Economic growth will reduce budget deficit

When the government spends more than it collects from tax it has to borrow money to make up the difference.

Tuesday June 10 2014

Finance Minister Maria Kiwanuka

Finance Minister Maria Kiwanuka displays the Budget brief case last year. File photo 


According to the Budget Framework Paper 2014/15, the fiscal deficit for the current financial year 2013/14, excluding grants is projected at -9.1 per cent.

This is an increase of more than 60 per cent of the -5.6 per cent fiscal deficit for financial year 2012/13. A budget or fiscal deficit is the gap between what the government spends and what it gets in income, mainly from taxes.
When the government spends more than it collects from tax it has to borrow money to make up the difference.

This is the current situation the Uganda government currently faces. This deficit is funded by borrowing mainly from the domestic market.

This borrowing is necessary in order to provide fiscal support, following the aid suspension of 2012, as well as the lower than expected revenue collections for the current financial year.
The borrowing has enabled the government to continue front loading public expenditure in physical infrastructure development, a sector that is so important for the growth of the economy.

How is the deficit financed
Almost all governments in the world finance their budgets using a combination of both domestic revenue and national debt. It makes sense for the government to borrow money not only to finance budget deficits, but to pay for investment that will help make a country more productive.

Budget deficits are financed by a country’s bonds. In Uganda, it is financed by the Bank of Uganda Treasury Bills and Government Bonds. Whenever the government borrows to finance the budget deficit, this borrowing adds to the country’s national debt. As the debt grows, it increases the deficit in two ways.

First, the interest on the debt must be paid each year. This increases spending while not providing any benefits. Also, if the interest payments become too high, this creates a strain on the economy, as those funds could have been used to finance other sectors of the economy.

Secondly, national debt levels can make it more difficult for the government to raise funds.

Too much debt can cause a crisis
When the government’s debt to GDP ratio is very high, creditors become concerned about a country’s ability to repay its debt. When this happens, the creditors demand higher interest rates to provide a greater return on this higher risk.

This results in an increase in the deficit each year. This can eventually become a self-defeating loop, as the country goes deeper into debt to repay their debt.
At some point, the interest rates on new debt can become so high, for the country to afford, and a country may default on its debt. This is what caused the Greece debt crisis of 2009. Fortunately, we are nowhere near that point here in Uganda.

Prudent debt policy is
Uganda’s debt policy is guided by the government’s Public Debt Strategy. Most of the government’s foreign debt is on concessional terms, over medium and long term.

Due to this very prudent government external debt policy, total government debt is currently at about 29 per cent of GDP. This is equivalent to about Shs16 trillion. Of course it would be better if we did not have to borrow at all.

But for as long as elected officials are always promising the voters in their constituencies more public goods and services in form new roads, hospitals, electricity and even tax cuts, and at the same time tax collections remain as low as they currently are, the government will always have to borrow to finance the its budget.

No politician would want to tell voters that roads in their constituency will not be built, or that they will not get electricity because tax collections are low, and the government does not want to borrow to avoid increasing government debt. That would be political suicide.

Therefore, as long as the political leaders continue to make these electoral promises and citizens continue to demand that the promises be honoured, while at the same time tax collections remain at the current low levels compared to GDP, the government will always have to borrow to finance the budget deficit.

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