How loans have left govt in tight spot

Uganda’s high level of vulnerability and precarious public finances have compelled the nation to enter into risky loan agreements that could worsen its already severe debt burden. 

Some of the loan agreements that the nation has entered into, which could have very ugly outcomes if not resolved quickly, show that the nation’s commercial loan negotiators seem oblivious to long-run outcomes. 

This has forced them to withdraw from certain loan covenants that had unstable penalties and, on occasion, mitigate the interest rate burden in a wrong way. 

For instance, an audit house investigation reveals that half of a $1.44b Chinese loan, which the government took out to finance its hydropower dam on the Nile, had variable LIBOR-linked interest rates that its negotiators worsened when they switched it for a 6.08 fixed interest rate in a deal with two private banks over a 15-year period. 

On the $645m portion of the loan where the government desired its variable interest rates fixed, the state has instead incurred an interest rate deficit totalling $33.8m since the 2018/2019 fiscal year, in a deal that went the wrong way. The remainder of the loan was concessional with a rate fixed at two percent. 

This interest rate swap was intended to lessen interest payment uncertainties. But the debt relief in this deal has not yet materialised, contrary to what many financial analysts had predicted.

Stanbic Bank and Standard Chartered Bank have so far paid $2.6m interest payments on that loan, and yet the government has so far paid them $36.4m, as agreed in the interest rate swap-deal, yet the two-way interest-rate payments had been planned to move closely together. 

“Under such circumstances, there is such a possibility that the government may make a financial loss by the end of the swap period,” Mr John Muwanga, the Auditor General, said, adding that he advised the permanent secretary to the Finance ministry and the Secretary to the Treasury (PS/ST),  Mr Ramathan Ggoobi, to review and assess the risks and benefits of continuity with the swap arrangement for the remaining duration. 

“The PS/ST explained that going forward, [the ]government will train officers to ensure that this subject is well understood and that the best hedging options are used in derivative transactions,” wrote Mr Muwanga in his audit report for the year ending June 30, 2023. 

This loan is the one the government got in 2014 through China’s Exim Bank to assist in funding the 600 megawatt Karuma hydropower project.
 
Debt cancellations 
In some other loan negotiations, Uganda has also had difficult times and has retreated when it became apparent that it would not be able to repay the loans.

For example, the aforementioned audit report data indicates that Uganda is supposed to pay penalties totalling Shs5.564 billion for the loan agreement it pulled out from to build the 45-megawatt Muzizi hydropower plant in Hoima District. 

In 2016, the state desperately needed project funding and negotiated separate financing agreements with the Africa Development Bank (AfDB) and KfW Development Bank to finance a €90.3m project that was needed for rural electrification in western Uganda. 

However, the project on the River Muzizi was shelved when the government cancelled the deal with the two companies in favour of pursuing a concessional loan. The Uganda Electricity Generation Company Ltd last year indicated that the government realised that it would not solicit the funds necessary to repay the loan after thorough review of the associated loan agreements. 

The state’s finance managers are now facing a mounting liability since they are mandated to pay KfW Shs931m for the cancellation of the loan agreement and AfDB Shs4.633b for both cancellation and commitment fees.  

“It further raises questions on the necessity and evaluation of loans before signing by management to ensure the implementation of projects to completion,” Mr Muwanga said of the cancellation, adding: “I advised management [of the Finance ministry] to carry out extensive assessment and planning to ensure that all loans signed are effectively utilised as agreed in the terms.”
 

Non-concessional loans 
In addition to facing unsightly loans, Uganda is defying its ideal framework for managing debt, which calls for reducing the amount of commercial borrowing—such as Eurobonds and bank loans—in its external debt portfolio. Mr Muwanga discovered that the state received two non-concessional loans totalling $739.8m for the 2022/2023 fiscal year in the external money markets. 

The government took out external debt at high interest rates, with short-term repayment periods in order to pay for ongoing expenses such as wages and administrative costs. This was a repeat of the practice in which the state was given four non-concessional loans during the 2021/2022 fiscal year that totalled Shs4.493b. 

These actions go against the government’s mandate, as stated in the public debt management framework that covers the fiscal years 2018/2019 through 2022/2023. Non-concessional loans are supposed to be taken out for projects that will not only yield a higher economic return than the interest on credit. 

The new debt sustainability analysis (DSA) report shows that the government will continue to rely on external borrowing over the medium term as the main avenue to finance the budget deficit.  

“This is consistent with the policy of reducing domestic debt which is typically costlier, to no more than 1 percent of GDP and also with the intention of reducing crowding out of the private sector which is the engine of growth,” it states. 

Debt spiral
The domestic debt is on the rise, although, growing by 114.5 percent, from Shs15.5t in the 2018/2019 Financial Year to Shs33.25t in the 2022/2023 Financial Year. 

“Domestic interest payments continue to form the bulk of interest payments given their high cost of issuance as compared to external interest payments that continue to be predominantly concessional rates. The large maturity of domestic debt in the first year of projection increases the refinancing risks of [the] government, but the maturities reduce significantly in the medium term,” the 2022/2023 financial year debt sustainability analysis (DSA) report released by the Finance ministry on January 30, 2024 reads.

It adds: “In contrast, external debt maturities follow a smoother path which peaks in the medium term, driven by principal repayments of commercial debt contracted in the last few years.” 

Despite this assurance, the government on February 7 acquired a Shs1.3t loan in the domestic market to support its Shs3.5t supplementary budget through a private placement among its primary dealers.

On February 8, Bank of Uganda announced another Shs235b Treasury bill auction in which it hopes to raise the money by February 14 still in the domestic market. 

Government records show that several investors in the domestic market have left it, mostly those from international countries whose holding of domestic debt declined significantly from 11.2 percent in June 2022 to 6.3 percent in June 2023. This followed the persistent increase of interest rates in more advanced economies that avail them more returns in bond markets. 

During the same period, the government borrowed less money from domestic investors, or Shs3.7t, than the previous Shs4.6t, in the same prior period, due to the under subscription of its treasury instruments, Mr Muwanga stated. 
 
Debt management
New official data from the audit house indicates that Uganda’s public debt stock has ballooned to Shs97.5t by June 30, 2023, a 10.74 percent increase from the Shs86.85t as reported on June 30, 2022. 

Several financial analysts project that by the end of the 2023/2024 fiscal year, it will surpass Shs110.6t, primarily due to budgetary support of Shs2.7t, project support of Shs8.2t, domestic support of Shs3.3t, and supplemental budget support of Shs3.5t. 

But Mr Muwanga worries that these persistent budget deficits, rollover of liquidity papers, bond switches, private placements, new borrowings for various development projects and foreign exchange losses arising from the depreciation of the shilling against stronger currencies are mounting the debt mayhem. 

“Uganda’s public debt has risen at an alarming rate, and while it is currently sustainable, there is a need for prudent management to ensure that the country debt levels do not become unsustainable,” Mr Ronald Ochen, a Ugandan Economist at the Civil Society Budget Advocacy Group, wrote in a recent commentary to this publication. 

A computation of Uganda’s debt-to-GDP ratio by the office of the Auditor General puts it at 52.7 percent in the 12 months to June 30, 2023, a 0.7 percent decrease from 53.4 percent, in the same prior period. 

The recommended percentage of safety of the ratio that captures a nation’s ability to repay debt, according to the International Monetary Fund, is 50 percent.  

“Measures to maintain debt at sustainable levels over the medium term will include: increasing domestic revenue collections through the full operationalisation of the Domestic Revenue Mobilisation Strategy, prudent management of the oil resource […],” the DSA report reads. 

Mr David Wandera, the executive director and head of financial markets at Absa Bank Uganda, argues that the government can get relief in financing its budget by issuing long-term bonds whose interest rates are spread for decades as an option to avoid debt distress. 

While at the Absa economic outlook forum at the Kampala Sheraton hotel on Tuesday, he said: “I know that there are talks about an infrastructure bond to fund things like the pipeline. That is going to boost our market depth.

Since the introduction of the primary dealers [firms that buy government securities directly from a government, with the intention of reselling them to others] in the market in 2019, we have seen the bonds traded actually more than quadruple from Shs6.6t in 2019 to about Shs23t in 2022. This is huge for Uganda because the overall cost of borrowing for government has actually reduced.”
 
Dwindling forex reserves
With multinational and bilateral creditors accounting for the majority of Uganda’s external debt—which increased by 71 percent over the previous five fiscal years—the country is up against an uphill battle to finance its external  debt, which reached Shs52.8t in the 2022/2023 fiscal year due to its dwindling forex reserves. These fell 18 percent to $3.6b in 2022—equivalent to 3.4 months’ worth of import cover.  

“To address this challenge of the declining forex reserves, we have minimised our interventions on the sales side to the market. We last intervened in the foreign exchange market on the sales side in the first week of June 2022. To date, we have not sold any foreign currency to the market largely because we are aware of the fact that our reserves were running low,” says Michael Atingi-Ego, the deputy governor of the Bank of Uganda.