The bond market has moved to the top of the investments deck
With the investment culture building up steam in Uganda because of the increasing awareness and exposure of the working middle-class, the once moribund bond market has moved to the top of the investments deck.
The recently acquired favoured position of bonds has for the most part been galvanized by increased internal government borrowing, and the loud drive pushing people to invest in bonds across various digital platforms because of the near-zero risk associated with them.
WHAT IS A BOND?
A bond is a loan given to a corporation or government by an investor: the one who buys it. It is financial security, and can be bought from the central bank through a subsidiary like a bank from what is called the primary market; or from other bond-holders through a bank of their choice in what is known as the secondary market.
They are used to raise money by corporations and governments with the latter using them to heat check the economy as a monetary policy tool to control inflation. Bonds are viewed as less risky investments because the default risk of governments is close to nothing.
THE OTHER SIDE OF BONDS
There is a never-discussed dimension of bonds that its crusaders conveniently choose to leave out to the disadvantage of the common investor who needs the full picture painted for them of this financial security before they pour their money into it. To begin with, bonds are an ideal investment for investors whose priority is safety, and not large returns.
Secondly, rising interest rates and bonds have an inverse relationship: when interest rates rise, bond yields fall and vice versa. This means that when new bonds are issued with high interest rates, automatically, the value of the old bonds drops indicating that their holders sell them at a loss — discount.
More times than not, this has been the case in the Ugandan bond market. Since January 2022, the central bank rate [CBR] has risen by 3.75 per cent from 6.5 per cent to 10.25 per cent in June 2024. This reveals that bond yields have been dropping in the last couple of years as Bank of Uganda [BoU] raises the CBR.
Likewise, bonds issued by BoU aren’t inflation-protected, and their yields are lower than the increasing price levels in the economy. When bonds are inflation-protected, the prevailing rate of inflation is added to the yield, thereby protecting the bondholder from rising prices.
This is not the case for Ugandan bonds. Inflation weakens the shilling; as per BoU, in the last five years, currency circulation has gone up on average by 12.6 per cent. Economists have come to associate increased money circulation with the level of inflation. In FY 2022/2023, headline inflation hit 8.8 per cent, and core inflation was 7.4 per cent.
In reality, inflation eats into the profit of the bond, suggesting that they are not suitable in inflation hotbeds because not only do rising prices weaken currencies; but the continuous deployment of monetary policy tools by BoU to curb the heating economy results in falling yields of bonds.
Then there are the various costs associated with bonds. For instance, they attract commission fees, and a withholding tax; and because of the always-rising interest rates, bond investors oftentimes buy them at a premium: that is, above their face value Besides, the bond market in Uganda is designed for the bondholder to benefit only when the bond market is soaring.
Financial instruments that initiate the function of profit in times of economic downturns in the bond market called contracts-for-difference [CFDs] through short-selling are non-functional. CFDs are functional in South Africa, Europe and South America; but the financial regulatory framework for their existence hasn’t been provided for in Uganda.
On buying bonds, businesswoman and investment enthusiast Moreen Oyulu had this to say, “With bonds, once you invest money in them, you’ll not see that money until the maturity date, all you’ll get is the coupon which is the interest you’ll have earned from the bond. In other words, if you needed that money for an emergency, you’ll not have access to it until the bond matures”.
“Before you invest in bonds, you have to examine your set of circumstances and factor in conditions like: ‘Do you have a monthly income from a job or any other disposable income? If you do not have that, then bonds are not for you’”.
“Because if an emergency occurs, you’ll not have access to the money locked up in bonds. I would instead recommend investing in a unit trust because they’re transactional: if you wanted your money out tomorrow, you’d get it. And with unit trusts, you have interest added to your account daily; which interest is higher than that awarded by treasury bills and bonds, not ignoring the fact that the interest earned isn’t taxed”.
Dr Enoq Twinoburyo, senior economic consultant at SDG Centre for Africa, had this to say about the danger of heightened domestic borrowing through government bonds, citing Ghana as an example.
“The Government of Uganda faces increasing interest rate risk, as domestic borrowing costs rise. The government’s long-term domestic debt structure entails substantial interest payments, and with an upward-sloping yield curve, future rates could escalate further. This is particularly concerning as market sentiment and outlooks are currently skewed towards downside risks, implying potentially higher future borrowing costs”.
“Although banks in Uganda hold excess reserves above the minimum required by the central bank, the sustained increase in government borrowing has limited the growth of private sector credit. This suggests a ‘crowding out’ effect, where funds that might have gone towards private lending are diverted to government securities, restraining private investment and broader economic growth”.
“The government’s reliance on bond roll-overs presents significant refinancing risks. As treasury redemptions grow, the rollovers now account for over 30% of domestic revenue. If market sentiment shifts and bondholders begin to price in higher risk, Uganda may face severe financing pressures, which could elevate debt servicing costs and restrict fiscal space”.
A bond rollover is when a bond that has reached its maturity is refinanced. This pauses a risk as it may be refinanced at a higher interest rate than it was paid for, pointing to a scenario where the government pays its debtors, and immediately has to borrow from them at a higher interest rate.
“The case of Ghana highlights the potential consequences of high domestic debt. Facing escalating debt, Ghana undertook a domestic debt restructuring (DDR) on government bonds as part of its agreement with the IMF to access the first tranche ($600 million) of a $3 billion bailout.
“This restructuring, while essential for securing the IMF program, was a painful reality, marking significant losses for bond-holders. Treasury bills and deposit accounts were excluded, safeguarding day-to-day banking operations, but domestic bonds experienced cuts in value, reducing market confidence and bondholder returns”.
Dr. Twinoburyo warns that, “Uganda’s over-dependence on domestic borrowing suggests it could face similar restructuring risks if debt continues unchecked”. In his words, “Ghana’s experience illustrates the importance of balanced debt management to avoid the need for such painful measures”.
In closing, it’s only fair that the prospective investor in Ugandan bonds is given the privilege to pick their side of the divide after being briefed on both sides of the debt security, and not the slanted version that is presently pushed.
kidambamark3@gmail.com
Source: The Observer
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