Uganda’s economy defies gravity, but for how long?

Uganda’s economy is now an irrepressible source of cheer, according to figures from the national treasury, even after grappling with Ebola outbreaks, lingering effects of Covid-19 and a darkened geopolitical climate.

The Finance ministry’s macroeconomic and fiscal report for the 2022/2023 financial year shows that the economy managed to manoeuvre those risks to post a positive trajectory.

Falling Inflation. Moderate industry growth. Rising gross domestic product. This is what a soft landing would look like.

Uganda’s economy grew at an astounding annualised pace of 5.2 percent in the 2022/2023 financial year, up from 4.5 percent the previous year, official data shows.

This was brought on by the aggressive increase in interest rates by the central bank following the Covid-19 pandemic, the expansion of the industry sector, as well as growth in the services, forestry, agriculture, and fishing industries.

“In nominal terms, the economy expanded to an estimated Shs185 trillion from Shs153 trillion observed in the preceding financial year,” said Matia Kasaija, the Finance minister, in the aforementioned analysis.

Around the world, inflation is cooling, prompting many central banks to stop their monetary tightening.

When the central bank increases interest rates at which it lends domestic banks short-term loans, it is said to be “tightening” monetary policy. In the end, this compels commercial banks to raise their lending rates for consumers and businesses, so they can generate a sizeable return on investment.

A higher interest rate may help control high inflation because, the economics theory suggests, access to credit becomes more expensive, which reduces consumption and investment. This is aimed to reduce money supply in the economy.

Tightening liquidity

In May 2022, the Bank of Uganda (BoU) was compelled to raise the central bank rate (CBR) from 6.50 percent to 10 percent after maintaining it at that level for a year.

The BoU maintained the 10 percent for 10 months, or until July, when inflation cooled to 3.8 percent. This then prompted the bank to lower the CBR by 0.5 percentage points to 9.5 percent, where it has remained stable for the past three months.

According to Mr Kasaija, this was largely aimed at protecting the economy against shocks such as a brief spike in inflation into double digits, which was mostly caused by rising fuel prices as a result of the conflict between Russia and Ukraine—the world’s major fuel producers.

By the close of the period under review, the country’s core inflation rate had dropped to 4.8 percent, below the 5 percent target set by BoU.

Many economists note that this was also largely fostered by the government’s reduction in spending since it is the largest spender in the economy.

The government spending decreased by Shs12 trillion, or 25 percent, in each of the four quarters of the approved budget for the 2022/2023 fiscal year, totalling Shs48.1 trillion, according to data from the Ministry of Finance.

As these economic indicators fared, businesses were struggling to access credit. Commercial banks’ loan interest rates continued to climb, peaking at 20.24 percent in February before falling to 18.95 percent in September.

This despite the fact that some economists believe that these are some of the compromises that needed to be made to keep the economy afloat.

“The government had to make an aggressive move by raising interest rates to save households high spending costs because inflation was so high. Yes, businesses were hurt because of the risen cost of borrowing, but the country needed to follow the priorities that point to households as the majority,”  Mr Corti Paul Lakuma, a senior research fellow in the macroeconomics department at the Economic Policy Research Centre (EPRC),  said.

But this move also raised the long-term bond yields sharply. Uganda’s government must now pay 3.93 percent more to borrow for a 364-day treasury bill from what it needed in May 2022 when the CBR began accelerating in the depths of the pandemic.

According to macroeconomic experts, these interest rates are good because they have at least cooled the heightened inflation that had got out of hand, depleting many households’ savings.

As those savings buffered, the high interest rates began to bite, causing consumers to spend less freely. This is where problems arose; some delicate businesses had to close shop after depleting their cash reserves.

High interest rates

In order to close gaps in their balance sheets, many banks are now hiking interest rates to highs of 19 percent as bankruptcies continue to rise nationwide. But this only reflects an economy in the rudest of health. A lot of financiers were recording high loan defaults in the last financial year, as a result of businesses struggling to sell and also run their operations in the depths of a slow economy.

A significant concern on the lending front is the rise in nonperforming loans, which, since the onset of this year, have surpassed 5.5 percent of the total gross loans.

The BoU anticipates that default rates for households and businesses will rise to 26.2 percent on a net basis in the 2023/2024 financial year, from the currently recorded 21.7 percent.

This is because banks are tightening lending terms to riskier clients while loosening them for prime borrowers, which entails higher interest rates to make up for lost revenue.

Even the Finance ministry is aware of this.  “There’s an anticipation that private sector credit might remain subdued in the immediate future due to the lingering impact of this monetary tightening on consumer and investor demand,” it stated in its 2022/2023 financial year performance report that was released on Friday.

“Over the medium term, the direction of private sector credit will be largely influenced by the economy’s growth trajectory. Nonetheless, the financial sector remains sound and adequately capitalised,” it adds.

The national treasury data shows that the country’s economic growth is expected to range from 7 to 10 percent over the medium term, mostly due to expected increases in manufacturing and agricultural productivity.

“The government is facilitating this through numerous initiatives, such as enhancing the quality of agricultural inputs, offering extension services, refining irrigation systems, and consistently investing in industrial parks and economic free zones.

Furthermore, the resurgence of private sector activity and investments, combined with the government’s sustained infrastructure investments and the expanding operations in the oil and gas industry, are set to provide additional stimulus to this growth trajectory,” it explains.

“However, it’s important to note potential challenges that could temper this growth, including immediate risks, encompass unpredictable weather patterns, potential delays in rolling out planned government projects, escalating global and regional geopolitical tensions, fluctuations in global commodity prices, and tighter global financial conditions.”

[email protected]