News Column

Now That UNRA Lost Sh36 Billion, Where Are Those Derivatives?

August 19, 2014

Jeff Mbanga

Today's column might sound a little dull, like those mathematics sessions in high school that used to take place after lunch.

It should not feel that way, especially if you want to understand a bit of the latest drama surrounding the Shs 36bn loss at the Uganda National Roads Authority. Around 2010 or thereabout, Bank of Uganda (BoU) invited some of us to Serena hotel, where we were treated to cups of coffee and tasty bites.

The occasion was all about BoU's five-year market development plan. Top officials from the bank took us through key strategies on how they intended to develop Uganda's financial market. Uganda's financial industry, compared to, say, Kenya's, remains remote and shallow; it is no wonder major banks operating in Kampala make key decisions from their swanky offices in Nairobi and Johannesburg. A bank like Equity has assets that total almost half Uganda's entire banking sector! There will be more on that in a future column.

There were some interesting things the central bank wanted to do. One of them was to promote the derivatives market. What the hell are derivatives, you might ask. See, in a world where the prices of goods and services keep changing by the minute, it is usually better to guard, or hedge, as bankers like to say, against this risk.

For example, an announcement that the housing market in the United States is about to collapse could send wayward fluctuations in the forex market, with its impact being felt as far as downtown Kampala. To avoid all this, traders go to some banks and buy risk-mitigating tools called derivatives, which help them to trade at a fixed price.

The prominent derivatives in this market are the swaps and forwards. So, if a trader wants to buy a container full of shoes in December to sell during the festive season, they can buy a derivative, which will allow them to buy dollars later at a fixed rate, regardless of what the market price will be at the time.

Today, a trader can go to a bank like Standard Chartered, which has tried to popularize these products, and buy a derivative to allow him purchase dollars at, say, Shs 2,600 each in December. It's a small price to pay now to cover for what could become a bigger loss later. If you doubt that, then just ask Uganda National Roads Authority(UNRA).

UNRA's Shs36bn foreign exchange loss, as discovered by the auditor general, could have been avoided if it had bought a derivative product. UNRA's million-dollar contracts are so huge it is reckless to leave them exposed to the whims and charms of volatile forex markets, where a simple rumour could whip up tensions globally.

UNRA says its money comes from the consolidated fund at Bank of Uganda, which gives it little control over it, and therefore it is limited when it comes to hedges. UNRA also says "even if BoU were to do the hedging, this would cost money as the currency fluctuation risk would have been passed on to a third party."

I am afraid those excuses do not hold water; they are flimsy at best and a poor attempt to create a red herring at worst. And why should UNRA care about the third party?

There is no law that stops UNRA from guarding against this risk. You can only feel for UNRA if it said it did not have the experts who can price these derivative products fairly. Then again, UNRA surely has the money to hire financial geeks who know these all too well.

Derivatives, it must be said, have a tarnished name as they were at the centre of the global financial crisis of 2008. But the derivatives in the United States of America, where the financial crisis was sparked off, were so complex Uganda will take ages to get to that level of sophistication.

The derivatives in Uganda's market are so simple many of the downtown traders in Kikuubo, no offence, flocking China to import stuff are using them. There is no reason as to why UNRA is not using them. But this is Uganda, sadly, where simple decisions are overlooked even when billions of shillings are at stake. You wonder what other institutions have lost money in these foreign exchange flac0tuations.

They must be many. Where are those plans that BoU had on paper to promote derivatives?

UNRA's loss should finally wake us to the need to guard against these risks. I fear, however, that many of us are in one big slumber it would take a more alarming figure than Shs 36bn to wake us up to the wastage in our public institutions. So much for that coffee and samosas, BoU.

Twitter: @jeff_mbanga

The writer is the business editor of The Observer.

For more stories on investments and markets, please see HispanicBusiness' Finance Channel

Source: AllAfrica

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