SADRN Policy Brief 3: Services sector development in Uganda: The role of financial services

The objectives of financial sector reform in Uganda were interest liberalisation, reducing directed credit, improving prudential regulation, privatisating financial intermediaries, reducing reserve requirements, liberalisation of securities markets and pro-competition measures. Interest rate liberalisation focused on positive interest rates, with rates linked to the weighted average of an auction-based treasury bill, followed by full liberalisation in 1994. To increase competition, entry barriers were lowered in 1991 but this was followed by a moratorium on new banks that was lifted only in 2005. Reserve requirements for commercial banks were raised in 2000 following collapses in the 1990s and in 2004. Directed credit and credit ceilings were gradually removed but re-introduced using European Union funding in the late 1990s to support selected sectors, emphasising export production. Other reforms included privatisation with government divesting its stake in commercial banks in the 1990s and early 2000s. In 1991, penalties were introduced for non-compliant banks and supervision was aligned with Basel 1. Legal and regulatory reforms to enhance the Bank of Uganda's authority started in 1993. Legislation governing microfinance institutions was introduced in 2003 followed by the Financial Institutions Act in 2004 with new regulations. In 1996 the Capital Markets Authority was established followed by the licensing of the Uganda Securities Exchange. Treasury bonds were introduced in 2004. Liberalising the exchange rate began in 1986 with a dual rate replacing the fixed rate, followed by a parallel foreign exchange market in 1992 marking the transition to a market-based system. This was followed by an inter-bank foreign exchange market, liberalisation of the current account and then capital account in 1997. Financial development can be assessed using the ratios of M2 money supply to Gross Domestic Product (GDP), M3 to GDP and domestic credit to GDP. From 1983 - 2008, M2 and M3 to GDP showed an initial sharp upwards trend followed by a decline and then a steady increase. Domestic credit to the private sector has not matched growth in the M2 and M3 shares of GDP. For instance from 1983-2008 M2 and M3 grew by 13% and 15% respectively while private sector credit grew by 11%. Deposit and lending rates rose from 9% and 15% in 1983 to 32% and 40% in 1989, with the spread widening to 15% in 1987. They then dipped, rose again and fell to about 8% and 20% in 1995, remaining at about those levels until the present. The inflation rate reflected these movements rising from about 25% in 1984 to a peak of 190% in 1998, driven by excess money supply, and then declining to single digit levels from 1994.