Although profit and loss is not generally considered a consideration for central banks, the financial shortfall that the Bank of Uganda (BoU) has suffered in the bond market has resulted in paper losses on various holdings.
The BoU derives most of its income from investing most of Uganda’s foreign exchange reserves in said bonds, a practice known as investing in fixed income assets.
According to experts, central banks are using the sale of bonds as a tool to increase bank reserves and drive down interest rates. When they buy bonds, the money moves from them to individual banks in the economy. Conversely, they reduce the money supply by selling bonds.
The Sunday Monitor could not immediately establish the extent of the damage in currency or Ugandan shillings, but according to the BoU’s annual report for 2022 – which was published earlier this month – while some returns had been made on investments during the financial year that ended in June 2021; there was a negative return on the investments made during the financial year which ended on June 30 of this year.
The negative returns come at a time when the BoU’s expenses, sometimes referred to as an operating deficit, have soared, eclipsing revenues by 233 billion shillings in the period ending June 30, 2022.
“The return on foreign assets fell from 0.62% at the end of June 2021 to -0.89% at the end of June 2022,” the report states in part.
The report blamed the situation on market volatility caused by various factors, including the Russian-Ukrainian war, continued lockdown restrictions in parts of China and the emergence of other variants of Covid19.
The toxic cocktail, according to the report, precipitated major shifts in monetary policies by major central banks to emphasize tightening rather than easing monetary policies. It also prompted central banks to apply aggressive interest rates to contain inflation.
“Policy rates were raised across the globe, which flattened sovereign bond yield curves, with shorter-term yields rising more than longer-term yields,” the report further noted.
According to sources within the institution, the BoU had invested in bonds with longer maturities. This left him disadvantaged by a policy that suddenly favored those who had invested in bonds with shorter maturities.
In an email sent to The Sunday Monitor earlier in the week, Mr Adam Mugume, Director of Research at the Bank, said new interest rates and major policy changes had resulted in the price falling obligations. This, he added, explains the losses.
“If the BoU sold the bonds before maturity, it would be a big loss. In other words, the revaluation of the bonds now at high interest rates and low prices implies a low value of the reserves invested in fixed-income assets,” Mugume explained.
The report also partially blamed the failure to cash in on rising interest rates in foreign markets in government spending patterns.
“Furthermore, the Bank’s ability to take advantage of rising interest rates has been reduced by increased government spending abroad and intervention in domestic markets to stem exchange rate volatility. . On the expenditure side, strong domestic demand for foreign currency contributed to an increase in foreign exchange costs.
According to sources at the BoU, the situation was not helped by the fact that Uganda’s foreign exchange reserves had dwindled considerably during the period of volatility.
The annual report states that foreign exchange reserves fell from the level of $4.2 billion or Shs 16 trillion (equivalent to 5.48 months of import cover) at the end of June 2021 to $4.1 billion. or Shs 15.6 trillion (equivalent to 4.17 months of import cover) at the end of June this year.
This reduction in the amounts of the country’s foreign exchange reserves is considered a major factor in the losses recorded.
“During the 2021/22 financial year, the BoU had foreign exchange reserves of approximately $4.6 billion. Global interest rates for the year were around zero, meaning minimal income earned on reserves. Global interest rates started to rise in this fiscal year when reserves declined,” Mugume explained.
The reduction in foreign exchange reserves violates the Foreign Reserve Policy which requires member states of the East African Community to maintain reserves equivalent to 4.5 months of import cover.
Uganda underperforms its neighbors Kenya and Tanzania in terms of dollar amounts, but not necessarily in terms of import coverage. Kenya recently reported that its reserves had fallen to $7.321 billion (equivalent to 4.13 months of import cover); Tanzania’s was $5.1 billion (equivalent to four months of import cover) at the end of June 2022.
Increase in the cost of operations
The cost of operating the bank, which has increased over the years, has reached unprecedented figures. While it was not possible to immediately establish what the bank earned in the year ending June 30, 2022, the report said the bank’s expenses exceeded revenues by an amount a staggering 233 billion shillings, implying an increase of 191 billion shillings over what it spent in the year. ended June 30, 2021.
The report said the bank’s expenses in the period ending June 30, 2021 exceeded revenues by 42 billion shillings.
Mr. Mugume explained that the bank generally spends, among other things, to cover the cost of printing and issuing secure money, to supervise financial institutions and to conduct monetary policy.
The bank attributed the increase in the operating deficit to the hostile global and domestic economic environment, including inflation.