Wednesday, March 30, 2018 /10:40 AM / BMI Research
BMI View: We expect the shilling to trade in a sideways pattern in the short term as there is little in the way of perceptible catalysts that will drive it out of its current trading band. Over the longer term, falling real interest rates and a higher import bill will cause thecurrency to depreciate although the extent will be tempered by relative undervaluation in real effective terms.
Short-Term Outlook (three-to-six months)
In the short term, we believe that the Ugandan shilling is likely to continue to trade broadly sideways between UGX3,600-3,700/USD, with few foreseeable catalysts for a move outside this band. Political unrest surrounding parliament's approval of a law that removes presidential age limits has largely failed to materialise and the threat of a sudden slowdown in financial assistance from donors has subsided. Inflation, which has continued to fall since our last update on the currency, is close to bottoming in our view and will head higher over the coming months. While this is likely to see real yields fall marginally, the move will not be sufficient to warrant sharp capital outflows. Finally, a relatively healthy reserve pile, equivalent to over five months of import cover, means that the authorities have the resources to fend off depreciatory pressures in the short term.
Long-Term Outlook (six-to-24 months)
Over the longer term, we continue to believe that the shilling will gradually depreciate against the US dollar, forecasting the currency at UGX3,800/USD and UGX3,900/USD at the end of 2018 and 2019 respectively. The major factor underpinning this expectation is a likely widening of the current account deficit from an estimated 5.6% of GDP in 2017 to 6.9% in 2018 and 7.3% in 2019 as rising oil prices and strong capital good demand associated with infrastructure projects drive up the import bill. At the same time, we are expecting inflation to head steadily higher over the course of 2018 and for the benchmark interest rate to be held at its current level, which will see real yields fall. With global monetary policy being tightened in 2018, led by interest rate hikes in the US, portfolio flows to cover the current account deficit will therefore be harder to come by.
The extent to which these factors lead to depreciation will be tempered by a relative undervaluation of the currency in real effective terms and by strong economic growth. With respect to the real effective exchange rate (REER), the shilling is trading at an increasing discount to its long-term averages. While we do not think that this will lead to nominal currency appreciation (as this has only happened in the past when the unit is more acutely undervalued), it will provide an anchor preventing rapid depreciation. As for economic growth, the economy is expanding at its fastest rate in two years according to the latest data and we are forecasting that this momentum will be maintained in 2018, when we are forecasting real GDP growth of 6.2%, up from an estimated 6.0% in 2017. This will help to attract foreign direct investment inflows, cushioning the currency against a sell-off.
Risks To Outlook
The risks to our view on the currency are tilted to the downside. Although there has been a more muted response to the recent law change that paves the way for President Yoweri Museveni to extend his time in power when his current term expires in 2021, we believe that risks of instability remain. In the event of unrest, we would expect a heavy-handed response from the authorities, which would put donor funds at risk, increasing depreciatory pressures. We also highlight the possibility that Museveni pursues erratic policies such as interfering in the DRC in order to distract or placate the electorate from the age limit issue and this also poses risks to donor flows. Uganda is also prone to droughts and when these hit, they tend to lead to increases in inflation and higher demand for hard currency for food and energy imports, both of which increase depreciatory pressure.