* World Bank takes unusual step to postpone loan
* Aid suspension in 2012 over graft lowered growth
* Sweden says law could deter investors (Adds government response to World Bank, details)
By Elias Biryabarema
KAMPALA, Feb 28 (Reuters) - Uganda’s central bank said on Friday it was selling foreign currency, the third day this week it has intervened to support the shilling which has weakened by around 3 percent since donors withheld aid over an anti-gay law.
After Thursday’s close of trade in Uganda, the World Bank took the unusual step of saying it was postponing a $90 million loan for the health system over the law, that toughens penalties for gays, drawing Western condemnation.
The Washington-based institution usually steers clear of politics and Uganda accused the bank of “blackmail”.
Aid is a vital source of hard currency in Uganda, so any slowdown in flows squeezes the market. When donors suspended aid in 2012 over corruption concerns, Uganda revised down growth. Sweden said the new law could also scare off investors.
“This so-called ‘cut’ is attempted blackmail to set Ugandans against their govt #anti-gay law popular back here,” Ugandan government spokesman Ofwono Opondo wrote on Twitter about the World Bank’s move. He said Uganda could live without the aid.
At 1116 GMT, the shilling was trading at 2,527/2,537 to the dollar, off session lows and hovering around the 2,530/2,540 level at which it closed on Thursday.
But it is still about 3 percent weaker than last week’s close of 2,455/2,465, prompting the central bank to step in.
“BoU is in the market on the sell side,” the Bank of Uganda said on its page on Friday, without giving more detail.
Traders said the central bank sold dollars, although the bank did not give details.
Sweden’s finance minister added pressure on Friday by saying the law would make it hard for it to continue funding projects, including efforts to support the judiciary and improve financial management in the civil service.
Denmark and Norway have already withheld aid, while other countries have threatened action or are reviewing ties, including the United States, Kampala’s biggest donor which provides more than $400 million a year, mainly for health.
“It will be difficult to continue the government-to-government support,” said Swedish minister Anders Borg.
“This is Swedish tax payer money. We are sending it to a country pretty far away and people will say why should we support a government that is harassing people in this manner,” Borg told reporters in the Kenyan capital, Nairobi.
Some traders have played down the risk, saying aid that would go straight to the government is still likely to come into Uganda but would instead enter via other projects, not directly run by the state.
Swedish aid to Uganda was projected at about $40 million in 2014 and a quarter could be affected, Swedish officials said.
Borg said the greater risk to Uganda’s economy could be damage to its reputation in the eyes of foreign investors.
“This issue ... will come up when I speak to Swedish investors,” the finance minister said. “This is a reputational risk when they go to their owners and their young clients in Europe and the U.S. who are very liberal in their views.”
Although the World Bank normally stays out of politics or issues such as gay rights, its president, Jim Yong Kim sent an email to bank staff saying the bank opposes discrimination and would protect the safety of all employees. He noted Uganda was not alone in such action.
“In the coming months, we will have a broad discussion about discrimination with staff, management, and our Board on these issues,” Kim said in the email obtained by Reuters. “Now is the right moment for this conversation.”
Additional reporting by Richard Lough and George Obulutsa in Nairobi; Editing by Edmund Blair and Andrew Heavens