to inflation. Governor Michael Atingi-Ego said the earlier increase would help contain inflation and keep expectations anchored.

The latest decision signals a more aggressive effort to manage currency and price risks. But rate increases also make borrowing more expensive and may reduce economic activity. Uganda has limited reserves, with about $6.7 billion covering roughly three months of imports, while Museveni favors cutting imports and raising export and tourism earnings.

Foreign-exchange reserves are a country’s stock of foreign currencies and other internationally usable assets. A central bank holds them to pay for imports, meet external obligations, and sometimes reduce extreme currency swings. They provide a financial cushion when demand for foreign currency rises.

Uganda’s reserves were about $6.7 billion and covered roughly three months of imports. In a currency crisis, the central bank could sell some dollars and buy shillings, supporting the exchange rate. That use of reserves is called market intervention. It can help temporarily, but reserves are finite and fall when dollars are spent.

Uganda’s cushion is especially limited because three months is below the East African Community’s recommended 4.5 months of import cover. President Yoweri Museveni has ruled out using reserves to support the shilling. He instead favors reducing imports and increasing export and tourism earnings, which could strengthen the reserve position over time.

Uganda’s foreign-exchange reserves stood at about $6.7 billion, according to the central bank’s annual report. Those reserves could cover roughly three months of imports. This measure shows how long a country could continue paying for imported goods using its available foreign currency, assuming other conditions remain similar.

The regional benchmark is higher. The East African Community recommends 4.5 months of import cover, so Uganda’s reserve cushion is about 1.5 months short of that guidance. The gap matters because the country has less foreign currency available to handle shocks, pay for imports, or calm a falling exchange rate.

The limited cushion restricts direct intervention in the foreign-exchange market. Uganda’s government therefore faces difficult choices as oil prices and dollar demand rise. President Museveni has rejected using reserves to prop up the shilling, instead supporting lower imports and stronger export and tourism earnings.

A currency weakens when demand for foreign currency exceeds the available supply. In Uganda, businesses and other buyers needed more dollars, while foreign investors were pulling money from emerging markets. That combination increased demand for dollars relative to shillings and pushed the shilling down.

Higher US bond yields added to the pressure. They made American government debt more attractive to global investors, especially as the US dollar strengthened. Investors withdrawing funds from Uganda and other emerging markets could sell local assets and convert the proceeds into dollars. This increases dollar demand and reduces support for the shilling.

The result was a 33-year low for the Ugandan currency and greater pressure on foreign-exchange reserves. Uganda had about $6.7 billion in reserves, covering only three months of imports. The central bank raised interest rates to limit these risks, but higher borrowing costs can weigh on economic activity.

When Uganda’s currency weakens, importers need more shillings to buy the same amount of dollars. Since fuel and many other goods are purchased from abroad, their local-currency prices can rise. Businesses may pass those higher costs to consumers, increasing overall inflation and reducing household purchasing power.

Fuel is especially exposed because Uganda needs foreign currency to pay for imported energy. The article reports that Brent crude surged by about 90% this year. Higher oil prices already increase import costs; a weaker shilling makes the dollar price of that oil even more expensive in shilling terms. That combination can worsen fuel-price pressure.

More expensive fuel can raise transport and production costs across the economy. It can also increase Uganda’s demand for dollars, putting further pressure on the shilling and reserves. The central bank raised rates to contain inflation and keep expectations anchored, but this response may slow borrowing and economic activity.

Raising interest rates makes borrowing more expensive and saving more rewarding. That can reduce demand for goods and services, easing pressure on prices. Higher rates can also make shilling investments more attractive, potentially supporting demand for the currency and limiting money flowing into dollars.

For Uganda, the central bank said rate increases were needed to contain inflation, limit the effects of higher energy prices and currency depreciation, and keep inflation expectations anchored. The two-percentage-point increase was a forceful response to the shilling’s fall and growing pressure in the foreign-exchange market.

The trade-off is weaker economic activity. Companies may postpone projects when loans cost more, while households may cut purchases because repayments rise. The article notes that higher borrowing costs threaten to weigh on economic activity. Rate hikes can therefore protect stability while making growth more difficult in the short term.

A country’s foreign-exchange position improves when fewer dollars leave and more dollars enter. Reducing imports lowers the amount of foreign currency needed to pay overseas suppliers. Increasing exports brings in payments from foreign buyers, while tourism earnings bring money from visitors. These flows can strengthen the supply of dollars available locally.

For Uganda, this approach offers an alternative to spending reserves to defend the shilling. President Yoweri Museveni has ruled out using foreign-exchange reserves to support the currency. Instead, he has urged the country to reduce imports and increase earnings from exports and tourism. That strategy targets the underlying flow of foreign currency.

The effects would take time, unlike a direct market intervention or an interest-rate increase. If export and tourism receipts grow while import demand falls, pressure on the shilling could ease and reserves could become more resilient. The approach is important because Uganda’s reserves cover only about three months of imports, below the regional recommendation.