The Bank of Uganda governor two weeks ago announced that the Central Bank Rate (CBR) had been raised by 4 percentage points to 20% for October from 16% in September.
The tightening of the monetary policy by the central bank is to curb runaway inflation due to high food prices and increasing cost of oil imports.
The monetary stance of by the central bank is aimed at setting a rate at which commercial banks can borrow from BOU. The CBR is determined by the inflation in the country. With Uganda's inflation at a high of 28.3%, then BOU had to increase the benchmark CBR to tighten the monetary policy.
"This should be seen as a clear signal to bring inflation under control," Bank of Uganda Governor, Emmanuel Tumusiime-Mutebile said.
The move by BOU has on the hand also prompted commercial banks to increase their lending rates on a monthly basis as they have to leverage on the cost implication. This move has affected borrowers who use commercial banks. With interest rates that were already considered to be high, with inflation reaching record levels since 1993 then it is getting ever harder to borrow.
"Should the upside risk to inflation continue in the months ahead, then monetary policy will be tightened further," Mutebile said.
The reason for increasing this rate is mainly meant to forestall eventual rise in inflation, raising the cost of borrowing and contracting money supply in the economy.
The aim of the central bank in this case is to curb down on the supply side of money so that it is matched with aggregate demand. This policy by the central is called inflation targeting.
Analysts have noted that this could stifle the supply side might also just slow down the demand meaning that the policy of BOU might just slow down macro-economic recovery. As lending rates are going up, then this means few customers are borrowing or have the ability to borrow.
If they needed to expand their businesses then it means they will have to wait until inflation begins to subside then they can borrow as lending rates are also likely to reduce. This means that economic growth projects will have to be adjusted downwards because credit is very hard to access.
On the other hand as commercial bank lending rates now ranging between 19% and 28% depending on the weighed risk by the bank, then this means every month a borrower pays more than the previous month.
If a borrower has been making monthly loan repayments, it means that they have to pay more. For the borrower it means paying more for everything as inflation is biting. This creates a ripple effect as the increased costs are then passed on to the consumer. Some banks have, however, extended loan tenures so that monthly payments are not affected. This means that the loan repayment can be extended.
Banks have also tightened their grip on who to lend money. There are sectors that have been blacklisted as high risk and lending to such a sector would lead to defaulting. Banks are doing this to avoid the rate on non-performing loans going up.
If inflation continues to rise, then bank lending rates will increase and credit will slowdown as banks will guard themselves against the risk of default.
It is the same trend in the region as the Kenya central bank last week announced it had raised CBR to 11% with inflation at 17.3% and a Shilling that has depreciated 20% to the Dollar.