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Understanding debt and its impact on the economy

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Added 21st June 2018 07:45 AM

At individual or household level, we all acquire loans of different magnitude and from different sources. This is the same with the National debt.

Understanding debt and its impact on the economy

At individual or household level, we all acquire loans of different magnitude and from different sources. This is the same with the National debt.

ECONOMY 
 
By Augustus Nuwagaba 
 
KAMPALA - On June 8, 2018, the President of the Republic of Uganda, President Yoweri Kaguta Museveni,  delivered the State of the Nation Address to Parliament.
 
On June 14, 2018, the National Budget was also presented to Parliament and the Country at large.
 
The budget is essentially a plan on proposed Fiscal estimates on Revenue and expenditure.
 
I was invited to both occasions and one of critical issues was National Debt. National Debt can be categorized into two categories namely: Foreign debt and Domestic Debt.
 
Currently, Foreign debt constitute USD 7.8bn while Domestic Debt stands at USD 3.4bn implying that the total Debt amounts to USD 11.2bn. The economics of National debt is not different from individual debt management.
 
At individual or household level, we all acquire loans of different magnitude and from different sources. This is the same with the National debt.
 
All countries from the largest economy United States GDP of 18.57 trillion to the poorest country Central African Republic with a GDP of USD 1.76bn, everyone has a debt at one time or the other.
 
Actually, it is important to note that usually, the richest people have the largest quantum of debt.
 
Similarly, the richest countries tend to be the most heavily indebted. For example, USA has a debt/ GDP debt ratio of 113.06%, Germany debt stands at 68.1% of GDP, Turkey has a debt amounting to 42.4% of GDP, and UK debt is 88.3% of GDP.
 
Uganda current debt  
 
As explained earlier, Uganda's debt currently stands at USD 11.2bn. The Debt/ GDP ratio is currently 38.6% of GDP (USD 28Bn).
 
This is construed to be within acceptable threshold because it is when debt is beyond 50% of GDP that the economy will be construed to be in the danger zone.
 
So, how do we understand Uganda's debt? Is it good or Bad? The goodness or badness of the National debt is understood through calculation of what we call Debt/ GDP ratio as already applied above.
 
Is the debt sustainable?. Does the country have capacity to service the debt?. At corporate level, is the company able to repay the loans i.e. is it a going concern?. Or you are insolvent, meaning you do not have capacity to repay the loans even if you disposed off whatever assets-current or long term.
 
The other critical issue in regard to debt is: What did you use the loans for? It is always important that loans are used for productive investments.
 
It is only through this that the country can invest, generate economic activity, accelerate growth and widen benefits to the population. This is what we call productive debt.
 
For Uganda, most of the loans have been acquired for infrastructure investments, particularly energy and roads. There is no dispute what so ever that these comprise the most fundamental pillars that stimulate economic activity and drive growth.
 
Uganda has experienced significant infrastructure deficit - Load shedding and poor road network. These raise the cost of conducting business? Poor roads and lack of electricity cannot attract foreign or Domestic Direct Investment.
 
It is therefore positive that the Uganda's economy is moving towards energy sufficiency. Similarly, previous gaps in road network are increasingly being closed.
 
The problem would be to invest such loans in consumptive sectors such public administration. It is therefore pertinent that you acquire a loan for completion of your project, generate returns rather than acquire a loan for a wedding or construction of your residential house.
 
However, notwithstanding the foregoing, there is need to consider the following:
 
Source of loans: It has been demonstrated that infrastructure investments are long term investments whose returns cannot be realised in short or medium term.
 
This therefore, posits to the need for carefully considering the source of the loans so that we focus on concessional borrowing. The aim is to apply Pecking order principle where cost of money borrowed is affordable.
 
This is when you can be able to meet your repayment obligation to your creditors. It should be noted that no one will carry out profitable economic activities unless the cost of doing business is conducive.
 
As indicated, the most driver of cost of doing business is the cost of money- interest rate. All banks whether World Bank or Commercial Banks exist because they lend out money to make profit. It is however imperative to note that agro based economies such as Uganda with nascent industries need low cost of borrowing, if the sought investments should be profitable and competitive.
 
The major challenge in Uganda remains high interest rates- currently in the range of 20-24%. This is compared to Botswana 8%, South Africa 10%, Kenya 14.5%, Rwanda 16%, UK 1.2% and China less than 1%. So, how will a Ugandan business person compete with businesses from these countries?
 
This is because the high cost of money will negatively affect the economy due to high repayment rate which definitely depletes the resource envelop to other critical services such as health, education, agriculture-extension and financing of SMEs.
 
Indeed, our debt repayment, this FY 2018/19 comprises 30% of the National Budget amounting to UGX: 10.2 trillion.
 
It is good that we can actually manage to repay, indicating that as a country, we are credit worthy and URA should be commended for enhancing domestic revenue collection.
 
But, in terms of impact on economic growth, it is essential to ensure that we do not remain in such a situation for long. As Peter Boockvar has asserted, "Debt is not realized as a problem until it is a problem".
 
Attract loans when proposed projects are investment ready; there have been circumstances when loans are acquired only to find that you are not ready to implement the proposed project.
 
This is undesirable because the creditors begin calculating their interest immediately they disburse the loans.
 
Local content for investment projects. It is positive that government has invested heavily in infrastructure projects, electricity dams and roads.
 
However, these projects would generate more benefits both forward and backward linkages, if the local content close in the contracts was strictly enforced. This would ensure that local suppliers of materials as well as local labour namely: local artisans, engineers, consultants etc benefit.
 
The growth would be real because the investments would involve the local people who need to feel the benefits. Uganda can borrow from Ethiopia, Vietnam and Mauritius where the local content closes in public investment projects are strictly enforced and the benefits have been phenomenal.
 
One pertinent issue is that while it is positive that we now generate excess power, it is important that this power is affordable.
 
Otherwise, there will be electricity line criss-crossing various areas but people fail to tap the power.
 
Similarly, this power will attract investors if it is cheaper compared to other countries. Currently, the cost of electricity in selected countries is as follows: USA 9.9 Cents, Mauritius 9 Cents, Ethiopia 9 Cents, Canada 10 Cents, Rwanda 14 Cents and Uganda 17 Cents.
 
The implication is that Uganda electricity is very expensive relative to the above selected countries. All efforts need to ensure the lowering of the cost of doing business, Otherwise, as regards, attracting investors, these countries would be more competitive in cost of industrial production.
 
The writer is an International Consultant on Economic Transformation in the African Region. Can be reached at: reevconsult@infocom.co.ug.
 
 

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