What new monetary policy statement means for the taxpayer and URA
Democratic Republic of Congo, Ghana, Kenya, Rwanda, South Africa and Uganda are different in many aspects especially in value of their economies. However, a common thread among these countries is their inflation targeting monetary policy. An inflation targeting tool is a monetary policy used to achieve one of the key mandates of central banks, which is price stability in the economy through use of interest rates to control the amount of money in the economy.
There are several arguments for and against such a type of monetary policy tool which we will not cover in this article but what is clear is that countries now seem keen on using interest rates to mitigate inflation. True to this trend, in January 2024, Tanzania was the “new kid on the block” adopting this monetary policy tool. Among the East African Community States, Burundi and South Sudan do not seem to be smelling the coffee yet regarding this tool, we wait to see if they too will adopt it.
Following last month’s Bank of Uganda (“BoU”) Monetary Policy Statement, the Central Bank Rate (“CBR”) which is really BoU’s interest rate was increased to 10.25% from 10%. The increase was aimed at tapering inflation which decreased to 3.3% in March 2024 from a rate of 3.4% in February 2024. Additionally, the CBR increase was also meant to further stabilise the Uganda Shilling that has steadily lost value since November 2023 and further plummeted in February 2024.
The CBR increase means the BoU has engaged breaks which simply slows down economic activity. Though the breaks have been engaged momentarily as BoU closely monitors the economic outlook, tax revenue collection will likely be affected. This is because a CBR increase temporarily affects consumption, investment, savings and production by reducing their demand which impacts revenue mobilisation. I discuss below each impact on tax collection:
Consumption
If you took out a loan from your bank be it a mortgage, salary loan, trading loan etc, chances are you are paying back the interest on your loan at a variable rate as opposed to a fixed rate especially for commercial bank lending. When the BoU increases the CBR, your banker will follow suit by increasing your loan interest rate going forward. For example, if you were paying interest of UGX 1,000,000 monthly, you could easily end up paying UGX 1,100,000. Hypothetically, your monthly spend falls short by the UGX 100,000 (1,100,000 – 1,000,000) used to pay interest.
This means you may have to reduce your consumption for example on the soap and bread you buy or even the nights out with friends which reduces the potential tax like VAT and corporate income tax that would be collected by the taxman from such spending. With limited money to spend, the overall price of goods and services can’t be increased thus reducing inflation and thereby achieving BoU’s price stability mandate.
Investment
BoU is a bank for commercial banks. If BoU raises the CBR, it makes the cost of borrowing money from the central bank by commercial banks expensive. Since banks are not operating charitable businesses, this high cost of money is passed on to you and I (the bank’s customer). As a result, if you are constructing a mall somewhere in Kyanja and want it completed using a loan facility, it means the interest on that loan facility would be at a slightly higher cost. In such a situation, the prudent action is to suspend investment. This means, delayed occupancy of tenants, reduced number of workers on the construction site etc. This reduces the potential tax collection for example rental tax, value added tax and excise duty collectible on a bag of cement etc.
Savings
When your bank wants to encourage you to save with them, they will possibly give you a competitive rate of interest on your savings. Similarly, this is what BoU does with commercial banks. By increasing the CBR, the commercial banks are given a competitive rate on their cash at hand with the central bank (technically known as reserves). The banks are therefore motivated to keep their reserves with BoU to earn a better return and not bring their money onto the market for public lending.
Although the reserves earn interest which interest would be subject to tax, this tax base is much lower compared to when such money is brought into the market to facilitate production which likely results in broad-based tax collection opportunities. Also, the lending within commercial banks is reduced because the cost of borrowing from another commercial bank is high with an increased CBR. As you may appreciate, this further results in a limited supply of money (which stifles inflation, a good macro-economic achievement) but reduces economic activity and consequently tax collection.
Production
Economists tell us that mild inflation is good for the economy since it stimulates production. It’s only when it exceeds set expectations that it calls for central bank intervention. That is exactly what BoU did, reduce the money supply by increasing the CBR. This means you and I will likely have limited savings because we can’t save what we do not have. This reduces capital accumulation either at the bank level or even with your savings cooperative scheme. Since capital is once of the factors of production, limited capital would ultimately reduce consumption, investments, and savings all of which reduce income and asset growth. This results in limited taxation opportunities which hampers tax collection.
Under the circumstances, as a taxpayer, you may want to consider cutting back on your debt and consider internal growth and reserve accumulation as you wait for BoU to exercise a more accommodative approach that reduces the CBR. For the taxman, this temporary setback is unfavourable to your tax collection mandate. However, given the near-term economic growth for FY 2023/2024 remains as previously projected by BoU at 6%, the panic button shouldn’t be hit yet.
By Trevor Bwanika Lukanga - Senior Manager, Tax at PwC Uganda
