• Authored By: Amos Sanday and Jude Sebuliba
02 May 2024

Many African currencies have weakened significantly against the US dollar (USD). For instance, the Ugandan shilling (UGX) has lost about 5.6 percent against the USD since October 2023. As of February 24th, 2024, the UGX was trading at 3,930 against the dollar, up from 3,620 in August 2023. This is better compared to other African currencies like the Naira that have lost almost 300 percent against the USD since June 2023. The Angolan Kwanza has lost 62%, Malawian Kwacha 63%, Congolese Franc, 35%, Burundian Franc 38% and the Kenyan Shilling about 15% over the same period.

The current volatility in African currencies, particularly the UGX, results from multiple factors, including widening trade deficits; short-term investors pulling out of the domestic market in search of higher returns elsewhere; global inflationary pressures arising from wars in Ukraine and Middle East; rising fuel import cost; global interest rate hikes; non-recovery of remittances; external debt repayments and profit repatriation by multi-national, which drains reserves; and the donor effect resulting from donor funding being withheld because of the passing of anti-gay legislation and human rights violations. Currency depreciation, the decrease in value of a country’s currency relative to other currencies, can have detrimental consequences for businesses, consumers, and the economy.

At the macro-level, currency depreciation could have a substantial impact on public debt, affecting both its size and sustainability. For instance, if public external debt is denominated in foreign currency, depreciation makes the debt larger and more expensive. This is because more domestic currency is required to repay the same amount of foreign debt. Consequently, the overall burden of external debt rises, leading to higher debt-to-GDP ratios.

Similarly, for countries with large foreign currency denominated external debt, currency depreciation leads to higher debt servicing costs.

Higher debt servicing costs resulting from currency depreciation could also contribute to widening fiscal deficits. The government may need to allocate more resources towards debt repayment, reducing funds available for public investment or social programs. Persistent depreciation could undermine the country’s creditworthiness by increasing country sovereign risk, making it more expensive for the government to borrow in international capital markets. Higher borrowing costs could further exacerbate debt sustainability concerns and limit the government’s ability to finance its operations and service existing debt. Depreciation thus, pose macroeconomic stability risks, particularly for countries with large external debt obligations like Uganda.

Sharp currency depreciation could trigger capital outflows, further complicating government’s debt management efforts by making the country more vulnerable to external shocks. This could have adverse consequences for economic growth, employment, and poverty reduction efforts.

For businesses, currency depreciation increases the cost of doing business. Particularly, businesses that rely on imported goods and materials face higher input costs when the domestic currency depreciates. As a result, the cost of production rises, leading to reduced profit margins or increased consumer prices. However, export-oriented businesses may benefit from increased demand for their goods and services as foreign buyers find them relatively cheaper. For businesses with foreign debt, currency depreciation increases the cost of servicing debt. Repaying loans denominated in foreign currencies becomes more expensive, potentially straining their financial health, especially if they lack hedging mechanisms to mitigate currency risk. Domestic currency depreciation could also affect investment decisions by firms, particularly those considering foreign direct investment (FDI) or expansion into international markets. A weaker currency makes foreign assets relatively cheaper for domestic investors, potentially encouraging outward investment, forcing businesses to delay domestic investment.

For consumers, currency depreciation means that they face higher prices for imported goods and services. Businesses that import goods may react by passing over higher prices to customers due to increased costs associated with importing. Rising import prices erode consumers’ welfare and purchasing power. Currency depreciation also has consequences on household budgets. It affects household budgets, particularly for imported items. Consumers may therefore need to allocate more of their income to essential expenses, leaving less disposable income for savings or discretionary spending.

Depreciation may also affect the cost of international travel, especially for Ugandans planning to travel to other countries. A weaker domestic currency makes travelling abroad more expensive, as it increases the costs of spending.

In conclusion, currency depreciation could have wide-ranging consequences for both businesses and consumers, affecting costs, purchasing power, and overall economic stability. Depreciating shilling could significantly affect public debt, increasing the size, and costs of servicing. Policy responses, including boosting exports and effective exchange rate risk management strategies, are important to mitigate the negative effects posed by currency fluctuations.

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