My Shilling For Your Pound

I was chatting on Skype today with my friend Walter, a fellow University of Chicago alumnus living in East Africa. Walter lives in Kenya and I live in Uganda – our countries are home to two of the worst-performing currencies against the dollar in the world.

Uganda’s total exports in 2009 (the last year with robust data) were 3.151B USD. This breaks down to about 260MM USD per month. This means Uganda would need a billion dollars (about four months, the common rule of thumb) of export reserves to internally stabilise the shilling. However, though the Bank of Uganda is secretive, it is clear to everyone in the region that the government does not have a billion-dollar piggybank waiting for this particular rainy day. Given that budget shortfalls have begun to affect even basic services and other recent observations, I estimate the amount of hard currency available to Uganda’s central bank may be as little as 100MM to 200MM USD – not even one month’s exports.

So what happens next? Well, Uganda is already in “austerity” mode, it just isn’t called austerity here because Uganda is already one of the poorest countries. Soldiers haven’t been paid in months, the few public services are growing even more limited in their scope and pitiful in their quality, and the shilling will continue to inflate. Already, people are wondering when the government will begin printing the 100,000 shilling note (the 50,000 shilling note is currently the largest denomination).

Uganda and Kenya face similar challenges. Neither has factories it can simply spool up. The workforce isn’t well enough educated to produce gains from efficiency. Agricultural output is low per acre, but this is because capital-intensive agricultural practices are not feasible; farm output is unlikely to improve substantially. Uganda and Kenya could try to import fewer dollar-denominated goods, but this is difficult – Uganda has substantial amounts of oil, but has failed to gain access to the capital and technology needed to exploit these resources. Kenya’s major trading partners interact with it through the port of Mombasa, where most bills of lading are executed in U.S. dollars.

What should Uganda do? First, if there is anyone who will lend, it should start borrowing in dollars. Second, it should attempt to make more of its incoming foreign aid (a substantial percentage of GDP) dollar-denominated cash aid. Finally, it should try to import goods like sugar, wheat flour, and other staples from Kenya to take advantage of the relative parity between the two currencies’ inflation trajectories.

Will this solve the problem?

Probably not; it’s a case of too little, too late. But there are other options.

Debt forgiveness, which this author is not particularly fond of as a solution and certainly would not advocate, would allow Uganda to crash its current currency (and debts with it), emerging with perhaps a new currency or at least a new central bank structure with better reserve limit rules. But debt forgiveness carries with it the same moral hazards as the American bank bailouts – Uganda’s government will not be taught to maintain its debts responsibly and will likely engage in the same extravagance it has grown accustomed to, buying fighter jets while its citizens live in poverty.

Another option, slightly more appetising, would be something akin to the American construct of municipal bankruptcy. In a municipal bankruptcy, American cities (or, in some cases, counties) are allowed to enter insolvency protection while a “workout” plan is approved by a judge. Often, creditor arrangements can be renegotiated without the need for actually completing the insolvency proceedings. While there remains a hazard that cities or counties will not “learn their lesson” (as has been the case in Orange County, California, for instance), this allows creditor claims to be temporarily frozen without capital reserves needing to be invaded (important in the case of Uganda, with its scarce hard currency reserves). Some of the debt renegotiation with creditors could be restructured as aid or low-interest loans, allowing creditors to feel they have not simply “forgiven” debts or created a future moral hazard.

In any event, the next 24 months in Uganda are likely to be ugly from a macroeconomic standpoint. The current central banking structure is inflexible, poorly-managed, and susceptible to large currency shocks. The only saving grace is that the Ugandan shilling is so remote that there is no international appetite for trade in the currency; if there were interest in trading the shilling, it would have been sunk by opportunistic traders in London or New York long ago.