Foreign reserves fall to all time low

High public service costs continued to weigh heavily on Uganda’s foreign reserves, resulting in a drawdown of $144.1m (Shs528.7b) in the three months to July.
In details contained in the September State of the Economy Report, Bank of Uganda noted that developments in the [balance of payment] resulted in a drawdown in reserve assets, which in the period dropped to three months of import cover, dropping under the Central Bank’s target of four months.
The reserves have been falling since 2022 due to mounting external debt financing costs resulting from an increase in the accumulation of commercial debt. It is the first time they have fallen to under $3.5b in more than 10 years. 
For instance, during the year ended June, according to data from the Ministry of Finance external debt service increased from $816.3m in the year ended June 23 to $1.05b due to a surge in principal and interest payments, fees for major flagship projects and debt service for budget support loans from the Afrexim Bank and Trade and Development Bank.
The Ministry of Finance noted that of the $1.05b due to external debt service, principal payments took 64 percent ($672.96m),  while interest and fees took 34 percent ($359.89m) and 2 percent ($19.04m), respectively. 
The increase has drained reserves, which are often raided to lengthen the maturity of external debt by flattening the yield curve.
During the three months to July, Bank of Uganda data indicates that the stock of reserves dropped to $3.32b, equivalent to three months of future import cover, excluding oil project-related imports, which was lower than the $3.46b worth of 3.2 months of imports registered at the end of April.
The reserves had earlier in December 2023 reduced to $3.7b, reflecting higher external debt service payments, inability to secure external loans at affordable terms, and limited forex purchase.
Therefore, Bank of Uganda said the fall in reserve assets underscored the need for improved public debt management and strategies to enhance foreign exchange inflows.
The Central Bank also noted that it had “taken measures to build foreign exchange reserves in the short term” by utilising foreign exchange swaps or cross-currency repos with no impact on the exchange rate and was working on a plan through which it would purchase gold domestically to diversify the composition of reserve assets.
Foreign exchange reserves, which can be held in cash and other assets such as gold, primarily balance payments, influence the foreign exchange rate movements and maintain confidence in financial markets.
In July, Bank of Uganda said it would initiate a Domestic Gold Purchase Programme to rebuild the country’s foreign reserves and support government’s value addition to the minerals and import substitution strategy by reducing imports of raw gold into the country.
Dr Adam Mugume, the Bank of Uganda director of research, said then that purchasing foreign currency from the domestic market had been constrained by low inflows, thus adopting a gold purchase programme that would also “support value addition to Uganda’s natural resources”.
Globally, the International Monetary Fund said, in the third quarter of 2022, central banks added $20b worth of gold to their international reserves. 
Earlier in April, Bank of Uganda had shown concern about the declining foreign exchange reserves, which as of June 2023 stood at $4.1b but had fallen to about $3.5b in the quarter ended April, largely due to external debt payments and the inability to purchase foreign currency from the market given the exchange rate depreciation.
Foreign exchange reserves continue to be under pressure, with Bank of Uganda previously warning that increased expenditure on public debt had curtailed its efforts to build the exchange reserves.
Data contained in the Uganda Revenue Authority Annual Data Book shows that government expenditure on debt servicing has been growing, expanding to Shs8.3 trillion from Shs6.7 trillion in the period ended June 2022. 
Data further shows that in the four years to June 2023, the cost of debt servicing increased by 44.9 percent from Shs3.7 trillion to Shs8.3 trillion, due to an upsurge in debt, which had risen from Shs57.1 trillion to Shs96.1 trillion ($25.3b), according to data from Ministry of Finance. 
URA data further indicates that the Shs8.3 trillion spent on debt servicing represents at least 32.5 percent of Shs25.7 trillion collected as domestic revenue during the period, of which Shs5.9 trillion was spent on interest payments and commitment fees, while Shs1.2 trillion and Shs2.4 trillion went to external debt and amortisation, respectively. 
Cost of debt servicing
Experts have previously warned that whereas Uganda’s debt is still within sustainable levels, the country risks entering a debt trap given that a large portion of the country’s domestic revenue now goes towards debt servicing, which limits allocation of resources to development financing. 
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