Aid with Ties

Aid with Ties


A country in need of the help it could do without.

By Donor News
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First published: June 10, 2005


Given the low domestic savings rate, narrow tax revenue base and inadequate export earnings, Uganda has had to depend on external financial assistance. And because of this, Uganda's external debt more than doubled during the adjustment period reaching US$ 3.54 billion as of June 1997 up from US$ 1.6 billion in 1987. A large part of the increase is attributable to credits obtained from multilateral institutions on highly concessional terms to support the Balance of Payments and finance development projects. By the end of 1995/96, Uganda remained heavily indebted with the external debt stock amounting to US$3.5 billion, stock of arrears of US$ 250 million and with large debt service commitments. The Multilateral debt as of June 1996 accounted for about 75 percent of the total debt stock, compared with only 43 percent in 1987, making the debt unsustainable.


External loan repayment accounted for over 27% of Uganda’s recurrent expenditure in 1992/93 and 1993/94, which was higher than the allocation to education, health, community and social services, and public order and safety. In 1994/95, the share allocated to external loan repayment including interest declined largely on account of accumulation of arrears and debt rescheduling. The government was thus overburdened with debt service and given the low export earnings, low domestic savings and a narrow tax base, the social sectors suffered severe cuts in expenditure.

In order to arrest this situation the Government had to undertake a number of initiatives. The World Bank’s HIPC Debt Initiatives is thus one of the channels through which government is meeting this challenge. This is a debt relief initiative that was given to heavily indebted countries with a good track record of reforms. Since then, the commitment and consistency with which Uganda has pursued sound macroeconomic policies and structural reforms enabled it to become the first country to qualify for debt relief under the 1996 HIPC Initiative has also enabled it to became the first country to benefit from the enhanced HIPC in April 2000 having met the programme benchmarks and successfully prepared a comprehensive poverty reduction strategy.

This has enabled government reallocate the resources that would have been used for loan repayment and interest payment to the social sector. Indeed social sector expenditures have risen since the inception of the HIPC debt initiative. The HIPC debt initiative has released resources that would have otherwise been used for debt service for investment in poverty reducing sector programmes. These resources are channeled through the Poverty Action Fund (PAF), which is an integral part of the Medium term Expenditure Framework (MTEF) that comprises a rolling three-year expenditure plan for the Government of Uganda.

PAF was set up in 1997/98 using resources from them Multilateral Debt Fund (MDF) and later on resources saved from HIPC debt relief. Subsequently, it has attracted additional bilateral donor funding and has indeed become a mechanism for ensuring the reallocation of additional resources directly to poverty reducing sectors.

Managing the Debt

Aid has no doubt enabled Uganda achieve impressive economic growth figures but there is still the question of “tied aid”. For example the last time the U.S. government revealed any data on this issue—back in 1996—72 cents out of every U.S. foreign aid dollar was spent on US goods and services. In September 2004, the United Nations’ Economic Commission for Africa’s Economic Report on Africa reported that “the donors’ habit of insisting that aid funds be spent purchasing goods and services from the same donor countries is crippling Africa’s chances of pulling ahead.” According to the report, “tied aid” reduces the real value of the assistance by some 25 to 40 percent, given that recipient countries are forced to buy imports that are not priced competitively. Tying aid promotes goods and services from the donor country and undermines the humanitarian purpose and the overall effectiveness of assistance. It results often in inappropriate aid, which does not meet the needs of the poor.

By allowing greater competition for the provision of services, a recipient country can benefit from buying from suppliers that compete on price, quality, and service. Untying aid can also help strengthen the local and regional economies and contribute to building local productivity.

However, as a step in the right direction, the U.S. and other rich nations agreed that by January 1, 2002 they would cut the strings and untie aid to least developed countries. Today, the U.S is yet to do it but the ECA report notes that four countries (United Kingdom, Norway, Denmark, and the Netherlands) were breaking away from the idea of “tied aid” with more than 90 percent of their aid “untied.”

While debt relief was envisaged to reduce the debt burden to sustainable levels, to date a number of creditors have not extended debt relief to Uganda. This financial year, only two HIPC debt relief agreements were concluded between Uganda and OPEC Fund and South Korea. Moreover, some creditors have sued the Government and have been paid. Since the HIPC Completion point for Uganda was reached, the country has borrowed US$1.5bn from multilateral creditors and although these loans have been secured on highly concessional terms, their impact on the debt stock, combined with lower export growth and low prevailing world market interest rates, has been to raise the Net Present Value (NPV) of the debt to exports ratio to 305%, which is more than double the HIPC debt sustainability threshold. Uganda’s policy of gradual deficit reduction will enable it to bring its debt stock back down to manageable levels.

The Ugandan experience shows that for the savings from the HIPC Debt Initiative to contribute positively towards poverty reduction there must be macroeconomic stability, political will, sustainable capacity in government to deliver services and to fight corruption, and good governance and security of life and property. There is also need to adopt policies of inclusion that bring together stakeholders in the fight against poverty. In particular, the Non-Governmental Organizations (NGOs) and Civil Society Organizations (CSOs) have to be involved in the fight against poverty since they help in identifying programmes for poverty reduction and at the same time help in monitoring the implementation of these programmes.

The G8 led by the current chair, Prime Minister Blair are pushing for 100% debt relief. Britain has already pledged to write –off 10% of the developing world’s foreign debt. If this does happen it will free even more resources for development purposes. Furthermore, the recently launched Commission for Africa is a related initiative that is pushing for the rich countries to finance an ambitious “Marshal plan” for Africa.

By Donor News
more from author >>
First published: June 10, 2005
The Challenges of Financing National Development

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