Effect of government borrowing on economic growth in Uganda

Abstract

The nexus between public debt accumulation and economic growth remains pivotal yet a contentious issue within development economics, particularly for low-income countries navigating the dual imperatives of infrastructure-led development and fiscal sustainability. For nations like Uganda, where post-HIPC debt relief was replaced by a renewed and rapid accumulation of public debt to finance ambitious national development agendas, understanding the precise growth implications of this fiscal strategy is not merely an academic exercise but a matter of urgent macroeconomic policy. Escalating debt-to-GDP ratios and the associated rise in debt servicing costs threaten to compress fiscal space, crowd out productive investment, and potentially undermine the long-term growth prospects they intended to secure. This study, therefore addresses a critical empirical gap by providing a contemporary, rigorous analysis of how Uganda’s specific debt trajectory shaped by strategic borrowing for Vision 2040 projects has influenced its economic growth from the post-relief era through to the present decade. The primary aim of this research is to empirically examine the effect of government borrowing on Uganda’s economic growth alongside other macroeconomic variables, distinguishing between short-run dynamics and long-run equilibrium relationships over the period 1994–2020. Moving beyond simple linear correlations, the study investigates the broader macroeconomic conditions in mediating the debt-growth relationship. This investigation is vital for policymakers at the Ministry of Finance, Planning and Economic Development and the Bank of Uganda, as it provides an evidence-based foundation for calibrating debt sustainability frameworks, optimizing the composition of public expenditure, and ensuring that borrowing genuinely catalyzes development rather than precipitating a costly debt overhang. Methodologically, the study employs an Auto-Regressive Distributed Lag (ARDL) bounds testing approach to cointegration, a robust technique suitable for analysing time-series data with a mix of stationary and non-stationary variables. Utilizing annual secondary data from the World Bank and Ugandan national sources, the model specifies economic growth (real GDP growth rate) as a function of total debt service, inflation, gross fixed capital formation, general government final consumption expenditure, and trade openness. Pre-and post-estimation diagnostics, including Variance Inflation Factor (VIF), Breusch-Pagan, and Jarque-Bera tests, confirm the model’s validity, ensuring the reliability of inferences drawn. The most salient finding is the statistically significant negative long-run impact of general government final consumption expenditure on economic growth. This result provides empirical validation for neoclassical and debt overhang theories, suggesting that borrowed funds channelled into recurrent, consumptive spending crowd out productive private investment and fail to enhance the economy’s productive capacity, thereby imposing a future growth penalty. Conversely, trade openness exhibits a positive and significant short-run effect on growth, highlighting the role of external sector vitality. While the direct coefficient on total debt service in the long-run ARDL model is marginally significant and negative, the more critical mechanism is captured indirectly through the negative effect of government consumption. The Error Correction Term (ECT) of -0.421 is highly significant, indicating a moderate speed of adjustment approximately 42.1% of any disequilibrium caused by external shocks is corrected within one year as the economy reverts to its long-run growth path. The main takeaway from this study is that for Uganda, the composition and productivity of public expenditure financed by debt are more consequential for growth than the sheer volume of borrowing itself. The empirical evidence challenges the assumption that debt-financed public spending is inherently growth enhancing. Instead, it reveals that when borrowing primarily funds recurrent consumption, it acts as a drag on long-term prosperity, validating concerns of a latent burden of debt.