Expensive borrowing: Govt is cornered both locally and internationally

Abroad, geopolitics is choking funding sources, while at home, investors are growing more aggressive, demanding sky-high returns. Government knows it’s cornered - and data agrees.

The auction that shattered the ceiling

On May 14, the bond market quietly made history. For the first time in over two years, a 20-year treasury bond crossed the once-unthinkable 18 percent interest threshold, landing at a cutoff of 17.945 percent, Bank of Uganda (BoU) data shows.

The interest is commonly known as the yield, which is the profit an investor gets from lending government through bonds.

When investors buy a bond, they are lending to government, which promises to pay back later with interest.

The cut-off yield is the highest yield government agrees to pay in an auction.

So, this time round government had to promise huge returns to investors, in addition to selling the bond at a steep discount - Shs89.43 for every Shs100 of face value, which is like buying a car for a big markdown and getting a fuel card thrown in.

“We are almost crossing 18 percent,” says Alex Kakande, a financial markets analyst.

“Anyone buying treasury bonds right now is looking at yields above 17.5 percent, especially on 20-year papers. Even the 10-year bond is yielding 17.5 percent - the highest in over two and a half years. The three-year bond is at 16.5 percent. This is dreamland for investors,” he says. 

But while bondholders are cheering, someone else is sweating: government.

The price of desperation

The high yields are great if you are lending. But for the borrower, government, they are a flashing red light, which signals that the market believes you are a risky or desperate borrower.

And it’s not hard to see why. Uganda Revenue Authority (URA) beat its mid-year target by Shs322b, collecting Shs15.3 trillion in the first half of the 2024/25 financial year.

But the near collapse of donor flows is creating a chaotic financial squeeze.

BoU data shows a steep fall in donor funding. Inflows dropped from $905m in June 2023 to just $146.4m in March 2025 - an 83.8 percent plunge.

Many economists think this is attributable to two big exits: USAID, which shut down in February 2025, and the Democratic Governance Facility, which closed in June 2023.

Uganda was averaging $500m per quarter in aid two years back, now the average has fallen to just about $300m - a painful shortfall for NGOs and donor-funded public projects. And government lenders know this.

Rising yields (interest rates) 

Normally, bond yields are driven by the movement of the Central Bank Rate, inflation, exchange rates, and creditworthiness

Right now, most of the above fundamentals have been stable.

BoU kept the CBR at 9.75 percent last week, annual inflation is under control (between 3.4 percent and 3.9 percent), and it’s expected to hover below the 5 percent target for the next two to three years, according to BoU.

So what is pushing yields through the roof? Speculation and desperation.

“Investors are pricing in risk. Government needs cash - urgently,” says Andrew Mwiima, a financial markets consultant. “It has maturing debt, a Shs4.9 trillion supplementary budget, and an election on the horizon. That combination makes markets bullish – they are demanding more for their money.”

This is good news for investors, and many have lined up cash to lend to government, but at a premium.

The bond market has been receiving several over-subscriptions over the last quarter, with Adam Mugume, the BoU director of research and policy, highlighting this during the May 14 monetary policy briefing.

Of course, not every high bid has been accepted, especially when investor sentiment gets jittery.

A case in point is the April 16 bond auction in which investors submitted bids worth Shs1.33 trillion, with many demanding interest rates of about 17 percent, but BoU only accepted Shs210b, in an auction in which it had planned Shs990b.

In the subsequent auction, however, government had little choice but to accept Shs775.3b out of the Shs1.7 trillion offered.

The twist? Yields had edged up from 17 percent to 18 percent.

BoU, which auctions on behalf of the Finance Ministry, tried to contain the surge, but it appears to be losing ground because speculators are building in a risk premium.

“It’s true that during election years, many investors bet on increased government borrowing. “They approach the auctions with confidence. They drive up demand, leading to persistent oversubscriptions,” Mwiima explains.

Bond rates are now market-driven as a result of liberalisation, unlike in the past, when government fixed rates.

Short-lived elevated rates?

Some analysts say the elevated yields will not last.

Simon Mwebaze, the Cornerstone Asset Managers chief executive, says while bond yields are high in both the primary and secondary markets, the spike is likely to be short-lived.

If there are improvements in tax collection, private sector credit, corporate earnings (which could attract capital into equities), and diaspora remittances, he says, BoU might soon be convinced to lower the CBR.

“This is a possibility. Yes, there may be donor pullbacks or tariff risks from the US, but I still think the current mismatch in bond yields is temporary,” he says.

Treading carefully

But for now, government is treading carefully by turning down a significant number of tendered bids that are perceived to be overly expensive.

In April, Secretary to the Treasury Ramathan Ggoobi, said: “We have been clear: Government, at least in the foreseeable future, will never borrow at any cost. The cost has to be reasonable … If money is expensive, we leave it and live within the available cash.”

Dealers and institutional investors interviewed for this article say they are taking that statement seriously and expect the current yields to fall over the next two quarters, or possibly in the first quarter of the next financial year, starting in July.

Whereas elections are indeed a factor push factors for the high yields, in past election cycles, the yields have not climbed this high - save for 2011 "Walk to Work" protests. 

Not even the 2021 lockdown drove them this far. Thus, the current rate might be a symptom of stress and an increasingly risky profile due to rising debt.

Bonds vs equities

The bond market is far more responsive to macroeconomic shifts than equities on the USE. 

This has been the case for some time, largely because the value of transactions in the bond market significantly outpaces those in equities.

On average, government auctions at least Shs2 trillion worth of treasury bonds each month, while the stock market sees only about Shs17b in share trades per quarter. 

This discrepancy is precisely why Capital Markets Authority is lobbying for bonds in the primary market to be traded on USE and to establish something like a bond index. 

The idea is that this could spur greater synergy between bond and equity trading on the local bourse.

The equities market, however, doesn’t respond to BoU rate movements as it ideally should. 

In fact, Mwebaze notes that BoU rate shifts account for less than 1 percent of trading activity on the local exchange. 

The direct impact is simply too small to trigger a meaningful shift in capital between equities and bonds when one outperforms the other or when BoU holds its rate steady.

Thus, if the CBR rises from 9.75 percent to, say, 13 percent - a steep and unlikely jump - it would ideally affect capital flow to listed companies because the cost of borrowing would spike as commercial banks raise their prime lending rates.

“Unlike mature markets, Uganda’s stock market reacts slowly to rate hikes due to thin trading and shallow capital flows,” Mwebaze says.

How government navigates the turbulence will define Uganda’s economic health in the years ahead.

[email protected]