Foreign exchange reserve coverage in East Africa will decline – IMF

The International Monetary Fund has expressed concern over the likely decline in foreign reserve coverage in the East African Community region this year due to the current global economic difficulties resulting from the war in Ukraine and rising interest rates in the United States.

The IMF says monetary tightening in the United States and rising risk premiums associated with the war in Ukraine have depressed exchange rates across the sub-Saharan African region.

During the Regional Economic Outlook for Sub-Saharan Africa at the Sheraton Kampala Hotel on Wednesday, IMF Resident Representative in Uganda, Ms. Izabela Karpowicz said the exchange rate in the East African region was reacting pressure from the strengthening US dollar.

“The exchange rate in the East African Community has been subdued and currencies in the region have seen depreciation against the US dollar,” she said.

Ms. Karpowicz said that, based on the IMF’s World Economic Outlook and IMF staff estimates, Uganda’s foreign exchange reserve is expected to rise by 4.0 months of future imports of goods and services in 2021 to 3.8 months of import coverage, Kenya from 4.4 months of import coverage in 2021 to 3.9 months, Tanzania from 4.9 months in 2021 to 4.6 months in 2022, Rwanda from 5 .1 month of imports in 2021 to 4.7 months of import coverage in 2022, Burundi 2.1 months of import coverage in 2021 to 1.6 months of import coverage in 2022 .

Specific to Uganda’s current situation with high prices, Ms Karpowicz said that since it is a supply shock there is generally little that monetary authorities can do.

“However, the authorities must be prepared to adapt quickly if inflation expectations are likely to rise materially in order to avoid second-round effects on wages and further price increases which, if not unchecked, would raise the potential for persistent above-target inflation. Exchange rate flexibility also remains essential to cushion external shocks and preserve buffers,” she said.

On the Ugandan fiscal policy side, Ms Karpowicz said that regardless of the state of social safety nets (SSNs), it is best to allow full price pass-through while protecting the most vulnerable.

“Price signals are crucial in inducing demand responses. Measures to prevent domestic prices from adjusting are costly, crowd out productive spending, and reduce incentives to produce. Specifically, fuel subsidies and tax cuts are costly, inequitable and inefficient,” she said.

In the Regional Economic Outlook, the IMF said in the report that for pegged currencies, authorities should strike the right balance between monetary and fiscal policy to maintain the credibility of the peg.

For countries with more flexible arrangements, depreciation can help cushion the effects of global tightening. But even for the latter countries, difficult decisions can be made.

The IMF adds that for many, there are clear limits to the short-term benefits of exchange rate depreciation, given the large currency mismatches and the impact on inflation.

“Targeted use of foreign exchange intervention can help combat excessive movements in exchange rates, but the scope of intervention is often limited by low levels of international reserves,” the IMF advised.