A London-based international provider of credit ratings, research, and risk analysis has downgraded Uganda’s rating to B2, punching holes in government officials’ narrative that the economy remains ‘resilient.’
However, Moody’s Investors Service, whose credit ratings and research help investors analyze the credit risks associated with fixed-income securities, changed the outlook to stable from negative.
The entity said the key driver of Uganda’s current rating action is the “sustained erosion of fiscal strength” that has occurred since the rating was assigned in 2013.
It said the Government of Uganda’s debt burden has risen 9 percentage points to 33 percent of GDP in the past four years, and is projected to continue rising towards 45 percent of GDP by 2020.
Debt as a percentage of revenues has risen by 54pp since 2012 and is expected to exceed 250 percent by 2018.
“Deteriorating debt affordability is reflected in interest obligations expected to consume almost 16 percent of revenues by 2018, far exceeding the median for B-rated countries of 8 percent,” said Moody’s.
This would represent a 50 percent increase in the overall debt burden since Moody’s initially rated the country in 2013.
Meanwhile, low, and in some respects eroding institutional strength will challenge the government’s capacity to manage the rising debt burden, it added in a statement issued recently.
Moody’s ratings contribute to transparent and integrated financial markets, protecting the integrity of credit.
Its ratings and analysis track debt covers more than 130 countries; 11,000 corporate issuers; 21,000 public finance issuers and 76,000 structured finance obligations.
The Ugandan government has previously used Moody’s ratings to prove to investors and lenders its creditworthiness.
Nevertheless, Uganda’s stable outlook reflects Moody’s expectation that, despite the anticipated further deterioration in the government’s fiscal metrics, Uganda’s credit fundamentals will generally remain commensurate to peers at the B2 level meaning a further rating downgrade is unlikely in the near term.
Concurrently, Moody’s has lowered the long-term local-currency bond and deposit ceilings to Ba2 from Ba1, and the long-term foreign-currency bond and deposit ceilings to Ba3 and B3 from Ba2 and B2, respectively.
Given the government’s weak revenue generation capacity, with a revenue-to-GDP ratio of 13.4 percent of GDP compared to the median of 23 percent of GDP for B-rated countries, the debt burden has risen faster than the government’s own resources, resulting in a debt-to-revenue ratio of 236 percent, one of the highest amongst B-rated sovereigns.
While Moody’s anticipated at the time of the initial rating assignment in 2013 a period of larger fiscal deficits and rising public debt levels in support of public infrastructure investments in key strategic areas, debt ratios have risen faster than expected, partly due to weaker-than-expected growth in recent years, coupled with exchange rate weakness.
Real GDP growth averaged 4.3 percent in annual terms from 2012-2014, compared to an average of 7 percent in the three years prior. Additionally, since end-2013, the exchange rate has depreciated cumulatively by more than 30 percent, and further exchange rate weakness also represents an additional threat to the debt burden given the high level of foreign currency government debt.
Debt affordability is also deteriorating, in part due to a shift in composition of the debt burden towards non-concessional borrowing. Around 80 percent of gross financing requirements will be contracted on a non-concessional basis, with around 45 percent of the gross financing requirement to be met by the domestic market.
Debt affordability has been a persistent vulnerability for Uganda, and the higher debt burden combined with the shift in financing sources will lead to further deterioration.
Moody’s projects that debt servicing will increase from 11 percent of government revenues in 2015 to almost 16 percent of revenues by 2018, far exceeding the median for B-rated sovereigns of 8 percent.
Although the Bank of Uganda’s monetary easing cycle in 2016 has begun to help offset rising domestic debt servicing costs, like other emerging and frontier markets, Uganda remains vulnerable to renewed depreciation pressure stemming from further global financial market volatility and capital outflows.
It is understood that much as the general elections held in February 2016 passed with only minor outbreaks of social unrest, aspects of the country’s institutional strength of the country have eroded over the last five years.
“In particular, control of corruption — as measured by the Worldwide Governance Indicators — has deteriorated since 2011, moving from the 21st percentile in 2005 to the 12th in 2015. We assess Uganda’s institutional strength at VL+, ranking it aside peers such as Honduras (B2 positive), Nicaragua (B2 stable) and Pakistan (B3 stable) which is particularly important within the context of a rising debt burden,” said Moody’s.
Countries with high levels of institutional strength — and in particular those with strong and effective institutional frameworks — are ordinarily able to tolerate higher debt burdens than those with weaker institutions.
Moody’s said the deterioration in Uganda’s institutional strength coincides with the expectation that on conservative assumptions, government debt levels will increase 1.5x in the five year period since the rating was assigned (2013-2018), a growth rate that is excessive for a country at such a low level of institutional strength.
Despite the anticipated further deterioration in the government’s fiscal metrics for the remainder of this decade, Uganda’s credit fundamentals will remain commensurate compared to peers at the B2 level, meaning migration to a lower rating level is unlikely in the near term.
Uganda’s credit strengths include strong growth prospects supported by infrastructure spending, rising per capita GDP which has doubled across the last decade, along with robust fiscal and monetary policy frameworks supported by the IMF Policy Support Instrument.
Furthermore, the expansion of the fiscal stance is being directed towards productive capital investment rather than recurrent expenditure, which should support medium-term growth prospects.
Uganda is in the early stages of developing its oil production capacity. Proven oil reserves of 2.5 billion barrels were found in the Rift Valley region in 2006 and in August 2014 hydrocarbon reserve were revised up to 6.5 billion barrels.
After a protracted period of negotiations, the government granted production licenses in August 2016 to three oil companies paving the way for production to begin.
The latest estimate from the government suggests that large-scale production will now begin in FY2019/2020, when a pipeline through Tanzania is completed. If the current plans are realized, real GDP growth in the 2017-2023 ramp-up period could be 2 to 4 percentage points higher than current growth forecasts.
Additionally, Uganda benefits from a credible monetary policy framework which has reined in inflationary pressures in the face of recent external and confidence shocks to the economy.
Partly as a result of these policies, many of the election-related risks that previously drove the negative outlook—notably, a severe depreciation of the shilling and inflation becoming unanchored—have not materialized to the extent anticipated, justifying a stabilization of the outlook.
What Could Move the Rating Up?
Evidence that infrastructure investment is generating growth and a stabilization of the debt trajectory would provide a path back to B1.
Clear indications that final investment decisions into the hydrocarbons sector have been concluded and the country is closer to commencing production would also lead to upwards rating pressure.
A further downgrade is unlikely at this juncture as Uganda compares favorably to B2 peers in terms of robust growth prospects, albeit at a lower level of development, and a low level of institutional strength.
However, two factors could contribute to downward pressure on the rating.
First, the government is increasingly reliant on the domestic banking system for its financing needs. Although the system is well-capitalized and liquid, it is small relative to the size of the economy.
Any indication that the banking sector would struggle to absorb new government bond issuance could adversely affect government liquidity.
Finally, social unrest triggered by high levels of youth unemployment combined with a fractious political environment could jeopardize economic stability and reduce the country’s future growth prospects.