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Rise in foreign currency loans could hurt Uganda’s economy

Saturday August 17 2013
econ

The building and construction sector in Uganda received the most foreign current loans. Photo/FILE/TEA Graphic

The World Bank has raised concerns about the growth of foreign currency-denominated loans in Uganda, arguing that it could destabilise the economy.

The Bank of Uganda (BoU) began restricting foreign currency-denominated loans this year, leading to a marginal contraction of 3.9 per cent to Ush3.04 trillion ($1.17 billion) as at the end of June this year, from Ush3.17 trillion ($1.18 billion) as at the end of December 2012.

The restrictions, which include ensuring that foreign currency-denominated loans are either short-term or are disbursed to borrowers with foreign currency income streams, came after the value of these loans peaked at the end of December last year.

READ: New BoU checks to cut risks on loans in foreign currency

Foreign currency-denominated loans, whose value stood at Ush826.94 billion ($401.4 million) at the end of June 2009, have been consistently growing at a rate faster than Uganda shilling-denominated loans; indeed between December 2011 and June 2012, shilling-denominated loans started contracting while the former hit all-time highs.

The World Bank, in its Uganda Economic Update Report released recently, says the shift from local to foreign currency loans is likely to dilute the effectiveness of monetary easing on the real economy, particularly in the event of a depreciation of the currency, which will make it more expensive for borrowers. 

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“Vulnerability arises from the fact that borrowers who hold their loans in foreign currency, can have difficulty repaying loans when the shilling is volatile,” said Rachel Sebudde, senior economist for Uganda at the World Bank, who was the lead author of the Economic Update.

She said that what is required is a stable environment, including not only low and stable inflation, but also a stable currency, adding that the restriction on denomination of loans should not necessarily affect availability of credit to growth drivers, so long as these sectors can still access this credit in local currency.

Uganda’s currency gained 3.63 per cent between January and June this year, a period when BoU indicated that it was pushing for lower interest rates through cuts in the benchmark rate.

ALSO READ: Will BoU’s rate cut raise demand for credit?

The currency had however depreciated by 8.04 per cent between December last year and June 2012 when interest rates remained high.

Ms Sebudde said that a stable currency will ensure that even if the borrowers wanted foreign-denominated loans to transact in foreign currency, for example to import goods, they can still borrow in shillings and convert to foreign currency without incurring major costs.

Economic growth in Uganda over the past 18 months has been mainly driven by the services and construction sectors, followed by the manufacturing and then the agricultural sector but the construction and manufacturing sectors have been some of the major recipients of foreign currency-denominated loans.

BoU data for the period ended December 2012 shows that the building and construction sectors were the major recipient of loans with 25.4 per cent, followed by the manufacturing sector with 22 per cent and trade and commerce sector at 20 per cent.

The World Bank says that the sectoral concentration could worsen as commercial banks increasingly facilitate loans in foreign currency, whose share of all loans has rapidly grown to a total of 41 per cent, up from approximately 29 per cent two years ago.

As at the end of June this year, the average shilling lending rate stood at 22.58 per cent, while the average foreign currency lending rate stood at 10.27 per cent; in December last year, the average shilling lending rate stood at 24.77 per cent compared with the average foreign currency lending rate of 8.75 per cent.

Last month, the International Monetary Fund said that a large differential between domestic and foreign currency rates and insufficient collateral had skewed lending sharply toward foreign currency to large corporations and upper-income individuals.

By David Mugwe and Bernard Busuulwa

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