The Central The Bank's decision is aimed at managing inflation and stabilising the economy. And there is good reason to take that objective seriously. Rising prices erode purchasing power, especially for households whose incomes cannot keep pace with the cost of living. Allowing inflationary pressures to persist would not necessarily offer struggling households any relief.
What if people cannot afford not to borrow?
Ugandans are contending with rising fuel prices, a shilling under pressure and the possibility of more expensive credit. On October 14, the Bank of Uganda raised its Central Bank Rate from 9.75 per cent to 12 per cent, tightening monetary policy as inflation risks mounted.
The logic is straightforward enough: make borrowing more expensive, moderate demand and help contain inflation. Uganda has seen monetary tightening play a role in managing inflationary pressures before, so the latest increase is not without an economic rationale. But there is a question that deserves a closer look: what happens when people are not borrowing because they want to spend more, but because the money they earn is simply not enough?
When money becomes more expensive, can people who are already short of it afford to use less?
The Bank's decision is aimed at managing inflation and stabilising the economy. And there is good reason to take that objective seriously. Rising prices erode purchasing power, especially for households whose incomes cannot keep pace with the cost of living. Allowing inflationary pressures to persist would not necessarily offer struggling households any relief.
Yet the familiar explanation that higher interest rates encourage people to borrow and spend less can overlook an important distinction: not everyone borrows for the same reason, and not everyone has the same freedom to stop.
FinScope Uganda's 2023 survey found that seven in every 10 adults were operating a personal budget deficit, meaning they needed more money than they earned to meet their budgets. Among people who had borrowed and were still repaying, 44 per cent said their main reason for borrowing was to meet regular expenses. Business purposes accounted for 22 per cent, while 12 per cent borrowed to cope with unexpected expenses.
These figures do not tell us how borrowers are responding to the latest rate increase. They do, however, offer a useful starting point for understanding the different financial circumstances in which monetary policy operates.
Consider two borrowers. One takes out a loan to purchase additional stock for a business, hoping that the investment will generate enough income to cover the repayments. If credit becomes more expensive, the business owner might postpone the purchase.
The other borrows to cover essential expenses because their income does not stretch to the end of the month. For this borrower, postponing the need for money may not be a realistic option.
Both are borrowers, but their choices are not the same.
This distinction does not invalidate monetary tightening. Higher interest rates can influence borrowing, spending and investment, while also helping to contain inflationary expectations and ease pressure on the exchange rate as they have previously done.
The effects, however, are neither immediate nor identical for everyone. The extent to which a CBR increase affects an individual's repayments depends on the type of loan, its terms and how lenders adjust their rates.
The challenge is that some of the pressures facing Uganda originate beyond the reach of domestic interest rates. A rate increase cannot make international oil cheaper or directly increase the supply of food. It can, however, help contain the wider inflationary effects of an initial price shock.
The Bank is therefore working to manage the consequences of pressures it cannot always eliminate at their source.
That leaves households facing two related risks. If inflation persists, their money buys less. If credit becomes more expensive, those who depend on borrowing may find it harder to bridge the gap between what they earn and what they need to spend. For some, these pressures may arrive together.
The question, then, is not whether the Bank should control inflation, or whether higher interest rates can work. It is whether the different circumstances of borrowers receive enough attention when we discuss how monetary policy affects the economy.
A business owner may be able to delay an investment. A household borrowing to meet regular expenses may have no comparable adjustment to make. That does not mean the Bank can simply disregard inflation or avoid difficult policy decisions. It means that the consequences of those decisions will not be evenly distributed.
FinScope's findings cannot predict how the latest increase will affect individual households. But they remind us that borrowing is not always a sign of a desire to consume more. Sometimes, it is a response to the gap between income and essential expenses.
When higher interest rates are intended to encourage people to borrow less, an important question remains: what happens to those whose borrowing is not a choice they can easily give up?