Monday, 2 January 2017

The Uganda Economic Outlook 2017: Economic prospects in 2017 to remain mitgated

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.

Monday, 25 July 2016

Do bailouts make economic sense?

In economic theory, a moral hazard is a situation when one party will have the tendency to take risks because the costs that could incur will not be felt by the party taking the risk.  This intuitively is my reading of private companies seeking a bailout from government, on grounds of being economically encumbered— of which some are supposedly under receivership. Private companies are supposed to promote growth in the real economy (create employment, privatise profits; and pay taxes) not impose a tax burden (nationalising their loses).  The list of 65 companies has a collective non-performing loan exposure of Ushs. 1.3 trillion shillings, just 2% of the GDP or 5% of the total commercial banks’ assets.  This share is rather small, compared to Europe’s fourth largest economy – Italy whose share on risky loans is 20% of GDP.  50% of those loans are characterised as non- performing loans.   However, the interesting perspective is that the bailout alternative in Europe remains off the table.  So the question becomes whether the proposed bailout for Ugandan companies makes economic sense.

At a macro level, there are compelling reasons for a no bail out. They perpetuate an ineffective status quo, risking a trumponics (a chain of bankruptcies) and ‘a lemons problem’ (government stake inefficient companies) but also likely to dent Central Bank independence and credibility.  This ‘too big to fail syndrome’ also comes with economic disincentives and is essentially used only in in economic downturn/crisis cases (not mere economic lapses). The Bank of Uganda supervision report for 2015 in June 2016 indicates that banking sector remains solid, liquid, profitable and well capitalised despite the rise in Non-Performing Loans (NPL). The banking sector’s total assets grew from USh.19.6 trillion to USh.21.7 trillion between December 2014 and December 2015. Profits after tax increased by 12% to UGX USh.541.2 billion in 2015. For the corresponding period, the volume of NPLs grew from USh.389.6 billion (4.1 % of total gross loans) to USh.573.4 billion in December 2015 (5.3%).  In addition, Uganda’s growth remains solid at about 5%.
Again, trickle-down economics suggests the throwing money at a few companies does not end up helping ordinary workers.  This position is shared by Mr Patrick Muhweire, CEO Stanbic Bank Uganda, who while at the July 2016 LeoAfrica Economic Forum, intimated the regressive effects of the bailout. He argued that these bailouts would not address the fundamental structural problem of unemployment, indicating his bank (largest bank in Uganda accounting for 18% of total banking assets) only employs 2000 people. So collectively these companies don’t employ a sizeable share of population. The majority of these companies fall under service sector, which employs less than half a million Ugandans.  
The alternative to debt is private equity and should be the first line that these companies should explore.  Deductively there is a reason these companies are not listed on the Ugandan Stock Exchange markets or least issuing corporate bonds.
Again can Uganda afford the bailouts? The government bailout would imply borrowing.  The Ushs. 1.3 trillion Bailout package would be approximately 7% of the budget for FY 2016/17 and 10% of the domestic revenues for FY 2016/17.  Domestic public debt was more than the domestic revenues in FY 2015/16. The level of domestic interest payments account already for a sizeable share of the budget at 10%. The existing stock of debt remains susceptible to both domestic interest rate shocks and exchange rate volatility.   The depreciation of the Shilling by Ushs. 600 in 2015 increased the external debt stock of USD 5 billion by Ushs. 3 trillion (27% of the domestic revenue FY 2015/16).  

Bailouts are essentially a stabilisation remedy to warrant restoration of liquidity in the financial and private sector. They performed quite well in the US and developed economies during the recent financial crisis, in some cases, the governments have made dividends on the bailout stimuli package. The conditions for bailout must be in place, in order to avoid the negative implications on borrower discipline that largely has offsetting effects on real economic activity.  The Government of Uganda is yet to yield any dividends from recent equity stake in some companies (Hotels) during CHOGM summit. The companies face structural problems and more pertinently deficient demand for their products.  The answer for these companies lies in restructuring these loans, rebuilding their internal management process to efficient levels and then tapping into equity for alternative sources of financing.  The main bottlenecks to doing business are the key areas Government should focus its citizens’ resources than selective crony capitalists.

Is Uganda's middle income large enough to meet is future public debt obligations

The Bank of Uganda state of economy June 2016 report indicates that Uganda’s disbursed public debt was Shs28.1 trillion (about 31 per cent of GDP), an increase of Shs5.6 trillion relative to April 2015. The increment is about 50 per cent of domestic revenues for fiscal year 2015/16. The provisional public debt including undisbursed stood at Shs46.1 trillion (which is about 52 per cent of GDP). The reports highlights domestic debt indicators remain outside the threshold. In fiscal year 2015/16 and 2016/17, Shs4.7 trillion and Shs4.97 trillion of maturing domestic debt were rolled over. This refinancing risk is likely to persist in short-term owing to the composition of domestic debt- majority being of short term nature.  The Uganda public debt views among economists and other practitioners remain varying.
 The debate, however, remains centred on macro assumptions. Also, the debt sustainability assessments are underpinned by assumptions related mainly to the medium to long term projections of the trade deficits, budget deficits, and growth of the economy, inflation, and exchange rate. The recent macro-economic performance trend suggests that some of these fundamentals have weakened over the last five years. This is in part due to structural weaknesses and a difficult global economic environment, which is indicative of the outlook.  What the debate has not sufficiently delved into, are the micro and household characteristics of Ugandans that have a bearing on debt repayment.
Accumulation of public debt essentially means higher future taxes. For an estimated population of 36 million, each Ugandan is indebted to a tune of Shs780,000. The question is how rich are Ugandans today? How large is the middle class? At macro level, each Ugandan is worth Shs200,000 per month (monthly GDP per capita), which suggests that debt is affordable. But is the cake evenly split?
The Uganda Census 2014 shows that most of the Ugandans fall outside the working population, where by 51 per cent of the population depend on 49 per cent working population (between 15 years and 64). The median age of Ugandans is only 15 years and the economic characteristics of this Ugandan are dismal. Only 70 per cent of the working population age is employed and the majority are under employed in agriculture – 64 per cent of working population are involved in the subsistence agriculture- hand to mouth employment. 
This backdrop suggests that Uganda's middle income is rather small. This is also supported by the 2014 Uganda poverty status report that indicates that 64 per cent of population earn less than Shs200,000 per month (($59.5 per month also equivalent to $2 per day). The USD 2-10 is considered as the realm of lower middle income. Less than one million Ugandans, earn more than $10 per day (Shs33, 700 per day or approximately Shs1,000,000).  This narrow income scope is also traceable in the respective registers of PAYE and the NSSF members; each having less than one million. Of the 998,557 on the PAYE register, only 560,000 earn more than Shs410,000 (in the tax bracket exceeding 410,000).   Another illustrative indicator is the number of cars in the economy; the maximum number of private cars within the registered scale UAA 001A to UAZ 999Z are less than 650,000. Factoring in non-private registered cars suggests a total stock of less than one million cars.  

Juxtaposing the sector composition of GDP and the respective employment suggests a paradox. The service sector that accounts for more than 50 per cent of GDP employs the smallest share of labour force. The state of nation address 2016 indicates service sector only employs 430,000.  The employment of the industry sector that includes manufacturing is un-auspicious.  While over the last three decades, the economic structure has changed from agriculture driven economy to a service driven economy, the employment structure has not changed. The prospects of oil on employment are very mitigated, with only 15,000 direct jobs and a total of 150,000 including indirect employment (1 per cent of the current labour force).
The middle income class argument in isolation does not tell the full story and probably is not a compelling argument but arguably it has a bearing on macro assumptions that underpin overall debt assessment including tax collection. In developed countries, income taxes particularly from this class, account for a sizeable proportion of public revenue.  As Uganda aspires to become middle income, in part leveraged by public loans, it is prudent to address the bottlenecks to meaningful employment, the vast of whom are youth.

High interest rates in Uganda- a structural Problem. ( also published in monitor newspaper)

The developed economies have since the global crisis begun in 2008 used a zero bound (ultra-low) Central Bank policy rates to boost consumption, investment and eventually re-engineering the economic growth recovery as well as reverse deflationary tendencies. Some economies particularly those with current account surplus (a case of savings outstripping investment) have adopted negative interest rate policies.  The persistent sluggishness in recovery suggests that central bank policies including the notable printing of money are only necessary but not sufficient; structural reforms are warranted.
The developing countries particularly Sub Saharan Africa (SSA) have also seen slackening growth trends over the last 5 years, registering the lowest growth in 2015 over this period.  Unlike the developed countries, SSA is faced with inflationary challenges which compromise the loosening of monetary policies since most Central Banks are inflation targeting including Bank of Uganda (BoU).  This in part explains the high interest structure. In Uganda, the high interest rates are also arguably a manifestation of structural impediments and a high risk structure. Illustratively, even if the central banks were unimaginably to adopt zero policy rate frameworks, the interest rates would still be double digit implying a rather high risk premium. Even when the Central Bank Rate (CBR) was reduced from 23% in November 2011 to 11% in June 2013, the corresponding decrease in lending rate was marginal from 27% to 23%.  The risk is also encapsulated in the country’s credit ratings that suggests Uganda’s risk premium to be about 4%.   In a largely informal society like ours (nearly 50% of the economy) and rural based, the risk of individuals and private firms is priced in double digits.   
The commercial Banks's balance sheets indicate that the loans are backstopped by the cheap deposits. So then why is the interest rate spread (difference between lending rates and deposit rate) high? Why is the profit structure of bottom 15 banks unpropitious? The answer lies in the high risk, intermediation and structural costs. The risk is also demonstrated by the growing non-performing loans and bad loans. In 2014, non-performing loans in the commercial banking sector totalled to a sizeable UGX 385 billion.  From the published bank financial statements for 2015, the trend is on the increase, with two of the top five banks registering significant increases. As a result each registered a drop in profitability of over 50 billion.  4 of the 25 banks made losses with the bad loans outstripping the losses incurred.
The structure of the financial sector also has a bearing on interest rates. The sector is dominated by commercial banks accounting for over 80% of the assets and the rest is dominated by National Social Security Fund. The Fund’s largest investments are in government securities(bills and bonds) and to an extent lending to commercial banks at the Central Bank Rate(CBR) plus.  The CBR is at 16% as of April 2016 and government security rates are averagely at 23% in 2016.  The dominance of the top 6 commercial banks implies their market behaviour determines the interest rates.  The banks have also increasingly invested their excess reserves in the government securities (also known as domestic public debt), which excess reserves corroborate the fear of private sector risk. This can also be explained by the low levels of financial intermediation, with private sector credit accounting for 15% of GDP, which is low compared to the SSA average.
The ramifications of high interest rates on an economy are pronounced, prohibitive and indicative of weaknesses in long term health of the economy. As embedded in the BoU policy stance of raising interest rates to mitigate inflation, the higher the interest rates the lower will likely be the aggregate demand and economic growth. The 2015/16 downward revision of projected growth to 5% is partly attributed the rising interest rates in 2015. The lesser than potential economic growth (output gap) has implications for our long term objectives including the achievement of medium income status.  High rates tend to encourage consumer based activities rather while explaining the imminent market failures in productive sectors (Agricultural and Manufacturing) as well as the low financial market depth and breadth.
Widening and deepening structural reforms beyond the financial sector is required. The financial reforms should target inter alia long term financing, development of secondary financial markets, diversification of the financial sector and competition of the banking sector. Pragmatic approach aimed at optimal fiscal (budget) allocative and operational efficiency is essential and a cost benefit review of the current composition of budget is merited. This should consolidate public finances for sustainable growth.