Overview:
Dr Muhumuza said the impact could be particularly severe for businesses with existing debts and those that depend on bank financing to purchase equipment, expand operations or produce goods for export.
KAMPALA. Businesses planning to expand, households servicing loans and investors seeking financing could face tougher conditions following the Bank of Uganda’s decision to raise its benchmark interest rate to 12 percent, as the fight against inflation threatens to slow economic activity.
The 2.25 percentage-point increase in the Central Bank Rate (CBR), from 9.75 percent, is intended to contain inflationary pressures arising from exchange rate depreciation, rising global oil prices and disruptions linked to the conflict in the Middle East.
However, economist Fred Muhumuza warns that tighter monetary policy could make it more expensive for businesses to borrow, discourage investment in production and undermine efforts to create jobs, particularly if high financing costs persist.
Dr Muhumuza said the impact could be particularly severe for businesses with existing debts and those that depend on bank financing to purchase equipment, expand operations or produce goods for export.
Higher interest rates generally increase the cost of new loans and may push up repayments for borrowers whose loans carry variable rates linked to market conditions. Banks may also become more cautious about lending as financing costs and perceived risks rise.
For manufacturers, farmers and traders, this could mean postponing expansion plans, reducing working capital or passing some of the additional costs on to consumers.
Dr Muhumuza questioned whether raising interest rates alone would address the economic pressures facing Uganda, arguing that government borrowing and attractive returns on government securities could divert money away from private businesses.
He said investors could choose government securities offering high returns instead of putting their money into productive enterprises that generate goods, exports and foreign exchange.
“So CBR is really trying to give a panadol to a symptom, and yet the underlying cause is deeply seated down there,” he said.
Growth outlook weakens
The rate increase comes as BoU lowers its economic growth forecast for the 2026/27 financial year to between six percent and 6.5 percent, from an earlier projection of seven percent to 7.5 percent.
Governor Michael Atingi-Ego attributed the downgrade to tighter domestic and global financial conditions, exchange rate depreciation, geopolitical uncertainty and elevated global energy prices.
The combination of expensive credit and rising production costs could put pressure on businesses already struggling with higher fuel, transport and imported input costs.
If firms scale back investment or expansion, the effects could extend to employment, household incomes and demand for goods and services.
Small and medium-sized enterprises could be particularly vulnerable where they have limited access to affordable financing or rely on short-term loans to sustain daily operations.
Households could also feel the effects if lending rates rise, leaving borrowers with less disposable income after meeting loan repayments. Reduced spending could, in turn, affect businesses that depend on domestic consumers.
However, the actual impact will depend on how commercial banks adjust their lending rates, the terms of existing loans and how long tighter monetary conditions remain in place.
Inflation remains a concern
BoU maintains that the increase is necessary to prevent rising energy prices and exchange rate depreciation from feeding into broader inflation.
Headline inflation rose to 4.6 percent in September, from 4.1 percent in August, while core inflation increased to 3.7 percent from 3.5 percent.
The central bank projects inflation to average between 5.5 percent and six percent over the next 12 months, with headline inflation potentially reaching between seven percent and 7.5 percent.
Mr Atingi-Ego said the higher rate was intended to contain inflation, limit the second-round effects of higher energy prices and exchange rate depreciation, and keep inflation expectations anchored around the medium-term target.
Higher interest rates can help moderate demand by making borrowing more expensive and encouraging saving. They may also support the Shilling if returns on domestic financial assets attract investment, although exchange rate movements depend on several other factors.
The challenge is that monetary tightening cannot directly lower global oil prices or resolve supply disruptions. It can, however, seek to limit the extent to which those shocks spread through domestic prices.
Dr Muhumuza called for the government to review its spending and borrowing priorities, arguing that fiscal policy must complement monetary measures.
He said authorities should consider which expenditure commitments could be reduced or deferred without undermining essential services, while exploring longer-term financing for infrastructure projects.
The policy challenge, therefore, is to contain inflation and protect the Shilling without imposing excessive pressure on private investment, business expansion and employment.