What the new Fuel Tax could mean for Uganda's Economy

Here are the plausible implications of the Ugandan Finance Minister’s increment in fuel tax ( 80/= on Diesel and 150/= on petrol) and how this could impact the economy in general and prices in particular.

1. Higher Consumer Prices: From a micro-economic perspective, when fuel prices rise, commodities and other goods in Uganda become more expensive. The increase in costs to produce (energy component), and transport the goods must be factored into a higher price for the consumer products.

2. Impact on Uganda's Exports: This will, in the medium term, have a negative impact on exports (declining volumes) since our products become more expensive and therefore less competitive, and this situation could be further compounded by the strength of the Uganda shilling which will continue to erode export earnings. (The outlooks on the Uganda shilling remain dismal in view of the upcoming CHOGM conference; a large inflow of US dollars is expected to continue to flow into Uganda, plus growing exports to our neighbors, and this will continue to further strengthen the shilling)

3. Impact on Uganda's Imports: One other thing to note is that fuel price increases may generally make Uganda’s imports look like “cheaper” alternatives since our locally produced goods are priced higher. However, from a micro-economic perspective, the volume of Uganda’s imports of consumer goods may decrease accross the board, even though they look relatively cheaper. The reason for this is that demand for petrol and diesel is inelastic in the short term. Commuters will still have to commute; truckers will still have to haul goods. Inelastic demand for means Ugandans will have to continue to buy and pay more for the fuel (because they have no immediate alternative) but will change their spending behavior elsewhere because of their inelastic or fixed amount of income. Less money is available to buy even the cheap imports currently flooding our market. However, high fuel prices could discourage the importation of consumer goods (increase transportation costs anyway), and encourage the importation of capital goods (machinery, plant, etc which allow for economies of scale and prospects for a better long term investment return).

4. Could this situation induce a shift in the structure of our imports in general? Yes and No?

Fuel oil is Uganda's single biggest import (the same for many other non-oil producing countries too). Uganda’s demand for fuel oil is expected to increase significantly in the medium term, so as to accommodate gross shortages in power generation capacity, to accommodate a generally expanding economy and a growing transportation sector (Uganda currently consumes approximately 10,000 barrels of oil every day). Assuming that International crude oil prices remain stable in the medium term (we see an upward trend at the moment, above US$ 70 a barrel), then the benefits of a strong shilling are clear in oil-importation terms; however, if international crude prices continue an upward trend, then increased (global) demand for the US dollar (by non-oil producing countries like Uganda) may happen, generally initiating a recovery of the US dollar, and this still ultimately wipes out our Uganda’s gains in favourable oil-import terms. If it was cheaper for us to import the same number of barrels of oil (strong local currency), it becomes less cheaper for us when the dollar starts to strengthen against our currency. (Note: by some estimates, over 70% of the worlds currency reserves are held in US dollars; indeed the pressures on the dollar are global).

5. Why the Fuel tax? It is important to note that the largest component of the price for fuel oil is really taxes. The Minister of Finance has traditionally found it easier to collect revenue using tax levied on fuel. What remains is to apply the effects of demand and supply on the final price. Ultimately, this is what determines the pump price.