Debt: Has Uganda mortgaged its oil with increased borrowing?

In 2012, Ghana went on spending binge including a cocktail of increased borrowing with prospects that its oil revenues will help clear the debt. Ghana had started oil production but then came the turbulence of the dramatic fall in global oil prices. Additionally, the economy went into slowdown mode as projections of 8 per cent growth turned into an actual growth of just 4.5 per cent. This prompted the government in Ghana to seek a bailout from the International Monetary Fund (IMF). It was a bitter pill for Ghana to swallow as the nearly $1b (Shs3.4 trillion) bailout meant the government implementing some tough choices like increased taxes, removal of exemptions and job cuts for public service members.

This is the warning for Uganda as it continues accumulating debt, although the levels are said to be sustainable. In a report titled “Economic Diversification and Growth in the Era of Oil and Volatility” released by the World Bank together with the Ministry of Finance Planning and Economic Development, there are hints on what Uganda should avoid if it is not going to fall into the Ghana trap.
“The government may be tempted to spend in advance some of its future oil revenue through substantial borrowing on the financial markets. This may generate short-term benefits through growth of private consumption but would have negative long-term consequences, as savings are sacrificed. It might also help to smooth investment expenditures over time, taking into account the limited absorptive capacity of the economy,” report reads.

Rising debt
Uganda has not been to the financial markets to borrow, although Ghana has. In fact, Uganda has been praised for not going to the global market and float a Eurobond because of the challenges faced by those that have borrowed using this tool.
A Eurobond is where a country uses a debt instrument known as a bond to borrow money in foreign currency. However, Uganda’s public debt is on the rise with the finance minister, Matia Kasaija, estimating it at Shs30 trillion, which is about 34 per cent of GDP, a level considered sustainable.
Borrowing is expected to continue with $2.3b (Shs7.7 trillion) expected to be approved by the EXIM bank of China for the construction of the first phase of the Malaba – Kampala route for the Standard Gauge Railway. There is expected additional borrowing for the construction of the refined products pipeline and expansion of more roads. The government also expects to borrow another $500m (Shs1.7 trillion) for the construction of the Kampala Light Rail Project. The construction could start in 2019.

Uganda’s debt levels could rise even faster if the government does not sequence some of the planned projects. The World Bank in the report reveals that frontloading – doing heavy investment projects at the same time – could lead the debt-to-GDP ratio to exceed the 50 per cent mark. For instance, the construction of Karuma, Isimba, Entebbe Expressway and now the Standard Gauge Railway are all ongoing at the same time.
“The challenge oil prospects create is that it creates an appetite to opt to front load projects, some of which are not advised by feasibility studies. In some cases, we are borrowing to undertake feasibility studies where the risk here is pre-determined bias leading to eventual positive feasibility reports,” says Mr Enock Twinoburyo, an economist and Ph.D. Research Fellow at the University of South Africa.
So, with all this borrowing, how will Uganda pay back these debts?

Oil money to pay debts
The government has been downplaying the possibility of defaulting on its debts because of the investments it is making to boost production. President Museveni has continued to insist that infrastructure projects will spur investments; hence contributing to economic activity. The working assumption is that the economic activity will generate taxes that can then be used to pay off the debts.
However, Dr Adam Mugume, the director research at Bank of Uganda (BoU), notes that going by the current trend of economic activity, oil is the only prospect available to repay back the debts.

“I don’t see how you can generate enough money to start repaying interest and then within the next five years in foreign exchange. We are only assuming now that either we have the oil revenue coming on board or we go and ask for debt forgiveness or we default. Apart from these three options, I don’t see how we shall repay our debts,” Dr Mugume said during a post-budget dialogue organised by the Uganda Economics Association (UEA).

Dr Mugume’s assertion is almost similar to that of Dr Fred Muhumuza, an economist, who pointed out during the World Bank report launch that: “Government says it is not borrowing on the basis of oil but the lenders are lending on the basis of oil.”
His assertion is on the basis that the loans that the government is getting, especially from China, are premised on the fact that Uganda is going to start producing oil and will have enough revenue to make payments on the debt.
This also comes at a time when the government is borrowing at none-concessional rates (market rates) for projects that are not generating the money to repay the loans.

Underperforming public investments
In the 5th Uganda Economic Update by the World Bank released prior to the Budget speech, there was a revelation that government is not reaping the returns of its investments in the various public projects.
“Over the past decade, for every Shilling invested in the development of Uganda’s infrastructure, less than a Shilling (only seven-tenths of a shilling) of economic activity has been generated. That is not good, and it will not translate into a transformed middle-income country anytime soon,” Ms Christina Malmberg Calvo, the World Bank Uganda country manager, said at the time.
In other words, the government is not making any returns for its high investments. The projects are financed using expensive loans. More so, the government continues to borrow money from the domestic market to cater for recurrent expenditure. This further compounds the debt service burden that weighs heavily on Uganda’s Budget.

“The debt service burden is fast rising, with interest payments accounting for 10 per cent of the Budget. More than 80 per cent of interest payments are also going to domestic interest payments. Remember domestic borrowing is essential to meet the recurrent nature activities,” Twinoburyo points out.
Twinoburyo adds “…at end of FY 2015/16, the total amount of domestic debt is slightly more than the expected the total domestic revenue. Our revenues can’t offset a sizeable share of maturing domestic debt so, for a second year running, we have had domestic debt rollover each of nearly Shs5trillion.”

The alternative
Some of the projects are expected to be self-financed once they come on board. For instance, the power purchase agreements for the Karuma and Isimba projects have incorporated a tariff that caters for loan repayment. The government must, however, provide money in case there is a shortfall in collections. The government will be required to pay even for the unutilised power by providing a subsidy in the price or increase the tariff to cater for the unused power.
Additionally, the Standard Gauge Railway is also under a separate arrangement where the government is expected to make payments on the loan whether it is operating at full capacity or not. The EXIM Bank of China will expect payments from the Uganda government.

Recently, even President Museveni has recognised that the debt burden Uganda continues to accumulate. During the budget speech, he noted that he requested the investors interested in the construction of the 600MW Ayago Power Dam to share in the risk of the project. He expected that this would come under the Public Private Partnership Act.
The government is also reconsidering some of the road construction projects. The next generation of roads like the Kampala-Jinja Expressway will be funded under this law. Ugandans will be required to pay a fee to use this road in order for the funders to recover their money. This takes the risk away from government to accumulate public debt.

Ugandan law bans mortgaging oil

In 2015, President Museveni assented to the Public Finance Management Act that details how oil revenue in Uganda shall be managed. In order to check prospects of increased government expenditure as oil money trickles in, the law states that all oil money shall be placed in a holding account that is overseen by parliament. It is from the holding account that money can be drown-down to finance part of the budget and the rest placed in a Petroleum Revenue Investment Reserve for purposes of building up savings just in-case of a drop in earnings if oil prices.
The Act also states that Uganda’s oil shall not be mortgaged for any borrowing.
“The financial assets of the Petroleum Fund including present or future financial assets shall not be earmarked, pledged, committed, loaned out, or otherwise encumbered by any person or entity,” the Act reads.

It adds that the Petroleum Fund shall not be used “…as collateral for debts, guarantees, commitments or other liabilities of any person or entity.” The government is also prohibited from holding “…a financial instrument that places or may place a liability or a contingent liability on the Petroleum Fund.”
However, this does not stop the government from placing interest payments on debt in the Budget and then request parliament to appropriate the funds that may come from the Petroleum Fund.