ordinary Ugandans Will not survive the current economic environment
Reasons Why Uganda’s Economy is in a Sorry State
By Prof Augustus Nuwagaba (PHD)
The main talk in every corner of Uganda is the question whether the ordinary Ugandan will survive the current economic environment. I want to begin on a positive note that with God’s grace, people will make it through the hardships. Ugandans have survived more hardships before and even this, we shall survive though many may be wounded. Let’s keep hope alive. What is the problem?
To begin with The first problem is the structure of Ugandan economy, The country’s GDP (monetary value of all goods and services in Uganda per year) is estimated at USD 25Billion. But where does this GDP come from? It is from the service sector largely telecommunications (44.3%), but ironically, the service sector employs a paltry less than 1% of the population. The agricultural sector which employs 76% of the population ironically contributes only 23% of GDP.
This means that the sector which is clearly the most economically endowed and therefore capable of creating jobs and broad based growth is surprisingly incapable of doing so. It is this contradiction that the country continue to enjoy growth but which leaves out the majority that remain with low incomes, hence low aggregate demand. One can argue that the UK, or USA economy has agriculture contribution of less than 2% of the GDP. This is correct but remember the peoples also engaged in agriculture sector in these countries is actually less than 1%! So, there is no contradiction:
Solution: There is deliberate need to re-structure the economy, provide long term financing in the agricultural sector, increase investments, improve seeds, fertilizers, irrigation and production infrastructure, marketing, research, land access, agricultural mechanization and value addition.
These cannot be done by the private sector. The scientific laws dictate that water flows by gravity along a slope, but if you want it to ascend a hill, you pump it. Therefore, the government will have to invest in such hardware, because the private sector will not invest in such investments. They prefer easy software like the service sector.
Secondly problem of the Ugandan economy is what we refer to as low financial depth. There is low saving to GDP ratio of a paltry 13%. The banked population is 8.3% (commercial banks) and 68% remain in non-monetary sector (subsistence production) In Uganda, we have narrow financial asset base. We do not have wide sources of financing economic enterprises.
For example, our commercial banks (25 of them) do not have access to favourable financing sources. National Social Security Fund (NSSF) for example, could have widened financial access, but it has remained cautious with investments largely in government securities. In countries like Singapore, and Kenya, the pension sector is well developed and NSSF funds are available and these institutions lend both government and banks which in term lend to borrowers at lower rates. Kenyan financial depth is 63% while Uganda remains at 27%, indicating a very narrow base, hence use of expensive money which drives interest rates high.
Solution: There is need to liberalize the pension sector through creation of competition with NSSF. This will enhance financial depth, hence, avail long-term and cheaper capital to financial institutions especially commercial banks. However, the danger here is the credibility of the players given the sensitivity of pension funds. If the people have no trust in players other than NSSF, the whole game will not work.
Thirdly problem is fiscal policy management. This emanates from three major elements that is High domestic borrowing by government. This currently stands at UGX 10.48 tn. The impact of this is that it makes government borrower Number 1, which effectively crowds out the private sector. For starters, government borrows through issuance of government securities (treasury bills and bonds with interest rates ranging from 14-15%) and this sets the bench mark for Commercial bank interest rates. There is no commercial bank which will ever charge an interest rate below the rate charged on government securities. It is this factor that hikes interest rates in commercial banks. In Uganda, the average interest rates has been 26%. In Rwanda it is 16%, in Botswana, 7%, South Africa 10%, UK 1.2%, while Japan is 0.9%!!!!
Solution: I can bet that if government stopped domestic borrowing, commercial banks would be on streets looking for people to lend, and they would not find any at the current interest rates, hence, would be forced to reduce interest rates drastically. Still on fiscal policy side, there is an issue of government expenditure. Currently, the flagship sector is infrastructure comprising of energy, roads, and railway.
Focusing on infrastructure is good because as a country, we have very serious infrastructure deficit. No one can dispute the long term multiplier effects of infrastructure investments. The only problem is that infrastructure development can enhance growth but if the implementing country takes conscious decisions regarding contract management. There are very many infrastructure projects going on but largely by foreign companies. This is not bad given the good will particularly the securing of funds from countries where these companies come from.
However, what should have been done is to carefully study the contractual provisions and incorporate important “local content” clauses in the contracts (Karuma, Isimba, roads, oil pipeline, and refinery). These contracts should have for instance stated that the contractors must use a certain percentage of local materials and labour. If contracts are left open as seems to be the case, these projects will most likely result in excess importation of materials and labour, culminating in more balance of trade problems and even dumping. Lack of utilization of local labour and failure to purchase local materials results in low aggregate demand, as local people will not earn income from such projects and this is exactly what is happening right now.
Solution: Government need to clearly scrutinize infrastructure contracts and ensure local content in implementation of infrastructure projects. It is this very factor that rapidly transformed Singapore’s economy in 1970s and 80s. The adherence to local content in the construction industry by foreign companies enhanced aggregate demand, hence, creating phenomenal economic growth which was unprecedented in Singapore, propelling the country from a Per Capita GDP of USD 321 in 1959, to the current Per-Capita income of USD 56,000.
Delay in payment of suppliers to government. Many people who supply government with goods and services take long without being paid. Currently, the domestic arrears are estimated at UGX 1.3 tn. This factor contracts business as people will not have money to purchase goods and services, hence, slow growth as we saw in FY 2015/16 as the economy contracted from 5.0% to 4.8%.
Solution: There is urgent need for government to make good her obligation and promptly pay for goods and services provided by local business entrepreneurs. It is definitely not correct to insist on controlling inflation by way of not paying suppliers. This instead “kills” economic activity, kills self-motive incentive and dampens growth. The best way to control inflation would be from the supply side, through increased production which will cause prices of goods to plummet.
External shocks. The major issue here has been the slow growth in China and the global fall of commodity prices. The major fall here include drastic reduction in prices of minerals and agricultural products. When this happens, given the structure of Uganda’s exports, then, Uganda as a country earns less export receipts. This happened at the backup of increased import invoices, hence, deterioration in the balance of trade, resulting into current account deficit, which negatively affects the exchange rate. In recent months, everyone has seen the depreciation of the Uganda shilling against major currencies especially the USD. Solution:
The only way to solve this problem is increasing production and productivity and enhance value addition which would increase export sector performance. The depreciation of the shilling would have been a great advantage if Uganda was a net exporter. This would mean that our manufactured products would be very competitive in foreign markets. Unfortunately, we are a net importer (import more in value than we earn from exports) and hence, suffer from persistent Balance of Trade deficit, which is a serious blow to our Balance of Payments (BOP) and hence, complicating the exchange rate. The depreciation of the UGX against the USD is party the reason for the high NonPerforming Loans (NPL) in commercial banks, estimated at UGX 906Bn in FY 2015/16, hence, distressing many commercial banks. This is because importers borrow money in UGX, but exchange into USD, in order to pay for the imported goods only to discover huge losses due to depreciation of the domestic currency.
Supply side constraints. These refer to natural factors such as drought which has already affected food production. While government has projected growth at 5.0% in FY 2016/17 estimated to increase to 6.0% in FY 2017/18, these projections can only be ascertained if one is in control of all the factors of production. Unfortunately, we depend on God and the rains have delayed and as recently reported, seeds given to farmers under OWC dried due to lack of irrigation systems. This was very unfortunate. The result will be high food inflation which will have a systemic effect on overall Consumer Price Index (inflation) and high cost of living.
Solution: There is urgent need to invest in irrigation systems and agricultural production infrastructure so as to control production and food supply, which is the major driver of inflation. This cannot be done by the private sector.
Establishment of long term financing sources. This issue has been a subject of debate for a long time. The issue emanates from the fact that as a country, we lack robust sources of financing long term investments. You find entrepreneurs using short term financing sources for long term investments. For example, it is not possible to finance most agricultural enterprises through short-term loans from commercial banks. Similarly, you cannot invest in a Shopping mall or Steel Rolling using financing sources from commercial banks. Actually, out of the estimated UGX 906 Bn NPL from all the 25 commercial banks in Uganda, 16% of the entire NPL portfolio was invested in Agricultural related enterprises. This shows the risk for commercial bank lending to agro-based entrepreneurs. Remember, high NPL increases risk for subsequent loans, hence, further hikes interest rates.
Solution: Establishment of long term financing sources. This should be done by re-capitalizing Uganda Development Bank (UDB). My other suggestion to government has been to establish an Agricultural Bank which would pool financing capital through listing on stock exchange. The “best practice” in this matter is the Agricultural Bank of China (ABC) which pooled USD 26 Billion (equivalent to Uganda’s total GDP) and is the 4th largest bank in the world. Interest rate in this bank is less than 1%. There is need to restructure agricultural production. The sector must be reorganized, revitalized from consumption based agriculture to commercial agricultural production. There is also need to re-package agro-based production and create value addition, guarantee marketing, storage and post-harvest management. This has to be done along the lines of organized groups that generate high production, mechanization and marketing.
The Writer is an International Consultant on Economic Transformation in African Region.