Implications Of The Proposed New Financing Options For Uganda’s Debt Portfolio

By Emmanuel Ssemambo
2012
Following the implementation of the Multilateral Debt Relief Initiative (MDRI) in 2006, Uganda’s indebtedness to external creditors was reduced by over half, thereby rendering external debt highly sustainable. This created ample room for further borrowing.

On the basis of this borrowing space, authorities in Uganda are considering new financing options to cater for some of the planned large scale infrastructure projects especially in the productive sectors such as energy, transport and agriculture.

The new financing options suggested are borrowing from the domestic market for fiscal purposes and the issuance of a bond in the international bond markets. Such borrowing if pursued without caution and proper analysis would inevitably plunge the country back into the sort of debt problems encountered in the past. The current economic conditions on both the local and international scene, lend greater credence to these concerns.
This paper attempts to address these above concerns by looking into the implications of the proposed financing options for the country’s debt portfolio. Analysis was based on the World Bank and IMF Medium-Term Debt Management Strategy (MTDS) framework for formulating and implementing a debt management strategy for the medium term.

The results reveal that with 67.5 per cent of the instruments denominated in foreign currencies, the existing debt portfolio as of end June 2011 is highly susceptible to exchange rate risk, but is sufficiently immunized from interest rate volatility for long periods of time. The only likely source of interest rate exposure remains the short term nature of domestic debt instruments which necessitates frequent rollover. Although overall portfolio refinancing risk exposure is low, domestic debt exposure is very highly.

A total of 9 borrowing strategies were designed under three general themes namely: (1) Concessional financing; (2) High domestic debt and; (3) Issuance of an international bond. These themes are modified slightly by changing the maturity structure, interest terms or a combination of domestic and external debt to create the rest of the borrowing strategies. The performance of these strategies is assessed under three market scenarios namely: parallel shift in the yield curve, depreciation of the exchange rate and a combination of the interest and exchange rate shocks. Cost is evaluated using two measures namely Annual Interest Payment to GDP and Interest cost adjusted for capital gains/losses to GDP, while risk is defined as the maximum deviation between the cost calculated under the baseline market scenario and that calculated under the alternative (shock) scenarios.
Strategy 1 (S1) which maximises concessional funding is the most preferred strategy as it yields the lowest cost and risk characteristics compared to the rest. All strategies involving alternative financing options whether domestic or external will inevitably make Uganda’s public debt portfolio more costly and riskier. However, S1 is highly susceptible to exchange rate risk given that all financing is from external sources and denominated in foreign currencies.

Domestic financing is associated with increased interest cost as attested by the high annual interest payments to GDP ratios for all domestic debt laden strategies, with the cost rising with the share of domestic funding in the strategy.

Use of external non concessional funding sources is less costly compared to domestic borrowing, but greatly aggravates the interest rate risk of the portfolio particularly where variable rate instruments are used.
The following recommendations ensue from the findings:
In the short run government should continue with concessional external debt funding, since it yielded the lowest cost, despite the huge exchange rate risk, but should adopt measures of moderating the impact of exchange rate risk.
External non concessional financing should be contracted on fixed interest rate terms, since variable rate debt was seen to greatly exacerbate the public debt portfolio risk.

Prior to accessing international bond markets, ample time and resources should be set aside to allow for thorough preparations that will ensure that all strategic considerations for first time bond issuers are addressed before the issuance. This will ensure that the country gets favourable pricing for its bond.
Where a bullet bond is issued, it is recommended to set up a sinking fund into which resources for repaying the bond at maturity are deposited on a periodic basis as a means of mitigating the refinancing risk associated with such instruments.

There is an urgent need to create the requisite legal and institutional requirements to enable MFPED perform the role of issuing domestic debt for financing the budget.

Government should adopt policies geared towards the emergence of institutional investors in the domestic debt market as a means of widening the investor base. Government should expedite the enactment of the requisite legislation as well as implement all the other modalities.

Furthermore, MFPED and BoU should invest in the development of their human resource in preparation for the new roles.