Bank of Uganda earns most of its income from investing the bulk of Uganda’s foreign exchange reserves in bonds, a practice referred to as investment in fixed income assets.
While profits and losses aren’t typically thought of as a consideration for central banks, the financial deficit that BoU incurred in the bond market has resulted in paper losses on various holdings.
Central banks, experts say, use sale of bonds as a tool to increase bank reserves and lower interest rates. When they buy bonds, money flows from them to individual banks in the economy. Conversely, they reduce supply on money through selling bonds.
According to BoU’s annual report for 2022 which was released earlier this month—whereas some returns had been made on investments in the financial year that ended in June 2021; there was negative return on investments made in the financial year that ended on June 30 this year.
The negative returns come at a time when BoU’s expenditure, sometimes referred to as an operating deficit shot through the roof, eclipsing income by Shs233 billion in the period ended June 30, 2022.
“Return on foreign assets experienced a slump, from 0.62 percent as at end June 2021, to -0.89 percent at close of June 2022,” the report reads in part.
Covid impact
The report blamed the situation on volatility in the markets caused by a variety of factors, including the Russia-Ukraine war, continued lockdown restrictions in parts of China and the emergence of other Covid19 variants.
The toxic cocktail, the report says, precipitated major shifts in the monetary policies of major central banks to emphasise tightening instead of easing monetary policies. It also prompted central banks to bring in aggressive interest rates aimed at containing inflation.
“Policy rates were raised across the globe, causing sovereign bond yield curves to flatten with shorter dated yields rising higher than longer dated yields,” the report further noted.
According to sources within the institution, BoU had invested in bonds with longer maturity dates. This left it disadvantaged by a policy that suddenly favoured those that had invested in bonds with shorter maturity periods.
According to the Daily Monitor, earlier in the week, Mr Adam Mugume—the director for research at the Bank—in an email to them, indicated that the new interest rates and the major policy changes culminated into a slump in the price of the bonds. This, he added, explains the losses.
“If the BoU were to sell the bonds before maturity, it would make a big loss. In other words, revaluing the bonds now at high interest rates and low prices imply low value of the reserves invested in fixed income assets” Mr Mugume explained.
The report also partially blamed the failure to cash in on the increase in interest rates on the foreign markets in government’s spending patterns.
“Furthermore, the Bank’s ability to take advantage of rising interest rates was curtailed by increased government foreign expenditure and intervention in the domestic markets to stem foreign exchange volatility. On the side of expenses, high domestic demand for currency contributed to an increase in currency costs.”
Shrink in reserves
According to sources at BoU, the situation was not helped by the fact that Uganda’s foreign exchange reserves had shrunk quite significantly during the period of volatility.
The annual report indicates that foreign exchange reserves reduced from the level of $4.2b or Shs16 trillion (equivalent to 5.48 months of import cover) at the close of June 2021 to $4.1b or Shs15.6 trillion (equivalent to 4.17months of import cover) as at the close of June this year.
That reduction in the amounts of the country’s foreign exchange reserves is deemed to have been a major factor in the losses posted.
“In FY 2021/22, BoU had foreign currency reserves of about $4.6 billion. The global interest rates in the year were around zero, meaning minimal income earned on reserves. Global interest rates started rising this financial year when reserves had declined,” Mr Mugume explained to the Daily Monitor.
Breach of EAC policy
The reduction in the foreign exchange reserves breaches the forex reserve policy that requires member states of the East African Community to maintain reserves equivalent to 4.5 months of import cover.
Uganda is performing worse than neighbours Kenya, Tanzania in terms of amounts of dollars, but not necessarily in terms of import cover. Kenya recently reported that its reserves had fallen to $7.321 billion (equivalent to 4.13 months of import cover); Tanzania’s amounted to $5.1b (equivalent to four months of import cover) as at the end of June 2022.
Rise in cost of operations
The cost of operating the bank, which has over the years been on the rise, reached unprecedented figures. Whereas it was not possible to immediately establish what the bank earned in the year ending June 30, 2022, the report indicates that the bank’s expenditure overshot income by a staggering Shs233 billion—implying a Shs191 billion rise compared to how much it spent in the year ended June 30, 2021.
The report indicates that the bank’s expenditure in the period that ended June 30, 2021 overshot income by Shs42 billion.
Mr Mugume explained that the bank usually spends on, among other things, meeting the cost of printing and issuing secure currency, supervising financial institutions and conducting monetary policy.
The bank attributed the increment in the operation deficit to the hostile global and domestic economic environment including inflation.
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