Chapter

4 Growth and Foreign Debt: The Ugandan Experience

Editor(s):
Mohsin Khan, and Simeon Ajayi
Published Date:
May 2000
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Author(s)
Barbara Mbire Barungi and Michael Atingi 

During the last years of the 1980s, the external debt facing the sub-Saharan African countries received increasing attention. The immediate causes of the region’s debt crisis during the decade were the economic slowdown and the sharp increases in international interest rates; the latter resulted from monetary contractions in some industrial countries and the fiscal policies being pursued by the United States. However, the roots of these difficulties lay in the oil price shocks and the resulting unprecedented increase in international lending to developing countries in the 1970s. The debt crisis decade of the 1980s was therefore almost the mirror image of the previous decade. The failure of many sub-Saharan African countries to adapt—especially in the area of their domestic policies—to the changed external environment aggravated the debt-servicing problem.

Many countries responded with structural adjustment programs supported by the World Bank and the IMF that aimed to induce growth, restore price stability, and reduce external imbalances. Despite attempts by donors to provide debt relief, and despite the continued provision of external assistance, the situation continued to deteriorate; by the turn of the 1990s the economic position of most of the countries in Africa had become precarious. As a result, most countries in sub-Saharan Africa now look back at almost a decade of lost growth. Uganda is no exception, and it is against this background of economic adjustment that Uganda’s debt-service payment problems are analyzed here.

In the Ugandan case the decline in the foreign exchange earning capacity of the economy was aggravated by the decline of international coffee prices and hence receipts. This adversely affected Uganda’s ability to service its debt and led to the rapid accumulation of arrears. The urgent need to rehabilitate the war-torn economy amid declining export receipts forced the government to resort to external financing, which led to a sharp rise in the stock of debt in 1987. By June 1993 the stock of debt outstanding and disbursed stood at $2.64 billion, with arrears of $253 million. This stock of arrears, which had been reduced from $586.3 million as of June 1982, had caused legal action against the government from some quarters and had greatly jeopardized the government’s ability to manage its foreign reserves effectively. According to indicators, the debt outstanding and disbursed is estimated at 105 percent of GDP, with a debt-service ratio of nearly 80 percent, which constitutes a major bottleneck to Uganda’s economic recovery and future development. There is a need to move the economy onto a growth path once again; on these grounds the government has developed an external debt strategy that involves prudent debt management.

Objectives

The major aim of this chapter is to provide an analysis of the debt crisis faced by Uganda and its implications for sustainable economic growth. This chapter therefore has the following objectives:

  • to examine Uganda’s external debt, including its size, structure, source, type, and composition;

  • to assess empirically the internal and external factors influencing external debt accumulation;

  • to analyze debt-servicing capacity and the sustainability of the debt (the Cohen model is used for debt sustainability analysis); and

  • to draw policy implications for macroeconomic management.

Dimensions of the External Debt Problem

By the end of 1992 Uganda’s total external debt was $2.6 billion. Over 60 percent was outstanding to multilateral institutions; debt service to multilaterals alone in 1991–92 was 31 percent of the total. Arrears stood at $253 million (117 percent of projected foreign exchange earnings). The debt-service ratio did not fall below 34 percent in the next five years.

Given this situation, it is likely that Uganda will find it difficult to service even its multilateral debt in the future without a substantial reduction in the debt-service obligations that it has to fund from its own resources. The Ugandan government has thus developed an external debt strategy with the aim of restructuring the country’s debt. It is hoped that creditors and donors will adopt a flexible stance in recognition of Uganda’s exceptional circumstances.

The decade of the 1970s witnessed average annual growth in the debt stock of 18.5 percent, whereas in the 1980s an average growth rate of 13.4 percent was recorded. The terms of trade over the same period averaged 176.11 and 107.56, respectively (1987 = 100), which also resulted in dwindling export receipts. Export growth was negative because of the decline of commodity prices in the world market. The arrears (part of the debt stock) position grew from $30 million in 1987 to $5.9 billion largely because of the persistently low level of foreign exchange inflows, which could not sustain the high debt-service ratio.

Since the External Loans Act (1962) gave powers to contract loans only to the minister of finance, all loans contracted for the public sector were government guaranteed. The Exchange Control Act did not until 1990 allow any agent except the central bank (the Bank of Uganda) to enter into external financial transactions; this meant that all external loans had a foreign currency guarantee by the Bank of Uganda. The nonguaranteed debt was contracted by the government on behalf of the private sector and is very small. By the end of June 1992 the stock of debt to the private sector was estimated at $52 million, which was just under 2 percent of all debt outstanding and disbursed. This rose to $75 million by the end of June 1993.

Size and Magnitude of Uganda’s Debt

Table 1 shows the size of Uganda’s external indebtedness in both current dollar and constant dollar values for the period 1970 to 1990. Growth of Uganda’s external debt fell sharply in 1973. This was mainly due to the donor community’s economic and financial retaliation after the declaration of economic war in 1972, which led to the expulsion of the Asian community (the backbone of the trade and commercial sector at the time) from Uganda. This resulted in both a slowing of disbursements and a freezing of commitments to Uganda. The steep rise of nominal debt by 22.1 percent in 1974 reflects a single disbursement from a multilateral creditor. The external debt in constant dollars fell between 1973 and 1975.

Table 1.Uganda: External Debt, 1970–90
In Current DollarsIn Constant Dollars
In millions of U.S. dollarsChange from previous year (In percent)In millions of U.S. dollars1Change from previous year (In percent)
1970138.4443.6
1971160.716.1448.510.1
1972183.113.9515.85.6
1973189.03.2432.2–16.2
1974230.822.1377.8–12.6
1975240.34.1357.5–5.4
1976278.115.7408.914.4
1977354.127.3479.117.2
1978426.020.3524.89.5
1979574.234.8591.012.6
1980732.727.6621.35.1
1981793.98.4687.310.6
1982933.417.6851.323.9
19831,016.18.9973.214.3
19841,031.11.51,012.74.1
19851,171.313.61,171.315.7
19861,286.69.81,244.36.2
19871,659.028.91,456.417.1
19881,799.08.41,502.93.2
19891,809.00.61,493.8–0.6
19902,200.021.61,656.610.9
Source: World Bank (1992).

Computed by deflating the nominal external debt value by the World Unit Import Value Index, 1985 = 100.

Source: World Bank (1992).

Computed by deflating the nominal external debt value by the World Unit Import Value Index, 1985 = 100.

Most of the external financing from multilateral during the 1970s came from the African Development Bank and the East African Development Bank. There was steady growth in nominal debt between 1975 and 1979. This was mainly debt from bilateral sources dominated by Arab creditors, who had a major influence on both political and economic trends in the country during that time. Between 1979 and 1987 a number of developments affected Uganda’s level of indebtedness. The civilian regime that came to power in 1979 was quick to take advantage of reestablished ties with the donor community. The sharp declines in nominal debt (similar pattern of growth rate in constant terms) in 1984 and 1986 reflect the political and economic instability. In 1984 the stabilization program adopted in 1981 was abandoned in the midst of intense civil strife. The year 1986 saw the coming to power of the National Resistance Movement (NRM) government and the launching of the Economic Recovery Program. The government, in order to implement this program, had to resort to external borrowing (albeit on concessionary terms), and this has resulted in the rise in debt since 1987.

Debt Profile

The financing of the debt was largely through official sources at both the multilateral and the bilateral levels (Table 2). Between 1970 and 1980, loans from multilateral institutions accounted for about 57 percent of the debt contracted, while the Paris Club share amounted to 4.9 percent; contributions of non–Paris Club bilateral and commercial creditors were 27.6 percent and 9.8 percent, respectively.

Table 2.Uganda: Outstanding Debt by Source, 1970–90(In percent of total)
Source1970–801981–90
Multilateral57.167.6
Paris Club bilateral4.99.5
Non–Paris Club bilateral27.614.7
Commercial9.88.2
Source: Bank of Uganda.
Source: Bank of Uganda.

In the 1980s, the share contributed by the multilaterals increased to 67.6 percent, while that of Paris Club creditors rose to 9.5 percent; the shares of non–Paris Club bilateral and commercial creditors declined to 14.7 percent and 8.2 percent, respectively. These changes are explained by the recent trend in the debt portfolio toward highly concessionary loans from the multilateral and Paris Club group of creditors. As a result of the prudent debt management policy being implemented by the government and the buildup of arrears to non–Paris Club and commercial creditors, less contracting of loans from the latter category is taking place.

External debt can further be broken down into public and publicly guaranteed, private nonguaranteed, and short-term debt. As can be seen from Table 3, public and publicly guaranteed debt has accounted for over 60 percent of Uganda’s total external debt since 1980. Short-term debt has generally been below 10 percent.

Table 3.Uganda: Total External Debt, 1980–90
Long-Term Debt
Total External DebtPublicly guaranteedNonguaranteedShort-Term Debt
(In millions of U.S. dollars)In millions of U.S. dollarsIn percent of totalIn millions of U.S. dollarsIn percent of totalIn millions of U.S. dollarsIn percent of total
1980732.7578.078.99.71.365.79.0
1981793.9543.068.47.71.038.34.8
1982933.4593.063.57.30.851.55.5
19831,016.1615.060.55.70.627.32.7
19841,031.1652.063.26.00.642.44.1
19851,171.3822.070.26.90.644.53.8
19861,286.6966.075.18.00.672.15.6
19871,659.01,320.079.69.60.666.24.0
19881,799.01,455.080.99.10.5235.213.1
19891,809.01,488.082.3
19902,200.0
Source: World Bank (1990, p. 579).
Source: World Bank (1990, p. 579).

Uganda’s debt-export ratio was high—over 1,000 percent—between 1990 and 1993, as a result of adverse terms of trade and the fall in coffee prices, as shown in Table 4. Consequently, the debt-service ratio was also high over most of this period, at over 60 percent. This heavy debt burden further strains the weak balance of payments position and Uganda’s quest for external viability. According to Sharer, De Zoysa, and McDonald (1995), given Uganda’s initially weak external situation, its frequent inability to meet all contractual debt-service obligations, and the lack of access to commercial financing beyond normal trade credits, the traditional criterion of spontaneous access to commercial borrowing as an indicator of external viability is not relevant. Thus, under these circumstances, one can best assess Uganda’s movement toward external viability in terms of the extent to which debt-service ratios and reliance on exceptional donor financing can be reduced.

Table 4.Uganda: Debt Burden Indicators, 1980–92(In percent)
1980198719881989199019911992
Ratio of external debt to exports of goods and services212.3479.1610.0744.81,084.61,436.51,549.3
Ratio of external debt to GDP55.731.430.743.663.387.9109.6
Ratio of debt service to exports of goods and services17.339.962.761.860.775.559.6

We argue in this chapter that the composition and profile of Uganda’s debt outstanding and disbursed and its debt-service obligations reveal an increasingly difficult external financial position, largely for the following reasons:

  • the persistent low levels of foreign exchange inflows cannot sustain the high debt-service ratio;

  • the preponderance of multilateral debt limits the benefits Uganda could obtain through traditional rescheduling;

  • a large proportion of debt owed to the Paris Club group of creditors was contracted after the cutoff date (July 1, 1981) and is therefore not eligible for rescheduling;

  • little precedent existed for rescheduling debt owed to non-OECD bilateral creditors, who account for the largest portion of nonmultilateral debt outstanding and disbursed; and

  • of the uninsured commercial debt, 27 percent cannot be rescheduled on favorable terms, because a number of loans are owed to contractors with work in progress or were secured on specific terms.

Debt Management

Perhaps the most significant underlying factor in Uganda’s debt crisis has been poor debt management. Debt management involves the deliberate and planned acquisition, deployment, and retirement of loans for the purpose of promoting economic growth and development. This entails articulation and formulation of external borrowing policy, control and surveillance of external borrowing, and the keeping of comprehensive and accurate data on external borrowing. These crucial aspects of debt management have not been well undertaken in Uganda’s case.

Prior to 1982, very little information existed on Uganda’s external debt, and there was no basic institution put in place to manage debt effectively through efficient data collection, assessment of sustainability, and advice on existing international resources. The Treasury Department in the Ministry of Finance and the Public Debt Section of the Accounts Department in the Bank of Uganda handled both the internal and the external debt; the composition, stock, and payment schedule were not clearly known.

Responsibilities for aid coordination and debt management were shared in varying degrees by the Aid Coordination Unit in the Ministry of Finance, the Commissioner/Treasury Officer of Accounts, the External Debt Management Office, the Foreign Exchange Operations in the Bank of Uganda, the Aid Coordination Unit in the Prime Minister’s Office, and the Aid Coordination Unit in the former Ministry of Economic Planning. The exact role of each institution was not clearly defined or backed by full legislative authority. This led to a weakened flow of information among the units concerned, which in turn resulted in poor coordination and recordkeeping as well as inefficient verification and monitoring of debt.

The External Loan Act of 1962 and the Loans (Guarantee) Act of 1958 jointly vest legal authority for contracting and managing external debt with the minister of finance. The Aid Coordination Unit in the Ministry of Finance assists in the negotiation of new loans and facilitates the flow of aid-related funds into the country. The treasury, as stipulated by the Loans Act, authorizes all disbursement requests and all debt-service payments. It therefore has comparative advantage in keeping external debt-related information up to date. Nonetheless, the treasury is institutionally weak and does not have adequate capacity to perform its debt-reporting function. As a result, the External Debt Management Office in the Bank of Uganda has taken over this responsibility. Dependence on this office has been further increased by capacity constraints within the Ministry of Finance’s Aid Coordination Unit and its apparent inability to take charge of the country’s aid portfolio, as authorized by law.

As a result of insufficient information and poor coordination, the government has not been able to ensure that all new debt is contracted on terms compatible with the country’s external debt burden and its ability to service and repay this debt in the future. In the mid-1980s the government succeeded in ensuring that the implementing ministries did not sign loans independently of the Ministry of Finance, although in some instances the implementing ministries have conducted negotiations with lenders and suppliers without earlier involvement of the ministry or the central bank. This has led to acceptance of financial commitments on unfavorable terms.

There had also been no clearly articulated policy defining the order of priority in which creditors should be paid, although maturities falling due to the IMF and the World Bank Group have always been serviced on time. As a result, creditors who have persistently pressured but who have not necessarily provided the maximum future benefits to Uganda have sometimes been paid in preference to other creditors. On some occasions the Bank of Uganda has had to resort to borrowing under the short-term commercial facility to make payments to key multilateral creditors.

Given the lack of coordination, it became almost impossible to keep accurate records of the volume and structure of Uganda’s external debt and to determine the time profile of debt projections. Poor debt management created a problem of debt servicing for the country.

Owing to these weaknesses, the government in 1991 conducted an extensive debt management exercise within the Bank of Uganda; as a result, the total national stock of debt has been derived, verified with the creditors, and recorded centrally. The debt records have been computerized, and staff involved in debt management are being trained in the principles of debt management and the use of computer software related to debt.

Effective July 1992, the government centralized all functions of various units by creating a Central Debt Unit in the Ministry of Finance, although the External Debt Management Office in the Bank of Uganda maintains the duty of keeping all records pertaining to monitoring of disbursements, maturities, and all other data related to debt. This move has improved the control and coordination of policy, eliminated duplication of effort, and ensured efficient transfer of information.

External Debt Strategy

Given Uganda’s debt crisis, the government decided to immediately develop and is currently implementing an external debt strategy to try to resolve the country’s debt problem. In brief, the aims of the debt strategy include

  • clearing the bulk of accumulated arrears, which were giving rise to legal actions against the government and threats to seize assets to satisfy claims, resulting in embargoes on disbursements and hence project disruptions;

  • bringing a halt to increases in the accumulation of penalty and late interest charges; and

  • reducing contractual debt service to a level commensurate with Uganda’s ability to pay.

The components of the strategy include rescheduling, debt buyback and restructuring of uninsured commercial debt, implementation of the Fifth and Sixth Dimensions facilities, and possible cancellations. Our major focus will be on debt rescheduling, which forms an integral part of the debt strategy.

Paris Club Reschedulings

Uganda has benefited from a number of debt cancellations granted by the Paris Club creditors, in addition to reductions obtained under the 1989 rescheduling on Toronto terms and the 1992 rescheduling on enhanced Toronto terms. These include cancellations by France, Germany, the United Kingdom, and the United States of loans originally provided on concessionary terms.

As of the end of June 1992, approximately $279 million in debt was outstanding to the Paris Club creditors, of which $81 million represented arrears and penalty interest, and $26 million represented principal and interest falling due in 1991–92. The Paris Club does not reschedule or reduce any debt that was contracted after a particular date, which in the case of Uganda was set at July 1, 1981. Of the total amount outstanding to the Paris Club, 42 percent ($118 million) was contracted before this cutoff date. Consequently, only about $50 million in arrears and current maturities was eligible for rescheduling in the June 1992 agreement reached with the Paris Club.

Uganda was permitted to reschedule all arrears of principal, interest, and penalty interest coming due by the end of November 1993. This was exceptional in that the Paris Club usually grants rescheduling of maturities due during current IMF programs only (which in the case of Uganda was due to expire on November 30, 1992). The concession enabled Uganda to budget for fiscal year 1992/93 on the basis of this agreement. The amount rescheduled totaled nearly $50 million in arrears and maturities, of which $36 million was arrears and $14 million was current maturities. The impact was to reduce the debt service due in this category to only $2 million, the amount due, and moratorium interest. Under the enhanced Toronto terms granted to the least developed countries, penalty interest is not usually permitted to be rescheduled, but this was conceded for Uganda.

Debt Incurred After July 1, 1993

Since close to half the debt owed to Paris Club creditors was contracted after the cutoff date, a conventional rescheduling of pre-cutoff date debt would have a limited impact on the country’s debt burden. Uganda will therefore have to seek annually the maximum deferral of debt ineligible for the usual Paris Club rescheduling. The arrears on the post-cutoff date debt amounted to approximately $34 million. The Paris Club initially insisted that this be paid in full by November 1992, which was the guaranteed consolidation period. It was conceded that Uganda’s domestic and foreign exchange budget would not permit this, but IMF assurances were made that at least half of this amount could be paid by November 1992. However, these deferrals are associated with terms that are stringent, with no grace periods, short repayment periods, and no reduction of principal or interest. The debt service that falls due is not deferred, and once deferred, arrears are not eligible for any future deferrals. This serves to intensify the debt overhang that the country is already experiencing, as it will not be possible to redefer these payments. It was also agreed that maturities up to November 30 could be restructured under this agreement. The year-by-year rescheduling approach adopted by creditors under these terms will require Uganda to return to the Paris Club on a regular basis for the foreseeable future.

Uganda benefited from the Toronto terms plan, which offered a menu of alternatives to choose from when the consolidated amount of $86 million was rescheduled in January 1989 (Table 5). One-third of the eligible debt was forgiven, and the maturity of the remaining debt was extended to 14 years, with an 8-year grace period. However, these terms have only partially addressed the problem, because the entire debt was not rescheduled at this single meeting, and because the burden of debt was postponed, which only intensified the overhang. In June 1992 the enhanced Toronto terms saw a write-off of debt worth 50 percent in terms of net present value. It included the exceptional element of rescheduling maturities outside the then-running IMF program and a rescheduling of penalty interest and 50 percent of the post-cutoff date arrears.

Table 5.Uganda: History of Paris Club Debt Rescheduling
Amount Consolidated (In millions of U.S. dollarsMaturity (In years)Grace Period (In years)
November 19816394.5
December 19831694.5
June 1987105146.0
January 198986Toronto terms: one-third write-off
June 199250Enhanced Toronto terms: one-half write-off
Source: Bank of Uganda.
Source: Bank of Uganda.

Non–Paris Club Bilateral Creditors

Non–Paris Club creditors are owed a significant amount of arrears and penalty charges, totaling $185.5 million as of the end of June 1992, with 1992–93 maturities totaling $47.3 million. In the course of the financial year 1992/93 the government entered into agreements with some of these creditors that saw the rescheduling of $17.6 million of arrears in that year.

This mainly resulted from the acceleration of maturities totaling nearly $17.6 million, while arrears amounting to $60 million were rescheduled. There was also a downward adjustment to the stock of arrears, totaling $14.7 million. The impact of these measures was to reduce the stock of debt outstanding and disbursed (including arrears) as of the end of June 1993. In the meantime, all the other creditors have been asked to reschedule their stock of arrears and maintain the concessional or semiconcessional interest rates that they apply to the underlying loans for rescheduling.

It should be noted that there are few precedents for rescheduling with some of these creditors, but it is proposed that the most favorable terms possible be requested from them.

Buyback and Restructuring of Uninsured Commercial Debt

A total of $242 million of debt was outstanding to uninsured commercial creditors as of June 30, 1992, of which $226 million represented obligations to nonbank commercial companies, mostly suppliers and creditors. Supervised under the debt reduction, a plan concluded on February 26, 1993, saw Uganda buy back $151.9 million of eligible debt out of its $2.6 billion debt outstanding and disbursed at 12 cents on the dollar, which represented 6 percent of the total debt, one-third of total arrears, and three-quarters of the commercial debt. The impact of this was debt forgiveness amounting to $133 million, using a grant provided by the International Development Association (IDA) under its debt reduction facility totaling $10 million. This deal provided some relief for the government to come up with longer-term debt restructuring strategies. It is also worth noting that Uganda became the fourth country to benefit from this facility, after Niger, Mozambique, and Guyana.

Given the relatively small stock of debt owed to commercial creditors, the London Club has not featured much in the restructuring of the Ugandan debt. The availability of the IDA debt restructuring facility and the bilateral grants made the buyback operation more significant for commercial debt.

The amounts to be converted into equity, approximately $13.1 million, mainly include arrears to private sector joint venture partners. The government has held discussions with these creditors to swap these arrears for government assets in accordance with the privatization program. East African Holdings and Shell are two companies with which the government has already concluded debt-equity swap agreements.

Multilateral Debt Service

The government has solicited bilateral donor assistance for servicing multilateral debt. Under the Fifth Dimension facility, Norway and Sweden have provided the government with resources equivalent to repayments due on the debt to the International Bank for Reconstruction and Development (IBRD), and the government has requested that these donors extend similar facilities for maturing African Development Bank (ADB) debt. The response has been positive: ADB maturities estimated at nearly $3.6 million of arrears and $1 million owed to the ADB were rescheduled. The government successfully negotiated with the East African Development Bank (EADB) a restructuring of amounts owed to it, and arrears guaranteed by the government as of June 30, 1993, are estimated at $15.3 million, down from $48.1 million a year earlier. The government had committed itself to a payment of nearly $6.8 million every financial year in order to clear these arrears over the next two and half years. It has divested itself of $33 million in arrears owed to EADB, and this is now to be paid by the private sector, which benefited from these loans. Other creditors that fall into this category of divestiture include Commonwealth Development Corporation, Commonwealth Technical Corporation, EXIM (India), and the International Finance Corporation (IFC), amounting to $51 million in arrears.

During the financial year 1992/93, $385 million in arrears was settled, of which exceptional financing accounted for $335 million (rescheduling alone contributed $141.3 million) and direct cash payments for $50 million. The maturities restructured through rescheduling are estimated at $45.7 million.

Impact of Debt Strategy

Although Uganda’s debt strategy has assumed the maximum feasible rescheduling and accepts the accumulation of arrears to certain creditors, the minimum debt-service requirement remains high, at over 60 percent of projected foreign exchange earnings. There is still a large financing gap, as shown in Table 6. The success of the debt strategy will therefore depend on limiting the extent to which the gap is financed through the accumulation of arrears. The financing gap has widened largely because foreign exchange earnings have fallen well below projected levels. Nonetheless, we hasten to mention the likely positive impacts of the debt strategy, mainly the reduction of arrears through rescheduling. Arrears could be reduced from $585 million in June 1992 to $76 million. This takes into account the debt buyback operation successfully executed in February 1993 and assumes that all rescheduling, restructuring, and cancellation in the various categories of debt are achieved in a timely manner. It is also estimated that the arrears buildup would be $650 million to $675 million at the end of the fiscal year 1992/93 and over $1 billion by the end of 1995 if the strategy were not implemented.

Table 6.Uganda: External Financing Requirements, 1989/90–1993/94(In millions of U.S. dollars)
1989/901990/911991/921992/931993/94
Requirements867772724898626
Imports (goods)584550441572122
Services (net)568582106170
Scheduled debt service1971852491,78680
Amortization77861257480
Interest (net)7762908410
IMF repurchases4337341819
Settlement of arrears19–65–1413015
Reserves buildup111135150
Other items (net)0658–1377
Own resources337260286325262
Exports (goods)210177173196168
Of which: Coffee159126119127116
Private transfers7880111114–1
Other items (net)49325575
Financing gap530512438583
Foreign financing
Existing commitments530512438466375
IMF purchases42898900
Project aid249236236236240
Import support196186186180135
Debt rescheduling431150
Disbursement from new sources00091158
Individual financing gap0002642
Source: Bank of Uganda.
Source: Bank of Uganda.

The impact of the debt strategy was largely realized during fiscal year 1992/93, which saw $385 million of arrears restructured, of which exceptional financing accounted for $335 million (rescheduling alone contributed $141.3 million) and direct cash payment for $50 million. The consequence of this was to reduce the stock of arrears by over 50 percent from the end-June 1992 level of $585.3 million to only $253.7 million a year later.

The maturities in financial year 1992/93 that were rescheduled are estimated at $45.7 million, whereas the impact of the debt strategy on maturities falling due between 1994 and 2000 is a reduction of interest and amortization amounting to $105.4 million (Table 7). Using the growth-cum-debt model described below, the impact of rescheduling on growth and debt indicators is shown in Table 8.

Table 7.Uganda: Impact of Debt Restructuring on Maturities Falling Due, 1994–2000(In millions of U.S. dollars)
Creditor1994199519961997199819992000Total
Before restructuring
Multilateral72.0285.05102.15120.05117.99110.9996.95705.16
Bilateral
Paris Club
Pre-cutoff date17.3916.8116.2418.0122.9321.8922.63135.90
Post-cutoff date13.148.365.975.268.137.888.4957.23
Non–Paris Club26.539.8941.1139.9546.6640.0637.23271.40
Commercial nonbank5.993.042.782.933.083.0120.83
Other8.2311.156.823.62.942.732.4237.89
Total143.27164.3175.07189.8201.69186.561,228.41
After restructuring
Multilateral73.3284.5899.71109.54102.9694.8282.16647.07
Bilateral
Paris Club
Pre-cutoff date17.1516.4915.8317.6122.7221.4720.23131.50
Post-cutoff date9.088.445.985.38.298.038.353.42
Non–Paris Club22.6935.0731.8132.6131.230.5227.95211.85
Commercial nonbank13.7412.8412.3412.7912.4612.12.4778.74
Other0.1310.1220.1130.0530.42
Total136.09157.54165.783177.90177.63166.94141.111,123.00
Reduction in debt service7.186.769.2911.9024.0619.6226.61
Source: External Debt Management Office, Bank of Uganda.
Source: External Debt Management Office, Bank of Uganda.
Table 8.Uganda: Impact of Rescheduling on Maturities Falling Due During 1994–2000(In percent)
VariableBefore Rescheduling (Annual average)After Rescheduling (Annual average)
Annual growth rate5.735.74
Debt-GDP ratio114.02112.47
Resource transfer as share of GDP0.160.22
Source: External Debt Management Office, Bank of Uganda.
Source: External Debt Management Office, Bank of Uganda.

Although the impact of rescheduling of maturities falling due during this period is marginal, there is a savings on resource transfer amounting to an annual average of 0.06 percent of GDP and a reduction of the potential debt-GDP ratio by 2.5 percentage points; however, an increase in economic growth by 0.01 percent on a yearly basis is realized.

However, the cancellation of arrears during financial year 1992/93 had the fairly substantial effect of raising the estimated growth rate of GDP by 0.79 percentage point, lowering the debt-GDP ratio by 6.98 percentage points, and realizing a savings on resource transfer of 8.5 percent of GDP in calendar year 1993.

External Capital Requirements

Uganda’s economic reform is highly dependent on external financing, given the collapse of the International Coffee Agreement (ICA) in July 1989 and the accompanying fall in coffee prices, which greatly affected the foreign exchange-earning capacity of the economy. Attempts to increase noncoffee exports may take time to increase export earnings sufficiently to cover the fall in coffee prices. At the same time, the economy needs a minimum level of imports to meet its growth and stabilization targets; this calls for considerable donor assistance together with the economic and structural reforms currently being implemented by the government. Although noncoffee export earnings are picking up, given the extremely small base of these exports the impact on the financing requirements has so far been marginal; a significant quantitative impact on the balance of payments can only be achieved over the medium term. Consequently, it may be that Uganda will continue for some time to be heavily dependent on donor support. As a result, Uganda continues to receive substantial disbursements from the donor community to cover the loss of coffee export earnings.

In addition to the increase in the level of external assistance, there has been a change in the pattern of aid allocation. Much of the 1980s saw project-related aid accounting for over 80 percent of gross disbursements; the trend in the 1990s is revealing a decline to less than 60 percent as donors increasingly seek to assist the government through import support aid, thereby providing not only much-needed balance of payments support but also the counterpart funding for the budget.

Causes of Uganda’s Debt Crisis

The growing problem of debt accumulation in sub-Saharan Africa has received considerable attention in the literature and is now recognized as a serious global economic issue. Greene (1989) attributes this debt problem to both domestic policies and external factors. Besides expansionary fiscal policies and borrowing against exports to maintain consumption levels, many of these countries pursued other policies that weakened their external positions—for example, maintenance of high levels of imports, overvalued currencies, government subsidy policies, and external financing of overambitious development projects. Beginning in the late 1970s the shift in the terms of trade against African countries and a decline in export earnings have been a major external influence and have greatly hampered these countries’ abilities to meet their debt obligations. Another factor that contributed to sub-Saharan debt burdens was the decline in net capital inflows. The rise in foreign interest rates, although less important because of the predominantly official character of sub-Saharan debt, may have affected a number of countries that made significant use of commercial borrowing.

The international economic environment has an important impact on sub-Saharan African economies. It drives the prices of African exports, the demand for those exports, and the effective interest rates countries pay. The terms of trade of developing countries are also indirectly affected by economic trends in the industrial countries.

A major external factor contributing to Uganda’s debt crisis was the dramatic decline in export receipts due to declining coffee prices and unfavorable terms of trade. The price of coffee (the major export) declined steadily from 1985 to 1993, and Uganda suffered annual declines in its terms of trade every year from 1986 to 1992. The result was a sharp increase in Uganda’s debt service to exports ratio, which between 1988 and 1993 was over 60 percent.

The high level of donor-financed development expenditures was another contributor. The reliance on external financing of the adjustment effort adopted in 1987 more than doubled Uganda’s external debt during the adjustment period, from $1.7 billion to $2.9 billion as of June 1994. Most of this increase was attributable to credits obtained from multilateral institutions to support the balance of payments and to finance development projects. Multilateral debt as of June 1994 accounted for about 71 percent of the total debt stock, compared with about 43 percent in 1987.

Ajayi (1991) argues that the division of external and internal factors into two seemingly watertight compartments is quite misleading, since external factors do impinge crucially on domestic factors; for example, changes in the terms of trade may influence the real effective exchange rate. Hence the major factors contributing to Uganda’s debt crisis can be thus summarized:

  • price shocks throughout the world in the 1970s, mainly reflected through an increase in import prices due to oil price hikes;

  • a deterioration in the terms of trade and a decline in export earnings, particularly in the 1980s, with a growth in arrears caused by the fall in coffee prices, which greatly affected not only the foreign exchange-earning capacity of the economy but also the ability to sustain the servicing of debt obligations;

  • a buildup of interest on late payments to $34.4 million as of the end of June 1992 (this is a contributory factor in the increase of the debt); and

  • highly expansionary fiscal deficits.

Having identified the internal and external factors influencing Uganda’s debt accumulation, we present an empirical assessment using regression analysis to estimate these factors. The model (based on Ajayi, 1991) has the following general form:

DSRi = f (TOT, CGDP, FRRI, FP, T, REER)

where

DSRi=the debt-export ratio
TOT=terms of trade
CGDP=growth rate of income in the industrial countries
FRRI=foreign real interest rate
FP=fiscal performance (fiscal deficit)
T=linear time trend
REER=real effective exchange rate (developed in Appendix I).

Table 9 shows the regression results. We find that a worsening of the terms of trade significantly worsens the debt-export ratio. As in Ajayi (1991), an increase in the foreign interest rate would tend to worsen this ratio just as an appreciation in terms of the real effective exchange rate would. However, from our estimations the worsening of the terms of trade appears to have had the most significant impact, given that much of Uganda’s experience over the period of study was characterized by a decline in its terms of trade. Despite the insignificant results for the fiscal performance variable, it is expected that a deterioration of the fiscal position will also have a negative impact on the debt-export ratio. The linear time trend variable is included to capture the likely influence of other external factors. The results in Table 9 (excluding the time trend and constants) show that the most important variables are the terms of trade and, to a lesser extent, the real effective exchange rate. This confirms that external factors have contributed significantly to Uganda’s debt situation.

Table 9.Uganda: Empirical Results for the Debt-Export Ratio
VariableRegression 1Regression 2
Constant4.1174.082
(7.880)*(18.651)*
TOT–0.535–0.565
(–3.256)*(–5.339)*
CGDP–0.012–0.005
(–1.011)(–0.594)
FRRI–0.071–0.073
(–1.038)(–1.346)
FP–0.014
(–0.228)
T0.0580.053
(4.322)*(19.526)*
REER–0.096–0.093
(–1.680)(–1.829)
R¯20.9790.983
D-W2.6412.269
Source: Authors’ calculations.Note: All variables except CGDP are in logarithms; t-statistics are in parentheses. Asterisked values are significant above the 5 percent level.
Source: Authors’ calculations.Note: All variables except CGDP are in logarithms; t-statistics are in parentheses. Asterisked values are significant above the 5 percent level.

Debt and Economic Growth

Since 1981, stabilization and structural adjustment policies have been pursued in an attempt to stimulate recovery; these have attracted a substantial amount of foreign resources in the form of loans, because the required investment level could not be met by domestic saving. The reliance on foreign saving is justified by the fact that gross domestic saving as a percentage of GDP has for most of the sample period (between 1980 and 1995) been negative (Table 10). The saving rate is seen to lag behind the rate of investment—a pattern that is exhibited in both the public and the private sector. Beginning in 1989 the saving-GDP ratio did improve, however, largely because of high private unrequited transfers, reflected in the current account of the balance of payments.

Table 10.Uganda: Selected National Accounts Data, 1970–95(In percent of GDP)
Exports of Goods and Nonfactor ServicesImports of Goods and Nonfactor ServicesForeign BalanceDomestic SavingDomestic InvestmentDomestic BalanceIncremental Capital-Output Ratio
197024.6221.10-3.5218.7615.243.52
197120.7524.904.1512.4516.60-4.1519.85
197220.7717.80-2.9711.178.202.974.71
197317.1913.75-3.4412.899.453.446.45
197417.3717.370.0013.4213.420.00-43.71
19758.6811.092.415.788.19-2.41-5.46
197611.649.56-2.088.326.242.0810.30
19779.307.88-1.417.486.061.413.14
197813.6018.795.193.048.23-5.19-2.68
197919.3517.49-1.878.396.531.87-0.50
198019.5226.136.61-0.406.21-6.61-1.35
198121.2529.448.19-0.747.45-8.191.49
198221.5133.257.731.439.17-7.741.54
198318.9724.655.684.269.94-5.681.27
19849.7530.9521.20-14.256.95-21.20-1.06
19859.6030.4020.80-13.057.75-20.803.90
19869.5532.0022.45-12.5010.00-22.5015.58
19878.4035.2026.80-13.1013.70-26.802.04
19888.7536.3527.60-14.8512.70-27.551.68
19899.1532.3523.20-12.4010.80-23.201.48
19907.2025.0017.80-5.7512.00-17.752.97
19916.9021.5014.60-1.8512.75-14.603.08
19926.9021.1014.200.0114.20-14.192.04
19936.8022.5015.70-1.1014.55-15.653.34
19947.0522.0014.95-1.3513.60-14.953.20
19957.2521.3014.05-1.0513.00-14.053.43
Sources: World Bank (1990); Ministries of Finance and Economic Planning; and Bank of Uganda.
Sources: World Bank (1990); Ministries of Finance and Economic Planning; and Bank of Uganda.

An analysis of data on consumption and investment reveals that the economy absorbed more than it produced and saved, which may lead to the suggestion that external financing and the accumulation of arrears have sustained the Ugandan economy during the period under review.

This gloomy situation is largely attributed to the narrow tax base, which shrank during the years of economic decline and inefficient financial intermediation resulting from financial repression. A substantial percentage of the budget deficit was monetized, resulting in accelerated inflation; a fall in the real rate of interest on deposits in formal financial institutions reduced intermediation. At the same time an increasing proportion of the declining supply of real domestic credit was being expropriated by government to finance current expenditures. Consequently funds for both working capital and fixed capital investment, which had mainly been financed by the banking system, were doubly squeezed.

The stock of external debt doubled from $1.29 billion in 1986 to $2.65 billion in 1993. This is largely attributed to the implementation of the economic recovery program of rehabilitative investment and policy reforms that was adopted in 1987. The continuous rise in the debt was further aggravated by the accumulated effects of unpaid debt service, interest costs, and rescheduling. Economic liberalization and restructuring resulted in an average annual real GDP growth rate of 5 percent, with a 2 percent rise in per capita real incomes over the period 1987–93.

The question then arises as to the sustainability of this economic growth and the current stock of debt. In spite of more than 10 years of implementing economic recovery and structural adjustment, the economy remains fragile and the export sector is struggling to recover, and import capacity is largely sustained by the donor community.

A number of models have been constructed to illustrate the impact of capital imports on aggregate performance of the sub-Saharan African economies. The majority of these models deal with labor-surplus economies and emphasize growth of capital stocks. The model used for analytical purposes in this chapter emphasizes the incremental capital–output relationship, which suggests that the rate of economic growth increases if the ratio of investment to national income rises and further suggests that an increase in capital imports increases the investment ratio (Chenery, 1966).

We use the two-gap theory of Chenery and Bruno (1962), which suggests that growth is limited by two constraints: the saving gap, which constrains the country’s ability to save and invest, and the foreign exchange gap accruing from limited export revenues—the targeted growth rate of the economy causes imports to exceed the economy’s ability to finance them. We also use a Harrod growth equation of the type

g = sk,

where g is the real growth rate of national income, s is the ratio of saving to national income, and k is the incremental capital–output ratio.

It is observed that gross saving in Uganda has been negative for most of the latter part of the sample period; when gross domestic investment is taken into consideration, the saving gap is seen to be extremely large. This has in most cases been accompanied by positive real growth rates, and it therefore suggests that growth has been driven by aid, so that

g = (s + a)k,

where a is the ratio of aid to national income. If g* is the targeted growth rate and k is the assumed constant over time, the rate of capital accumulation necessary to achieve the target growth rate is denoted by

g*/k = s + a.

Let s + a = c; then a = cs; hence, cs represents the saving gap.

This analogy seems to imply that aid inflows to Uganda should have the potential effects of supplementing domestic savings (and hence capital accumulation) and increasing the proportion of income saved.

If this is the case, then aid increases the capacity for economic growth and should enable the country to reach a self-sustaining level that subsequently leads to a reduction of aid contracted. The assumption is that the increase in aid is greater than the increase in consumption.

With regard to the foreign exchange gap, the assumption is that the value and the volume of exports are given as exogenous (X = X0), whereas the demand for imports largely depends on the targeted rate of economic growth. Imports of capital goods depend on the level of investment, and demand for intermediate goods derives from the capacity utilization rate. Since domestic inputs are an imperfect substitute for imported intermediate goods, the latter increase or decrease with an increase or decrease in production, respectively (Khan and Knight, 1983). The cost of financing such imports has in most cases exceeded the earnings of foreign exchange by exports, and a foreign exchange gap arises that, if not closed by aid resources, reduces targeted economic growth.

Given that M = mY, where m is the marginal propensity to import, and Y is national income, the size of the foreign exchange gap is then denoted as mYX0 and can be described in terms of aid (a) as

a = m – (X0/Y).

The implication of the foreign exchange gap is that potential domestic saving is being frustrated because the capital goods necessary to undertake the desired investment are not produced locally, nor can they be acquired externally. Additional foreign exchange would raise the level of investment and subsequently the rate of economic growth; this would imply that aid not only raises investment but also permits an increase in domestic saving.

In the ex post accounting sense, the two gaps are exactly equal, so that:

a = cs = m – (X0/Y).

The changes in the domestic balance each year have a strong bearing on the changes in the external balance (see Table 10 for domestic and foreign imbalances). By linking the internal and external imbalances, the sources of financing for the domestic balance are seen to be changes in the external balance. Available data seem to identify the capital account of the balance of payments as the source of financing this overall domestic imbalance, and this is made up of medium- and long-term loans. This appears to justify the contracting of debt, particularly during the period of stabilization and structural adjustment of the Ugandan economy.

Debt Viability: Growth-cum-Debt Model Scenario

A growth-cum-debt model developed by Solis and Zedillo (1985) and used by Ajayi (1991) is adopted in this paper for the analysis of debt sustainability. It focuses on how debt affects the growth prospects of a debtor country. (Details of the model are presented in Appendix I of Chapter 2.)

Using a growth dynamic equation denoted by

Dt = Dt-1(1 + τ),

where Dt is the total external debt, and its growth rate (τ) is varied for values between –0.03 and 0.07; interest rates of 2, 4, and 7 percent are used. These values are chosen in accordance with the external debt strategy implemented by the government of Uganda. This debt strategy calls for taking out highly concessionary loans and for the maximum possible reduction in the stock of debt. The rates of interest and of growth of the debt stock chosen for this analysis are therefore in line with the government debt strategy.

The incremental capital-output ratio (ICOR) of 2.375 is the average for the years 1987–95, the period under the Economic Recovery Program1 (see Table 10); s = 0.42 (the reciprocal of ICOR).

Simulations using different rates of interest and amounts of external debt were run for the period 1993–2000. The following indicators were used:

g=growth rate of GDP
DB1=debt-GDP ratio
DB2=resource transfer.

The variables DB1 and DB2 are defined as

DB1 = D/GDP

DB2 = [(DtDt-1) – (rtDt-1)]/GDP.

The results of the simulation, shown in Table 11, reveal that Uganda cannot at this time sustain debt that attracts interest rates of more than 7 percent a year with growth of more than 2 percent a year on average. This permits a real growth rate of only 2 percent a year; given a population growth rate of slightly more than 2 percent a year, there is zero or negative growth in real per capita incomes. Accompanying it are debt-GDP ratios that are seen to be high for every rate of growth of the debt stock; there is no positive resource transfer noted in this scenario. The scenario with interest rates of 4 percent shows that a zero growth rate in the debt stock is consistent with 4.42 percent annual growth in GDP, and a positive transfer of resources is only possible at a rate of growth of debt above 4 percent a year.

Table 11.Uganda: Simulation Results of the Growth-cum-Debt Model
τgDB1DB2
r = 0.02
0.070.0533136.530.0638
0.060.0538130.630.0493
0.050.0542125.010.0357
0.040.0547119.650.0230
0.030.0551114.530.0111
0.020.0555109.660.0000
0.010.0559105.01–0.0104
0.000.5562100.57–0.0201
–0.010.066696.33–0.0292
–0.020.057092.29–0.0377
–0.030.057388.44–0.0456
r = 0.04
0.070.0377145.780.0409
0.060.0387139.140.0263
0.050.0398132.840.0127
0.040.0407126.860.0000
0.030.0416121.19–0.0180
0.020.0425115.79–0.0227
0.010.0434110.67–0.0329
0.000.0442105.80–0.0423
–0.010.0450101.17–0.0511
–0.020.045796.77–0.0592
–0.030.046462.58–0.0668
r = 0.07
0.070.0107163.280.0000
0.060.0129155.07–0.0146
0.050.0150147.36–0.0281
0.040.0170140.12–0.0404
0.030.0189133.30–0.0510
0.020.0207126.88–0.0622
0.010.0207120.83–0.0718
0.000.0240115.12–0.0806
–0.010.0256109.72–0.0887
–0.020.0271104.63–0.0963
–0.030.028599.82–0.1029
Source: Authors’ calculations.Note: Calculations are based on an incremental capital-output ratio (σ) of 0.42.
Source: Authors’ calculations.Note: Calculations are based on an incremental capital-output ratio (σ) of 0.42.

The simulation also shows that low interest rates (e.g., 2 percent) attract higher rates of economic growth, as greater resource transfer is permitted for every level of τ, and this is consistent with low and high DB1 and DB2, respectively.

The simulation results are compared with balance of payments projections for fiscal years 1993/94 through 2002/03 provided by the Ugandan authorities. The projections assume that all interest and amortization falling due are fully externalized, just as the model used here assumes. The projected average annual growth rate of external debt up to fiscal year 2000/01 is 3.44 percent, with a computed average interest rate of 1.64 percent a year. Table 12 gives the Ugandan authorities’ projections, and these are compared with those simulated by the model used in this chapter.

Table 12.Comparison of Ugandan Authorities’ Projections with Simulated Variables Generated by the Growth-cum-Debt Model
VariableUgandan Authorities’ ProjectionsGrowth-cum-Debt Simulation
g5.006.27
DB1121.13112.94
DB2 (as percentage)2.12.0
Source: Authors’ calculations.
Source: Authors’ calculations.

The higher growth rate of 6.27 percent a year simulated by the model is based on the assumption that all foreign resources are fully used for investment. This is one major problem with the two-gap model: the model assumes that all foreign capital is used to complement domestic saving, thereby raising investment and economic growth. However, some of the foreign capital is used to finance consumption (Griffin, 1970), and capital inflows may affect relative prices by changing the sectoral balance of the economy (through changes in production patterns), and hence the income distribution and the domestic saving function.

The Ugandan authorities projections appear to have allowed for current consumption because some of the foreign resources are actually used for budgetary support that ends up for current consumption.

Both scenarios (see Table 12) show that there will be a net transfer of resources to Uganda from the donor community averaging 2 percent of GDP annually for the period 1993–2000. This occurs largely on the grounds that the rate of loan contracting is projected to be higher than the computed interest rate for this sample period. A simulation of economic growth rates and of debt-GDP and resource transfer ratios is carried out for the period 1993–2000, and this involves changing the domestic saving ratio and the ICOR used to generate the variables in Table 12. The numbers simulated for the different macroeconomic variables are then compared with their base values, that is, zero growth in the saving ratio and an ICOR of 2.375.

The results specifically reveal that policies designed to increase the efficiency of capital (i.e., lower the ICOR) for any given level of the domestic saving ratio do generally raise the rate of economic growth and lower the debt and resource transfer ratios expressed as a percentage of GDP. Any increase in the domestic saving ratio for any given level of ICOR has the same effect.

It is then suggested that the government pursue policies that increase utilization of the existing capital stock and increase the aggregate domestic saving ratio. These policies are analyzed elsewhere in this chapter.

A major problem of aid extended to Uganda is its fungibility. Even the World Bank,2 which used to take pride in the soundness and high rate of economic return of its projects, has of late funded projects that could be ranked lowest on the list of economic priorities. To date, World Bank financing has not necessarily been geared to the most attractive projects. Bilateral aid has also tended to promote fungibility because of the sourcing conditions attached to these lines of credit. A good proportion of the raw materials and technical assistance, which is not always the most efficient, has to originate in the donor country.

Another impact of aid on Uganda’s investment pattern is the extent to which it has stimulated the consumption of importables. To date, nearly 30 percent of tax revenue is generated from external trade sources, of which a good proportion is financed by the donor community. Efforts to stimulate domestic saving through tax incentives have proved unsuitable for mobilizing domestically generated resources. It would then appear that Uganda can only continue recording positive growth rates with the funding of the donor community—a very discouraging situation.

An analysis of the types of investment funded by the donor community reveals that nearly 60 percent of it is allocated to social overhead capital and economic infrastructure (transport facilities, electric power, education, health, and road construction). Directly productive activities such as factory construction have only succeeded in attracting a relatively small proportion of total aid. Although infrastructure deserves priority, the general bias against directly productive activities has tended to lower the aggregate output of the economy. This point is important in relation to debt servicing, which is reaching crisis proportions in the country; because the gestation period of these projects exceeds the grace period, they add to the debt-servicing problem. The government borrows from bilateral sources in order to make payments to multilateral creditors, like the World Bank, that have financed such projects. Private investment, on the other hand, is relatively low and cannot on its own be relied on to make best use of the massive investment in overhead capital and economic infrastructure.

Ndulu (1991) suggests that in a situation where capacity underutilization obtains, a high investment growth rate could result in a low real economic growth rate; that is:

g = gp + gu,

where gp is the sum of capacity growth driven by investment, gu is the rate of capacity utilization, and g is the actual economic growth rate.

From this definition it is possible to observe that high investment (gp) rates can coexist with declining or relatively low economic growth rates as long as capacity underutilization obtains. Capacity underutilization is prevalent in Uganda; in fact, the statistics from the index of industrial production indicate an average of less than 50 percent utilization of installed capacity.

It could then be argued that economic growth should influence not only capacity growth but also the rate of capacity utilization. One way to enhance growth, therefore, is to emphasize resource allocation between capacity expansion and utilization, given the fact that saving (and hence investment) ultimately depends on income growth.

An analysis of the components of investment reveals that foreign saving is the largest contributor and has a higher elasticity with respect to output than that of domestic saving. This is largely because domestic resource mobilization is inelastic to policies designed to mobilize it; external capital may then be a key force propelling any growth that is accruing from investment.

The Cohen Model

The level at which debt sustainability can be attained is further investigated using an analytical framework adopted from Cohen (1985). Details of the model are provided in Appendix II.

If a country pays all interest falling due every period, the value of debt remains constant. If an indebted country neither repays its debt nor services the associated interest payments, the debt grows at the rate of interest. The interest rate exceeds the country’s growth in exports. The central focus of Cohen’s analysis is on that minimum level (b) of debt repayment that keeps the debt-export ratio constant. In Uganda’s case we use the trade deficit as a proxy for b. What trade deficit is feasible if the debt-export ratio (defined as D/X, the debt stock–export ratio, where the debt stock is of the preceding year and exports are for the current year) is to be kept from rising? In other words, what trade deficit (b) gives us D/X0 = 0?

Table 13 gives values for b and D/X; the 1982 D/X ratio is chosen as a starting point and D/X0 is then kept constant. As an example, the economy would have had to have run a trade deficit of $29.1 million on its current account, instead of the recorded surplus of $114 million, in 1985 for D/X to have remained constant. The variable b* compares with b in that b* is the computed trade deficit that should have been run given D/X, the rate of growth of exports, and the interest rate on the stock of debt outstanding and disbursed; b is the actual trade deficit recorded (or expected to be recorded) for the period 1993–2000.

Table 13.Uganda: Empirical Analysis Using the Cohen Model, 1981–2000
Drr*xdxmd/xbb*
1981793.913.2345293–5230.01
1982933.426.30.03396.8615.03379.692–17.17–18.75
19831,016.4410.04367.7–7.35421.12.5460.4–20.78
19841,031.1650.06342.2–6.94407.92.9765.729.13
19851,171.3530.0537910.75264.12.72–114.921.02
19861,286.6430.03406.87.34438.22.8831.4–69.48
19871,659360.02333.6–17.95591.33.86264.7–125.8
19881,799350.02266.3–20.17658.26.23391.927.57
19891,809460.03277.74.287106.48462.3–366.2
19902,20047.80.02177.8–35.97617.610.17439.8–28.88
19912,30073.80.03173.8–2.25474.412.66300.6–208.5
19922,59297.80.04150.2–13.5851215.31361.8236.6
19932,65253.10.02174.115.91591.514.89417.4300.75
19942,783.152.80.02218.425.45629.312.14410.9199.73
19952,880.851.80.02250.0518.61666.410.74487.35121.76
19962,969.9510.02290.9512.31707.39.9416.3585.06
19973,05349.60.02317.459.11755.99.36438.4575.31
19983,143.547.40.02344.58.52808.48.86463.971.41
19993,252.744.30.01373.88.518648.41490.268.13
20003,395.840.70.01405.68.51925.18.02519.5
Sources: World Bank (1990); Ministry of Finance, Uganda; Bank of Uganda; and authors’ calculations.Note: Definition of variables
  • D = debt stock

  • r = interest rate

  • r* = computed interest rate

  • x = exports

  • dx = growth of exports

  • m = imports

  • d/x = debt-export ratio

  • b = trade deficit (actual and projected)

  • b* = computed trade deficit

Sources: World Bank (1990); Ministry of Finance, Uganda; Bank of Uganda; and authors’ calculations.Note: Definition of variables
  • D = debt stock

  • r = interest rate

  • r* = computed interest rate

  • x = exports

  • dx = growth of exports

  • m = imports

  • d/x = debt-export ratio

  • b = trade deficit (actual and projected)

  • b* = computed trade deficit

Table 13 suggests that the trade deficits recorded for the years 1983, 1984, 1987, 1988, and 1990–92 were not consistent with the stock of debt, and this therefore required the economy to run a surplus on its trade account through either exporting more or cutting down on imports, if D/X was to be held constant, so as to create an environment of debt sustainability. The rest of the sample period 1980–2000 suggests that a deficit could be run on the current account, not because of good performance in the export sector but rather on grounds that the computed rate of interest on the stock of debt happens to be lower than the growth in exports. It is sufficient that debt grows strictly less rapidly than the rate of interest. The years 1993–2000 permit the running of a deficit on the current account largely on the grounds of the implementation of the external debt strategy, which calls for contracting of highly concessionary loans, and a reduced stock of debt through restructuring of existing debt and reduced growth in the stock of debt.

The Cohen and growth-cum-debt models can be compared for the period 1993–2000. With the Cohen model, the interest rate computed from Table 13 lies between 1 percent and 2 percent (the average is 1.75 percent for the sample period), with an average annual growth rate in debt outstanding and disbursed of 3.44 percent, which permits a net resource transfer as reflected by b*.

The growth-cum-debt model, which uses interest rates of 1.64 percent and a growth in the debt stock of 3.44 percent, also suggests a positive net inflow of resources averaging 2 percent of GDP annually. The two models therefore seem to suggest that net resource inflows are possible—at least up to the year 2000—largely because of the external debt policy being pursued by the government.

Summary and Policy Implications

This chapter has analyzed the external debt burden of a severely indebted low-income country and raises the crucial issues of growth and debt sustainability. As of the end of June 1993, Uganda’s total debt stock was estimated at $2.6 billion, with a debt-service ratio of over 80 percent.

Uganda’s external debt since the 1970s has remained predominantly multilateral debt, with institutions such as the World Bank, the African Development Bank, and the IMF representing over 70 percent of the total debt stock. Uganda’s debt-export ratio also remains high at over 1,000 percent. The fact that much of the debt accumulated is from multilateral creditors limits Uganda’s flexibility in reducing its debt-service burden through traditional reschedulings.

Uganda’s accumulation of external debt is due to both domestic and external influences. The external causes include the shift in the terms of trade and a resulting decline in coffee export earnings. The domestic causes include poor macroeconomic policies arising from fiscal indiscipline, exchange rate misalignment, overall economic mismanagement, and poor debt management.

The multilateral debt problem is one that has to be tackled specifically if any meaningful debt relief is to be experienced. The international financial institutions’ main strategy for dealing with the huge debt claims has been concessional lending. Indeed, the international community has been generous in providing debt relief to Uganda, reflecting its adjustment record and its status as a severely indebted low-income country. However, the burden of its debt to multilateral creditors remains extremely heavy, and it is in view of this that a multilateral debt fund is to be set up specifically to address multilateral debt relief.

The accumulation of arrears compounds the problem. The successful implementation of the debt strategy depends on negotiating reschedulings in all categories of debt, on the achievement of a number of cancellations, and on the availability of funds to institute buy-backs. Uganda is also receiving considerable concessional debt relief.

Debt relief is only part of the answer, however; continued government commitment to structural reforms and sound debt management is essential. The Ugandan government is currently implementing adjustment policies with the prime objective of restoring investment and economic growth. Increased domestic saving financed by resource mobilization through appropriate monetary policies could also raise the estimated growth rate, without any increase in aid inflows.

The two models used in this paper (the growth-cum-debt model and the Cohen model) show that Uganda is in a position to run a trade deficit between 1993 and 2000 of up to 6 percent of GDP on its current account while maintaining a constant debt-export ratio. This can be largely attributed to the debt strategy, which has greatly reduced the interest rate of loans contracted and further decreased the overall size of the debt through restructuring and debt reduction.

The target growth rate of 5 percent a year as estimated by the Ugandan authorities could be raised to 6.27 percent for the period 1993–2000. This is possible only if the resources devoted to current consumption funded by aid could be reduced. Any policy that limits estimated current consumption to domestically generated revenue while devoting external finance to investment could enable the achievement of faster economic growth.

Finally, Uganda has already made significant progress as a result of rescheduling agreements and more favorable lending terms, over and above recent improvements in export prices. The result has been a decline in its debt ratio. The overall increase in capital inflows has improved the prospects for less reliance on exceptional financing in the form of net accumulation of arrears, rescheduling, and gross use of IMF resources. The sustainability of a favorable balance of payments without exceptional financing depends very much on domestic performance. For growth to be sustained, strong and persistent adjustment efforts by the government have to be continuously maintained. These efforts should particularly address the productive base and reduce structural bottlenecks in the economy. At the same time, they should adopt appropriate macroeconomic policy to avoid the reemergence of uncontrollable inflation and encourage flexibility in the clearing of financial markets.

Appendix I. The Real Effective Exchange Rate

There are many methods of deriving the real effective exchange rate. The method used for this study is

REER = λi ei (Pi/Pd),

where

λi=trade weight of Uganda’s ith trading partner
ei=nominal exchange rate between Ugandan shillings and the currencies of the major trading partners
Pi=consumer price index (CPI) of trading partner country i
Pd=Ugandan domestic CPI.
Appendix II. The Cohen Model

The stock of debt at the end of previous year is given by

Equation (2) becomes

(D/X0) = (D/X′) * (D/X) = (D/X′)d, where d = D/X.

Given that

where x = growth of exports,

If r is the world real interest rate, and B the trade deficit,

(RX)d + B

(D/X0) = (D0/D)dxd.

If

D0/D = (rD + B)/D = r + (B/D),

then

(D/X0) = (rx)d + B/X.

Let

B/X = b.

Equation (4) then becomes

(rx)d + b.

For

References

The methodology used in computing ICOR in this chapter is derived from that of the Central Bank of Ecuador (FitzGerald and Vos, 1989). The impact of a foreign exchange boom (derived from exports) accompanied by average or lower growth rates of GDP is a high ICOR, and for Uganda the years 1976 and 1986 typify this. The ICOR is, of course, undermined or less meaningful when the economy is experiencing zero or negative growth.

The World Bank is the single largest source of credit to Uganda. In 1992 it accounted for 60.8 percent and 41.0 percent of total debt outstanding and disbursed from multilateral and all sources, respectively.

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