Uganda unlikely to achieve middle income status by 2020, World Bank says

Vendors on a busy Kampala street
For Uganda’s economy to achieve middle-income status by 2020, the annual GDP growth rate should rise to 12% each year until then, according to the World Bank. But 12% GDP growth per annum is twice the average rate the Bank projects Uganda’s economy will grow in the period to 2020.

The fact-check on the government’s middle-income aspirations was made by the the World Bank’s latest economic update for Uganda, which said economic growth in financial year 2016/17 will come in at between 4% and 5%.

The update said economic activity in the first half of the year (July — December 2016) was subdued because of a number of shocks, “the most significant of these being the impact of adverse weather conditions on agriculture and civil unrest in South Sudan.”

And, even though the central bank adjusted its policy to stimulate the economy in the wake of last year’s elections, the impact of those actions was undermined by shocks to the economy. “It is unlikely that there will be a dramatic acceleration in the rate of growth in the second half of the year” as the economy adjusts to the shocks, it said.

The shocks include a “jittery” financial system “on account of the high level of non-performing assets and the resolution of issues related to the Crane Bank”; the instability in South Sudan; the “anticipated effects of the news of a breakout of avian flu in Uganda on tourism, production and export of poultry products”; and the uncertain global economy.

In the second half of the year, tighter loan requirements by commercial banks and their reluctance to lend due to an increase in bad loans will restrain private investment and, therefore, economic growth, according to the report. This is in spite of the Bank of Uganda’s relaxed monetary policy and reduced domestic borrowing by the government, which will lead to an increase in the credit available to the private sector.

The bank says commercial bank credit has remained expensive despite the reduction in the central bank rate over the past one year. “In the 12-month period to September 2016, the rate of growth of credit to all sectors declined, despite the gradual unwinding of tight monetary policy.” This was in reaction to an increase in non-performing loans and foreign exchange risks, and the result of heightened risk management practices, according to the World Bank.

In addition to limiting private growth, the bank says expensive commercial bank credit has locked out the majority of Uganda’s businesses and households. Although the number of Ugandans with access to a formal financial institution has gone up to 52% from 28% in 2009, most Ugandans still shun credit from financial institutions. “Consequently, domestic credit has financed only 13 percent of GDP over the past decade,” the update said.

It adds: “Inclusion is constrained by the low level of public confidence in financial institutions; by the undeveloped state of long-term savings products such as pensions and insurance; and by the undeveloped state of credit and mobile service infrastructure.”

But the central bank governor disagreed with the World Bank’s view that the high cost of credit is “a binding constraint” on the economy’s potential or the argument that a reduction in interest rates will lead to an expansion of output and a growth in incomes.

The conclusion is “premised on a rather over-optimistic view of the real sector and its borrowing capacities,” Emmanuel Tumusiime-Mutebile said. “Formal sector, creditworthy businesses, which are the main business clients of the commercial banks, comprise a small share of the Ugandan economy.

“There is a much larger pool of informal businesses and micro-enterprises, but the capacity of this sector to utilise credit effectively is constrained by a raft of problems, including scarcities of business and technical skills, the high costs of inputs, and often volatile market conditions.”

The sector’s ability to “make profits consistently and thereby service loans is precarious,” Mr Mutebile said.

The banking sector’s role in providing credit to the private sector will remain very difficult and limited, the governor said, until the private business sector embraces “good, modern business management, and a clear separation of business and personal interests on the part of business owners.”

Meanwhile, the update throws doubt on the government’s target to attain lower middle-income status by 2020. The second national development plan aims for an annual per capita income of $1,033 (Shs3.7 million). To achieve this, total gross domestic product would have to grow by 12% each year until 2020.

The World Bank, however, projects that annual GDP growth will stay at 5% until 2017/18, only rising to 6% in 2018/19. Growth will come from “an acceleration of implementation of major public investment projects,” low energy prices, and economic activity in oil-related activities “which could accelerate FDI inflows, infrastructure development, employment and the development of local industries.”

These activities will shield the economy against weak external growth, leading to an expansion of about 6% in 2018/19. To grow even faster, the update says Uganda would “need to accelerate and sustain high levels of investments that can support accumulation of both human and physical capital.”

That would require a deeper financial system offering cheap credit to finance “a significantly increased growth in private investment,” according to the World Bank.