Effect of interest rate and inflation on foreign exchange rates in Uganda

Abstract

Exchange rates, inflation rates and rates of interest are indispensable variables of macroeconomic, which can change the growth pattern and direction of economic stability and development in a country. Over the years, the Ugandan Shilling has recorded significant volatility against the major currencies especially the Sterling Pound and the US Dollars. For instance, in July 2015, the Ugandan shilling depreciated at rate of 11.16% and 14.45% to the GBP and USD respectively. This study examined the effect of inflation and interest rates on foreign exchange rates in Uganda. A descriptive research design was employed to answer the research question. To attain the aim of the research, secondary data was entirely used. The research applied quarterly data for a period of 10 years from 2009 to 2018. The study also carried out tests on normality autocorrelation and multicollinearity. Analysis of data was done by the use of descriptive statistics, the multiple regression analysis and the pearson correlation. The results found that the consumer price index significantly and positively affects foreign exchange rates while foreign direct investment significantly and negatively affects foreign exchange rates. Conversely, the study found that Interest Rates (IR) and the Gross Domestic Product (GDP) had an insignificant and negative relationship with foreign exchange rates while money supply (M3) has an insignificant positive effect on foreign exchange rates. The study findings concluded that inflation has a direct effect on exchange rates and that forex rates in Uganda are inversely affected by foreign direct investments inflows. The government of Uganda through the Central Bank should ensure the CBR (Central Bank Rate) is set at reduced level but favorable to the economy which will in turn make the commercial banks to reduce the interest rates to ensure that the charged rated don’t cause adverse effects on other macroeconomic factors which might in turn affect exchange rates