1. My Ugandan authorities thank the staff for the candid and constructive policy dialogue during the mission for the Article IV consultation and the fourth review under the Policy Support Instrument (PSI). The authorities remain committed to maintaining macroeconomic and financial stability, sustaining high and broad-based growth, and reducing poverty significantly. They agree with the broad thrust of the staff report and request Directors’ support for the completion of the fourth review. All assessment criteria for the period were met. Also, all but one of the indicative targets were met; base money exceeded marginally the allowed 5 percent band.
Recent economic developments
2. The Ugandan economy continues to record buoyant performance because of disciplined macroeconomic policy implementation, and strong effort in carrying out structural reforms. Real GDP growth was broad-based, propelled by services and manufacturing. During 2008/09, however, Uganda has been buffeted by two shocks: the recent high, albeit subsiding, fuel and food prices; and the global economic and financial crisis. The shocks have triggered a rise in annual inflation from low single digits in the first half of 2007/08 to about 14 percent in November 2008. Further, real GDP growth is estimated to slow from 8.9 percent in 2007/08 to 7.4 percent in 2008/09 due to the adverse impact from the shocks.
3. Balance of payments performance and capital inflows have been strong, resulting in some appreciation pressures on the Uganda shilling against the US dollar in 2007/08. The shilling, however, experienced sharp depreciation pressures in October 2008 mainly because of the recent dollar appreciation against major currencies. In addition, the downside risks posed by the global financial crisis have resulted in investors in treasury bills and government bonds not rolling over these instruments on maturity, with the associated capital outflows. Gross international reserves remain at comfortable levels, being equivalent to about 6 months of imports at end-October 2008. All told, the real effective exchange rate appreciation has been modest. However, if the appreciation persists, it may, with a lag, hurt export competitiveness.
4. The macroeconomic performance and the outlook for the remainder of 2008/09 is in line with the Memorandum of Economic and Financial Policies (MEFP). The authorities recognize and remain committed to resolving a number of challenges to sustain the high growth performance. These challenges include scaling up resources to finance infrastructure, especially roads and energy; transforming the agricultural sector; strengthening the IFMS to ensure prudent budgeting, execution and monitoring; and putting in place mechanisms for appropriate management of oil revenues expected to come on stream in 2010.
Objectives and policies going forward
5. The authorities are replacing the Poverty Eradication Action Plan (PEAP) with a new five-year National Development Plan (NDP). The NDP aims at real GDP growth of about 8 percent per annum over the medium term, supported by macroeconomic stability, open trade, sound public finances, and measures to address key constraints to private investment. In this regard, Uganda’s recent sovereign credit rating that improved from a single B to a B+ is expected to boost confidence in the economy. Furthermore, the authorities plan to raise substantially public investment in infrastructure – roads, energy and railways – for the next three years to address one of the principal constraints on growth in Uganda. Understandably, the authorities are monitoring the economic situation closely in the wake of the global economic and financial crisis, and will use the available monetary and fiscal policy tools to limit damaging effects on the economy.
6. Regarding the budget for 2008/09, revenue has been somewhat lower in the first few months of the year but is projected to reach the target, as further improvements in tax administration take hold. Also, spending is expected to be as budgeted. However, should development spending be lower than projected, due to delays in implementation of road projects, unspent funds will be carried over to the next fiscal year. Going forward, the authorities will consider introducing a fiscal rule to tamper strong spending pressures, particularly when oil revenues begin to flow in 2010. For a transparent and prudent use of Uganda’s oil wealth, a specific line on oil will be introduced in the National Accounts and incorporated into the Medium Term Fiscal Framework (MTFF). Furthermore, the authorities are committed to working on the three main areas where cash management could be improved and the build up of domestic expenditure arrears avoided: (i) cash flow forecasting;
Monetary and exchange rate policies, and financial sector reform
7. Uganda remains committed to keeping the average underlying annual inflation around 5 percent, guided by the reserve money target. The significant part of the run-up in prices in 2007/08 can be attributed to increases in international food and fuel prices. Monetary policy tools will continue to be used to anchor inflation and its expectation by, inter alia, reducing the growth of base money. The subsiding of international commodity prices in the wake of the global financial crisis may help reduce inflation further. In the context of the global financial crisis, reliance will be on an appropriate mix of sterilization instruments to manage liquidity, using a combination of domestic Open Market Operations and foreign exchange sales.
8. The Bank of Uganda (BOU) is preparing for an inflation-targeting framework for monetary policy. The Uganda Bureau of Statistics (UBOS) rolled out a new measure of underlying (core) inflation that would more accurately capture inflation trends and is expected to roll out a quarterly GDP series by end 2008. The BOU is in the process of designing appropriate monetary and exchange rate policy communication strategies. In this regard, the BOU will produce a semiannual monetary conditions report that would relate current economic and financial market trends to the real economy, growth in monetary aggregates and implementation of monetary operations, and the inflation target.
9. The exchange rate remains market-determined. However, interventions in the foreign exchange market will continue to deal with speculations that may cause damaging exchange rate movements. In view of the shallowness of Uganda’s foreign exchange market, the authorities will also pay particular attention to other contributing factors in the effort to prevent undue exchange rate volatility.
10. Uganda’s financial system has been relatively insulated from the global financial crisis, but the increasing risk aversion from investors and the spiral effects of a depressed world economy could present significant challenges. The banks have remained sound and stable as improved supervision has helped them build large capital cushions, while deposit mobilization has provided a stable source of funding. The diversified structure of the banks’ balance sheets and income sources should also contribute to resilience in the banking system. Nevertheless, the BOU will carefully monitor developments in the banking system, particularly in light of the deterioration in the external environment.
Other structural reform
11. The government attaches utmost importance to meeting Uganda’s growing demand for electricity. Financing arrangements for the Bujagali hydropower project have been completed and its construction is on track for commission by 2011. In the near-term, the government will continue to support the private sector by carrying some of the cost of temporary electricity generators.
12. To facilitate private sector’s access to financing, Uganda is implementing a financial market development strategy in coordination with the other Central Banks of EAC partner states. Under the auspices of the EAC, the Monetary Affairs Committee (MAC) is stepping up its technical, policy and institutional preparedness for eventual EAC monetary union.