Introduction
There are two broad concerns about commercial bank lending interest rates in Uganda. The first is to do with the level of commercial bank lending interest rates and the second is to do with recent increases in commercial bank lending interest rates, particularly the raising of interest rates on existing loans. The second issue has become particularly thorny to KACITA traders, who are opting to demonstrate to force Bank of Uganda to reign on commercial banks and stop them from upward adjustment of interest rates on existing loans. Furthermore, KACITA traders are of the view that the increase in commercial bank lending rates is on account of Bank of Uganda increase of the policy rates, that is, the bank rate for commercial banks, the rediscount rate, and the Central Bank Rate. Here we explore major facts and myths on Uganda’s interest rates. The major myth is that interest rates are high because of increases in Bank of Uganda policy rates. And the major fact is that, recent increases in Bank of Uganda’s policy rates was intended to tame the high inflationary pressures that were threatening the macroeconomic stability of the economy, growth, and employment.
Bank of Uganda’s Policy Interest Rates and Weighted Commercial Bank Lending Rate
Level of Commercial Bank Lending Interest Rates
For a long time, commercial bank lending interest rates in Uganda have been high. It is erroneous therefore to attribute the level of commercial bank lending interest rates to increases in Bank of Uganda’s policy rates. As can be seen in the figure below, commercial bank weighted lending interest rates have been over 20% per annum, with a rise from about 20% per annum in May 2011 to about 24% in November 2011. Yet, Bank of Uganda’s policy interest rates (bank rate and rediscount rate) fell from about 18% per annum in January 2009 to about 7% per annum in July 2010. Thereafter, the Bank of Uganda’s policy rates began to increase. Despite these changes in Bank of Uganda’s policy rates, commercial bank weighted lending interest rates ranged between 20% and 21% per annum, suggesting a weak link between Bank of Uganda’s policy rates and commercial bank lending interest rates during the period before July 2011 when Bank of Uganda resorted to inflation targeting.
What then explains the level (high) of commercial bank lending interest rates in Uganda? While the explanations are many (including commercial bank level explanations e.g. catering for non-performing loans), the major one is the prioritization of control of inflation and maintenance of a competitive exchange rate within a framework of an economy that is highly dependent on foreign aid. With a decision to let interest rates be determined by market forces, absorption of excess liquidity created by aid dependence could only be possible at a cost of high commercial bank lending interest rates. Furthermore, Uganda took a major decision to strengthen the commercial banks and ensure that they support external trade (enforcement of the Basel Standards of banking). Quick fixes of strengthening the banking sector meant inviting foreign banks to do business in Uganda because creation of domestically owned banks that would effectively meat Basel standards would have taken much long time. The same KACITA traders would have complained about the lack of commercial banks that could help them with their international trade financial transactions.
There are innovative ways that could have been used to have a strong commercial bank system in place while at the same time ensure that the economic agents in the productive sectors (agriculture and industry) still get affordable credit. One way is for the Government to subsidize credit to the productive sectors; efforts in this regard (e.g. Agriculture Credit Facility) have not been very useful, especially in terms of outreach. The other is to establish appropriate financial institutions for financing the productive sectors (e.g. agriculture bank, UDC, UDB).
Inflation Targeting
Before July 2011, Bank of Uganda conduct of monetary policy was through Reserve Money Programming. At the beginning of July 2011, Bank of Uganda changed its monetary policy framework from Reserve Money Programming to deal with the challenges to monetary policy created by rapid growth and diversification of the financial system. The change in monetary policy framework saw the introduction of a new interest rate called the Central Bank Rate which is meant to guide the seven day interbank rates. The Central Bank Rate set once a month and announced publically is meant to signal the stance of monetary policy during the month.
In a bid to tame rising inflation, Bank of Uganda has since March 2011 pursued a tight monetary policy stance. This has been reflected by upward movement of policy rates like the rediscount rate, the bank rate and CBR. The CBR has since July 2011 moved upwards 10 percentage points from 13% in July to 23% in November. The corresponding increases in the rediscount rate were from 16% to 28% and for bank rates from 17% to 29%.
The movement in the policy rates especially the CBR has had an impact on the other market interest rates such as commercial bank lending and deposit rates. Weighted average commercial bank lending rates increased from about 20 percent in June 2011 to about 24 percent in October 2011. However, the rise in interest rates was at a cost of a decrease in inflation and remarkable appreciation of the Uganda shilling.
The KACITA Paradox on Monetary Policy
Some few months back when inflation was higher than today and when the exchange rate had depreciated close to shs3,000 per one US dollar, KACITA demonstrated against the depreciated shilling and high inflation. Through appropriate policy actions (whose costs are higher interest rates) Bank of Uganda has managed to reduce inflation somewhat and also strengthen the Uganda shilling, which results we believe KACITA is happy with. However, KACITA does not want to accept the cost of these achievements! KACITA is now demonstrating against high interest rates (calling for controls), which came about as a cost of containing inflation and exchange rate depreciation. KACITA is silent about the benefits its members have so far got arising from a more favourable exchange rate (to them) and also due to lower inflation. KACITA is demanding controls (of interest rates) when controls fit them and flexibility in price determination when flexibility fits them. Conduct of monetary policy the KACITA way is impossible; you cannot eat your cake and have it! We are tempted to conclude that the KACITA demonstrations may not be about economic issues after all.
Conclusion
The conduct of monetary policy by BoU is on the right course, with focus on lowering the rate of inflation. We should be mindful that the external economic environment is still very unstable and inflation in neighboring Kenya is standing at 19% per annum. KACITA should cherish the economic freedoms her members have enjoyed and stop calling for controls. KACITA should sort out concerns about interest rates on existing loans with their bankers rather than resorting to BoU to compel it to impose controls on interest rates.