In Uganda, It’s Bust Before Boom

Uganda picked the wrong time to mortgage its future to oil.

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The astonishing oil price drop of late 2014 reminds us of the inherent weaknesses of petro-states. Oil-dependent countries like Russia, Venezuela, and Iran are struggling to cope with sagging revenues. But what if your oil hasn’t even started to flow?

Consider the grim case of Uganda. For most of its existence, Uganda has been a net petroleum importer, painfully dependent on the whims of world oil markets and international aid donors. Then in 2006, the country discovered oil, inspiring visions of a financial bonanza. If managed wisely, the oil revenues might eventually have improved the lives of broad segments of the population. Instead, even before any of the money has materialized, President Yoweri Museveni’s government has chosen to borrow heavily against future income to finance its short-term agenda.

On the surface, the Ugandan economy appears to be doing well. Growth has averaged 6 percent per year since 2005, and debt decreased dramatically between 2004 and 2008, with assistance from two debt relief initiatives organized by the IMF and World Bank. Since 2008, however, a spate of government borrowing against unrealized oil revenues has turned Uganda into one of the most heavily indebted countries in the world. Even before the drop in oil prices in late 2014, there were concerns that the government was mortgaging Uganda’s future on unrealistic long-term expectations. With the sudden downturn in prices, those expectations could soon come face-to-face with a suddenly very harsh reality.

The bulk of Ugandan government borrowing against future oil revenues has focused on grand infrastructure schemes built and funded by the Chinese. In 2014 alone, the government signed deals with China to build two hydropower dams worth $2.2 billion, a standard gauge railway that could cost up to $8 billion, and a $600 million fertilizer plant. Additional projects include a $2 billion oil field being developed by the state-owned China National Offshore Oil Corporation and a $350 million road between Uganda’s capital, Kampala, and Entebbe International Airport. The possibility has even been raised that a Chinese bank may bail out Ugandan parliamentarians in danger of going to jail for failure to honor their debts.

The Ugandan government contends that loans from China are preferable to those from the West because they offer lower rates and greater flexibility but don’t require prompt or advance payment. Opposition groups counter that these grand infrastructure projects are nothing more than schemes to divert funds for personal and political gain. Critics point out that the Museveni government has promoted its allies to leadership positions in institutions responsible for these projects, such as the National Roads Authority and the Finance, Transport and Energy ministries. Such arrangements provide ample opportunity to siphon funds from these projects, and their rapidly rising budgets lend additional credibility to accusations of corruption.

Costs for the Ugandan section of the East African Standard Gauge Railway are especially out of control. The project had an initial price tag of $4.5 billion for the Ugandan side of the railway, compared to $3.8 billion for the Kenyan side. Estimated costs in Uganda subsequently shot up, first to $8 billion and then to a staggering $11 billion, prompting the parliament to appoint a select committee to investigate. Such abuses have prompted opposition groups to label Chinese loans as odious debts, which they claim are being contracted by members of the Museveni government for personal gain and are, therefore, not binding on the country. The Chinese would no doubt disagree.

The current levels of government mismanagement and corruption are recent developments. Between the 1986 end of the civil war and the 2006 discovery of oil, Uganda made substantial economic progress under Museveni. Courting the good will of the Western donors who financed a large portion of its budget, the government introduced economic reforms that put the country on a path of steady growth and led to a substantial reduction in poverty. At the same time, it made gains in the major areas of governance crucial for sustaining economic expansion and moving to higher levels of development. The World Bank found improvements in measures of voice and accountability; political stability and absence of violence; government effectiveness; regulatory quality; control of corruption; and rule of law.

Since the discovery of oil in 2006, Uganda has seen either a deterioration or very limited progress in four of these six measures. After making fairly steady progress in voice and accountability during the late 1990s and early 2000s, Uganda began retrogressing in 2007. By 2013, the country had the lowest score of the new East African oil producers, which include Kenya, Tanzania, and Mozambique. Similar backsliding has occurred in scores for regulatory quality and control of corruption. Most disappointing is Uganda’s recent performance in rule of law. After having led the new East African oil producers in this measure before 2007, Uganda has since made no significant gains – even as civil-war-ravaged Mozambique has made tremendous strides.

The discovery of oil in Uganda has facilitated not only a shift away from democracy in particular, but from the West in general. In 2012, it was discovered that government officials had misappropriated vast amounts of aid. In response, Western donors went on strike, withholding $300 million. The notorious anti-gay law passed in early 2014 also caused an outcry in the West, leading to delays in loan payments and halted aid programs. But the government was undeterred. A spokesman shrugged off criticism: “The West can keep their ‘aid’ to Uganda over homos, we shall still develop without it.” Though aid resumed after the Constitutional Court ruled the anti-gay law illegal, Ugandan politicians are vowing to pass a revised version. With the prospect of future oil revenues, the Ugandan government feels free to ignore Western demands, and has preferred to move towards borrowing from the Chinese, which requires little in the way of accountability, improved governance, or institutional development.

Increased authoritarianism, corruption, and foreign debt following the discovery of oil are nothing new. This phenomenon is so common in petroleum-rich developing countries that economists refer to it simply as “the oil curse.” Briefly stated, the influx of oil revenues absolves the government of the need to raise taxes or develop non-oil sources of public or personal wealth, while the country’s untaxed citizens have little incentive to hold their rulers accountable as long as they keep up an orgy of public spending. Uganda, however, has given the phenomenon a unique spin by exhibiting all the symptoms of the curse before the oil has even started flowing.

As oil prices continue to plunge, Uganda’s future looks bleak. At its current pace, Uganda will soon reach its pre-relief level of debt (74 percent of GDP as of 2004). Worried investors are already starting to price in the growing risk: The yield on one-year paper has risen from 11.9 percent in June 2014 to 14.2 percent this month. At current prices, it is unlikely there will be sufficient funds to service outstanding obligations, especially if the foreign oil exploration companies, such as Tullow, drastically cut back operations or go out of business. This raises an important and hitherto unexplored question: What happens if Uganda is unable to service its Chinese debt? If recent developments in Venezuela are a precursor, things could get ugly very rapidly. Oil prices will not stay low forever. The question is whether Uganda and the Museveni government will be able to weather the storm.

REUTERS/Hardman photo/Handout (UGANDA)

Robert Looney teaches economics at the Naval Postgraduate School in Monterey, California.