Raising Capital to Balance Budget Deficits in Uganda: Issues, Options and Strategies

LAGOS, Nigeria, Capital Markets in Africa: Uganda’s fiscal deficit has widened sharply in the recent past increasing from 2.5 percent of GDP in 2011/12 to 6.2 percent of GDP in 2015/16 driven mainly by an increase in public investment in infrastructure, in particular roads and hydropower projects.  At the same time, due to the global financial and economic crisis of 2008, foreign aid to developing economies like Uganda declined significantly as advanced economies adopted austerity measures. The sharp increase in financing needs meant that the Ugandan Government had to look beyond the declining concessional loans to finance fiscal deficits.  Indeed, the share of concessional loans as a percent of total stock of external debt has reduced from 96.6 percent in 2003 to 83.2 percent as at end-June 2016. Government had to consider a wider array of avenues to finance the budget deficit including recourse to domestic borrowing and considerations of commercial external debt, which carry a heavier repayment burden.

Starting July 2012, Uganda resorted to explicit domestic borrowing to finance the budget deficit through the issuance of Treasury Securities. Since the reforms were made to the domestic debt policy, Government has managed to raise close to 2 percent of GDP annually through Treasury bills and bonds. The success of domestic borrowing is attributable to a developing financial market, notably the expansion of the banking system and the emergence of the non-bank sector, specifically pension and provident funds such as the National Social Security Fund (NSSF) which contribute about 35.3 percent of the total holdings of domestic debt. The banking sector holds about 44 percent of the total stock of domestic debt. In December 2013, Government undertook yet another measure to attract investors by extending the yield curve through the introduction of a 15-year Treasury bond. Other tenors of Treasury bonds include the 10, 5, 3 and 2 year bonds. Uganda’s Capital Account is fully liberalised and therefore resident and non-resident, domestic or foreign investors can fully participate in auctions of Treasury Securities.

The interest cost of Treasury Securities, currently at an average of 17 percent per annum, however, renders Securities an expensive financing choice for Government. Moreover, higher issuance of Government debt could crowd out the private sector from banking system credit. Therefore, notwithstanding the advantage of raising proceeds in local currency, Government has capped new issuances at less than 1 percent of GDP over the medium term. The stock of domestic debt to GDP currently estimated at 13 percent is still considered sustainable and Government intends to maintain it at the same levels over the medium term.

Over the past 5 years, the Government began to contract semi-concessional loans which include a grant element of less than 35 percent. Specifically, Government has signed contracts with the Exim bank of China on semi-concessional terms to finance infrastructure projects such as the Hydro Power Projects of Karuma and Isimba.  These loans carry an estimated interest rate of LIBOR plus 3.5 percentage points – for the non-concessional portion. However, the loans are structured in such a way that the Government makes an initial deposit to cover insurance fees, management fees and other forms of commitments. This usually necessitates hefty sums of foreign exchange, which when sourced from the local foreign exchange market, lead to exchange rate volatility. The other challenge of semi-concessional loans is the likely currency mismatch at repayment time as most of the projects financed by external borrowing will not directly earn or save foreign exchange. Furthermore, given the relatively short grace period, foreign exchange requirements are bound to be significant.

Going forward, as additional options, Government is exploring Public Private Partnerships (PPPs) to mobilise investment for commercial infrastructure projects. Uganda is one of the few countries that with a PPP Act, which as passed in 2015. One of the potential advantages of PPPs is that the private sector may be able to implement projects more efficiently than Government. However, important to note, is that PPPs are not necessarily a cheap form of capital because private investors require commercial rates of return commensurate with the risks they bear.  Other considerations Government could make are to float a Euro bond although this presents similar challenges of currency mismatch. In addition, the Euro Bond would require a lump sum payment at maturity.

All the above notwithstanding, concessional borrowing remains the preferred financing choice given its favourable terms.  Concessional loans carry a grant element of not more than 35 percent and attract an average interest cost of 0.8 percent per annum as well as a grace period of 10 years. Non- concessional loans, on the other hand, carry an average interest cost of 2 percent and a grace period of only 5 years, rendering the former a more favourable option to Uganda.

Ultimately, any benefit that will be derived from the increased public debt will largely depend on the Government’s Debt Management Policy and Practices and the viability of projects financed by debt. To support this the Government established the Public Debt Management Framework (PDMF) in 2013, a national framework to guide the issuance, contracting and management of debt in order to keep it at low and sustainable levels. Indeed according to the Debt Sustainability analysis carried out by the Ministry of Finance Planning and Economic Development of Uganda and the International Monetary Fund (IMF), Uganda’s debt as at November 2015 was sustainable and was expected to remain the same over the medium term. The major risks arose from the depreciated exchange rate, which increased the debt burden but which would be mitigated by the plan to extend planned infrastructure projects over a longer period of time. 

The more sustainable strategy, though, would be to reduce significantly the reliance on borrowing and minimising the debt burden. The government should, therefore, adopt policies to increase domestic revenue, such as implementing improved tax administration measures and broadening the tax base. Furthermore, Government should invest in productive projects that can refinance the debt during its life or at maturity.

Contributor Profile:
Christine is Assistant in charge of Macroeconomic Policy Analysis in the Economic Research Department of Bank of Uganda. She holds a Master’s degree in Economic Policy and Planning from Makerere University Kampala and possesses 10 years’ experience in policy formulation at the central bank.

This article features in the September edition of INTO AFRICA Magazine, which focuses on reviews of Africa’s economies in the first half of 2016.