In economics two expectation theories; adaptive and the rational dominate the deduction of future trajectories. The former essentially relies on the past to predict the future while the latter relies on the past but rationally factors in the prevailing policy framework. It is the latter backdrop that advised this article.
Both 2015 and 2016 have been economically challenging for developing countries, particularly Sub-Saharan Africa (Uganda inclusive), owing to domestic currency challenges, the fall in commodity prices, and a sluggish global economy. The global challenges are also encapsulated in the slower growth in China, the Euro zone as well the Brexit and Trump uncertainty. At the backdrop of Sub-Saharan Africa (SSA) registering the lowest growth in 15 years for 2015, its average growth is expected to slow sharply to 1½ % in 2016 (lowest in 20 years)-according to the 2016 October IMF Regional Economic Outlook. This slowdown is also reflective of slow economic performance of the 2 largest economies Nigeria, and South Africa. The two account for 50% of SSA output (GDP).
Real sector performance is expected to remain sound but below full potential prospects. Uganda’s economic growth eased to 4.8% in FY 2015/16, lower than the downward revised target of 5% and the 5% growth in 2014/15. Over the last 5 years, growth has slowed; averaging 4.3% per annum compared to an average of 7% in 1993-2010. Growth over the next year is expected to be supported by increased public investment expenditure and easing monetary policy stance. In the October 2016 monetary policy statement, the Central Bank Rate was reduced to 13% compared to 17% in March 2016. The high frequency indicators of economic activity (Business Tendency Index and Composite Index of Economic activity) remained positive the second half of 2016, showing the confidence investors have about doing business in the country as well as well as a continued recovery in the level of economic activity.
However, the downside risks prevail which suggests that aggregate demand and economic growth will remain subdued in the range of 4-5% over the next year: Global growth forecasts for 2016 have been revised downwards and particularly Uganda’s major trading export partners (Europe, China, and S. Sudan) remain with output gaps (difference between full potential and actual output). China’s growth is slowing, Europe is grappling with Brexit uncertainty, and S Sudan – Uganda’s largest informal export partner is locked down in political conflict and uncertainty. However, Kenya – Uganda’s top destination for its exports is poised to still grow modestly at 5-6%. Overall, external demand for Uganda exports will be mitigated over the next year.
Private sector credit growth, a leading indicator of the financial sector’s contribution to economic activity, has slowed- registering a 1% reduction between September 2015 and September 2016. Private sector credit growth is expected to remain slow, owing to fact that banks will be focused on repairing their balance sheets. From the published bank financial statements for 2015, the Non-Performing Loans (NPLs) are on the increase, with two of the top five banks registering significant increases. As a result each registered a drop of over UGX 50 billion in profitability. 5 of the 25 banks made losses with the bad loans outstripping the losses incurred. The first half of 2016s saw a rapid rise in non-performing loans on the bank books, with NPLs to total gross loans reaching 8.31% in FY 2015/16 compared to 3.97% in FY 2014/15. This in part manifested in the recent takeover of Crane Bank by Bank of Uganda (BoU) for failure to meet the requisite capital requirements. Crane Bank (t Forth largest bank in Uganda by asset value) was regarded as a Domestic Systematically Important Bank (DSIB) along with other two other banks- implying strong linkage with other commercial banks, and likely effect on the banking sector.
In addition, the private sector continues to compete with Government of Uganda (GoU) for credit, as also exhibited by recent growth of domestic public sector surpassing the levels of private sector credit. The increased domestic borrowing by Government of Uganda has not only increased beyond some benchmarks set out in the in the 2013 Public Debt Management Framework, but has also in part limited the scope of private sector to borrow (also known as crowding out). By end June 2016, total domestic securities (domestic debt) stood at UGX 11.7 trillion while the total private sector credit stood UGX 11.4 trillion. At the end of June 2015, they stood respectively at UGX 9.97 trillion and UGX 10.97 trillion. Government domestic borrowing in first quarter of FY 2016/17 at UGX 678.6 billion already exceeded the limit of set out in the annual approved budget of UGX 602 billion. This trend suggests that the private sector borrowing space will remain tight and crowded out by Government borrowing.
Theoretically, inflation constrains growth prospects. Uganda’s overall inflation averaged 9.5% per annum between 2011 and 2015, which essentially means 6 shillings in 2011 is worth 10 shillings today. This also indicates that purchasing power over the corresponding period has dwindled. While the October 2016 inflation of 4.2% is below the medium term target of 5%, the average annual (year to year) inflation January to October 2016 is 5.5%. However, prevailing risks suggest a likely increase inflation to 8-10% in next 6-12 months. The drought in many parts of the country this year will lead to food crop prices increasing in the next months.
The depreciation of Ugandan shilling also tends to heighten inflation pressures, particularly through imports, Electricity, Fuels and Utilities (EFUs). The exchange rate is predominantly used as the measure of external competitiveness, and in the Ugandan context- the shilling has been depreciating over last 30 years. The pace of depreciation of the shilling has been more pronounced over the last couple of years, and the largest depreciation (22%) experienced in 2015. The external weakness continue to prevail, particularly with current account deficit of 9% of GDP, slowing Foreign Direct Investment (FDI) and dwindling foreign exchange reserves of USD 3 billion (4.4 months of import value) in October 2015, compared to 6 months of import value in 2008. According to United Nations Conference on Trade and Development (UNCTAD) database, FDI to Uganda has reduced from USD 1.205 billion in 2012 to USD 1.057 billion in 2015. Also the oil prospects remain mitigated in the short run. The shilling depreciation pressure has increased in recent months reaching UGX 3500 against the US dollar. Owing the shilling depreciation at an average of 8.3% per annum over last 6 years, it is prudent to assume a similar trend, suggesting that shilling against the USD will be in the range of 3600- 3800 in 2017.
Overall, Uganda over the last 8 years has seen some of the economic buffers in form of strong economic growth, high levels of foreign currency reserves, modest and low inflation as well as stable currency, dwindle. Also the economy as a result of twin deficit (trade and budgetary deficits), together annually accounting for over 15% of GDP have increased the external liabilities in excess of USD 14 Billion dollars (54% of GDP). This implies that economy faces long term structural constraints and economy will remain susceptible to external shocks, manifesting into rising inflation, and weakening shilling. The heightened inflation expectations coupled with a weak currency indicate that the monetary policy stance is likely to be tight in 2017, which is an increase in CBR in 2017). Control of inflation comes with sacrifice of some growth prospects. As a policy response, GoU ought to maintain effective coordination of monetary policy and fiscal policy. Imperative is to regulate to the appetite to borrow domestically as well as improving the efficiency in public spending of appropriated budget. The business as usual days are behind us, real economic solutions with limited political interference will be key in the medium term.