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.