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.

Thursday, 10 March 2016


On the 18th February 2016, Ugandans cast their vote re-electing President Museveni for his fifth term, following his 30 year rule. The election wasn’t immune to controversy with a realm of issues highlighted by different commentators and election observers. Of particular interest to the economics of this country is monetization of the elections as well as substantial machinery purchase by police. A trend of increased budget allocations has always been a norm during election and pre-election years; the budget for 2006 election year encountered a supplementary budget to tune of 10% of the approved budget, while the 2011 saw a record supplementary budget to a tune of 33 percent of the budget. The same year also encountered a heightened expansion in money supply (inform of deposits and current in circulation).  While 2016 elections have seen the smallest share of the supplements as a percentage of the approved budget, the Financial Year (FY) 2015/16 approved budget was a sizeable nominal increment (30%) from the FY 2014/15.  Notably also the annual budget allocations nearly remain split evenly between development and recurrent expenditures despite the increased focus on infrastructural investments.  These trends in part exhibit the large administrative structure anchored around the president; also arguably reflective of the politics of lifetime presidency. As such, there usually pass-through effects on the economy in terms of heightened inflation, shilling depreciation, subdued private sector credit and resultantly a restrictive policy environment as remedy. In the next five years, we need to revisit the basic economic fundamentals that attach sizeable weight to the factors of production mainly land and labour as well entrepreneurship and capital.
Land as a primary factor of production should come high on the scale of preference of reforms but seemingly this has not been the case over the many years. According to the Sixth World bank Uganda Economic Update: “Searching for the GRAIL- Can land support the prosperity drive?”, Uganda's land is largely customary owned with only less than 20% of land registered (compared to 64% in Rwanda, 60% in Kenya and 50% in Ethiopia). The limited registration of land in Uganda coupled with weak institutional capacity for land administration has resulted into illiquid markets (characterized by limited land supply to match the overwhelming demand), consequently affecting development of the financial system and agricultural sector. Land disputes are estimated to reduce agriculture sector output by 5-11%.  Uganda also has a high population density of 194 persons per square kilometer compared to 80 persons in Kenya, and 116 persons in Ghana. This implies land is absorbing the majority of the labor force, without corresponding increases in the level of productivity.

When it comes to labour structure, it has a lot to do with the population growth trend of this economy. The latter has been growing at over 3% over the last decades, as such, going by the classical Malthusian theory of population, Uganda risks a population curse. At macro level, discounting economic growth by population growth implies an annual average GDP per capita growth rate of 3.5% over the medium term. Compounding the current annual per capita of USD 700 by 3.5% implies attaining a lower middle income GDP per capita of USD 1000 in 2027.  While growth rates look rosy, the discount factor is also large.  
In addition, population has consequences for the labour market developments, including but not limited to the rising level of unemployment and falling labour participation rate. This trend is irrespective of the fact Uganda has less than 900,000 degree graduates (just only 2.5% of its population). Over the last five or so years, average income or even wages have fallen in real terms, owing to the precarious economic environment of high inflation and high interest rates. An eclectic view at labour structure shows that the majority of labour force is in self-employment to a tune of 73%, most of whom, are in the informal sector and the agricultural sector. Informality is a reflection of market failures and calls for proactive government intervention.

By and large, the business as usual approach needs a tweak. Reforms are urgent, but difficult. There is need for an effective public service and this will require a couple of hard choices ranging from restructuring to reinforcing accountability.  Holistic restructuring is necessary, as opposed to the isolated Kampala Capital City Authority (KCCA) and the Uganda National Roads Authority (UNRA). As a matter of fact, few public institutions would garner high private sector interest if they listed on the stock exchange markets, a reflection of inefficiencies in these entities.  The KCCA and UNRA examples show that hard decisions have to be encountered, jobs may be lost, but these short term costs will be compensated by long term benefits. For example in the 1990s, the Swedish Social Democrats government made large cuts in the civil service. Around the same time, Canada cut government expenditure by 18.9% without social turmoil – and without greatly reducing health, justice, or housing programmes. They did this while maintaining tax levies, so the result was a reduced public deficit and falling public debt. These reforms in KCCA and UNRA should be subject to review periodically, to ensure there is value for money. Even in the current system, it would be necessary to require that the audit recommendations be either followed according to a strict schedule, or rejected with a convincing justification. The laxity on the latter has arguably had its fair share on the economy. Notably, the audit of the Auditor General's office has been pending for 10 years now.
These reforms can only go as far as the political environment allows. My appeal to the President over the next 5 years is to walk his talk "the next five years – there will be no playing games; no corruption and a more focused budgeting". There are no simple solutions and lasting reforms can only be achieved on the basis of a political and social consensus.

Uganda GDP is LIKE Kampala SHOPPING malls, Rosy in short run BUT SUSPECT in the LONGRUN

The Ugandan economy today lends credence to the famous Africa rising of the 2000s, and recent economic trends suggest an Africa rising paradox but a far better continent than the one dubbed hopeless of the 1990s. An aerial view of Uganda's banking sector, telecommunication, and the supermarket industry among others over the last five years suggests the struggle for the private sector is imminent as exhibited by forced acquisitions, mergers, farm downs, downsizing and closures. This has not been helped by the exacerbating economic fundamentals globally and domestically that are characterised by heightened inflation, depreciating shilling, and high interest rates. The latter is highly associated with the monetary policy response by the hiking of the Central Bank Rate (now at 17%) and growing government domestic borrowing through issuance of treasury bills and bonds reaching UGX 10.7 trillion in February 2016. The 364 Treasury bill rate reached 24.6% in February 2015 compared to average lending rate to private sector of 25%, implying the institutional investors including banks will prefer to invest in the government securities than the risky private sector given that government is considered risk free.

All these factors weigh negatively on Uganda's GDP. To many , GDP is abstract but stands for Gross Domestic Product, which is a measure of the level of economic activity over a period of time usually a quarter or year. GDP essentially looks at monetary value of all output (goods and services) generated within boarders of an economy, irrespective of who generates it (foreigner or Ugandan). Every country wishes to have expanding GDP, which in itself is an indicator of economic growth. When GDP expands, employment increases, workers, business and governments are better off. The latter would garner more revenue from heightened economic vibrancy of households and firms. However, high grow rates can fuel inflation, usually a case of too much demand, common with fast growing economies like Ethiopia.  The reverse is true, when the euro zone encountered recession in 2014 (consecutive GDP decline over 2 periods); the zone subsequently registered a deflation (prices falling over a period of time), a case of demand deficiency.
By and large, Uganda remains a small economy despite posting impressive average GDP growth rates of 7% annually between 1990-2010, before slowing down to an average of 5% over the last 5 years. The recent slowdown implies output gap (the difference between the actual output/production capacity of an economy and its potential output.  Uganda’s GDP was UGX 75 trillion (USD 25 billion) at the end of June 2015 and is expected to grow at 5% reaching UGX 79 trillion (USD 23 billion) in June 2016. In UGX, the economy would have expanded, but due to shilling depreciation, the value in dollars would be less. Over the long term, the exchange rate has increased from UGX 400 to the dollar in 1990 reaching UGX 3400 to date.   The key growth fundamentals backstopped by prudent fiscal and monetary policy related largely to influx of foreign capital, aid, private investments and resultantly employment in absolute numbers as well as labor participation increased. These streams of income and investments supported largely the evolution of the service sector, and asset (land and real estate) bubbles.  The growth of the latter exceeded the growth if the formal income and revenue streams (mortgages, remittances and household incomes), implying a mystery stream of income- arguably corruption.
GDP usually doesn't take into account the depreciation of the capital and buildings. The earlier  estimations also included some activities that have since sunken; a number of infant businesses that die within the first five years (statistically high), many buildings that have stalled, the roads that don’t last five years and number of half occupied shopping malls.  Overall the challenge has been that public and private investments that supported the earlier growth transition didn’t not focus on raising productivity in key sectors; manufacturing sector has only accounted for 7% of national output or GDP over last decade. Structural transformation hasn’t resulted; the interlinkages between sectors (agriculture, service and industry) remain very weak. The economy remains largely informal; accounting for 49%. Financial markets remain illiquid, small and undeveloped. While Uganda has bred business gurus, including the five that made it to the Forbes magazine list of richest Africans in 2012- each worth more than USD 50 million, none has yet to register any of their business companies on Uganda Securities Exchange (USE). The supply side of the national budget-public revenue has not grown significantly as a share of GDP, Revenue accounts for only 13% of GDP. All these factors emphasize structural impediments.
The macroeconomic policies may have dealt with short term economic fluctuations but the problems often go deeper than just demand (growth) dynamics. For example, monetary policy has been effective in controlling inflation by curbing demand through high interest rates but on the other end, inflation is rather a supply problem. The inflation cycle seems to be repetitive every three years, associated with global food and fuel prices or the domestic drought.  Fixing supply problems requires structural policies.
To a layman, the Ugandan economy may be equated to GARDEN CITY, very promising in its infancy but long term sustainability is suspect. The true ownership also remains blurry.