OREANDA-NEWS. August 11, 2015. Fitch Ratings has affirmed Uganda's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'B+' with Stable Outlooks. Fitch has also affirmed Uganda's Short-term IDR at 'B' and Country Ceiling at 'B+'.

KEY RATING DRIVERS
The affirmation reflects the following factors:

Uganda's economy has regained its momentum, expanding 5.3% in FY15 (ended June 2015), up from an average of 4.3% in the previous three years and above the 'B' median of 4.6%. Fitch expects growth to pick up steadily, averaging 5.8% in FY16-17, supported by infrastructure investment, particularly in power generation. The Bank of Uganda has hiked rates by 350bp this year to 14.5% to contain the expected inflationary impact of a sharply weaker exchange rate, despite below-target inflation. This swift policy response contrasts sharply with the delay in 2011 in responding to excess liquidity and higher food prices, which saw inflation spike 30%.
The fiscal impact of the construction of the 780MW Karuma and Isimba hydro-power dams (HPPs), estimated to cost USD2.3bn (or 8% of GDP), which was expected to fall in FY15 has been moved into FY16, due to continued delays in signing the financing contract. As a result of under-execution on capital projects and revenue over-performance, the budget deficit for FY15 is estimated at 4.5% of GDP against 7.3% at the time of the budget.

The budget announced in June 2015 (FY16) expects the deficit to widen to 7% of GDP, largely due to a 3% increase in capital spending, including the HPPs. Low levels of infrastructure investment in comparison with peers and weak implementation capacity have been highlighted among the factors limiting Uganda's long-term growth potential. The authorities aim to raise revenue by 0.5% of GDP annually, through new tax measures and improved efficiency.

Government debt has risen steadily, increasing to 31.9% of GDP in FY15 from 20.8% in FY10, due to rising domestic and external borrowing. Fitch expects the construction of the Karuma and Isimba HPPs to raise debt above 40% of GDP by FY18, although it is expected to peak significantly below the 'B' median of 51.6%. An unchecked increasing debt burden would put downward pressure on the ratings.

External imbalances and adverse sentiment towards emerging markets are expected to exert continued pressure on the shilling, which has fallen 18% against the dollar since January 2015, but the freely floating exchange rate regime, together with the central bank's willingness to hike rates, underpins policy credibility.
Fitch forecasts the current account deficit to widen sharply to 12% of GDP in FY16 from 9.7% in FY15, driven by higher capital imports for the construction of the two large HPPs. The government expects the import-intensive phase of these to last for two years, with about 80% of the USD2.3bn value of the project being imported. With the majority of the project financed by a loan from China, it is not expected to exert pressure on reserves.
Foreign direct investment has traditionally financed a meaningful share of the current account deficit and foreign exchange reserves are expected to continue to rise and compare favourably with 'B' peers.
Rapid economic growth has helped to lift two-thirds of the population out of extreme poverty over the past decade, but per capita income remains low - less than one-third of the 'B' median - due in part to high population growth of 3.3%. The ratings remain constrained by weak governance and a weak business environment, both below the 'B' median.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently well-balanced. The main factors that could, individually, or collectively, trigger negative rating action include:
- A substantial weakening in public finances relative to peers.
- A sharp widening of the current account deficit, not matched by an increase in long-term financing, which would increase external vulnerability.
- A marked deterioration in the political environment and/or security, undermining Uganda's long-term growth performance.
- A weakening of the macroeconomic policy-making framework.

The main factors that could, individually, or collectively, trigger positive rating action include:
-A continued track record of sound economic management as well as investment in infrastructure, supporting robust growth and rising per capita income.
-A narrowing in the current account deficit, as a result of improved export performance, supporting a further build-up in reserves.
-Strengthening of public finances, focusing on improved tax revenue generation.
-Regulatory reforms to foster an improved business environment.

KEY ASSUMPTIONS
The ratings and Outlooks are sensitive to a number of assumptions:

Fitch assumes that GDP growth will recover to 6% by 2018 supported by rising infrastructure investment and the development of the oil sector. Oil production will start beyond 2017.

No drought is assumed.

Fitch assumes that the pace of structural reform will continue, in combination with the authorities' commitment to prudent economic policies.

Political stability is maintained.