Uganda’s debt likely to scale 50% GDP threshold, say AG

Uganda’s debt could soar to 53 percent this financial year, above the debt to gross domestic product (GDP) threshold, which threatens to upend an economy rebounding from the ravages of the Covid-19 pandemic and a blip caused by the geo-political conflict in eastern Europe.

“Suffice to note, debt to GDP ratios are projected to go 18 slightly above the 50 percent policy threshold by the end of FY2021/22 and to peak at 53.1 percent in FY2022/23,” the Auditor General observes in his latest report for the 2022 financial year.

The debt-to-GDP ratio is a measure that compares a country’s total debt and what it produces. The ratio reliably indicates a country’s ability to pay back its debt. A high debt-to-GDP ratio may make it more difficult for a country to pay both internal and external debt and may lead creditors to seek higher interest rates to compensate for financing risk due to likely default or unnecessary debt extension.

Though the IMF has recommended 50 percent as the point of safety, many developed countries have gone up to 200 percent. However, according to the IMF, developing countries are more prone to economic shocks and exchange rate risk, thus limiting them to 50 percent.

Experts are warning that un-sustained borrowing could snowball towards debt stress as the economy projected by the IMF to grow at 5.3 percent, hurtles towards the cliff.

The Auditor General, Mr John Muwanga, warned in the report: “Public debt is continuously on the rise, a fact that is attributed to persistent budget deficits [mismatch of government revenue and expenditure], rollover of liquidity papers, bond switches, private placements, new borrowings for various development projects and foreign exchange loss arising from the depreciation of the shilling against stronger currencies.”

The figures from the Auditor General’s report show a consistent increase in the total debt as evidenced by an increase of 109 percent in the five years from FY2017/18, which stood at Shs41.4 trillion to Shs86.6 trillion as at June 30, 2022.

This has also greatly impacted on service delivery as a large chunk of what is collected by Uganda Revenue Authority (URA) is injected into payment of loan interests.

The Auditor General’s report reveals that during the previous financial year, 24.1 percent, an equivalent of Shs5.5 trillion of the revenue collected, was utilised towards interest payments and Shs1.4 trillion in principal debt repayment, representing 6 percent of the domestic revenue collected.

About 30.1 percent, which is worth Shs6.9 trillion of the total revenue collected, was used to service the debt, leaving only 69.9 percent worth Shs15.93 trillion available for funding other critical government expenditures. This left a paltry amount available for service delivery, which constitutes 30.89 percent of the total revised budget of Shs51.56 trillion implying that 69.1 percent was financed by grants and loans.

An economist, Abubakar Mayanja, argued that for an economy to rebound from a tailspin, investment is key to create a stimulus.

But he fears that too much debt may lead to debt distress and this may cripple investment in the most productive sectors of the economy.

“When you look at the budget of Uganda, it has been growing on nominal terms and so the demands on government to meet its own obligation to meet its recurrent expenditure, payment of salaries, if you add pressure of debt service, it becomes difficult to fiscally operate,” he said, adding: “So, the root cause of domestic borrowing is the structural fiscal deficit where government always has a higher expenditure than the revenue it generates from taxation and it has been increasing so the demands of government in turns of its needs for money then it goes into the market to borrow.”

Fitch ratings last month revised the outlook on Uganda’s long-term foreign currency issuer defaulting rate (IDR) from stable to negative. The revision of the outlook to negative reflects heightened fiscal and external financing and liquidity pressures, partly related to reduced availability of concessional external financing, tighter domestic and external financing conditions, and large twin budget and current account deficits (CAD).

These pressures are evident in declining foreign exchange reserves, a scheduled increase in debt service payments, rising government interest costs, a less favourable public debt structure in some respects and a rising net external debt-to-GDP ratio.

Fitch offers sovereign credit ratings that describe each nation’s ability to meet its debt obligations and sovereign credit ratings are available to investors to help give them insight into the level of risk associated with investing in a particular country.

A confluence of events could further complicate recovery as the acting Director for Budget at the Finance ministry, Mr Ishamael Magona, warned that the country only has about Shs24 trillion out of the total budget of Shs51.56 trillion for this financial year.

As a result of Uganda’s negative ratings, it could borrow at higher interest rates if it seeks the Eurobond as Kenya has done in the past. A Eurobond is a bond issued offshore by governments or corporates denominated in a currency other than that of the issuer’s country and are usually long-term debt instruments.

But the deputy Secretary to the Treasury, Mr Patrick Ocailap, told the Monitor that debt was manageable and government will not seek a Eurobond. 

“Yes, debt has been growing over the years. As of June last year, I think the numbers that I have debt-to-GDP ratio, in nominal terms June 30 last year, was 48 percent, just two points below the 50 percent threshold, which is a big achievement,” he said.

He, however, argued that countries ought to be rational in contracting debt and it should be spent across the productive sectors of the economy.

“The expansion of debt should be seriously curtailed. Our policy stand has been very clear. Most of the world economies adjusted to the effects of inflation, which are supply chain distortions as a result of covid and supply shocks the world realised. As a result of subdued aggregate demand, most Central banks as their cup of tea reacted by putting in place monetary policies to increase the level of interest rates to curb inflationary levels in the economy,” Mr Ocailap said.

To deal with inflation, the Central Bank adjusted the Central Bank Rate (CBR) in Uganda from 6 percent in 2022 to 10 percent currently. One of the fiscal measures that the government undertook, according to Mr Ocailap, was to improve efficiency in tax collection and austerity measures that halted wastage on travel abroad and workshops, among others.

Mr Ocailap estimates that these austerity measures will result in savings worth Shs242 billion, which shall be repurposed to productive areas such as the Parish Development Model, agro-processing, Naads, and community roads to move produce from farms to markets.

Recent Debt Sustainability Analysis (DSAs) reports by the Finance and the IMF show that Uganda’s debt is sustainable but at moderate risk of debt distress in the medium and long term.

However, an economist at the Economic Policy Research Centre (EPRC), Ms Linda Nakato, warned that Uganda could be caught up in a “public debt safety trap”.

“It is [DSA] not as comprehensive as it should be in order for us to get a true position of how we are performing because there are several different factors that influence our debt sustainability position and hence our decision to borrow, but why we felt that this may give a false sense of security is that the fact it has a limited scope because if we are to go into the different factors based on the monetary and the macro-economic factors, based on governance, we have a lot of corruption issues, then we have a bigger challenge as in regards to public debt to guard us from falling into distress,” Ms Nakato said.

Countries are caught up in a safety trap when a favourable debt position based solely on DSA results increases their borrowing appetite and carefree fiscal behaviour, especially when the public debt is still below the set national or international debt limit. This is primarily fuelled by the “pseudo” safety due to more fiscal headroom to borrow, especially for countries overly relying on DSA results to assess debt policy sustainability and make borrowing decisions.

In her view, getting out of the public debt safety trap requires a holistic view of debt sustainability. This includes understanding the external and internal macroeconomic environment and its relationship with debt sustainability because sound debt management is more effective when linked to a credible macroeconomic framework that promotes stability.

Ms Nakato said sound and good fiscal management reduces riskier debt portfolios and reduces vulnerability to shocks and strengthens the link between budgetary or debt management and monetary policy, especially with the noticeable increase in domestic debt and inflation. She added that reducing corruption, promoting fiscal transparency, rewarding accountability and enforcing fiscal rules are key in sustaining borrowing.

The Auditor General also disclosed in the statement of financial performance that domestic arrears exponentially rose from Shs4.65 trillion in 2021, to Shs7.55 trillion in 2022 constituting a 62 percent increase.

Usually, the borrowing rates in the domestic market are higher compared to International Development Association (IDA) concessional terms that offer low interest rates.

Mr Mayanja said domestic borrowing is dictated by the prevailing conditions in the global markets.

“For example, the US has increased interest rates to control inflation so the cost of borrowing is a bit higher and also there is a lot of fatigue from the countries we traditionally borrowed from, which also had a crisis of their own during the pandemic, and so the government naturally turned to the domestic market,” he said.

He added that the perils of domestic borrowing “creates a scenario where the private sector from which government generates taxes to pay its debt doesn’t have the opportunity to grow because the capital is more expensive because government is borrowing this money at a high rate.”

As a result, one of the structural problems that arises is that most of the savings that should have gone towards long-term investment end up in short-term government instruments and that limits the expansion of the economy.

Mr Ocailap said they have cut back on borrowing this financial year and “decided that the portion we want to borrow this year from the domestic market to switch to an international market and get relatively cheaper borrowing.”

He added: “We watch international markets. That switch will give us some reprieve on domestic borrowing.’

He further said there are both monetary and fiscal policy measures that have been enforced but policy wonks have resisted the temptation of subsidies.

“We stood our grounds and said no [to subsidies]. You are not supposed to play to the gallery. We elected the option by doing cautious by cutting back on expenditure and improving our efficiency in revenue collection in support of the monetary policy side, where interest rates were increasing. We are vindicated, inflation is back to single digit, interest rates in domestic markets should be abating, the commodity prices have also responded positively and our exchange rate has been stable,” he said.

The tax body is seeking to roll out a raft of tax reform proposals contained in six recently-tabled bills in the August House. But there are fears that these taxes could disincentivise the few shouldering the tax burden and in Mayanja’s view is an attempt to “kill the goose that lays the golden egg”. 

The Auditor General also listed a number of contracts where government had lost funds worth billions of shillings as a result of the cancellation of the contracts and commissions, which accrued as a result of unspent funds meant to be spent on these projects.

For instance, the contract for the construction of the Muzizi Hydropower Dam was cancelled barely after government had paid a total of Shs3.967 billion in commission fees to the German Development Bank (KFW).

“I noted that from the date of execution of the said loan to the cancellation, the government had paid to the KFW a total of Shs3.967 billion in commission fees for unutilised funds. This in effect caused a financial loss to the government the said amount as there was no benefit for the money. The failure to absorb the funds therefore can be categorised as a nugatory expense,” reads the report.

In a July 14, 2022 letter, the KFW indicated that the total amount payable on the loan would be €1,171,875 (equivalent to Shs4.657 billion) as cancellation and commitment fees.

The audit noted that the initial agreement entered into by the government and the KFW had a draw-down period of December 30, 2021. Following the lapse of the draw-down period, the government successfully secured a renewal of the facility.

The Auditor General said this anomaly amounts to an unnecessary payment which could have been avoided either by allowing the facility to lapse or not renewing it before cancellation.

There is no evidence that the minister sought the advice of the Attorney General before the cancellation process was undertaken, the report partly reads.

A review of the status reports provided to the Finance ministry by Uganda Electricity Generation Company Limited (UEGCL) on the execution of the project revealed that funds totalling Shs2.695 billion had been doled towards the compensation of Project Affected Persons (PAPs) and acquisition of land.

The report also revealed that billions of shillings have been doled out in commissions as a result of unspent funds for the construction of the Kampala-Jinja Expressway and Tororo-Gulu Railway line.

Canceling contracts

For instance, the contract for the construction of the Muzizi Hydropower Dam was cancelled barely after government had paid a total of Shs3.967 billion in commission fees to the German Development Bank (KFW).

“I noted that from the date of execution of the said loan to the cancellation, the government had paid to the KFW a total of Shs3.967 billion in commission fees for unutilised funds. This in effect caused a financial loss to the government the said amount as there was no benefit for the money. The failure to absorb the funds therefore can be categorised as a nugatory expense,” reads the report.

In a July 14, 2022 letter, the KFW indicated that the total amount payable on the loan would be €1,171,875 (equivalent to Shs4.657 billion) as cancellation and commitment fees.

The audit noted that the initial agreement entered into by the government and the KFW had a draw-down period of December 30, 2021. Following the lapse of the draw-down period, the government successfully secured a renewal of the facility.

The Auditor General said this anomaly amounts to an unnecessary payment which could have been avoided either by allowing the facility to lapse or not renewing it before cancellation.

There is no evidence that the minister sought the advice of the Attorney General before the cancellation process was undertaken, the report partly reads.

A review of the status reports provided to the Finance ministry by Uganda Electricity Generation Company Limited (UEGCL) on the execution of the project revealed that funds totalling Shs2.695 billion had been doled towards the compensation of Project Affected Persons (PAPs) and acquisition of land.

The report also revealed that billions of shillings have been doled out in commissions as a result of unspent funds for the construction of the Kampala-Jinja Expressway and Tororo-Gulu Railway line.

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