Uganda's adjustment efforts in the external sector have included a number of areas: (a) trade policy, foreign exchange market reforms, and overall liberalization of current account transactions; (b) export diversification efforts; and (c) debt management strategies. Over the adjustment period, reforms have aimed at increasing the efficiency of foreign exchange allocation mechanisms and encouraging export diversification and foreign capital flows through the maintenance of an open, flexible, and competitive exchange and payments system. Thanks to these external reforms, Uganda has made substantial progress toward attaining external viability and a sustainable balance of payments.
One of the consequences of the sound macroeconomic policies pursued by Uganda over the adjustment period is the substantial inflow of private capital. During 1993/94, Uganda's external situation and its terms of trade were further buttressed by an improvement in world coffee prices. By mid-1994, a sudden sharp surge in coffee prices had boosted this positive terms of trade shock to a level that, together with large private sector transfers, raised a number of issues for macro-economic management, given the likely impact on the equilibrium exchange rate, and monetary and other nominal variables, as well as on Uganda's efforts at diversifying its export base.
Foreign Exchange Market, Payments, and Trade Reforms
One of Uganda's more important and successful external sector reform measures during 1987–94 was the move to a flexible foreign exchange system. Following the early devaluation of 77 percent in 1987 and a series of minidevaluations through October 1989, a real exchange rate peg was maintained until June 1990. These adjustments to the official exchange rate reduced the differentials between the official and parallel rates, but sizable spreads persisted. The discount on the parallel rate (that is, the difference between the official and the parallel rates, as a percentage of the parallel rate) averaged about 63 percent between 1988 and the first half of 1990. The early devaluations came against the background of an acute shortage of foreign exchange, which had forced the Government to intensify import restrictions in 1986 through a foreign exchange allocation and import licensing system. Foreign exchange was allocated by a ministerial committee headed by the Prime Minister, and priority was given to payments for debt service, oil imports, other government and parastatal imports, and expenses for embassies abroad. The parallel market, with an exchange rate premium of over 100 percent, supplied the foreign exchange for most nondebt, non-oil, and nonproject imports.
By 1987/88, the first attempts were made at rationalizing the import regime through the introduction of an open general licensing (OGL) import scheme. The scheme was essentially a mechanism for allocating donor balance of payments assistance for the importation of raw materials and spare parts for specified firms and products. Initially, the OGL provided access to foreign exchange for 25 firms and 8 commodities and services. The list was expanded to 38 in 1988/89, and, in 1989/90, the sectors covered were increased and the number of firms was raised to 63 in the context of the ESAF program agreed with the IMF. Given the considerable bureaucracy involved in processing applications, the pace of utilization of donor assistance was exceedingly slow.
To increase donor disbursements, the Government introduced in December 1988 a special import program (SIP) under which foreign exchange was allocated on a first-come, first-served basis and was used to finance a broad range of goods on the positive list.4 Increasingly, as the availability of foreign exchange improved, the SIP became the principal vehicle for channeling donor import support funds.
In July 1990, the exchange and payments system underwent a significant reform. Foreign exchange bureaus were established and authorized to finance, without approval from the Bank of Uganda, imports not on the SIP negative list for amounts below $5,000. For larger transactions, letters of credit and preshipment inspection were needed. Although these restrictions remained, the shift toward a more liberal exchange and payments system was nevertheless profound. Several other current account transactions, particularly in services, were liberalized. On the supply side, a number of reforms were also introduced. From 1986 until early 1988, all exporters were required to surrender foreign exchange receipts to the central bank at the official rate. From 1988 onward, exporters of nontraditional crops were permitted to retain 100 percent of their earnings in foreign exchange and to use the receipts to import goods on the SIP positive list. In June 1989, this scheme was extended to cover tea and cotton; after the introduction of foreign exchange bureaus in 1990, the proceeds from all noncoffee exports and private transfers were permitted to be sold to the bureau market.
The introduction of the bureau market occurred with an initial spread between the official and bureau exchange rates of about 50 percent. Although a parallel market continued to operate, the spread with the bureau rate became insignificant. With this major step toward encouraging market forces to determine the allocation of foreign exchange, the authorities shifted the focus of exchange rate policy to reducing the spread between the bureau and official exchange rates. Thereafter, from July 1990 to end-1991, the differential between the official and bureau rates was reduced considerably, to 27 percent, in part through continued regular small devaluations of the official rate.
In January 1992, the Government introduced a Dutch auction system for allocating donor import-support funds—whereby successful bidders pay the bid price—and the official rate was set at the auction rate. As a result, all foreign exchange transactions in the economy began to take place at market-determined rates. However, the markets remained segmented in terms of the transactions covered, the participants, and the absence of spot sales in the auction market. These factors accounted for the large spreads between the auction and bureau rates. Three developments in 1992 furthered the integration of the markets. First, in March the average bureau rate was adopted as the official exchange rate, thus covering a wider range of transactions. Second, in April, the auction guidelines were amended to provide for the participation of the bureaus in the auction system, forcing a move toward convergence of the bureau and auction rates. Third, in June the disbursement and procurement procedures for import-support foreign exchange were modified to facilitate spot sales of import-support resources. The move toward a unified exchange system had important spillover effects on the trade system. The adoption of the more depreciated bureau rate as the official exchange rate, for example, removed the implicit tax on coffee receipts, and exporters were able to offer higher producer prices. At the same time, the OGL and SIP import schemes were phased out and replaced by a broadly based import scheme with a short negative list.
During 1992/93, as expected, the auction market exchange rate depreciated by about 2.8 percent and by end-June 1993 was trading at a discount of about 8.5 percent vis-à-vis the bureau rate. On November 1, 1993, the auction system for allocating donor import support was abolished and an interbank market in foreign exchange was introduced, together with an elimination of all restrictions on current international transactions. Although the bureau market remains an integral part of the exchange system, the official rate is quoted as the average of the midrate in the interbank market. During 1993/94, the spread between the bureau and interbank rates averaged about 1 percent, and transactions turnover grew significantly. At inception, transactions (purchases and sales) in the bureau market averaged $4 million a month and, by June 1994, had increased to over $82 million (Table 4). In the interbank market, transactions turnover expanded from about $56 million in November 1993 to some $103 million in June 1994. The extent of transactions covered compares favorably with total foreign trade, which is estimated at just over $940 million for 1993/94. The unification of the foreign exchange markets and the move toward convertibility of the Uganda shilling have been quite impressive, and in 1994 Uganda accepted the obligations of Article VIII, Sections 2, 3, and 4 of the IMF's Articles of Agreement, expressing its commitment to an open and free payments and exchange system.
Summary of Exchange Rates and Volumes
(In millions of U.S. dollars, unless otherwise specified)
Summary of Exchange Rates and Volumes
(In millions of U.S. dollars, unless otherwise specified)
| 1993 | 1994 | |||||||
|---|---|---|---|---|---|---|---|---|
| Nov. | Dec. | Jan. | Feb. | Mar. | Apr. | May | June | |
| Interbank purchase | 28.30 | 51.86 | 37.88 | 49.59 | 53.31 | 48.40 | 53.25 | 58.57 |
| Interbank sales | 27.97 | 47.73 | 36.44 | 47.40 | 48.72 | 47.54 | 52.86 | 54.88 |
| Interbank midrate (U Sh/US$) | 1,165 | 1,146 | 1,113 | 1,047 | 1,079 | 1,007 | 966 | 963 |
| Bureau purchases | 30.82 | 38.39 | 29.30 | 31.36 | 38.66 | 38.51 | 38.70 | 43.36 |
| Bureau sales | 27.30 | 33.33 | 31.85 | 36.80 | 36.13 | 37.25 | 37.30 | 39.83 |
| Bureau midrate (U Sh/US$) | 1,172 | 1,162 | 1,135 | 1,058 | 1,086 | 1,022 | 980 | 962 |
| BOU intervention | — | 6.97 | 1.60 | 3.70 | 3.50 | 2.50 | 0.80 | 2.50 |
Summary of Exchange Rates and Volumes
(In millions of U.S. dollars, unless otherwise specified)
| 1993 | 1994 | |||||||
|---|---|---|---|---|---|---|---|---|
| Nov. | Dec. | Jan. | Feb. | Mar. | Apr. | May | June | |
| Interbank purchase | 28.30 | 51.86 | 37.88 | 49.59 | 53.31 | 48.40 | 53.25 | 58.57 |
| Interbank sales | 27.97 | 47.73 | 36.44 | 47.40 | 48.72 | 47.54 | 52.86 | 54.88 |
| Interbank midrate (U Sh/US$) | 1,165 | 1,146 | 1,113 | 1,047 | 1,079 | 1,007 | 966 | 963 |
| Bureau purchases | 30.82 | 38.39 | 29.30 | 31.36 | 38.66 | 38.51 | 38.70 | 43.36 |
| Bureau sales | 27.30 | 33.33 | 31.85 | 36.80 | 36.13 | 37.25 | 37.30 | 39.83 |
| Bureau midrate (U Sh/US$) | 1,172 | 1,162 | 1,135 | 1,058 | 1,086 | 1,022 | 980 | 962 |
| BOU intervention | — | 6.97 | 1.60 | 3.70 | 3.50 | 2.50 | 0.80 | 2.50 |
Since the establishment of the interbank market in foreign exchange, the weighted average midrate steadily appreciated by over 17 percent from U Sh 1,165/$1 in November 1993 to U Sh 963/$1 as of June 1994. Strong supply factors have complicated management of the exchange rate. Most of the pressures have originated from economic fundamentals such as improved terms of trade, but there have also been increases in coffee prefinance inflows and in private transfers, triggered by the private sector's renewed confidence in Uganda's current macroeconomic policies and exchange system. In order to moderate movements in the exchange rate, the Bank of Uganda has become much more active in intervening in the foreign exchange market. Between December 1993 and June 1994, BOU intervention totaled about $22 million. The issue of exchange rate policy and BOU intervention within the wider context of promoting nontraditional exports and maintaining macroeconomic stability has become a major concern for Uganda in light of recent surges in coffee prices following reports of frost damage to Brazil's 1995/96 crop. This is likely to remain a major issue in the immediate future and is discussed in more detail below.
Export Diversification
Uganda's main traditional exports are coffee, cotton, and tea, although both tea and cotton have suffered significant declines over the past 15–20 years. Currently, efforts are being made to revive these traditional sectors, along with the development of a number of non-traditional crops and commodities that offer significant prospects for Uganda, including horticultural crops, high-value fruits and vegetables, vanilla, silk, simsim (sesame seed), hides and skins, maize, beans, and fish products. Successful diversification of exports is important to shield Uganda from adverse terms of trade movements such as those of 1986/87–1992/93, when coffee prices declined by 70 percent.
In 1986, before the recent adjustment efforts, total exports amounted to about $406 million. As a result of declining coffee prices, exports fell to about $157 million by 1992/93. In 1986, nontraditional exports (exports other than coffee, cotton, and tea) stood at only $3 million. By 1992/93, this figure had increased to about $46 million, and, in 1993/94, nontraditional exports amounted to $71.6 million, representing 30 percent of total exports ($237.4 million). The performance of some nontraditional exports has been quite impressive, although this was partly due to regional demand for food related to refugees. Bean exports, which had been nonexistent until a few years ago, represented $12 million of the total value of exports in 1993/94. Maize exports surged from about $2 million in 1990 to $15.7 million in 1993/94 and exports of fish products more than doubled between 1992/93 and 1993/94, from about $4 million to about $11 million.
Legislation and policies introduced in the past few years have generally favored investments in nontraditional exports. The Investment Code introduced at the beginning of 1991 created a favorable environment for foreign investors. Additionally, export formalities have become easier with the now well-established export certificate scheme and the streamlining of export documentation. Recently, the Uganda Investment Authority set up a one-stop information point for foreign investors, though there is a need for greater promotional activity. Finally, the Export Policy Analysis and Development Unit was established in the Ministry of Planning and Economic Development to analyze policy issues and help promote export development by resolving export bottlenecks.
Although these are important strides in the promotion of nontraditional exports, a number of remaining issues need to be addressed in order for Uganda to fully diversify its export base. The financial system remains a significant constraint on export development. The Export Finance and Guarantee Scheme launched by the BOU needs to be strengthened and the participation of banks in other schemes encouraged. Working capital is very expensive and hard to come by in Uganda. Term financing is scarcely available, and investors are forced to depend on their own resources or donor finance for investment funding. Also scarce is venture capital in the form of equity capital, the most appropriate source of funding for new and high-risk, high-return investment. In general, other constraints to the growth of the nontraditional export sector include the human and technical resource base and key infrastructural facilities. These infrastructural facilities include proper roads, airport facilities, and storage and container facilities. Despite Uganda's commendable efforts in enhancing the investment climate through appropriate legislation and overall macroeconomic policies, more vigorous efforts are required to resolve many of the constraints that are impeding the full development of nontraditional exports.
Overall Balance of Payments and Debt Management Strategies
During the past seven years, Uganda's overall balance of payments has been influenced by the dramatic decline in export receipts as a result of declining coffee prices and by the resumption in donor-financed development expenditures. The resumption in donor financing enabled imports to grow, but with a declining export base, the current account deficit (excluding grants) as a percentage of GDP initially worsened from 1.8 percent in 1986/87 to a peak of more than 19 percent in 1990/91. Since 1990/91, however, the current account deficit-GDP ratio has been on a declining trend, reaching 8.8 percent in 1993/94. Including grants, this ratio was 2.2 percent in 1993/94, compared with about 1.3 percent in 1986/87 and 9.6 percent in 1987/88, the first year of adjustment. The overall balance of payments improved significantly, from a deficit of $79 million in 1986/87 to a surplus of $70 million in 1993/94 (Table 5). The improvement in Uganda's overall balance of payments enabled a steady buildup of gross international reserves. In 1986/87, gross international reserves were at a level equivalent to only 0.7 month of imports of goods and nonfactor services, but by 1993/94 they had increased to the equivalent of almost three months. The improvement in Uganda's overall balance of payments situation has also facilitated the normalization of relations with external creditors and the progressive reduction of external arrears.
Balance of Payments
(in millions of U.S. dollars, unless otherwise specified)
Includes commercial banks, private direct investment, and errors and omissions.
Balance of Payments
(in millions of U.S. dollars, unless otherwise specified)
| 1987/88 | 1988/89 | 1989/90 | 1990/91 | 1991/92 | 1992/93 | 1993/94 Est. | ||||
|---|---|---|---|---|---|---|---|---|---|---|
| Current account | -201 | -230 | -278 | -187 | -132 | -96 | -87 | |||
| Trade balance | -246 | -281 | -375 | -370 | -279 | -416 | -465 | |||
| Exports, f.o.b. | 298 | 282 | 210 | 176 | 172 | 157 | 237 | |||
| Coffee | 286 | 276 | 159 | 127 | 117 | 99 | 152 | |||
| Noncoffee | 12 | 6 | 51 | 49 | 55 | 58 | 85 | |||
| Imports, c.i.f | 545 | 562 | 584 | 545 | 451 | 573 | 703 | |||
| Project-related | 176 | 136 | 199 | 218 | 169 | 221 | 199 | |||
| Other imports | 369 | 377 | 385 | 327 | 282 | 352 | 504 | |||
| Nonfactor services | -111 | -128 | -56 | -102 | -108 | -131 | -90 | |||
| Net Interest | -57 | -67 | 77 | -58 | -87 | -49 | -42 | |||
| Private transfers | 120 | 114 | 78 | 81 | 136 | 241 | 270 | |||
| Official transfers | 92 | 131 | 153 | 262 | 206 | 259 | 258 | |||
| Import support | … | … | … | 87 | 75 | 111 | 83 | |||
| Project support | … | … | … | 175 | 131 | 148 | 175 | |||
| Other | — | — | — | — | — | … | -18 | |||
| Capital account | 128 | 133 | 233 | 86 | 10 | 88 | 157 | |||
| Official (net) | 56 | 56 | 48 | 122 | 38 | 127 | 178 | |||
| Disbursements | 186 | 211 | 292 | 214 | 163 | 231 | 294 | |||
| Import support | 45 | 68 | 167 | 99 | 69 | 84 | 119 | |||
| Project support | 141 | 143 | 125 | 115 | 94 | 148 | 175 | |||
| Amortization due | … | … | 77 | -92 | -125 | -104 | -115 | |||
| Private capital (net)1 | 72 | 77 | 185 | -36 | -28 | -39 | -22 | |||
| Overall balance | -74 | -96 | -45 | -101 | -121 | -8 | 70 | |||
| Financing | 74 | 96 | 45 | 101 | 121 | 8 | -70 | |||
| From monetary authorities | -13 | 18 | 22 | 35 | -6 | -32 | -78 | |||
| Gross reserve change | -4 | 12 | 11 | -15 | -24 | -38 | -96 | |||
| IMF (net) | -17 | 7 | -1 | 52 | 22 | 10 | 18 | |||
| Short-term | 7 | — | — | -2 | -4 | -3 | — | |||
| Change in arrears (net) | 47 | 18 | -19 | 65 | 98 | -330 | -31 | |||
| Exceptional financing | 40 | 60 | 42 | 1 | 29 | 370 | 39 | |||
| Toward arrears reduction | 40 | 57 | 41 | 1 | 29 | 332 | 23 | |||
| Current maturities | — | 3 | 2 | — | — | 39 | 17 | |||
| Residual financing gap | ||||||||||
| Memorandum items | ||||||||||
| Foreign exchange reserves | ||||||||||
| in months of imports of goods | ||||||||||
| and nonfactor services | 0.7 | 0.8 | 0.5 | 1.3 | 2.2 | 1.8 | 2.9 | |||
| Current account/GDP | -9.6 | -9.8 | -10.5 | -8.1 | -5.2 | -3.2 | -2.2 | |||
| Excluding official transfers | -14.0 | -16.9 | -16.7 | -19.4 | 13.3 | -11.7 | -8.8 | |||
| Debt-service ratio before | ||||||||||
| rescheduling (including IMF) | 62.3 | 74.0 | 81.0 | 95.9 | 127.7 | 85.1 | 56.5 | |||
| Debt/GDP | 20.2 | 29.1 | 83.1 | 106.8 | 104.5 | 88.5 | 73.6 | |||
Includes commercial banks, private direct investment, and errors and omissions.
Balance of Payments
(in millions of U.S. dollars, unless otherwise specified)
| 1987/88 | 1988/89 | 1989/90 | 1990/91 | 1991/92 | 1992/93 | 1993/94 Est. | ||||
|---|---|---|---|---|---|---|---|---|---|---|
| Current account | -201 | -230 | -278 | -187 | -132 | -96 | -87 | |||
| Trade balance | -246 | -281 | -375 | -370 | -279 | -416 | -465 | |||
| Exports, f.o.b. | 298 | 282 | 210 | 176 | 172 | 157 | 237 | |||
| Coffee | 286 | 276 | 159 | 127 | 117 | 99 | 152 | |||
| Noncoffee | 12 | 6 | 51 | 49 | 55 | 58 | 85 | |||
| Imports, c.i.f | 545 | 562 | 584 | 545 | 451 | 573 | 703 | |||
| Project-related | 176 | 136 | 199 | 218 | 169 | 221 | 199 | |||
| Other imports | 369 | 377 | 385 | 327 | 282 | 352 | 504 | |||
| Nonfactor services | -111 | -128 | -56 | -102 | -108 | -131 | -90 | |||
| Net Interest | -57 | -67 | 77 | -58 | -87 | -49 | -42 | |||
| Private transfers | 120 | 114 | 78 | 81 | 136 | 241 | 270 | |||
| Official transfers | 92 | 131 | 153 | 262 | 206 | 259 | 258 | |||
| Import support | … | … | … | 87 | 75 | 111 | 83 | |||
| Project support | … | … | … | 175 | 131 | 148 | 175 | |||
| Other | — | — | — | — | — | … | -18 | |||
| Capital account | 128 | 133 | 233 | 86 | 10 | 88 | 157 | |||
| Official (net) | 56 | 56 | 48 | 122 | 38 | 127 | 178 | |||
| Disbursements | 186 | 211 | 292 | 214 | 163 | 231 | 294 | |||
| Import support | 45 | 68 | 167 | 99 | 69 | 84 | 119 | |||
| Project support | 141 | 143 | 125 | 115 | 94 | 148 | 175 | |||
| Amortization due | … | … | 77 | -92 | -125 | -104 | -115 | |||
| Private capital (net)1 | 72 | 77 | 185 | -36 | -28 | -39 | -22 | |||
| Overall balance | -74 | -96 | -45 | -101 | -121 | -8 | 70 | |||
| Financing | 74 | 96 | 45 | 101 | 121 | 8 | -70 | |||
| From monetary authorities | -13 | 18 | 22 | 35 | -6 | -32 | -78 | |||
| Gross reserve change | -4 | 12 | 11 | -15 | -24 | -38 | -96 | |||
| IMF (net) | -17 | 7 | -1 | 52 | 22 | 10 | 18 | |||
| Short-term | 7 | — | — | -2 | -4 | -3 | — | |||
| Change in arrears (net) | 47 | 18 | -19 | 65 | 98 | -330 | -31 | |||
| Exceptional financing | 40 | 60 | 42 | 1 | 29 | 370 | 39 | |||
| Toward arrears reduction | 40 | 57 | 41 | 1 | 29 | 332 | 23 | |||
| Current maturities | — | 3 | 2 | — | — | 39 | 17 | |||
| Residual financing gap | ||||||||||
| Memorandum items | ||||||||||
| Foreign exchange reserves | ||||||||||
| in months of imports of goods | ||||||||||
| and nonfactor services | 0.7 | 0.8 | 0.5 | 1.3 | 2.2 | 1.8 | 2.9 | |||
| Current account/GDP | -9.6 | -9.8 | -10.5 | -8.1 | -5.2 | -3.2 | -2.2 | |||
| Excluding official transfers | -14.0 | -16.9 | -16.7 | -19.4 | 13.3 | -11.7 | -8.8 | |||
| Debt-service ratio before | ||||||||||
| rescheduling (including IMF) | 62.3 | 74.0 | 81.0 | 95.9 | 127.7 | 85.1 | 56.5 | |||
| Debt/GDP | 20.2 | 29.1 | 83.1 | 106.8 | 104.5 | 88.5 | 73.6 | |||
Includes commercial banks, private direct investment, and errors and omissions.
The reliance of the adjustment effort on external financing has, however, created a relatively large debt burden for Uganda. Uganda's external debt more than doubled during the adjustment period, reaching $2.9 billion as of June 1994. A large part of the increase was attributable to credits obtained from multilateral institutions to support the balance of payments and finance development projects. However, most of the new credits were on highly favorable terms. Multilateral debt as of June 1994 accounted for about 71 percent of the total debt stock, compared with some 43 percent in 1987. Over the same period, IMF credit outstanding rose from $249 million at end-1986 to $361 million at end-June 1994. As a result of Uganda's conservative foreign borrowing policies and limits on nonconcessional loans, and the recovery of exports, as well as help from donors and creditors, the debt-service ratio has begun to edge downward. From a peak of 128 percent in 1991/92, the ratio in 1993/94 had dropped to 56.5 percent, and further declines are expected in the medium term.
Uganda's debt strategies have included rescheduling and debt cancellation arrangements, as well as debt buy-back operations. In July 1993, using the debt reduction facility of the World Bank, Uganda bought back $153 million of commercial debt at a substantial discount. Although the debt-GDP ratio remains high (73.6 percent as of June 1994), it has shown a recent declining trend from 106.8 percent in June 1991.
This heavy debt burden puts a tremendous strain on the balance of payments and Uganda's quest for external viability. Progress toward external viability and a sustainable balance of payments should be assessed with a focus on the reliance of a country on exceptional financing, the evolution of debt-service payments, and market tests such as access to spontaneous borrowing.5 Given Uganda's initial weak external situation, its frequent inability to meet all contractual debt-service obligations, and the lack of significant access to commercial financing beyond normal trade credits, the traditional criterion of spontaneous access to commercial borrowing as an indicator of external viability is not very relevant. Under these circumstances, one can best assess Uganda's movement toward external viability in terms of the extent to which debt-service ratios and reliance on exceptional financing are being reduced. Uganda's debt-service ratio has shown a recent declining trend; although it could be argued that rescheduling agreements and more favorable lending terms have contributed to part of this decline, other important contributors are undoubtedly the recent improvements in export prices, as well as the effects of adjustment policies. Even though Uganda's debt-export ratio remains high at over 1,200 percent in 1993/94, it has declined significantly from 1,500 percent in 1991/92. This decline represents the improved terms of trade and successes in encouraging nontraditional exports; as a result of recent higher coffee prices, this improvement is expected to continue into the medium term. Consequently, the debt-service ratio should decline further. Uganda's debt burden could, in addition, benefit from stock of debt operations, though the modalities of these have not yet been agreed to by Paris Club creditors.
The reduction in Uganda's debt-service ratio and the overall increase in capital inflows have improved the prospects for less reliance on exceptional financing in the form of net accumulation of arrears, rescheduling, and gross use of IMF resources. Currently, Uganda's stock of external arrears is scheduled to be eliminated in 1994/95, and it is likely that its current account deficit can be financed by normal capital inflows, especially as the debt burden becomes more manageable. The sustainability of the balance of payments without exceptional financing is of course linked to domestic economic performance. Uganda has already demonstrated its ability to generate high growth rates, which should—with the appropriate export orientation of government policies—translate into larger export volumes over the medium term. Nevertheless, future growth of a higher magnitude will not materialize unless Uganda can satisfy certain key prerequisites—notably to improve domestic savings and investment ratios. Uganda has already made significant strides in these areas, and further progress should reduce the reliance on foreign savings in the form of official transfers. There is considerable scope for Uganda's domestic economic performance to improve as a result of higher levels of direct foreign investment. In many respects, the macroeconomic climate has been made quite conducive, and much attention is being paid to strengthening the legal and regulatory environment.
Terms of Trade Shock, Private Transfers, and the Economy
Much of Uganda's recent experience has been characterized by a decline in its terms of trade, but this trend has been reversed in the past two years, initially by the 42 percent increase in coffee prices (from $0.80 a kilo to $1.14 a kilo) between 1992/93 and 1993/94, and more particularly by the near-tripling of those prices (to $3.20 a kilo) in mid-1994 in the wake of reported damage to the Brazilian crop. Current projections suggest that this turnaround could well be sustained for some years. Added to this, Uganda has reaped some of the fruits of its success in stabilizing the economy, in particular the return of confidence as evidenced by increased private transfers, which are expected to remain buoyant and to contribute to a further strengthening of the current account position. In 1990/91, private transfers amounted to $81 million, but by 1993/94, they had grown to an estimated $270 million. The combined effect of these developments has important policy implications for Uganda, given the relative size of coffee exports in its overall exports and the limited availability of monetary instruments to achieve its desired objectives.
Recent studies on the effects of commodity booms and surges in capital inflows on domestic economies would suggest that three of the most important policy implications for Uganda are the following:6 (i) the potential for a marked appreciation of the real effective exchange rate; (ii) the possibility of a relaxation in the fiscal stance; and (iii) the possible effect on consumption-saving and investment behavior of domestic agents.
The experience of most countries shows that capital inflows or increased foreign exchange inflows from commodity booms have been associated with an appreciation of the real effective exchange rate, which is the first critical issue facing Uganda. The larger transfers will lead to an increase in domestic absorption, and such additional spending is usually accompanied by an increased demand for nontradable goods. Any increase in the demand for nontradable goods is likely to cause a rise in their relative prices and hence an appreciation of the real effective exchange rate. In addition to the pressures on the domestic price level, the increased inflows will tend to cause the nominal exchange rate to appreciate. Policymakers generally face a dilemma as to whether to allow a more rapid appreciation of the nominal rate or an increase in the domestic price level. It is also crucial for Uganda to avoid the so-called Dutch disease, that is, a severe negative effect on non-traditional exports because of falling external competitiveness as a result of a temporary boom in another commodity. Any attempt to reduce the real exchange rate appreciation in the short run through Bank of Uganda intervention in the foreign exchange market will have to be accompanied by sterilization to avoid domestic monetization of foreign exchange purchases. The overriding challenge for Uganda is to develop the appropriate monetary instruments—in particular, to deepen the existing treasury bill market—to achieve the desired objectives. Close attention must also be paid to the interest rate consequences of financial sterilization, a situation that may even cause the inflow of private capital to continue, as well as give rise to greater fiscal burdens.
The second critical issue for Uganda is the need for the fiscal position to remain conservative. It is expected that in periods of commodity booms, government revenues will rise. It is important for the fiscal stance to follow a long-run sustainable position based on a permanent income hypothesis rather than to react to the temporary increase in revenues with higher consumption expenditures. This ensures that large deficits will not recur after the boom cycle is over. Additional government revenues are best saved and carefully invested in infrastructural projects in order to enhance the productive capacity of the economy. Given Uganda's limited financial instruments available to sterilize the monetary effects of the additional inflows in the short run, a tight fiscal stance offers additional avenues to achieve the same results.
Finally, the overall consequences of the increased inflows will be determined in the last analysis by the consumption-saving and investment decisions of private agents, as well as the output response of the economy. The extent to which the consumption of imported goods rises will cause the inflows to be self-sterilizing. It is also quite likely that the higher domestic demand will lead to some increase in real GDP. This depends of course on the existence of sufficient excess capacity in the economy. The increased inflows provide an excellent opportunity for domestic agents, in particular coffee farmers, to smooth out their consumption over time and for investors to evaluate and react to likely changes in the profitability of projects. For many small farmers in Uganda, years of declining incomes have resulted in a running down of assets, and the coffee boom provides an excellent opportunity to replace those investment goods. However, for the saving and investment decisions of the private sector to be realized, it is imperative that the current financial sector reforms in Uganda be speeded up in order to improve financial intermediation and the efficient mobilization and channeling of private savings to productive ends.
The SIP covered a broad range of imported products, including some agricultural and industrial raw materials, capital goods, and transportation equipment and spare parts.
See, for example, Calvo, Leiderman, and Reinhart (1993) and Schadler and others (1993b) on capital inflows; and Cuddington (1989) and Deaton (1992) on commodity booms.