Uganda not immune to contagion of the Euro Crisis

What Euro zone Crisis means for Uganda.(article as of end september 2011 published in the Uganda Bankers institute quarterly publication)

From late 2009, fears of a sovereign debt crisis developed among fiscally conservative investors concerning some European states, with the situation becoming particularly tense in early 2010. This included euro zone members Greece, Ireland, Spain and Portugal and also some EU countries outside the area. In the EU, especially in countries where sovereign debts have increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany. The pronounced sovereign debt increases in only a few eurozone countries has become a perceived problem for the EU area as a whole. If it wasn't for the euro, Greece's debt crisis would be an isolated problem -- one that was tough for the country, but easy for Europe to bear.

The EU debt piling and the Euro zone currency crisis, threaten not only the collapse of the Euro currency but the future of European Union and the health of world economy. The EU consists of 27 countries of which 17 countries share the EU currency .These economies depend so much on government spending as a percentage of GDP in that austerity will negatively impact on growth and still leave a high debt to GDP ratio . According to the EU's statistics body Eurostat, Italian public debt stood at 116% of GDP in 2010, ranking as the second biggest debt ratio after Greece (with 126.8%)

There are fears of a possible Greek default that continues to sway the financial markets; Portugal and Ireland are going through deep recession (just about the solvent camp) whiles the likes of Spain and Italy are solvent but illiquid. The likely debt default by Greece could spell Turmoil in the Euro zone and the EU at large, as there are fears of contagion. This could spark the debate on getting rid of Greece which would permanently undermine the security of troubled economies the famous PIIGS(Portugal,Ireland,Italy,Greece and Spain) of EU as well create the divide between the 17 countries of the Euro zone and remaining EU ten.

There is no simple solution to EU debt crisis but for certainty a rescue plan calls for collective support to the insolvent and illiquid countries, and imminently supporting the Greece in its inevitable debt restructuring as well as shoring up the European banks to withstand sovereign debt default. Thanks to the Germany Parliament that voted on September 29, 2011, in favour of expanding the powers of the European Financial Stability Facility (EFSF).Under the plan, the EFSF will be enlarged to €440bn (£382bn)-see http://www.guardian.co.uk/business/2011/sep/29/germany-backs-euro-bailout-fund. It will also be given the ability to give “precautionary loans" to struggling European countries, buy EU government debt, and provide funding to shore up the capital reserves of European banks. The vote approves the increase of Germany's guarantees from €123bn to €211bn. Germans approval though still faces the legislation challenges by other Euro zone countries, By 28th September 2011-Five countries (Estonia,Austria,Malta, the Netherlands and Slovakia.)were yet to ratify the measures The biggest concern being Slovakia since it did not participate in the first Greek bailout of 110 billion euros in May 2010.. As much as this wades off the immediate threat of a Greek default, the real debate remains on whether there will be enough funds to bail out larger economies such as Italy. Today banks don't have money and so don't some governments in Europe

The Euro crisis may also be only the first episode in which post-financial-crisis vulnerabilities converge to such devastating effect, implying that similar dangers for developing countries could emerge from sovereign debt crises. The Crisis in EU defacto will have implications on all frontier markets including in our economy (Uganda) esp. the banking sector due to increased financial volatility and the economy as a whole The transmission mechanism of this crisis will be felt through the entire financial services industry:

Most EU’s big spenders like Germany, France and Spain are taking necessary budget cuts as remedy to current debt crisis coupled with afore mentioned hard hit economies and this could  imply that Ugandan exports will be affected. Uganda exports coffee, tea, fish, flowers, vegetables and tobacco to EU countries. Uganda’s tourism sector which fetched USD 660 Million in 2010 and Remittances from Ugandans abroad will likely reduce as a lower euro will reduce the purchasing power of European tourists travelling to developing countries, and the value of remittances originating from Europe.

Due to the global nature of currency interconnected markets, Foreign Direct investments are expected to reduce. The higher interest rates on loans in Europe today and the apparent negative real interest rates, both foreign direct investments and portfolio flows are expected to reduce. The World Bank President Robert Zoellick intimated recently ahead of the global finance leaders in washington the week of 20^th september 2011 that stock markets in developing countries have been hit hard and capital flows have declined sharply since August when the euro zone's debt crisis intensified.  The markets have witnessed a flight-to-quality phenomena of late. Gold, Silver, the Yen and the Swiss Franc have seen tremendous growth in demand due to their perceived safe haven status, and this has pushed the price of the commodities to historical highs while the currencies have firmed strongly against the dollar.  However it should be noted that over the last few years, China and India have been major providers of FDI to Africa and to Uganda in particular. While the FDIs from the EU to Uganda have been majorly to the nascent Oil and Gas industry which implies FDI levels may not necessarily reduce significantly. The Euro crisis may constrain trade and other bank credit available to developing countries as it raises questions about the viability of European banks—especially those based in developing countries whose assets likely include large amounts of their own government’s bonds. But all international banks will be viewed as having either direct or indirect (through other banks) exposure to the developing countries-Uganda inclusive

With the EU debt crisis investors are switching to more stable currencies like the Dollar. In the week (22^nd -26^th September 2011) the Euro hit the record low (as per that time period) against the yen as investors thought safe haven in Japanese yen. The same week, the Ugandan currency hit an all time low of 2920.  Against the backdrop of envisaged reduction of exports, FDI, and remittances, the Ugandan currency could depreciate further.

Reducing development aid: Uganda’s main bilateral partners are from Europe  so as EU countries are pressed to cut budgets or least some of the countries are insolvent or illiquid, the development aid budgets will likely reduced as evidenced by some of the EU bilateral development partners who are reducing the partners countries they give development aid. Since the Global crisis in 2008, the development assistance has been on the reducing trend and projected to reduce further. The reduction is not solely based on the crisis but also on the fact the with Crisis, there is an increased demand for results and accountability

Source: IMF estimates and projections

However, the Euro Crisis coupled with the US credit rating worsening and China showing signs of weakness, especially in exports and labour osts have been rising steadily due to second round inflationary effects, the Crisis could be more devastating Uganda  than it was in 2008-. As much as the 2008 crisis had limited impact on Uganda and Africa as a whole but this time around there is slim silver lining for Uganda compared to the previous crisis. The fundamentals of macro-economic stability are poorly calibrated this time around. Inflation is edging higher(September headline inflation at 28.3%), the local unit is depreciating unabated, import cover is slightly above 3 months, corruption which acts as a quasi-monetary easing mechanism is still rampant, the fiscal regime is too lax given the economic cycle not forgetting the aforementioned transmission mechanisms FDIs, remittances and reduced exports . This is also backed by the World banks president’s statement that poorer countries had less fiscal space compared to 2008 to counter an economic downturn and some were “walking a monetary policy tightrope” trying to balance inflation pressures and effects of the euro zone crisis.

It is not all doom from the Euro crisis for Uganda and Africa as a whole- While Europe is preparing for a difficult consolidation course, whose nexus is still uncertain, Uganda should  now have the chance to shift into a higher gear, use the benefit of a lower level of debt (though rising) and a younger population and make possible investments that signify a more sustainable use of capital than we have experienced in the past few years

Uganda should;

• Closely monitor and tightly regulate the operations of foreign banks and of their links with domestic banks which may be prudent in the current circumstances.
• rely less on exports to the industrial countries and more on their own domestic demand and regional trade
• Continue tightening of the monetary policy to help revamp the investor interests since apparently the current inflation is higher than the treasury bills( negative real interest rates)Fiscal prudency in line with the national development plan investments needs to be  exercised complimentary to current monetary measures
• Ought to buttress its balance sheet by turning some of its assets into valuable assets that perform well in a downturn, like the one we expect. Gold bullion is a natural start. Silver and diamonds are also fair bets. A strong balance sheet will ensure that Uganda comes out of the global downturn on a much stronger footing.
• should exercise transparency of oil resources and management probably through joining international Extractive Industry Transparency Initiative .The oil proceeds could help bolster public investments, re-build reserves and as well reinforce economic activity

                                                                                                     

lessons u could learn from Asian tigers

The four Asian Tigers (Hongkong, Taiwan, Korea and Singapore) have been the fastest growing countries in the world for the past three decades. These countries have been hailed as models of development for other emerging economies. The main factors argued for their growth are mainly high saving rates and investment rates, outward orientation, factor productivity macro discipline, and other public policies. However there is continued lack of consensus over these factors despite most of the researchers agreeing over the promotion of a dynamic export sector and factor productivity as the major factors of growth.

Common characteristics of Asian Tigers

• Focus on exports: Where as other developing countries use import substitution strategies for economic development, the Asian tigers focused on export oriented industrial development to richer countries. Domestic production was discouraged through government policies such as high tariffs. also trading the surplus with the richer countries
• Human capital development – they developed specialized skills for their personnel in order to improve productivity
• They had an abundance of cheap labour  
• Sustained rate of high growth rates (probably double digits) for decades
• Non democratic and relatively authoritarian political systems during the early years
• High tariffs on imports in the early days
• Undervalued currencies
• High saving rate

A case of Singapore in particular between 1966 and 1990, the economy grew at remarkable 8.5% per annum, 3 times faster than that of the US growth, per capita income grew at 6.6% rate roughly doubling every decade. This achievement seems to be the kind of economic miracle. The employed share of the population surged from 27% to 51%. The educational standards of that workforce were dramatically upgraded. Also the country grew awesome levels of physical capital, investment as share of output rose from 11% to more than 40%.

Factors that engineered the robust growth in Asian economies

Although consensus has not yet been reached by different scholars/researchers and policy makers, the following are the mostly argued to be the factors behind the Asian tigers growth;

Skilled labour force- In the 1960s these nations were poor and had abundance of cheap labour. This excess labour was absorbed by labour intensive industries. Eg in 1965 Korea industry sector only employed 9.4% as opposed to 21.6% in 1980 yet agriculture employment fell from 58.6% to 34% over the same period. The excess labour was transformed into productive workforce through the education reform and yet remained competitively cheap. The focus was placed on education at all levels, all children attending elementary education and compulsory high school education. Money was also spent on improving college and university system.

Capital accumulation With respect to physical capital, the reasons can primarily be traced to the high savings rates. Policies also probably played a significant role in increasing the investment rate of the economy (High savings rates do not automatically translate into high domestic investment rates but nevertheless, the high savings rates have led to high domestic investment rates in Taiwan for example).As much as capital accumulation was key to the growth of these countries, capital productivity (recall labor transferred to industrial sector was accompanied with education reforms to add to its productivity) was essential. Capital productivity was attained through adopt foreign knowledge and technology. The technological catch up coupled with capital accumulation was significant to the Asian tiger’s growth.

Note For most researchers they argue that factor productivity (labour should be enhanced with education and capital enhanced with technological progress) is key for economic growth.

Outward oriented strategies/policies- The more rapid growth can be growth can be associated with much greater openness. Both exports and imports grew about twice as fast in the Asian economies as they did in the latin America. Asian economies maintained much high ratios of exports and imports to GDP. In hongkong and Singapore openness was achieved by ending all restrictions on imports and giving free rein to export sector. In Japan and Korea, and Taiwan, trade barriers were initially during the early 1970s however, the tariffs were gradually reduced. Among the tactics used in different countries were: exchange rate policies to favor exporters, export incentives, and selective tariff protection; financial repression, slowing financial sector development and consumer lending to provide cheap financing to industry – for exports, and for key industries; a high level of consultation between bureaucrats and business – both individual companies and industry groupings.

Slow growth rates of population- This played a great role in reducing family sizes (dependency ratios), creation of an educated labour force, accumulation of household and government savings, rise in wages and impressive growth of investments in manufacturing technology. 1965 each of the Asian tigers established family planning programmes and as a result fertility declined. Emphasis was also placed on civil education, increasing the rate of entry of women into the workforce and education sector; leading to delayed marriages. By 1995, the average fertility level was an average of two children per family (couple). Compare it with the Uganda’s current fertility rate of 6.7 births per mother. Smaller families produced 3 major demographic changes; slowed growth in the number of school-age children, a lower ratio of dependants to the working age adults and a reduced rate of labour force growth.

Ethnic homogeneity-Most of these Asian tigers had largely homogeneous ethnicity e.g. 98% of the Taiwan’s population is Han Chinese. Most researchers argue that ethnic homogeneity is beneficial with respect to creating institutions that are conducive to economic growth. Ethnic fragmentation leads to lower public expenditure on schooling, worse financial institutions, and lower spending on infrastructure. Also lower transactions are associated with ethnicity homogeneity.

Culture and Religious beliefs- Racial and religious harmony is regarded by the government as a crucial part of Singapore's success and played a part in building a Singaporean identity. Due to the many races and cultures in the country, there is no single set of culturally acceptable behaviours. BUddism is the most widely practiced religion in Singapore, with 33% of the resident population declaring themselves adherents at the most recent census. The religious beliefs of Singapore, hard work, innovativeness coupled with their culture of openness and harsh punishments for criminal offences led to a corruption free economy.

Flying Geese Hypothesis-In this case, countries in East Asia aligned successively behind the developed or advanced industrialized countries in their order of different stages of growth in the wild geese flying pattern. In this pattern the leading goose pattern is Japan, the second tier of countries are four tigers (Hongkong, Korea, Singapore, and Taiwan) where as the third 3^rd stage consisted of countries such as Indonesia, Thailand, and Malaysia).China and Vietnam served as the rear guard in the formation. The “flying geese” hypothesis predicts as labor cost surges in one economy, firms tend to move their investment to the less developed neighboring countries or regions to take advantage of lower wage rates. In the recent East Asian economic history, the phase of flying geese lasts less than two decades. The New Industrializing Economies (South Korea, TheTaiwan, Singapore and Hong Kong) absorbed most of the Japanese investment in the1960s and 1970s when the production cost in Japan rocketed up Eg in the early years Japan influenced most of these countries like Taiwan after the 2^nd world war and these countries adopted the Japanese economic model of economic development. E.g. China external trade development council and the bureau of industrial development were based on the Japanese models. Japan beyond being major trading company with developed countries, it became a major trading company with the Asian tigers e.g. under the policy of agriculturising Taiwan and industrialization of Japan, the Japanese heavily invested in Taiwanese agriculture.

Knowledge driven economy-it was realized that there is need for research and development if a country was to grow to economic maturity. The Asian Tiger governments committed to improving research and development. E.g. in Malaysia the research activity was/is determined by the needs of the industry including the needs of Small & medium industries. Even in these countries, the skills focus was professional and managerial occupational skills, research skills, professorship skill and technical skills. The industries became knowledge driven industries and e.g. in Singapore gradually 2 out of 3 jobs were for knowledged and skilled workers in manufacturing sector and 3 out of 4 of the export services sector. Investment in R&D meant that evidence advised policy decision making in these countries.

Effective and stringent public policies. This consisted of credible macro economic policies that kept inflation low, interest rates low, fiscal policies that focused on raising saving rates and investment rates, as well as policies that enhanced the development of infrastructure. These factors consequently promoted private investment and growth. For example, in Singapore despite the lack of natural resources and the absence of a large domestic market, high growth rates and eventually development were realised. This remarkable success has been attributed largely to sensible and effective policies and the early attention paid to Singapore’s infrastructure

Politically, many of the tiger economies have a recent history of military rule. However, a number of them have liberalized in recent years and Taiwan, Thailand, and South Korea are now amongst the most democratic countries in Asia. This political liberalization may make it more difficult for the tiger governments to resist demands to expand the size of their higher education systems still further.  This kind of political system gives government the leverage to meet its development goals according to what it considers priorities as opposed to a democratic system where issues of equity, gender, ethics, etc are paramount.

Pegging performance to milestones

Much has been written about pegging remuneration to performance in the business world. The unique feature of the Singapore system is that public service remuneration was pegged to performance which was benchmarked against the milestones that had been agreed upon by the agencies and the parent ministries. At the highest levels, political office holders and senior public servants had their salaries pegged to economic performance and the salaries of the top echelons of a group of key professional classes. At the lower levels, compensation was pegged against performance against milestones.

Quality and standardization: Emphasis was placed on production of high quality standardized goods that would compete at the global level. Experts on Standardisation and quality assurance were brought in from Japan, US and UK.

budget overview 2011/12

Budget 2011/12.

Reference made to Table 1 below.  The proposed budget for 2011/12 is 9,840 Billion compared to the approved budget for 2010/11 of 7,556 Billion-which shows a 30% increase. However the projected expenditure for 2010/11 is 9,325.7 Billion, recording a deviation between the approved budget and the projected expenditure of 24%. The increase of the proposed budget 2011/12 from the projected expenditure outturn for 2010/11 is marginal – of 6%.  Notably also inflation for the year ending May 2011 is 16%, implying without the use of supplementary budget in the coming FY, the 6% increase is less than the prevalent inflation rate of 16%. Thus in real terms the proposed budget 2011/12 is lower than the projected expenditure outturn for 2010/11.

Table 1: Budget comparisons between FY 2010/11 and 2011/12
Details	Approved Budget 2010/11	Projected outturn 2010/11	proposed Budget 2011/12	Deviation between Projected outturn 2010/11 and Approved Budget 2010/11	Deviation between Proposed Budget 2011/12 and Approved Budget 2010/11	Deviation between Proposed Budget 2011/12 and the Projected outturn 2010/11
Amount In Billion UGX	7556	9325.7	9840	23%	30%	6%

Budget Priorities:

The budget priorities are in line with the National Development. The priorities this year are; Infrastructural development in roads, Railways, and Energy, enhancing agricultural production and productivity. Employment creation esp. for the youth and women, human resource development and improving public service delivery;

The biggest allocation is to the education sector.

NDP, MTEF Alignment

·         At aggregate level, the MTEF is marginally mis- aligned to the NDP in that the anticipated overall expenditure framework in the MTEF is 0.5 percent less than what the NDP stipulates (Table 2).

·         The mis-alignment is even larger at sector allocation level, with a misalignment of 37 percent between the MTEF and NDP in FY 2011/12.

·         However, if the supplementary funds were allocated in accordance to NDP priorities, the sectoral misalignment would have been reduced.

Table2 : NDP alignment to MTEF
	FY10/11	FY11/12	FY12/13	FY13/14	FY14/15
Overall Deviation	(10.6)	(0.5)	(1.6)	(3.5)	(14.5)
Composition Deviation	36.18	37.29	36.74	42.44	36.24
Source: Calculations based on Budget speech MTEF 2011 data

Deviation between the NDP and Budget FY 2011/12

	FY 2011			FY11/12
Sector Shares	MTEF	NDP	Deviation	MTEF	NDP	Deviation
01 Agriculture	6.1	6.6	(0.5)	4.7	6.0	(1.3)
02 Lands, Housing and urban Development	0.3	0.5	(0.2)	0.4	0.6	(0.2)
03 Energy and Mineral Development	5.5	6.7	(1.2)	13.0	11.8	1.2
04 Works and Transport	14.6	23.6	(9.0)	14.2	23.7	(9.5)
05 Information and Communication Technology	0.2	0.8	(0.6)	0.1	0.9	(0.8)
06 Tourism, Trade and Industry	0.7	2.0	(1.3)	0.6	1.9	(1.3)
07 Education	17.5	14.6	2.9	15.3	13.1	2.2
08 Health	9.3	14.5	(5.2)	10.7	13.6	(2.9)
09 Water and Environment	3.5	4.6	(1.1)	2.9	4.4	(1.5)
10 Social Development	0.4	1.6	(1.2)	0.3	1.5	(1.2)
11 Security	9.1	6.2	2.9	7.5	6.1	1.4
12 Justice/Law and Order	7.5	3.7	3.8	6.0	3.3	2.7
13 Public Sector Management	11.8	7.0	4.8	11.2	6.2	5.0
14 Accountability	6.9	4.1	2.8	8.9	3.9	5.0
15 Legislature	2.3	1.4	0.9	1.8	1.2	0.6
16 public Administration	4.2	2.1	2.1	2.5	1.8	0.7
Total	100.0	100.0	0.0	100.0	100.0	-
Source: Calculations based onBudget speech MTEF 2011 data

Fiscal Framework

• The graph below shows that expenditure spike in 2010/11 FY. The spark led to a higher deficit but the projected to decline in the outer years starting FY 2011/12.
• Given the revenue trend for the earlier, it seems ambitious to predict the progressing revenue to GDP ratio when it as averaged 12-13% over the years

FY	2007/08	2008/09	2009/10	2010/11	2011/12	2012/13	2013/14	2014/15	2015/16
Domestic revenue % of GDP	13.3%	12.6%	12.4%	13.2%	13.7%	14.3%	14.8%	15.3%	15.8%
URA revenue % of GDP	12.9%	12.2%	12.1%	12.9%	13.4%	14.1%	14.6%	15.1%	15.1%
Expenditure % of GDP	18.2%	17.4%	19.6%	24.0%	21.5%	21.3%	21.2%	18.7%	19.0%
Donor grants and loans % of GDP	5.1%	5.3%	5.1%	6.9%	6.3%	5.9%	5.9%	3.9%	3.9%
Fiscal deficit  Incl. grants	1.9%	1.9%	4.7%	6.6%	4.1%	4.6%	4.7%	2.3%	2.2%

Future prospects and challenges

• Oil Forecasts-Discoveries made to-date can support production of over 100,000 barrels of oil per day for 25 years.  At the current barrel price of 130 USD, that would mean potentially gross revenue of 13,000,000 USD per day for the next 25 years. This figure does not take into consideration the transaction costs. Bearing in mind the oil prices will only go higher in future.

·         Job Creation and Employment Strategy: Interventions include: a youth entrepreneurship venture capital fund to be established (Ush. 25 billion), undertake a youth entrepreneurial training programme (Ush. 3.5 billion), and undertake business development skills clinics (Ush. 1 billion).

·         Improving Government Effectiveness in Service Delivery: Several measures from which Ush. 40 billion has been saved have been instituted as follows: effected cuts of 50 percent on advertising budgets for all Ministries and Agencies; effected cuts of 30% on the budget for allowances, workshops and seminars, travel inland and abroad, fuel and vehicle maintenance, printing and stationary, welfare and entertainment, books, periodicals and newspapers, special meals and the purchase of furniture for selected Ministries and Agencies; and freeze the purchase of Government vehicles, except for critical areas such as hospitals, police and the security services and an immediate forensic audit of Government salaries, wages and pensions will be conducted to establish credibility.

In addition, the following measures will be implemented, in collaboration with the ministries of Public Service, Works and Transport and the Public Procurement and Disposal of Assets (PPDA) Authority to improve service delivery:-Hold Accounting Officers, including Chief Administrative Officers personally responsible for the delivery of performance targets, once funding has been made available to them; Implement performance contracts for top civil servants up to the level of Heads of Departments to strengthen performance management and enhance transparency and accountability; Enforce use of unit costing for all government procurement, against which mis-procurement will occur if reserve prices are not met; and Enforce use of government-procured equipment in the maintenance of national district and community access roads, with operational financing from the Uganda Road Fund and Uganda National Road Authority. Any waivers to use private sector contractors will first have to be approved by the Treasury.

Inflation Measures in short to medium term folds;

First the focus on curbing food prices with through mainly increasing agriculture Productions and Productivity: interventions include: maintaining the Agricultural Credit facility (Ush. 30 billion); through NAADS increase commercialization of improved seeds and other planting materials; strengthen disease and pest control, and in collaboration with the private sector provide irrigation and water harvesting technologies.

·         50% excise duty tax reduction on sugar prices. To the critics, this reduction is insignicant-50% reduction is 25 UGX reduction from the 2,700 UGX price per kilogram. Of Which 25 shilling cannot afford anything today in Uganda.

·         Completion of the 250MW bujagali Hydro project which will reduce to some extent energy costs

·         Excise duty removal on kerosene. The critics again argue that removal of excise duty on kerosene means 200 UGX has been taken off from the 2800 UGX per litre of kerosene. 200 UGX cannot afford a sachet

Challenges;

·         Corruption; the World Bank 2005 /APRM mechanism estimates 500BN loss every year through corruption. Which implies over the last 12 Years- 6 trillion shillings has been lost and yet the average government expenditure over the same period has been about 5-6 trillion UGX. This implies a full budget year has been lost in the last 12 years

·         Budget indiscipline- use of supplementary budgets undermines credibility of budget