Interest rates to remain high - experts

Jun 04, 2009

INTEREST rates are likely to increase due to the Government’s expanding fiscal deficit that has been fuelled by the economic downturn, economists have predicted.

By Sylvia Juuko

INTEREST rates are likely to increase due to the Government’s expanding fiscal deficit that has been fuelled by the economic downturn, economists have predicted.

Lawrence Bategeka, a research fellow at the Economic Policy Research Centre, said: “Because of the current environment, the Government is likely to operate a huge fiscal deficit. This is likely to lead to higher interest rates and inflation.”

According to the central bank, the cost of money remains high despite efforts to keep it low.
Bank of Uganda (BoU) slashed its bank rate by 3.4% from 19.3% to 15.8% in March, a move that forced a number of banks to reduce their interest rates.

BoU routinely publishes banks’ lending rates. The rates show that some banks charge as high as 24%.
A bank manager said lending rates are a reflection of unsustainable levels of the budget deficit and high cost of doing business in the country. The high cost of doing business is in form of utility, labour and security costs plus fraud and other risks, which have to be covered by high returns.

The large fiscal deficit, which is financed largely by donors, has in the past posed difficulties in managing the resultant significant liquidity injections. This has exerted upward pressure not only on the interest rates but also exchange rates.

Economists said the Government’s decision to transfer project accounts from commercial banks to the central bank was expected to orchestrate a fall in lending rates in the long-term.
However, because of other factors like the high cost of doing business, the move has not drastically impacted on the rates.

Finance ministry officials predict in a report that because of the global economic downturn, interest rates will continue to come under pressure.
They say the harsh economic environment has in part led to an increase in interest rates on government securities.

“This increase is closely associated with the credit crunch, which has made access to credit difficult. As a result, corporate institutions and private investors who previously borrowed from abroad have resorted to borrowing domestically,” says the national budget framework paper.

They noted that increased demand for locally available capital had pushed up interest rates.

“The situation has been exacerbated by a significant reduction in private foreign inflows for investment in local firms, which previously brought in foreign capital. Another factor is increased perceived risks of borrowers from developing countries who now face a higher risk premium in the international credit markets. This translates into higher interest rates domestically.”

The report says that to avoid increasing liquidity in the domestic economy, it would be prudent to issue government securities.

“Due to the current conditions, issuance of more government securities will only lead to higher interest rates, with severe consequences for private sector growth, which is the engine for sustainable long-term economic growth.

This also means the option of issuing government bonds to finance priority public investments is limited,” the report says.

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