Modelling the effect of interest rates on household debt levels in Uganda (2010-2024)

Abstract

This study investigates the effect of interest rates on household debt levels in Uganda from 2010 to 2024, a period marked by increasing financial inclusion and persistent macroeconomic instability. Using monthly time series data from the Bank of Uganda, the study models household debt as a function of lending rates, inflation, GDP growth, money supply, and the Composite Index of Economic Activity (CIEA). The Autoregressive Distributed Lag (ARDL) approach was employed, given the mixed stationarity of the variables, to capture both short- and long-run dynamics. Diagnostic tests, including CUSUM stability tests and checks for serial correlation and heteroskedasticity, were conducted to ensure model robustness. Results reveal a statistically significant long-run negative relationship between interest rates and household debt, where a 1% rise in interest rates reduces household credit by Ugx. 0.0311 Million. Conversely, inflation and economic activity positively affect debt levels, with CIEA exerting the strongest influence (coefficient = 4.4201, p < 0.01), and inflation contributing modestly (coefficient = 0.0188, p < 0.01). Interestingly, money supply negatively influences household borrowing in the long run, while its short-run effects are positive and lagged. The error correction term indicates a moderate adjustment speed of 13.85% per month toward long-run equilibrium. Granger causality tests affirm unidirectional causality from interest rates and economic activity to household debt, highlighting the predictive role of these variables in shaping borrowing patterns. The study concludes that lending rates, economic activity, and inflation significantly shape household debt dynamics in Uganda. High interest rates constrain borrowing, while inflation and economic growth fuel debt accumulation. Policymakers are advised to adopt balanced monetary policies that ensure affordable credit access while safeguarding against excessive indebtedness. Strengthening financial literacy, enhancing regulation of lending institutions, and improving macroeconomic stability are critical steps toward fostering sustainable household borrowing. Further research could explore the interaction between formal and informal lending channels and the role of demographic factors in household debt behavior.

Subject Keywords: Interest rates; household debt levels; Uganda