Determinants of investment in machinery and equipment by tea processing firms in Uganda

Abstract

The Government of Uganda recognizes that increased agro-processing is key to maximizing output from the agricultural sector hence accelerating economic growth. To this end, government is focusing its efforts towards attracting Foreign Direct Investment into the agro-industry. To date, investment analyses in Uganda have been based upon national aggregate investment rates and investment rates for a sample of different categories of industries through time series. Such analyses have not provided the information necessary to understand the links between, inter alia, profitability, output, firm size, firm's age, foreign exchange rates and investment at the firm level for specific sub-sectors within the agro-processing industry. This study uses the flexible accelerator model to determine the factors that affect the level of investment and its growth in plant and equipment for tea processing companies in Uganda. Data used were obtained from a sample of five randomly selected tea-processing firms for a fourteen-year period from 1990 to 2003. Firm specific data include profits, capital stock, value of processed tea, firm size, firm age, and interest rates. National data used include CPI, foreign exchange rates, interest rates, M2, net domestic credit, index of industrial production, and GDP. Both the static and dynamic investment behavior models were estimated. The findings of this study indicate that increase in firm profits, firm output, firm size, level of financial depth and overall liquidity in the economy increase the level of investment in machinery and equipment by tea firms. On the other hand, exchange rate depreciation, increase in firm age, inflation and interest rates decrease the level of investment. In addition, growth in firm profits, firm output and overall liquidity of the economy lead to investment growth. However, growth in inflation and interest rates reduce investment growth. The study posits that development of the agro-processing industry is vital to establishing the foundation for sustainable growth in Uganda since this sector exhibits both forward and backward linkages with other sectors. Therefore as government strives to attract investment through implementation of the Marketing and Agro-Processing Strategy (MAPS) and the Medium-Term Competitiveness Strategy (MTCS), support to agro-processing in general, the tea processing firms in particular can be channeled through policies aimed at ensuring macroeconomic stability and policy incentives specific to the growth of the sector. This includes reduced uncertainty associated with inflation, foreign exchange and interest rate risks. Increased investment in agro-processing machinery and equipment in the tea industry may lead to improved value-addition, hence increased productivity, which would boost the competitiveness of Uganda's tea exports.