To understand what is going on in the economic arena, we need to clearly discern what are referred to as economic fundamentals.
By Prof Augustus Nuwagaba
A lot has been said about the prevailing economic hardships in Uganda.
Many people are not only finding it difficult to eke out decent living, but have found themselves in a cob web of debts. Similarly, many business enterprises are not only experiencing low profitability but are chocking with indebtedness, some facing outright closure.
As expected, in FY 2015/16, many commercial banks posted declining profitability largely emanating from non- performing loans. These are real problems affecting economic activity; yet, the country must sustain the growth trajectory as it has set herself to achieve the middle income status (per capita income of $1,000 by2020 and high income status (per capita income of $9,500) by 2040.
In order to understand what is going on in the economic arena, we need to clearly discern what are referred to as economic fundamentals. Basically, for an economy to grow, people must access capital-means of financing their envisaged economic activities. Currently, the cost of borrowing in Uganda is among the highest in the world.
Most commercial banks charge interest rates in the range of 20-24%.In his state of the nation address; President Museveni decried the high cost of borrowing from commercial banks. While there are many determinants of interest rates, one basic determinant is the level of domestic borrowing by the Government.
The fact that the Government continue with a large fiscal deficit (expenditure that is more than domestic revenue), it will be forced to borrow, if it has to meet her targeted expenditure obligations. Domestic revenue is still 13.2% of GDP which remains very low even by East African standards. The borrowing is largely effected through issuance of government papers-securities which mainly comprise treasury bills. The interest payable on treasury bills constitutes the benchmark from which commercial banks will determine their prime lending rates, after which the banks add other operational costs such as salaries of workers, utilities, among others.
Because commercial banks and other financial institutions have to manage risk, they prefer to lend to government (purchase treasury bills) rather than lend to private business enterprises (which are more risky). This clearly crowds out the private sector, hence, rendering economic activity subdued. Indeed, the contraction of credit in FY 2010/11-FY 2012-13 resulted in decline of GDP growth rate from 5.6% to 3.4 respectively. But this GDP growth also comes from the telecommunications and other service sectors, yet, these employ very few people.
The sector that should have been more economically democratic is the agricultural sector. This is because it employs more than 70% of the population but ironically, its contribution to GDP has been declining. We still have 68% of the population that is non- monetized. This discounts domestic revenue as subsistence activities are outside the tax bracket and do not boost economic activity. The subdued economic activity has been exacerbated by government budget management approach where infrastructure development (roads, railway, energy etc) continue to be the flagship sectors in the budgets (FY2010/11-FY 2016/2017). While it is fundamental to invest in infrastructure development, it is equally critical to assess the source of financing and the rate of return on such investments.
The use of short term financing for long term investments creates a “contraction effect” to the economy unless government makes deliberate attempts to innovate alternative means of accelerating velocity of money (money circulation over incomes). Because infrastructure has a “locking effect” on money-the correct economic term is that money invested in infrastructure becomes ”stock” and in order to have such stock create vibrant economic activity, other fundamentals are required. These include: enhanced production and productivity of sectors like agriculture, increased export sector performance (to boost exchange rate) and reducing unnecessary domestic expenditure such as bloated public administration.
You want to balance the need for infrastructure development, which is a long term investment, with prudent expenditure-hence, reducing the appetite of government borrowing. Otherwise, as we always say; in economic management, you will have a dilemma. You cannot achieve high domestic borrowing, long term investment in low return projects, low export receipts, high import invoices and hope to have low interest rates and high economic activity. It is impossible! Similarly, the private sector needs to be careful on investment decision.
A closer observation reveals that many business people have used short term financing for long term investments particularly in real estate development. They borrow at high interest rate and the returns have not been forth coming to cater for loan repayment. What has been the result? Auctioning of the investments since the owners have failed to repay bank loans.
I have been interacting with many of my friends in the private sector and most of them are in distress. At first, many people dismissed them as spendthrifts, socialites and wasteful, but as it has turned out, even the most frugal ones are also in distress. This implies that the winds of economic hardships are “locking all boats”. Without being overly pedantic, I would call for a “bail out” from government aimed at rescuing the private enterprises in distress.
In economic management, a bail out is never regarded as a solution to solve an economic problem, but the reality is that most companies in Uganda right now, are in serious financial quagmire and therefore need intervention. I know that the Ugandan economy is built on neo-liberal economics but as I have clearly demonstrated, we need a new type of economic approach right now and this is interventionism. Bailing out private business is always thought of by many economists as a moral hazard”.
People would question why government would move to socialize losses from private companies, while maintaining “privatizing profits” –companies never share profits with non-owners. The profits remain individual owner’s gains. Bailing out private companies therefore remains a paradox, but as President Obama said in the middle of the Global financial crisis, in 2008-2010, “it would have been even more immoral for a government to sit on the fence, when companies that provide employment, tax revenue and accelerate economic growth slip into a massive closure”.
The results of massive closure are usually more catastrophic; hence, President Obama had to unleash “the mother” of all stimuli, hence bailing out most American private companies under the weight of the global financial meltdown. It is this act alone in 2008/2009, which “saved” the world from slipping into economic recession, reminiscent of the 1929 recession, when the Federal Reserve of USA downplayed the urgent need for blanket stimuli to American companies.
The results of this recession were felt worldwide. The writing is clear on the wall.
The writer is a consultant on economic transformation in the African region