Demystifying Uganda's Treasury Bond: A Guide to Risks and Opportunities.

December 19, 2023

Many recent conversations have centered on the potential risks involved with investing in Treasury bonds. Aspiring investors, who are just beginning to understand the mechanisms of Treasury Bonds, quite rightfully raise queries such as, "What happens if the government defaults and refuses to repay? or what happens if the Government in power changes", often drawing parallels with countries like Zambia, Egypt, and Ghana that have issued warnings about potential defaults on their Euro Bonds. Furthermore, the escalating debt crisis in Kenya, heightened by the forthcoming maturity of their 2 billion Dollar Euro Bond in June 2024, together with Ethiopia's recent failure to repay a Euro Bond, marking its first brush with default, have ignited a fresh wave of discourse on the possible risks inherent in investing in Treasury Bonds.

This leads to an important question; can the Government of Uganda also default on its Treasury bonds?

Just like any other form of borrowing, bonds also carry a risk of default. However, there are various types of bonds and each carries different risks. The countries mentioned earlier, along with several other African nations, issued what are known as Euro Bonds in the early 2010s. Euro Bonds are foreign-denominated bonds, primarily in Dollars, issued to western international investors and traded on the international market. These Euro Bonds are quite different from the traditional domestic Treasury Bonds issued in the local currency and traded within the issuing country.

African Countries with Euro Dollar Bonds. Photo by Gregory Smith

Uganda is not on the list above.

Uganda has not yet issued any Euro Bonds; all its borrowings are either domestically through Treasury Bonds or internationally from countries like China and organizations like the European Union, World Bank, and IMF. Therefore, in Uganda, the only bonds prevalent in the bond market are the locally traded Treasury Bonds.

Uganda’s Treasury Bonds

Treasury Bonds are debt instruments by which the Government borrows from the local public in the Ugandan currency. Countries worldwide issue Treasury Bonds as both a monetary and fiscal policy instrument. In Uganda, these bonds are traded either through the primary auction market where they are bought directly from the Bank of Uganda or the secondary market, which involves buying from commercial banks or individual investors. Ugandan Treasury Bonds have tenures ranging from 2 to 20 years, unlike in developed countries where there are bonds with tenures of even 50 years.

Several differences between Euro Bonds and traditional Domestic Treasury Bonds come with varying risks. The Euro Bonds are issued in dollars, traded internationally, and all repayments are made in dollars. This foreign exchange risk is high for African countries since we barely generate enough foreign exchange earnings needed to repay these bonds, considering we are net importers. In contrast, traditional Treasury Bonds are issued in the local currency that the issuing government can control—governments can print more of their local currency to repay maturing bonds, an option not available with dollar denominated bonds.

Do Governments honor Long-term Bonds after changes in Government or because of any economic challenge? Undeniably, yes! Failing to honor domestic bond obligations would drastically harm Uganda. Major bondholders, such as NSSF and all major banks, have invested heavily in Treasury Bonds. Neglecting these obligations will lead these institutions to fail, bringing down the entire financial economy. As of October 2022, the pension and banking sectors together hold over 70% of the total outstanding debt. Any government default would lead to these robust financial institutions not meeting their obligations and going bankrupt, a situation that neither the Bank of Uganda or the Government would tolerate. Because of these deep ties to the country's financial system, Domestic Treasury Bonds are considered the safest investments.

Euro Bonds, held mostly by international investors, do not enjoy the same protections. Although a default may not immediately impact the country's local financial system, it could make future borrowing challenging.

Lastly, the question of Time value of money and inflation, like all investments, the returns on bonds are impacted by inflation. Uganda's inflation rate hovers around 5-7 percent over the past 10 years, while the return on bonds is nearly 14% for the least expensive bonds. Despite inflation, the returns are still higher. However, the principle of the time value of money implying that money today is worth more than tomorrow, applies even in this case, affecting all types of investments, including real estate.

Happy Investing.

Alex Kakande