Uganda’s capital inflows are weakening largely as a result of offshore investment outflows on domestic debt securities, declining budget and project support loans and banks increasing their placements of deposits abroad, according to the Bank of Uganda (BoU).

Through its latest state of the economy report for September, BoU says while foreign direct investments (FDIs) have been strong other financial flows have weakened substantially and weighed on forex reserves.

Uganda’s portfolio investment account deteriorated in the three months to July with net outflows increasing to $194 million from $75.6 million in the quarter to April largely attributed to offshore investment outflows on domestic debt securities.

On the other hand, the ‘other investment account’ recorded net outflows of $352.7 million from net inflows of $120.9 million in the same period, with the banking regulator attributing it to banks increasing their placements of deposits abroad and a decrease in both budget and project support loans.

“The other investment account also recorded net outflows of $352.7 million in the quarter to July, from net inflows of $120.9 million registered in the quarter to April, as banks increased their placements of deposits abroad and a decrease in both budget and project support loans,” the bank says.

“These trends highlight Uganda’s challenges with capital outflows and reduced external financial support, which could impact economic stability.”

Uganda’s gross foreign exchange reserves fell to $3.3 billion in July from $3.7 billion in December 2023, with coverage of imports at three months (excluding oil projects), reflecting higher external debt service payments, inability to secure external loans at affordable terms, and limited foreign exchange purchases by the BoU due to unfavourable domestic foreign exchange market conditions.

FDI inflows remained robust and increased by $55.3 million to $813.7 million in the three months to July, mainly on account of investment in the oil sector.

“While net foreign direct investment inflows have been strong since 2021, mainly reflecting oil related investments, net portfolio and other investment inflows have been weak and volatile, as experienced reflecting less favourable global financial conditions,” the bank says.

“Despite strong oil-related FDI, Uganda faces challenges with volatile financial inflows and reduced external support, impacting overall financial stability.”

Net other investment inflows have seen a significant decline in recent years from a peak of $ 500 million in the 2019/2020 fiscal year to around $ 200 million in the 2023/2024 fiscal year as external project and budget support inflows fell.

According to the bank these developments in the financial account are primarily reflected in a combination of factors, including offshore exits, high debt service payments and constrained donor support inflows.

“On the upside, however, FDI inflows remained robust to support the surpluses registered during the reporting quarters. Overall, while robust FDI inflows provide some stability, addressing the issues of capital flight, debt service, and donor support is crucial for maintaining financial health,” the bank says.

The BoU has taken measures to build foreign exchange reserves in the short term including foreign exchange swaps/cross currency repos (repurchase agreements) in 2024 with no impact on the exchange rate.

“Additionally, the Bank plans to purchase gold to diversify its composition of reserve assets, an approach which does not directly affect the foreign exchange market,” the bank says.

FDI inflows remained robust and increased by $55.3 million to $813.7 million in the three months to July, mainly on account of investment in the oil sector.