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IMF cautions Ugandan banks over treasury bonds

Peter 17th Sep, 2024 Economy Business Edge Reporter
IMF cautions Ugandan banks over treasury bonds

Bank of Uganda headquarters in Kampla. FILE PHOTO


In a new report, the International Monetary Fund (IMF) has warned commercial banks against overreliance on Government securities saying it raises serious financial concerns for the country’s economy.

Over the years, Ugandan banks have invested significantly in the country's treasury bond market, holding a substantial portion of government securities, which are needed to finance public projects and sovereign debt management.

According to the IMF, Ugandan banks’ holdings of government debt as percent of their total assets rose significantly from 21% in 2019 to 29% in 2023, which according to the IMF has resulted in elevated interest rates and contributed to subdued private sector credit growth.

  • “It also poses potential credit and liquidity concerns for banks in times of financial strain or sovereign credit downgrade,” the report reads in part.

Whereas some jurisdictions have regulations that mandate a level of government securities that banks must hold, the yield on government securities relative to other investment opportunities can influence the amount banks invest in many developing countries with fragile economies. If yields on government securities are low compared to other assets, banks might reduce their holdings in favor of more profitable investments.

However, the report notes that Uganda’s inflation outlook remains non-threatening though there are upside risks. Headline and core inflation are projected to continue their upward momentum, averaging 4.6% and 4.9%, respectively, in FY24/25 as the economic recovery strengthens, nearing the BoU’s target of 5%. Upside risks to inflation come from commodity price volatility, weather conditions, and exchange rate depreciation pressures stemming from limited capital inflows.

  • Overall, it says the country’s medium-term prospects are supported by the projected start of oil production in the last quarter of 2025.

“While Uganda is not expected to become a major oil exporter, oil production is expected to temporarily boost growth and help bring more durable improvements in fiscal and external positions,” according to the report.

Real GDP growth is estimated to have reached 6% in FY23/24, helped by favorable weather conditions, subdued inflation, and the positive impact of the roll-out of the Parish Development Model (PDM).

Additionally, the IMF is cautioning the Government against squandering the oil revenues on consumption and corruption.

“Once oil production starts, the windfall revenues should be used to alleviate structural impediments to growth, improve social development and ensure inter-generational equity,” the report reads.

  • A delay of oil production and slower-than-expected implementation of reforms pose other downside risks. With mostly rain-fed agriculture, Uganda remains vulnerable to climate shocks. Broader economic impact from the oil sector investments, favorable weather for agricultural harvests, accelerated structural reforms, and improved global economic conditions could improve the outlook.
  • A prudent fiscal management framework is needed to ensure effective use of oil resources once oil production starts, with part of the oil revenues used to scale up much needed growth-supporting and social spending, and the rest saved to ensure inter-generational equity.

Public debt is expected to remain at about 50% of GDP over the medium term, with the Debt Sustainability Analysis indicating that the external debt burden and public debt indicators remain below their respective thresholds and benchmarks though there is a moderate risk of overall and external debt distress. Also, the IMF is concerned that public spending on education and health remains below those in peer countries and affordability is identified as a top constraint by primary students failing to complete primary school.

The IMF argues that with Uganda’s population projected to more than double by 2060 from its current level of 46 million and 70% of that population projected to be of working age, Uganda faces enormous investment needs in education, skills, and health if it is to benefit from the demographic dividend.

Additionally, there is concern about climate change impacts on the country, with the frequency of floods and droughts increasing the country’s vulnerability to climate change in a context of high poverty levels and over-reliance on rain-fed agriculture.

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