Businesses in Uganda are increasingly turning to offshore borrowing, attracted by lower interest rates and relaxed regulations, as interest rates on loans dominated by the local currency remain high in a slowing economy. The Bank of Uganda’s (BoU) fourth-quarter bank lending survey reveals that commercial banks have made it more challenging for sectors like building, mortgage, construction, and real estate to access loans. As interest rates rise, smaller businesses and riskier borrowers face higher costs, prompting a surge in offshore borrowing.
Industry players are capitalizing on the comparatively lower interest rates and favorable regulations associated with offshore borrowing. This move is driven by the significant difference in interest rates, with offshore rates as low as 5 percent compared to domestic rates reaching 18 percent. The decision to raise interest rates domestically was an attempt by the central bank to control inflation, which exceeded the nation’s target last year, reaching 6.3 percent.
Despite efforts to cool down the economy, commercial banks are facing challenges meeting core capital requirements and managing non-performing loans. To alleviate this pressure, banks are increasing lending to the government, a safer alternative compared to private borrowers. However, this has implications for the domestic borrowing market as it adds pressure on the government to meet its borrowing needs domestically.
The economic landscape is further complicated by a decline in aggregate demand locally, contributing to low inflation rates. The government’s efforts to drive industrialization and economic growth are facing challenges, with concerns raised about the country’s ability to sustain these initiatives. The majority of the population employed in agriculture, coupled with low wages, poses obstacles to driving demand for local industries. As a result, Ugandans are diverting investments into government papers, creating a potential debt trap for the country.
The private sector’s shift towards foreign currency-denominated loans, combined with the government’s reliance on foreign currency to finance deficits, has reduced dollars from domestic lenders. This has led to an increase in offshore borrowing. The government’s servicing of loans using nearly $1 billion annually has contributed to a reduction in foreign exchange reserves. The Ugandan shilling has experienced depreciation, influenced by various factors, including corporate demand and outflows from portfolio capital.
