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.