[allAfrica.com] Will Shilling Keep Falling? The Monitor (Kampala) ANALYSIS March 19, 2003 Posted to the web March 20, 2003 By Badru D. Mulumba Kampala The shilling fell to Shs 2015 to the dollar at the end of last week. It has since started to climb back after the Bank of Uganda sold dollars to buy shillings. Several reasons were given for the fall - a rising oil price, doubts over donor aid, importers stockpiling ahead of the war - Badru D. Mulumba investigates the likely causes and the future path of the currency: - The slippery behaviour of the shilling has exposed the slippery nature of the Ugandan economy. The rise or fall of a currency can be seen as an indicator of confidence in a country's economy. Uganda relies heavily on donor aid and imports all of its oil. In the past few weeks, uncertainties surrounding the disbursement of aid and the price of oil have shaken confidence in the direction of the economy - and hence the shilling has performed weakly. The question now, in the days or hours before the US heads into a Gulf War, how will the shilling fare? Initially, the shilling was pushed down by rumours that the World Bank was unlikely to release budget support money for 2002/3. The World Bank reportedly wanted government to produce a report on how it used the Poverty Support Reduction Credit (PRSC). It feared that when the government increased defence spending last October, anti-poverty efforts suffered. Donors had never approved the 23 percent budget cuts across all ministries, which the government said was necessary to fight the civil war against the Lord's Resistance Army in the north of the country. In February, the minister of Finance, Planning and Economic Development Gerald Ssendaula admitted to Parliament that the World Bank wanted assurance that Government would not make further cuts before it approved budget support for next financial year 2003/4. Bank of Uganda director for research Michael Ating-Ego admitted last week that one of the factors that led to the depreciation was the fear that donor aid would not flow in. Consequently, importers rushed to purchase dollars before the price skyrocketed, while those with dollars hoarded them waiting for the shilling to fall further and reap a higher profit. But on Thursday 13 March, the Treasury announced that the World Bank had released an equivalent of $166m in budget support for 2002/3 and was processing $166 million for 2003/4. But foreign exchange dealers - doubting the ability of the central bank to support the currency - shrugged off good economic data indicating high exports and private remittances from abroad and continued to sell the shilling at a lower price. Exports and money sent home from abroad bring in dollars, which should in theory boost the value of the shilling. Bank of Uganda analysts say the Shs 2000 shilling/dollar rate say the shilling is undervalued, especially since exports are performing well. "The economic fundamentals are all right," Deputy Governor David Opio-Okello told a press conference on Thursday. The BoU projects that exports will earn Uganda more than $550m, up from $475m last year. Private remittances from abroad are projected to be $640m, up from $540m last year. He also said aid disbursement from donors was on target to reach $450m. He revealed that BoU sold $28m in the foreign exchange market in the past two weeks and has $917.5m in reserves that it can call upon to keep the shilling stable if need be. In currency markets confidence is everything and the market failed to react to the BoU intervention. And by the morning of Friday 14 March, the shilling fell further to 2015 per dollar buying. The chairman of the Uganda Forex Dealers Association Stephen Mwanje said Friday afternoon: "Don't forget it was only yesterday. Until that time they [dealers] were not too sure that BoU had the money. I think now, they [BoU] are aggressive because they have the money. They [BoU] came to the market later in the morning. They sold up to three times the usual amount." Foreign exchange dealers say the central bank sold about $25m on that day alone. This is significant, compared to $37.6m and $26.25m sold in January and February respectively, and indicates how seriously the Bank of Uganda takes the shilling weakness. But even after the intervention, by late trading on Friday the shilling had only slightly strengthened by about Shs 50, climbing to Shs1965 per dollar on the buying side. Other factors, which could have influenced the shilling weakness, have been the reports of business undertaking contingency stocking before war begins. Increased demand for the dollar could also result from investors taking their money out to other countries. So far, there has been little evidence of this. Even if short-term fears have been dispelled, the longer-term fears are that the looming war in Iraq would increase the oil bill, eat into more foreign exchange and put further pressure on the shilling. "Demand still seems quite high," said Mr Mwanje. "The shilling seems headed up. It does not depend on exports or remittances, but on inflow of aid. Once, donors are jittery, or once there is anything that affects the aid, a depreciation will always be expected." In 2000, there was a huge depreciation, then appreciation, of the shilling, largely because of world oil price movements. Crude oil that rose to a high of $34 by November 2000 and then fell dramatically to $25 a barrel by mid December 2000. The shilling rose strongly when the price fell, with one dollar buying Shs 1,735, compared with Shs 1,850 three weeks earlier. Oil is able to influence the value of the shilling because it takes up a big chunk of the import bill that was in 2000 estimated at over $300m. Even when coffee prices have fallen globally - hurting export revenues - it has not had a large effect on the shilling because crude oil prices stayed stable.   =============================================================================   Copyright © 2003 The Monitor. All rights reserved. Distributed by AllAfrica Global Media (allAfrica.com). =============================================================================