Govt has work cut out not to let its fiscal deficit burn

Fiscal deficits, on the other hand, are a gamble—a bet that the government pays out more than it receives, particularly over time. But this bet does not convince everyone, mostly the country’s macroeconomists.

With interest on public debt now eating up a sizeable amount of Uganda’s budget and domestic revenues, onlookers argue that the country is facing “serious financial difficulties.” Rising debt servicing expenses are making it harder to collect taxes. In fact, the Bank of Uganda computes that of every Shs100 that Uganda’s taxman collects, Shs32 goes toward debt service.

According to the apex bank’s projections, servicing external debt will represent 35 percent of gross domestic product (GDP) in the 2024/25 fiscal year. The Treasury attributes the recent increase in Uganda’s public debt to a number of factors, including a shift in spending toward infrastructure and the impact of the Covid-19 pandemic.

Previously, public debt was 34.6 percent of GDP in the 2018/2019 fiscal year, but it increased to 50.6 percent in the 2021/2022 fiscal year and is expected to reach 53 percent in the 2023/2024 fiscal year, according to official government data. This exceeds the IMF’s recommended threshold of 50 percent for low-income countries. New data from the World Bank also shows that “many countries are on a path to crisis due to record debt levels combined with high interest rates.”

In a recent IMF publication, Ugandan Economist Amos Sanday writes that many “developing countries become distressed every quarter that interest rates stay high and face the difficult choice of servicing their debts or investing in public health, education, or infrastructure.”

Uganda particularly is grappling with drying aid, budget support, and development assistance from Shs2.781t to Shs28.94b as a result of the anti-gay law’s enactment. This has compelled the state to increase its borrowing to fill up the accumulating financing shortfalls. The Finance ministry even—at a certain point—opted for non-concessional loans to pay for current expenses as well as new debt for budget support.

And at times, when the public debt has mounted with less cash in the government’s hands, it has rolled over some debt and switched bonds, mounting another debt burden, Dr Sanday says. The consequence of this is that even though it temporarily relieves the government from immediate financial pressures, it can lead to a longer-term consequence of increasing the overall debt burden. 

“Growing evidence suggests that Uganda may become caught up in a ‘public debt safety trap’ where a favourable debt position, largely based on traditional debt sustainability metrics, falsely signals that the country has more fiscal headroom to borrow, especially when debt is still below the set national or international limit,” Dr Sanday opines.

The Treasury has now presented a national budget of Shs58.34t to Parliament for the FY 2024/2025. This is an increase of Shs5.64t from the Shs52.7t budget for FY 2023/2024.

According to the second budget call, the government expects Shs29.957t from domestic revenues and Shs278.1b in non-tax revenues. This is consistent with the taxman’s revenue target of Shs30t. This target hasn’t been adjusted because a high margin of the country’s narrow tax base (3.5 million people) doesn’t pay its taxes. Instead,  URA has slightly over one million compliant taxpayers.

The government needs this money for its expenses, but there are looming dangerous fiscal risks. According to the Treasury, these risks could cost the government Shs8t in unavoidable costs related to the macroeconomic, environmental, legal, and contingent liabilities and thus pose potential fiscal risks to Uganda’s public finances. Among them are external risks brought on by geopolitical unrest, tight financial conditions and corresponding fluctuations in commodity prices around the world that they do trigger.

The Middle East conflict and the Russia-Ukraine war have raised geopolitical tensions that Finance minister Matia Kasaija fears will further disrupt global supply chains and drive up volatility in the global commodity prices. In addition, the recent instability within the “East African region, like the conflict in South Sudan and the DR Congo, could disrupt regional trade and increase government spending requirements, especially on security, thereby posing significant fiscal risks to the budget for 2024/
2025 fiscal year.” 

As a result, it is anticipated that central banks in developed nations will tighten their monetary policies to protect their citizens from sharp increases in commodities. This, however, leads to capital flight since bond investors are primarily seeking for higher returns overseas, something that “affects forex inflows to Uganda, thereby exerting significant pressure on the Ugandan shilling, which can in turn give rise to risks on the cost of living, production, and debt servicing.” 

Finance Minister Matia Kasaija, in a fiscal risk assessment report for the FY 2024/2025, explained that “... tighter global financial conditions particularly make the cost of external borrowing significantly higher. This, combined with a decline in access to concessional financing, poses significant financing constraints on the national budget.” 

To the economy, the Treasury fears that Uganda, a net importer of petroleum products, could carry on this increase in global crude oil prices, leading to imported inflation, if this global inflation or volatile price of goods on the global market materialises at all. 

“This is due to a rise in the country’s domestic fuel pump prices which feed through to energy, fuel and utilities inflation as well as core inflation, leading to an increase in production costs and overall prices of goods and services,” the Treasury said.

After conducting a “sensitivity analysis” to assess the fiscal impact of these high-grade potential risks, the Treasury researchers found that they could easily wipe away Shs1.1t in government revenue.

The Treasury used a one percent decline in real GDP growth, a 10 percent increase in the cost of imports, and a 10 percent depreciation of the exchange rate to calculate their material fiscal impact.

According to Minister Kasaija, a one percent decrease in real GDP growth corresponds to a Shs307.7b drop in revenue, which would result in an equal increase in the fiscal deficit.

The higher fiscal deficit would primarily need to be financed by borrowing from the domestic market because short-term expenditures remain unchanged, he noted, arguing that obtaining last-minute funding from external sources can be challenging.

The Finance ministry’s calculations also show that a 10 percent decline in the exchange rate leads to Shs241.7b more in revenue and Shs1.143t more in expenses, mostly affecting external interest payments and amortisation.

In addition, a 10 percent increase in import prices results in lower revenue gains and higher expenses because the private sector’s demand for imports would be negatively impacted, which lowers import duty revenue receipts while simultaneously raising the government’s import bill.

“This would result in a Shs835.1b increase in the fiscal deficit due to the double effect of both a reduction in revenue and an increase in government expenditure,” Minister Kasaija stated.

Should all these shocks happen at the same time, they could mount a Shs1.143t overall budget deficit.

The fiscal risk statement also illuminates other risks such as the loan guarantees the government placed itself on, which the Finance ministry’s researchers note could result in losses of Shs2.992t, court cases that could cost Shs4.41t, and pension liabilities of Shs316b.

If the government’s new financial plan is implemented, there may be a potential offset of these deficits, but it still does not seem like enough given that the majority of the Treasury’s proposals to the August House are meant to aid the taxman in tax administration. 

A few taxes have been proposed, despite the opposition of many economists who contend that they are placing an enormous debt burden on the same taxpayers. Among the options they mention is the agricultural industry, which employs the vast majority of people while paying lower taxes.

In an effort to raise about Shs1.9t a year, the government has imposed new taxes on mineral water, diesel, gasoline, agent banking, among other items.

This potential revenue is threatened to be offset by these risks without being realised as things look like which “emphasises the significance of strong fiscal management and proactive preparation in safeguarding the country’s economic future against potential challenges,” according to some of the recommendations the Treasury observes.

“These factors necessitate a vigilant and adaptive approach to fiscal policy that not only responds to immediate fiscal pressures but also strategically prepares for future uncertainties,” it says

“In addition, the growing complexity of public debt, as well as the accompanying refinancing and interest rate risks, necessitate a more refined debt management approach that ensures debt sustainability while still supporting critical public investments,” it adds.