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2012

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Working Paper 152 - Dynamics of Inflation in Uganda
10/09/2012 23:00
Working Paper 152 - Dynamics of Inflation in Uganda
In October 2011, East Africa witnessed a considerable surge in inflation reaching on average 20%. In Ethiopia inflation rate reached 34%, and Kenya experienced record inflation levels in excess of 18.5% in the same month. Tanzania was not an exception to the rule. It witnessed a sharp rise in inflation to a maximum of 17.9. Uganda recorded the second highest level of inflation in the region hitting 30.5% during the same period. This remarkable rise in price has been an issue of concern for policymakers and the general public. Such dramatic increases in inflation are bound to have significant welfare implications for the poor. Recent studies have identified several factors underpinning sudden rise in inflation in developing countries, namely, external factors, internal factors, and accommodative policy in the form of exaggerate rise in money supply. This paper attempts to determine the main drivers of inflation in Uganda using a single-equation Error Correction Model (ECM), proposed by Durevall et al. (2012), which includes, besides money aggregate, domestic and foreign variables by extending the model to include the role of agriculture in inflation dynamics. The paper acknowledges the structural differences of agrarian economies, in general, and Uganda, in particular; these economies are characterized by underemployment, large informal sector, and a low degree of unionization of the labor force. In this setting, the quantity theory of money provides a more appropriate framework for analysis rather than the Phillips curve approach that is more suited to developed economies. This framework accounts for the role of money as a major determinant of inflation, along with supply shocks. Data for the domestic prices, the real effective exchange rate, and monetary aggregate (M3) are obtained from the Bank of Uganda. The paper interpolates annual real GDP to obtain monthly series of output. In addition, we use cereal production as a proxy of agricultural production-data on cereal production was obtained from the FAO. The monthly components of cereal are imputed from annual data. In addition, we de-trend cereal production, using the Hodrik-Prescott filter, to compute their cyclical component. Similarly, we de-trend components of relative prices. Data cover the period starting from January 1999 to October 2011. This paper draws three major findings. First, over the long-run domestic and foreign variables are important determinants of inflation in Uganda. The monetary aggregate portrays an equilibrium relationship with Inflation and therefore expansionary policy that drives up money supply is inflationary over the long-run. There is evidence of considerable rise in real money growth, attaining a maximum of 36% in November of 2010, prior to recent rise in inflation. The results support previous findings by previous studies pointing to agricultural supply shocks as crucial for inflation in Uganda. Constraints on agricultural production together with high demand both domestically and from neighbouring countries push domestic food price and hence creates a rise in overall price levels, given the high percentage share of food price in Consumer Price Index (CPI).  The paper identifies external factors, mainly world food price and energy prices, as key factors in explaining equilibrium inflation in Uganda. Like most of countries in the region, Uganda is not an exception, in that movements in world food and energy prices are directly transmitted to countries via import prices or prices of internationally traded goods. Secondly, similar to the long-run, internal and external factors drive inflation in the short-run. The study identifies Ugandan food prices and monetary growth as key domestic drivers, while global food prices also affect inflation in short-term. Lastly, the paper finds evidence of inflation inertia due possibly to persistence in expectations of agent, since they are backward looking, and price and wage stickiness. The study proposes a close monitoring of dynamics in world food and energy prices in order to curtail their secondary effects. Policymakers should push for massive investment in the agricultural sector in order to mitigate the effects of adverse climatic conditions which most countries in the region have been subject to.Read more
Working Paper 146 - Bank Financing to Small and Medium Enterprises in East Africa: Findings of a Survey in Kenya, Tanzania, Uganda and Zambia
26/03/2012 13:56
Working Paper 146 - Bank Financing to Small and Medium Enterprises in East Africa: Findings of a Survey in Kenya, Tanzania, Uganda and Zambia
Various studies have shown the contributions of SMEs to exceed 60 percent of total formal employment in the manufacturing sector in both advanced and developing economies. In Africa, the contribution of the SME sector to job opportunities is even more important with SMEs accounting for about three-quarters of the total employment in manufacturing (including the informal sector). In spite of the importance of the topic, relatively little research exists on the role of bank finance in SMEs around the world. This is partly due to the absence of comprehensive data on SME finance. Nonetheless, existing studies show that, contrary to the conventional perception that financial institutions shun SMEs, banks consider the SME segment strategically important. This paper contributes to the growing literature on SME finance. Its purpose is to shed light on current trends and practices in bank financing of SMEs in four East African countries, i.e. Kenya, Tanzania, Uganda and Zambia. The comparison among these countries is interesting because they are neighbours, they are all growing, emerging economies and they have implemented a number of financial reforms in recent years, with their banking systems becoming increasingly integrated. In particular, this paper forms part of a broader African Development Bank regional project on this topic, whose objective is to identify best practices in SME lending as well as constraints that impede growth in the SME finance market so as to draw relevant policy implications. The study uses tabulated questionnaires followed by on-site interviews with banks’ senior management. The format and the questions of the questionnaire were drawn from previous surveys developed for analysis in different markets and slightly adapted to cover topics not included in the previous surveys but which may have an impact on SME bank financing in East Africa such as micro-prudential regulation. The questionnaire solicits response to 90 questions divided in three broad analytical areas, which are described in detail in this paper. The first area deals with banks’ involvement in SME lending. The second area focuses on the determinants of banks’ involvement with SMEs such as corporate strategy, market structure, government policy and regulation. The third area attempts to understand how banks engage in lending to SMEs, with a special emphasis on the nature of their business models and risk management systems.   The study found SME segment to be of strategic priority to banks in the region. SMEs are considered a profitable business prospect and provide an important opportunity for cross-selling. Banks consider that the SME lending market is large, not saturated and with a very positive outlook. A number of obstacles are, however, constraining further engagement with the SME segment, including SME-related factors such as the lack of adequate information and collateral as well as their largely family-owned structures. Macroeconomic factors, business regulation, the legal and contractual environment, the lack of a more proactive government attitude towards the segment, some areas of prudential regulation and some bank-specific factors are also perceived to negatively affect the SME lending market in the sample countries. Even so, the study shows, banks have adapted to the environment and developed mechanisms to cope with it through innovation and differentiation. Most banks have dedicated units serving SMEs, to which they offer largely standardized products though the degree of personalization is growing. And albeit advanced transaction technologies based on scoring and risk-rating systems remain relatively underdeveloped, banks are gradually automating their risk management frameworks to achieve efficiency gains. On the whole, the findings are broadly consistent with similar studies in other geographical contexts and those suggesting that the strategic interest of East African banks in the SME segment can make an important contribution to closing the “SME financing gap” in the region compared to other developing countries. The growing engagement of formal finance institutions and SMEs should be encouraged through reforms to soften the negative impact of obstacles hindering the involvement of banks SME financing.Read more
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