Government treats symptoms, not disease of debt

With little leg room to manoeuvre from the self-inflicted debt trap, government has decided to incur a debt to pay off a debt, attracting condemnation from several seasoned finance professionals and economists.

Government will be refinancing an accumulated domestic debt, amounting to about Shs8.5 trillion that is due next financial year, which is about two months away.

This action is technically referred to as debt refinancing.

If Uganda was a company, this move – debt refinancing, would invoke an image of a desperate company on the verge of bankruptcy, trying to make some last-minute efforts to remain afloat.

Most of finance professionals, economists and budget policy experts note that debt refinancing is akin to treating symptoms instead of the underlying causes of a disease. This is because it offers temporary relief before the pain uncontrollably piles up again.

“Government is postponing a problem it cannot solve,” says the Makerere University School of Economics lecturer, Dr Fred Muhumuza.

He continues: “Look at it this way: it is time to pay up your due debt but you don’t have the money, you are compelled to renegotiate the payment.”

The problem, he says, is not so much the rescheduling of the debt but its aftermath on the economy, credibility of the government and service delivery.

The accumulated debt - domestic debt owed to lenders within the country through treasury bills/ bonds (which are debt instruments) issued regularly by the Central Bank to the investing public - continues piling up for as long as the government keeps replacing existing debt with a new one.

The problem just does not stop there. Each time there is a postponement, there are also harsher terms.

“Under this arrangement, interest rates are reviewed upwards. Generally, new terms entered tend to be stricter and unfavourable. So debt refinancing is a bad thing!” Dr Muhumuza told Prosper Magazine last week on Wednesday when contacted.

Credibility issues

Just like Dr Muhumuza, the chairperson of the Budget Committee in Parliament of Uganda, Mr Amos Lugoolobi, believes debt refinancing is not worth the risk.

When contacted last week, he said debt refinancing compromises the image of the government in the eyes of serious potential financiers, many of whom dislike to associate with the governments whose credit rating is low, thanks to their history of failing to pay their bills in time or owing too much money.

Beside attracting unfair terms, debt refinancing ties up capital that the private sector players could have deployed in expansion or creation of economic activities instead of being crowded out at a time that the effects of the Covid-19 pandemic are still taking an immeasurable toll on the economy, businesses and livelihoods.

But the veteran legislator admits that it is difficult to stop debt refinancing because the government is always caught between a rock and a hard place.

Mr Lugoolobi was also of the view that the accumulated interest rate that the country incurs as a result of this action erodes revenues that would have been committed in service delivery.

The law

In another interview with the Civil Society Budget Advocacy Group (CSBAG) executive director, Mr Julius Mukunda, the right thing to do would be to get rid of the debts as planned between the two parties. That, he says, is a much cheaper option than debt refinancing.   

Previously, debt refinancing was not part of the budget items because it was not considered as one. But soon it became a requirement under the Public Finance Management Act, 2015 because Parliament felt it has an impact on the consolidated account.

Whereas the Financial Year 2021/22 Budget is projected at Shs41.2 trillion it is actually less than that if you deduct the Shs8.5 trillion of the domestic debt that is already committed by government to pay for activities that have already taken place.

“According to Mr Mukunda, rolling over the debt is actually not bad if was not increasing every year. This situation, he says, complicates the country’s capacity to clear its obligation, considering the increasing interest rate that comes with it. So, it should be avoided.

Government

The director economic affairs at the Ministry of Finance, Mr Moses Kaggwa, explains that this is no easy decision. He said we don’t like incurring debts but very few countries finance their budget 100 per cent with their own resources.

“You have the Covid-19 pandemic and then we get shortfalls in revenue of about Shs2.5trillion which is actually due to the pandemic, and remember we have a responsibility to provide services to the people, so what do you do,” he asked rhetorically.

However, analysts say that government is going ask for Shs8 trillion from the domestic market, meaning banks once again will lend to government instead of you.

While debt refinancing is presented as occupying the top position in the budget in the short term, sectors like security and works will take the lion’s share of the tax payer’s money in the next financial year.

Revenue collection shortfalls

According to the Auditor General’s report to Parliament for the Financial Year Ended June 30 2020, pertaining to domestic refinancing,  government    planned    to    pay    back    maturing    Treasury Instruments  by  borrowing  afresh  from  the  market  (domestic refinance)  to  a  tune  of  slightly more than Shs6.4 trillion.

   However,  this  was  not realised  as  Shs1.4 trillion  was  borrowed  from  Bank  of  Uganda instead of the market.

The  Permanent  Secretary   in response, explained that the shortfall  in  taxes  was  mainly  due  to  the  slowdown  in economic activity  as  a  result  of  the  Covid-19  pandemic  (70.4 per cent  of  the  shortfall  in  tax  revenue  was  in  the  last  four months of FY 2019/2020).

Delayed and/or non-implementation of  some  measures  such  as  widening  the  scope  of  withholding tax agents, non-implementation of the rental solution as well as late  implementation   of   digital   tax   stamps.

Additionally, government’s decision to allow companies that were affected by Covid-19 to defer until September 2020 the payment of Pay As Your Earn (PAYE) and  corporate  income  tax, all had an impact on revenue, compelling the government to raid the domestic market through the Central Bank.

Domestic debt has been mainly used to finance deficits and implement monetary policy in many African governments so that it now constitutes a large share of the total debt stock, according to African Forum and Network on Debt and Development (AFRODAD). 

As for the coordinator for the East African Budget Network, Mr Julius Kapwepwe who is also the director programmes at Uganda Debt Network, the total sovereign debt for Uganda is currently in the region of Shs66 trillion, with 30 per cent of that being domestic debt.

He said:  “Officially, whether by government or even some of the Multilateral Financial Institutions the debt is somewhat suppressed to about Shs60 trillion. Recall that domestic debt covers the securities such as bonds and treasury bills, domestic arrears to corporate and  individual providers of goods  and services to the government, land compensations, recoverable debt due to mineral exploration companies, contingent liabilities and accruals, both by Local Government and the Central Government.”

Rising debt

Uganda has had a long history of debt.

First, it was one of the countries to have benefited from Highly Indebted Countries Initiatives (HIPC) in the 1990s and MDRIS in which all her debts were canceled by 100 per cent.

However, recently, the trend of public debt has been increasing at an exponential rate more than three times the rate at which the country got the debt reliefs yet debt and its structure have a great impact on the functioning of the economy.

Furthermore, the ratio  of  domestic  debt  to  private  sector  credit is beyond the threshold, according to the Auditor General’s (AG) Report.

The AG cautioned that if government does not restrain its hunger for loans, the debt will be unsustainable and future governments will not be able to borrow.

Mr Stephen Kaboyo, the managing director Alpha Capital.

Debt refinancing is basically turning over expensive debt and replacing it with a debt with a favourable term.  Uganda’s debt profile has average maturity of four years which is too short in terms of managing debt service which leads to a pile up of debt payment, which puts pressure on the budget.

Julius Kapwepwe, the coordinator for the East African Budget Network.

It is time government realised that its activities in the domestic market are hurting the economy. As long as its appetite remains untamed, resources that would have been freed up for small and medium enterprises to do business are tied up or taken by the government.

The cost of shifting to domestic borrowing

The switch to domestic borrowing  could  lead  to  pressure  on  institutional  investors  and  banks  to  absorb  “too  much”  government   debt and  this  may  have  a  negative  effect  on  financial  stability.  Moreover,  expanding  the  market  for  domestic  government  bonds  may  have  positive  externalities  for  the  domestic  corporate  bond  market.  But  there  is  also  the  risk  that   the  public  sector  may  crowd  out  private  issuers. 

Finally, there are political economy reasons that may make domestic debt more difficult to restructure. In fact, a few highly indebted countries which were able to use debt relief initiatives to address their external debt  problems  are  still  burdened  with  high  levels  of  domestic  debt.  It  is  also  important  to  correctly  evaluate  the  cost  of  borrowing  in  different  currencies.  In  an  environment  in  which  several  emerging  currencies  are  expected  to  appreciate  vis-à-vis  the  United  States  dollar,  the  ex  post  interest  rate  in  domestic currency may end up being higher than that in dollars.

Source: UNCTAD