Uganda's quest for $919m loan could raise interest on treasury bonds by 2 percent

A decision by Uganda’s Treasury to obtain Ush3.5 trillion ($919.5 million) in loans from commercial banks to finance the supplementary budget is expected to boost interest rates earned on treasury bonds by around two percent in the short term, alongside constrained social service delivery, weak tax revenue collections and a modest growth forecast.

The loans are meant to finance various infrastructure projects and contingent and classified expenditure items attributed to state house and security agencies. This package appears significantly higher than the Ush2.5 trillion ($656.8 million) loan previously obtained from Stanbic Bank Uganda in 2020 for paying salaries and wages to public employees during the Covid-19 lockdown period.

The financial year 2023/24 has been characterised by poor tax revenue performance, slow business activity and weak exchange rate.

Tax revenue collections posted a shortfall of Ush600 billion ($157.6 million) between July and November 2023, a figure projected to hit Ush1 trillion ($262.7 million) by close of June 2024. Lower tax revenues usually translate into higher government borrowing levels.

“From our modelling, the shortfall is projected to reach one trillion Uganda shillings by end of this financial year unless comprehensive measures are taken to close this gap. This shortfall is likely to cause a lot of financing constraints to the entire government and service delivery to the citizens. This letter, therefore, is to request you to provide this Ministry with the planned administrative interventions by Uganda Revenue Authority to address the current revenue deficits,” reads a letter sent by the Finance ministry to the commissioner-general of Uganda Revenue Authority dated December 7, 2023.

The Uganda shilling suffered considerable depreciation against the dollar between September and November 2023, under pressure from huge dividend payments made by foreign multinationals and rising policy interest rates declared by central banks in developed economies. The Uganda shilling closed at Ush3,757 to the dollar at the end of September and Ush3,781 in October. It closed at Ush3, 817 in November, according to latest Bank of Uganda (BoU) data.

Pothole reality
The local business confidence index stood at 59.1 points in September, compared with 59.6 points registered in October, before clocking 58.5 points in November, BoU data shows.

Financial analysts say the loan could raise interest rates earned on certain treasury bonds by two percent as financial markets digest the consequences of increased official borrowing activity.

“There is high appetite for debt financing in government these days because of huge funding needs attached to new road projects, bridges and airports. These investments are being executed at the expense of social service delivery. Mobilising money for those projects in the domestic market will directly affect yields earned on government securities.

“For example, the 10-year treasury bond currently trades at 15-15.5 percent but could increase to 17 percent as government ramps up its new borrowing programme. Yields on government bonds might trade between 14 percent and 18 percent at implementation of those projects. We might not see much impact on economic growth from those projects till they are completed, similar to Kenya’s situation in recent times. Nonetheless, the World Bank remains the cheapest source of long-term debt for us and government ought to restart its conversations with that institution on a positive note. There is enough financial capacity at the World Bank to lend Uganda $1 billion for various infrastructure projects for more than 30 years at less than one percent interest per year,” Allan Lwetabe, investment director at the Deposit Protection Fund of Uganda said.

“Interest rates on government bonds will certainly go up under the new borrowing arrangement,” warns Dr Fred Muhumuza, an economist.

“Some 35 percent of this year’s budget has been dedicated to debt servicing and this ratio might rise further in the next financial year. This, in turn, will affect social services negatively. The presence of numerous potholes on our roads partly reflects that reality.”

“The high liquidity ratios imposed by BoU on commercial banks plus the high Cash Reserve Ratio and low deposit growth have forced banks to pursue a delicate balance between investing in government securities and keeping hard cash on their books. This means some banks might not be able to participate in the new government borrowing programme. The economy is struggling a lot though imports have increased. But the bulk of our imports originate from the EAC, meaning they are tax-free. This means more pain for tax collection efforts in a situation of low economic growth and few external taxation opportunities.”