Is Uganda’s economy in intensive care?

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  • Government  domestic borrowing hits Ugx. 1,351 bn from Ugx. 1,100 bn

 

  • External debt now at $ 10.7 bn

 

  • Public debt burden at 6 % of the GDP

 

  • FDI declines by 50% to $ 514m
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  • Debt Sustainability Analysis: Uganda is likely to face moderately high risk
  • economic activity decelerate sharply

 

  • Shilling depreciates17.2 % in the half of FY 2015/16,

 

  • More loans given out for consumption

 

  • last 5 years, GDP growth has averaged 4.5 % % compared to 7.5 in 2011

 

The Bank of Uganda released the State of economy December 2016. Read on.

 

Banking Sector

 

As at end September 2016, the total capital to risk weighted assets stood at 22.5 per cent compared to 20.1 per cent in September 2015.

 

The non-performing loans (NPLs) to gross loans rose from 3.8 per cent in September 2015 to 8.3 per cent in June 2016, but declined to 7.7 per cent in September 2016.

 

The average return on equity (ROE) and return on assets (ROA) declined from 17.1 per cent and 2.7 per cent to 14.9 per cent and 2.5 per cent, respectively.

 

Banks’ annual after tax profits during the first half of 2016 are estimated at 214.2 bn, slightly below Ugx. 269.8 bn realized during the corresponding period of 2015.

 

The high NPLs are in part driven by speculative borrowing. There was a lot of borrowing to finance real estate in anticipation of high demand for housing in the event of a take-off of the oil sector.

 

A BoU survey of the industry banks found that the three most important causes of borrower default, which were behind more than 60 per cent of the currently NPLs were: failure of Government to pay its contractors and suppliers; cost overruns and insufficient cash flows; the effect of the political instability in South Sudan, and the diversion of funds by borrowers away from their intended use

 

Government Securities

 

Yields on the 91-day, 182-day and 364-day Treasury bills (T-bills) averaged 14.1, 15.0, and 15.5 per cent in the three months to November 2016 compared to 20.1, 22.0 and 22.5 per cent, respectively in the same period of 2015.

 

In line with the T- bills, the yield on the benchmark 2-year Treasury bond (T-bond) also declined to 15.9 per cent from 20.5 per cent over the same period. The 5-year,10-year and 15- year T-bond rates declined to 16.7, 17.0, and 17.5 per cent in the quarter to November 2016 from 17.2, 17.6 and 17.5 per cent, respectively in the previous quarter.

 

Lending and deposit interest rates

Lending rates declined from a weighted average peak of 25.2 per cent in February 2016 to 22.8 per cent in October 2016.

 

Time deposit rates declined from 17.3 per cent in January 2016 to 11.5 per cent in November 2016

 

Since April 2016, the CBR has been reduced by 4.0 PPs but the Weighted Average Lending rate (WALR) for shilling denominated loans declined by 2.4 PPs. The paucity of lending rates reflects provisioning for bad debts and structural rigidities in the financial sector, including the high cost of doing business.

 

Overhead costs contributed about 7.0 per cent of the lending spreads in 2015, and have since increased to 13.0 per cent.

 

Private Sector Credit

 

Credit to the private sector grew by an average of 7.5 per cent in the year to October 2016 down from 18.9 per cent in the period to October 2015.

 

The slowdown in credit growth was reflected across sectors with the exception of lending to electricity & water and personal & household loans.

 

The slowdown in growth in PSC was driven largely by provisioning for bad loans, which has heightened risk aversion in banks. The demand for credit has remained relatively robust.

 

The supply of credit has however remained subdued, an indication that the subdued growth in PSC could be driven by tightening credit standards.

 

Annual growth in PSC to the Manufacturing, Trade and Business services sectors has been negative since June 2016.

 

Lending to other major sectors of the economy also weakened, save for household and personal loans. This is consistent with the findings of the Bank Lending Survey for Q1-2016/17, which indicates that all sectors except personal and households registered net tightening in credit standards in part due to efforts to improve the quality of the loan portfolio.

 

Fiscal Developments

 

During FY 2015/16, URA revenue collections amounted to Ugx. 11,230.9 bn, which was Ugx. 404.6 bn below target. Total domestic revenue (both URA and Non-URA) amounted to Ugx. 11,377.2 bn, a shortfall of Ugx. 350.0 bn when compared to the target of Ugx. 11,727.2 bn.

 

The overall expenditure amounted to Ugx. 16,664.2 bn Which is less than the budget by approximately Ugx. 1,845.8 bn.

 

This variance is largely explained by the low absorption within the externally financed development expenditures. There was low absorption for both project grants and loans, which is estimated at 58 per cent and 73 per cent, respectively.

 

The deficit for FY 2015/16 was 4.6 per cent of GDP as compared to 7.0 per cent of GDP projected at the time of the budget for FY2015/16.

 

Nevertheless, recurrent expenditure was above by Ugx. 271.3 billion or 3.0 per cent of the budget amount. Wages and salaries were above the budget by Ugx. 176.4 bn. Non-wage recurrent was higher by Ugx.327.1 bn and domestic arrears payments were higher by Ugx. 43.4 bn.

 

Given the expenditure overrun of Ugx. 271.3 bn and the shortfall in domestic revenue of Ugx. 350.0 bn both totalling to Ugx. 621.3 bn, it necessitated higher domestic borrowing. Government borrowing was increased from the earlier planned Ugx. 1,100 billion to Ugx. 1,351 billion. In addition, the Government position with BOU reflects an advance of Ugx. 548 bn as at end June 2016.

 

The implementation of the budget for FY 2016/17 seems to have faced challenges in the initial phase of budget execution.

 

Total government revenue (including grants) during the first four months of FY 2016/17 amounted to Ugx. 3,966.9 billion, representing a shortfall of Ugx. 362.8 billion when compared to the amount programmed in the PSI due to underperformances in both domestic revenue and grants.

 

Total domestic revenue amounted to Ugx. 3,742.7 bn compared to the target of Ugx. 3,939.3 bn, representing a shortfall of Ugx. 196.6 bn.

 

Similarly, relative to the URA target as per the approved budget, domestic revenue registered a shortfall of Ugx. 165.6 bn. Total government expenditure and net lending in the first four months of FY 2016/17 amounted to Ugx. 5,759.0 bn, which was Ugx. 476 bn lower than the programmed expenditure.

 

Expenditure for FY 2016/17 was front-loaded with about 53 per cent of the total budget being released in H1. As a result, domestic financing requirement has been increased by Ugx. 300 bn to Ugx. 912 bn to cover the projected underperformance in revenue collections.

 

If Government revenues continue to underperform, and there is recourse to the domestic market to salvage the revenue deficit, then PSC may be constrained further.

 

There is also a risk that increased domestic financing will lead to a substantial increase in yields on Government securities, which may not only keep lending rates elevated, but also lead to an increase in interest costs.

 

The World Bank issued a statement indicating that it has withheld new lending to Uganda effective August 22, 2016 due to poor portfolio management, which in addition to the cancellation and suspension of two loans, is having ripple effects on the economy.

 

World Bank International Development Association (IDA) loans account for 48.7 per cent of the external debt stock. Therefore, this suspension will have adverse implications for public consumption and investment and consequently growth.

 

Already, government expenditures have been revised downwards by Ugx. 848 bn on account of the projected under performance in revenue collections and repayment of borrowing from BoU during FY 2015/16 of Ugx. 408 bn.

 

These expenditure cuts may constrain domestic demand further, given the already soft growth in PSC. Domestic demand was lower in FY 2016/17 due to a slack in Government consumption, partly driven by delays in implementation of development programs.

 

In line with the need to foster growth, increase economic efficiency and reduce the cost of doing business, the fiscal stance has focused on addressing infrastructural constraints in the economy.

 

Given the infrastructural gap, the consequence of this policy pursuit has been the widening fiscal deficit. We need to strictly adhere to this policy in order to sustain medium-to-long-term growth while maintaining monetary stability.

 

Public Debt Stock

 

The need to lump up infrastructure investment has contributed to a rise in our debt portfolio in recent years

 

External debt has risen more rapidly, and on a commitment basis, is now estimated at USD 10.7 billion as at end October 2016.

 

However the modest decline in the undisbursed amount, from 51.6 per cent of the total committed debt as at end June 2016 to 50.0 per cent as at end October 2016 still highlights the existing challenges in project implementation.

 

The Uganda’s public debt burden has risen by 12.7 percentage points to 38.6 per cent of GDP in 2016/17 from 25.9 per cent of GDP in 2012/13 and is projected to continue rising towards 45% of GDP by 2020. Debt as a percentage of revenues has risen by 54pp since 2012 and is expected to exceed 250 per cent by 2018.

 

This has prompted Moody’s recent down grade of Uganda’s long-term bond rating by one notch to B2 from B1, but changed the outlook from ‘negative’ to ‘stable’.

 

Deteriorating debt affordability is also reflected in interest obligations expected to consume almost 16 percent of revenues by 2018, far exceeding the Moody’s median for B-rated countries of 8 per cent.

 

Moody’s said Uganda’s debt burden has “risen faster than the government’s own resources, resulting in a debt-to-revenue ratio of 236 per cent, one of the highest amongst B-rated sovereigns.” Uganda’s revenue-to-GDP ratio is 13.4 per cent of GDP versus the median of 23 per cent of GDP for B-rated countries, according to Moody’s.

 

The preliminary Debt Sustainability Analysis (DSA) shows that Uganda is likely to face moderately high risk. There is also a risk of a further increase in the already high interest costs in the budget, which currently account for more than 10 per cent of Government expenditure. In addition, there are also perceptions in the market that Uganda may not be able to service its rising debt levels.

 

Various infrastructure development projects, with high medium-to long-term multiplier effects on growth will be implemented over the next five years. Most of these projects will be financed from external sources. A careful sequencing of these projects is necessary in order to avoid undesirable consequences of unsustainable debt.

 

Balance of Payments

 

The balance of payments recorded a surplus of USD 80.2 million in FY 2015/16. This was an improvement compared to a deficit of USD 352.8 million recorded in FY 2014/15.

 

The current account deficit improved from a deficit of USD 1,971 million to a deficit of USD 1,467 million, largely driven by a decline in the private sector import bill, reflecting a combination of low global crude oil prices and subdued domestic demand.

 

Total private sector imports declined by 17.7 per cent. Oil imports declined by 35 per cent to USD 647 million while non-oil imports declined by 14.5 per cent, mainly driven by declines in imports of capital and intermediate goods (19.6 per cent) and consumption goods (12.9 per cent).

 

Export growth on the other hand remained subdued, reflecting weak global demand, low commodity prices and the fragility and violent conflicts in South Sudan

 

 

The financial account continued to be the main source of financing the deficit in the current account. Net inflows in the financial account increased by USD 182.6 million largely due to project support disbursements.

 

Foreign Direct Investment (FDI) on the other hand declined by 50 per cent to USD 514 million on account of lower oil-related FDI.

 

Preliminary estimates indicate that, the current account deficit improved by US$31.4 million to a deficit of US$366.1 million during the quarter ended October 2016, from a deficit of US$397.6 million in the preceding quarter.

 

The improvement in the current account balance was largely on account of a US$84.2 million improvement in the primary income balance. In comparison with the same period a year ago, the current account deficit declined by US$30.9 million from a deficit of US$335.2 million registered in the quarter ended October 2015.

 

The capital account balance declined to a surplus of US$17.6 million during the quarter, due to reduced capital transfers. The financial account recorded a net incurrence of liabilities of US$320.2 million during the quarter ended October 2016, a US$59.5 million decrease from a net incurrence of liabilities of US$379.6 million during the previous quarter.

 

This resulted in an overall balance of payments deficit of US$26.0 million during the quarter ended October 2016, with a net draw down in reserves assets of US$26.4 million excluding valuation changes.

 

The stock of reserves at the end of October 2016 was estimated at USD 2.9 billion, equivalent to 4.3 months of import cover. Going forward, the current account deficit is expected to remain fragile on account of increased private sector imports for the festive season. This may however be moderated by increased personal transfers.

 

Exchange Rate Developments

 

During the first half of FY 2015/16, the shilling depreciated 17.2 per cent largely on account of a weak current account balance, global strengthening of the United States Dollar and speculative behaviour in the foreign exchange market associated with the 2016 general elections.

 

The shilling remained relatively stable in the second half of FY 2015/16 and the first quarter of FY 2016/17. The exchange rate has in recent months however experienced sustained depreciation pressures.

 

In October 2016, the Shilling depreciated by 1.6 percent M-o-M. This was however an appreciation of 5.5 percent Y-o-Y. In November 2016, the Shilling depreciated by a further 3.6 percent to an average midrate of UGX 3,560/US dollar. On annual basis the Shilling depreciated by 3.8 percent in November 2016.

 

The recent weakening of the Uganda Shilling is explained by both external and domestic economic developments. On the global scene the US dollar has been strengthening against all major currencies.

 

The prospect of faster interest rate rises in the US is pulling investors back towards US assets, driving the dollar to highs. Emerging Market and Developing Economies (EMDEs) have been particularly affected, as some of the EMDEs currencies have fallen to new record lows.

 

The US dollar index, which measures the strength of the US dollar against a basket of major international currencies, indicates that the US dollar strengthened by 2.0 percent in November 2016. Over the same period, Uganda’s trade weighted exchange rate index, the nominal effective exchange rate (NEER), depreciated by 1.8 percent, as trading partners’ currencies also weakened against the US dollar. This indicates that about half of the bilateral Shs\US dollar depreciation is accounted for by the global strengthening of the US dollar.

 

Regional currencies, have also weakened save for the Kenya and Tanzania Shillings. In November 2016, the South African Rand and the Zambian Kwacha weakened by 3.9 percent and 1.3 percent, respectively.

 

In Kenya, the stability was supported by Central Bank of Kenya (CBK) intervention, which injected close to USD 200 million into the market. This notwithstanding, the Kenya Shilling depreciated by 0.4 percent, during the same period.

 

The domestic factors explaining the weakening of the shilling include continued expectations of huge demand from ACTIS and a pickup in demand from offshore players, NSSF, telecom, manufacturing and oil firms amidst subdued dollar inflows.

 

The UK private equity firm, ACTIS sold its stake in Umeme and was expected to source for close to USD 30 million from the market. Consequently, key players in the interbank foreign exchange market built positions in expectation of this demand from ACTIS. It was not until Friday, November 18, 2016 that ACTIS’ demand of USD 18 million was settled.

 

During October and November, demand pressures were evident in the foreign exchange market. There was elevated demand for foreign exchange from the key sectors of energy, manufacturing, communications, trade, and offshore institutional investors amidst subdued inflows.

 

Analysis of volatility indicates that the shilling/US dollar exchange rate was relatively more volatile in October and November than in the preceding period.

 

This volatility was driven by a combination of domestic and external factors that created a lot of uncertainty in the market. Indeed, most of the currencies of Advanced and Emerging Market Economies have been very volatile of recent.

 

The Euro/US dollar and the Rand/US dollar exchange rate were more volatile than the Shilling/US dollar exchange rate in October and November.

 

A critical analysis of historical trends shows that there are usually depreciation pressures in August-October, and occasionally spilling over to early November. The depreciation pressures subside as demand pressures recede and inflows increase usually towards the festive season.

 

The risk though this time is that there are huge maturities of offshore holdings of Government securities. As at December 2nd, the total offshore exposure maturing over the next 7 days amounts to Ugx. 796.0 bn, which is about 34 percent of the total exposure.

 

At the currency of Ugx. 3,620/US dollar, the exchange rate has overshot its long-run steady-state level, estimated at Ugx. 3,450 – 3,550 per US dollar.

 

The continued depreciation of the exchange rate is a major upside risk to domestic inflation and may necessitate tightening the monetary policy stance.

 

Given these downsides, equilibrating the Balance of Payments through an interest rate adjustment seems to be a more plausible policy option.

 

Domestic Economic Activity

 

Against the backdrop of lower commodity prices and a less-supportive global environment, economic activity has decelerated sharply in recent past.

 

Over the last five years, real GDP growth has averaged 4.5 per cent compared to an average of about 7.5 percent between 2000 and 2011.

 

The domestic economic growth outlook remains subdued, although the low point of the cycle appears to be behind us. In FY 2015/16, the economy expanded by 4.8 per cent in real terms and by 8.5 per cent in nominal terms.

 

The key sectors that contributed to growth were services particularly information and communication services, agriculture and construction, while manufacturing experienced a notable slowdown. The poor performance of the manufacturing sector is in part due the dismal growth of PSC to the sector and lack of effective demand.

 

Demand for manufactured output has been affected by the conflict in South Sudan, which has curtailed Uganda’s manufactured exports to this important export market.

 

In the short-term however, the contribution of public infrastructure investment to aggregate demand is limited given the related import content of the related inputs. This investment is therefore not expected to provide a stimulus to aggregate demand in the short term.

 

There are downside risks to the projected growth path. Our trading partners’ economies are expected to grow at a slower rate than previously assessed, which will continue to weigh on Uganda’s merchandise exports.

 

The uncertainty surrounding post-Brexit, political uncertainty in the major trading partners, delayed implementation of public investment and adverse weather conditions that are expected to affect agricultural production could affect the growth trajectory.

 

Consumer Price Inflation

 

Annual CPI inflation averaged 4.3 percent in the November 2016 quarter compared to 5.3 per cent in the quarter to August 2016.

 

The Uganda shilling overvaluation in the first 10 months of 2016, contributed to dampening of inflation, mainly through its tradables component. non-tradable inflation averaged 5.3 per cent compared to 5.6 per cent in the same period.

 

However, the CPI data for the year ended November 2016 indicates a resurrection of upward inflation trend largely due to bad weather conditions that have affected food crop production.

 

Save for Energy, Fuel and utilities (EFU) inflation which declined to minus 4.1 per cent from minus 1.9 per cent during the year ended October 2016, the rest of the components of inflation edged up in November 2016.

 

Annual overall inflation rose to 4.6 per cent from 4.1 per cent in October, driven by a sharp rise in food crops and related items inflation. Food crops and related items inflation rose to 7.1 per cent from 1.7 per cent over the same period. Core inflation also rose, albeit marginally to 5.2 per cent from 5.1 per cent, driven mainly by services inflation, which rose to 6.6 per cent from 3.5 per cent in September 2016 largely on account of increase in education- related costs. Over the last four years, BoU has been very successful in achieving the inflation objective.

 

Source: Bank of Uganda State of the Economy Report December 2016

 

 

 

 

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