Bank of Uganda’s Executive Director for Financial Markets, Stephen Mulema, says a reduction in domestic borrowing could bring interest rates down.
In order to meet its financing, government usually borrows from the private sector through the central bank’s financial market.
The BoU issues treasury bonds and bills, also known as government papers, which private sector players like banks, businesses, entities like National Social Security Fund and individuals buy.
The government pays high interest rates on the papers, ranging from 14 to 17 percent, way above the interest one would get from saving money, even in a fixed account.
The treasury bonds are also risk free since the government pays back. Banks like the government papers because unlike lending to the private sector they fetch higher returns.
Geoffrey Onegi-Obel, a financial expert, says if government borrows heavily domestically a bank can survive on government papers and still make huge profits. He says the huge profits banks post year-on-year is actually more from government papers than from private sector lending and other bank charges.
The BoU early this week reduced the central bank rate (CBR) from 15 to 14 percent, a reduction that is expected to lead to a reduction in interest rates.
But commercial banks rarely automatically reduce interest rates even if the CBR is down. Presently interest rates are hovering between 25 and 30 percent.
Speaking in an earlier interview, the Chief Executive Officer of Standard Chartered Bank, Herman Kasekende, said if government reduces domestic borrowing it will be a signal for interest rates to go down. This in turn would boost private sector borrowing.
Kasekende also cited high default rate, low compliance and a poor savings culture as some of the risk factors banks consider to determine interest rates. The latest loan default rate figure from the BoU is over seven percent.
In an interview, Mulema explained the link between the CBR, interest rates and government papers.
Mulema said even if the Bank of Uganda reduces the CBR but as long as the government borrowing remains strong there may be no real change in interest rates.
The government for years has been borrowing an average of about 1.5 trillion Shillings domestically, but this financial year it has indicated that it will reduce domestic borrowing by half. This is from 1.4 trillion Shillings in 2015/16 to 612 billion Shillings.
Last week government borrowed 150 billion Shillings via treasury bonds and bills. It is not clear how resistant to more borrowing the government can be in the wake of demands from public universities’ non-teaching staff, distressed companies and other fiscal needs.