How the weakening shilling is affecting debt servicing

Dar es Salaam. Tanzania is facing a mounting challenge in debt servicing as the US dollar appreciates against the shilling.

Tanzania is experiencing a shortage of dollars, pushing up the exchange rate between the greenback and the local currency.

The shilling is now at an all-time low of about Sh2,500 to the dollar as quoted by commercial banks compared to around Sh2,300 in March.

That represents a rise of about Sh200 per dollar in government debt servicing. This means that the cost of repaying the external debt, which is largely denominated in dollar, will surge by over Sh200 for each dollar, putting pressure on the government's finances.

For instance, as of the end of June 2023, the national debt stood at about $42.44 billion, with 70.7 percent, or $30.01 billion, being the external debt.

The Bank of Tanzania's monthly economic review for July highlighted that the currency composition of the external debt was predominantly denominated in the US dollar, which accounted for 66.9 percent ($18.27 billion).

Considering the exchange rate of Sh2,334.3 in June, the dollar-denominated debt was valued at Sh42.67 trillion.

However, with the dollar value increasing to average of Sh2,439.67 yesterday, according to the central bank indicative exchange rates, the same debt is now valued at Sh44.5 trillion, resulting in an addition of Sh1.83 trillion if the debt was repaid yesterday.

“Almost half of the external debt stock is owed to multilateral institutions, followed by commercial creditors,” the central bank stated in part.

The most significant portion of the debt stock was for transportation and telecommunications economic activities, followed by social welfare and education, and energy and mining.

Speaking to The Citizen, financial experts stressed the importance of proactive measures to safeguard the economy against currency fluctuations.

The head of research at the Tanzania Institute of Accountancy (TIA), Dr Gorah Abdallah, said strengthening domestic industries, encouraging foreign investment and boosting exports could help to stabilise the exchange rate in the long run.

He said due to limited production capacity, the country has been incurring significant costs by importing goods, leading to higher demand for foreign currency than what is available in circulation.
"It's obvious that when you have higher demand than supply for these funds, you'll inevitably feel the pinch of a shortage. The sustainable solution is to boost domestic production to reduce imports," said Dr Abdallah.

"Our country is still not self-reliant, but we possess resources such as agricultural products. By enhancing productivity in sectors like agriculture, we can sell more and generate foreign currency,” he added.

Efforts to get the Finance ministry’s response were unsuccessful yesterday.

Central bank data shows that whilst exports of goods and services amounted to $12.76 billion in the year ending June 2023, imports were at $17 billion.

“The cumulative effects of the shocks, particularly the war in Ukraine and monetary policy tightening in advanced economies continued to depress the external sector of the economy,” the BoT said in part.

Following its July 25-26, 2023 meeting the US Federal Reserve raised interest rates to a 22-year high in an effort to significantly reduce liquidity to the financial markets and tamp down high inflation.

This decision resulted in far-reaching consequences for economies worldwide including Tanzania.

The situation is further exacerbated by global economic headwinds such as the war in Ukraine that disrupted supply chains.

An assistant lecturer at the University of Dar es Salaam’s Business School, Mr Godsaviour Christopher, said this can also be an opportunity for Tanzania to earn foreign exchange through investments.

He said as the interest rate is increased, it pushes up the cost of capital, which will, in turn, discourages investment in the US to some extent.

“As the Federal Reserve increases the interest rate, this means that investment will become more expensive in the US economy compared to the rest of the world. This will lead to capital flight out of the US, thus increasing foreign direct investment in the rest of the world,” he said.

However, he said Tanzania might also benefit from this if the interest rate level is lower than that of the US.

“Furthermore, as the Bank of Tanzania is also moving to target interest rates instead of the amount of money supply with its monetary policies, this is among the lessons we can learn from the Federal Reserve,” said Mr Christopher.