V Uganda, 1987–94

Amor Tahari, M. Nowak, Michael Hadjimichael, and Robert Sharer
Published Date:
October 1996
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Robert Sharer and Calvin McDonald 

This case study presents a long-term perspective on investment and output performance in Uganda. Against the background of long-term trends in saving, investment, and output, it describes the initial conditions that led to the adoption of adjustment policies. The macroeconomic policy mix, together with important structural policies, is analyzed and the outcomes are assessed for the period 1987–95, during which Uganda pursued an ongoing adjustment program supported by successive arrangements with the Fund under the structural adjustment facility (SAF) and the enhanced structural adjustment facility (ESAF).

Since the end of the civil war in 1986, Uganda has made significant and impressive progress in improving its growth performance under the Government’s Economic Recovery Program (ERP). This progress has been achieved in the context of a conducive political environment, and through the pursuit of sustained macroeconomic stability and important structural reforms.1 Despite the successes achieved so far and the relatively high levels of growth, averaging 6.4 percent a year during 1987–95, still higher levels of growth may be required in order to meet the needs of Ugandans through increased employment generation, poverty reduction, and adequate provision of social services. For higher growth, Uganda needs to raise both its domestic saving and its investment efforts, combined with ongoing structural reform programs. The study addresses Uganda’s growth potential and aims to draw out policy implications for faster growth by analyzing the obstacles to more rapid capital accumulation, as well as the response to structural adjustment.

A brief description follows of Uganda’s long-term growth record and highlights trends in output, savings and investment. Then the conditions that led to the need for adjustment policies, the macroeconomic policy mix, and key outcomes are presented. The paper next focuses on the impact of fiscal, monetary, and debt policies on growth. Finally, it considers structural policies and presents concluding remarks.

A study of this nature is naturally constrained by a number of factors. First, the analysis is largely qualitative and tentative, given inadequate data. The data constraints for Uganda are extreme, especially for the 1970s as a result of the civil unrest. Consequently, important quantitative relationships between investment, saving, and their determinants are difficult to establish. Second, this task is made more difficult because of the prolonged periods of extreme political and social instability that have characterized Uganda’s recent history, all of which have influenced investment and saving responses to economic stimuli. Third, although it is apparent that structural reforms are important to investment and saving behavior, it is difficult to quantify the magnitude of their importance.

Growth Record and Cross-Country Comparisons

During the period 1965 through 1995, Uganda experienced annual average rates of real GDP growth of 2.8 percent.2 The path of growth, however, varied markedly over the period under consideration, reflecting the military, political, economic, and social events that characterized the country in the past 30 years.

Following independence, Uganda initially experienced a period of considerable economic progress, which was sharply halted in the 1970s when a military regime assumed power under General Idi Amin and the country moved away from the outward-oriented policies pursued in earlier years. There was a relatively brief attempt to stabilize and revitalize the economy during the regime of Milton Obote in the early 1980s, with financial support from the Fund, the World Bank, and debt rescheduling from Paris Club creditors. This attempt was halted by the eruption of a civil war in the early 1980s, which led to the collapse of the economic stabilization efforts. The ensuing period was one of economic devastation until the National Resistance Movement (NRM) Government came to power in early 1986. In 1987/88, the NRM launched a comprehensive ERP with the support of the IMF, the World Bank, and bilateral donors.

Uganda’s long-term performance over the last three decades can be usefully divided into five main periods. During 1965–70, before the military and social crisis that enveloped the country in later years, Uganda experienced average annual economic growth of 4.8 percent, with an average real per capita GDP increase of 2.5 percent (Charts 5-1, 5-2). Ratios of gross domestic investment and gross domestic savings to GDP averaged 14.4 percent and 16.0 percent a year, respectively (Charts 5-3, 5-4). For most of this period, the country’s external accounts were in balance as well. The period 1971–75 showed the beginning of economic stagnation following the coming to power of the Amin regime. Local industries were granted significant protection, and the size and involvement of the public sector in economic activity expanded considerably. Efficiency and financial discipline suffered, and substantial damage was done to the competitiveness of the economy, particularly to the export sector. Real economic growth decreased sharply and averaged 0.2 percent a year, and gross domestic investment and gross domestic savings to GDP declined to an average of 10.9 percent and 11.1 percent a year, respectively. The period 1976–80 was a phase of continuous contraction in economic activity, and by 1980 Uganda had become dependent on one crop (coffee) for 98 percent of its exports, and, largely because of the sharp decline in incentives on account of the overvalued exchange rate, the volume of coffee exports was barely half the volume it had been in the early 1970s. The volume of other traditional exports—particularly cotton, tea, and tobacco—became negligible, and copper exports ceased. Over these years, economic activity collapsed and, in real terms, GDP declined by an average of 3.5 percent a year. Savings and investments declined to averages below 6 percent of GDP, and real per capita GDP declined by an average of almost 6 percent annually.

Chart 5-1.Uganda: Real GDP and Growth, 1965–95

(In percent)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

Chart 5-2.Uganda: Real Per Capita GDP, 1965–961

(In Uganda shillings)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

1 Fiscal years up to 1995/96.

Chart 5-3.Uganda: Gross Domestic Investment, 1965–95

(In percent of GDP at current factor cost)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

Chart 5-4.Uganda: Gross Domestic Saving, 1965–95

(In percent of GDP at current factor cost)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

During 1981–86, real economic growth recorded an annual average growth rate of 3.0 percent, but although domestic investment picked up, savings continued to decline. The cumulative effects of distortionary policies had reduced market transactions and led to more subsistence activities. The share of agriculture in GDP exceeded 56 percent (Charts 5-5), with nonmonetary GDP representing 36 percent of total GDP and nontraded agriculture representing 55 percent of total agricultural production.

Chart 5-5.Uganda: Real GDP By Sector, 1965–95

(In percent)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

The period 1987–95 has been one of sustained adjustment, characterized by renewed economic growth and major progress in structural adjustment. Substantial structural reforms have taken place in the economy in price liberalization, exchange and payments liberalization, public enterprise reform, financial sector reform, civil service reform, and army demobilization. The recovery over this period has been marked by an annual average real economic growth of 6.4 percent, an increased contribution of industry and services to output performance and higher monetization levels in the economy. The ratio of gross domestic investment to GDP also increased markedly, to an average of 14.3 percent, the highest level since the mid-1960s. The high levels of consumption, on the other hand, resulted in a decline in the ratio of gross domestic savings to GDP, averaging -3.2 percent a year. In 1994, the gross domestic savings-to-GDP ratio registered a positive 2.4 percent as a result of an improved trade balance and a shift to positive real interest rates on financial savings instruments brought about by the combination of interest rate liberalization and declining inflation.

Between 1987 and 1995, the gross national savings-to-GDP ratio improved dramatically (Chart 5-6). This mostly reflected higher private and official transfers brought on by a greater level of confidence inspired by political stability, and economic liberalization, particularly in exchange and payments where the exchange market was unified, restrictions were eliminated, and the trade system was made freer.

Chart 5-6.Uganda: Gross National Saving, 1987–95

(In percent of GDP at current factor cost)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

Attempts at comparing Uganda’s growth performance to sub-Saharan African (SSA) countries are severely constrained by data inadequacy and must be restricted to basic economic indicators. For the period 1976–94, Uganda’s average real GDP growth of 2.4 percent was in line with the SSA average (Chart 5-7), but the ratios of gross domestic investment and gross domestic savings to GDP—9.9 percent and 0.8 percent of GDP, respectively—were far below the SSA averages of 18.2 percent and 11.6 percent a year. By contrast, for 1987–95, the period of the adjustment efforts, Uganda’s real GDP growth averaged 6.4 percent compared with the SSA average of 1.6 percent. The gross domestic investment-to-GDP ratio improved substantially (13.8 percent), thus reducing the gap with the average of SSA countries (17.9 percent), but the gross domestic savings-to-GDP ratio averaged -4.2 percent, well below the SSA average of 11.0 percent a year.

Chart 5-7.Uganda: Sub-Saharan Africa Comparison, 1976–94

(In percent)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

1 Note: GDI = Gross domestic investment, GDS = Gross domestic savings.

A number of cross-country comparisons have been undertaken to investigate the factors influencing long-term economic growth.3 These comparisons focus on so-called endogenous growth models where the assumption is that “knowledge” and factor accumulation interact in such a way as to produce ‘nondecreasing returns to scale. One critical implication is that economic conditions and policies can influence the accumulation of factors and their productivity.

In most specifications, the accumulation of physical capital—measured by the investment-to-GDP ratio—and investments in human capital are significant. Notwithstanding the data problems and other shortcomings of such cross-country empirical analyses, the estimated models predict that, given Uganda’s initial human capital in the mid-1960s, its accumulation of stock of physical capital, and its population growth rate, per capita GDP growth over the last 30 years should have been higher. This finding suggests that other factors, including policy-induced distortions, as well as the long periods of civil unrest have been impediments to long-run growth in Uganda and, possibly, the higher rates of capital accumulation. The impact of macroeconomic variables such as inflation, budget deficits, exchange rate premiums, and worsening terms of trade on growth are a major focus of this paper. Other variables, such as the degree of monetization, trade regimes with relatively few distortions, and government savings, are also considered as critical for capital accumulation and the growth in factor productivity.

Initial Conditions

This section considers the political instability, macroeconomic imbalances, and the consequences of policies pursued in the 1970s as creating the initial conditions leading to the need for the adoption of stabilization policies in the 1980s. The analysis includes an estimate of the deviation of output from Uganda’s underlying growth potential, and the impact of export growth and consumption on aggregate demand. The association between the output gap and investment behavior is also examined. The impact of stabilization policies is then summarized. First, the early adjustment attempts in the 1980s are briefly reviewed and then the more sustained efforts during 1987–95 are considered.

Output Deviations

During the 1970s, the Ugandan economy was stagnating or contracting. Real GDP growth averaged 0.2 percent for 1971–75 and -3.5 percent for 1976–80. Fitting a simple time trend of actual output growth rates for 1965–95 suggests that growth deviations during the 1970s from trend averaged about -2.4 percent a year (Chart 5-8). Relating actual output growth to the underlying trend in Uganda, however, is subject to serious qualifications. Such an approximation does not fully capture the output potential of the economy, since economic performance in the 1970s was affected by major disruptions that, it could be argued, caused a significant pause in economic activity. Alternatively, one can consider Uganda’s output potential in terms of a peak-to-peak trend (simple time trend of GDP growth peaks) over the period and measure actual output growth deviations in relation to this trend. In this regard, the average deviation in growth from peak-to-peak trend was -5.9 percent a year.

Chart 5-8.Uganda: Real GDP Growth and Trends, 1965–95

(In percent)

Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

The poor performance during this decade reflected in large part the severe disruptions to the economy, including the expulsion of members of the Asian community who dominated the industrial and commercial sectors. The result was an acute shortage of technical and managerial expertise and a marked neglect of the productive sectors. This situation was later aggravated by the disruption and general uncertainties that surrounded the liberation war and the fall of the Amin regime in the late 1970s.

In addition to these instabilities, macroeconomic policies were generally inappropriate. During 1970–77, budgetary deficits averaged 33 percent of total expenditures with bank borrowing covering an average of 60 percent of the deficit. This fueled domestic credit expansion of 28 percent a year, and average broad money growth of 23 percent. Combined with the declines in output and an overvalued exchange rate, these policies led to an average annual inflation of 30 percent. The situation worsened considerably in the late 1970s, with the inflation rate rising to an average of over 70 percent between 1978–80 on account of an even more rapid growth in money supply and expansionary fiscal policies.

External Shocks

Although a significant part of the macroeconomic imbalances can be explained by war-related disruptions and expansionary monetary and fiscal policies, Uganda also experienced severe movements in the terms of trade in the mid- to late 1970s. Following a 27 percent deterioration in the terms of trade in 1975 associated with higher import prices and a decline in coffee prices, the terms of trade regained the 1974 level in 1976, and improved by 79 percent in 1977. By 1978, however, the terms of trade deteriorated to the 1976 level, and this worsening trend continued to the end of the decade. The mounting cumulative balance of payments deficit were thus a result of the increasingly unfavorable external environment, as well as the maintenance of an overvalued exchange rate, the lack of flexibility in adjusting administered prices, and the expansionary fiscal and monetary policies. Toward the end of the decade, the deficits were increasingly financed by the accumulation of external arrears.

The macroeconomic imbalances created by government policies reflected, in part, an inappropriate response to the adverse movements in the terms of trade as well as a futile attempt to maintain consumption levels in the face of declining resource availability. The extent and the persistence of the decline in real exports throughout the 1970s warranted an adjustment in fiscal policies to reflect the substantial fall in national incomes. Additionally, the dependence of the economy on coffee exports made a powerful case for reforms in trade and payments and domestic pricing policies in order to encourage diversification of the economy. Instead, the response of government policy was to have a negative impact on investment and saving behavior in the economy. Although in nominal terms, aggregate demand rose nearly fourfold between 1974 and 1978, real aggregate demand fell by about 11 percent compared with the average for 1970–73. In 1978, for example, the real value of exports of goods and nonfactor services was only 40 percent of the level in 1970. On the other hand, consumption as a proportion of total domestic demand increased from an average of 88 percent in 1970–73 to over 95 percent by the late 1970s. Most of this increase was due to expansions in government consumption expenditures. Thus, the overall domestic saving ratio declined significantly.

Output Gap and Investment

Between 1970 and 1980, the output gap (measured as actual growth deviations from underlying trend) changed from 9 percent above trend to almost 15 percent below trend. Over this same period, investment as a ratio of GDP declined from 12.1 percent to 6.3 percent. Because of the difficulty of obtaining data on capacity utilization, it is not possible to explain the extent to which the variability in investment can be attributed to spare productive capacity. Also, for this period, separate data on private and public investments are not available. Nevertheless, it seems clear that the deficiency in real aggregate demand contributed to the fall in the investment ratio, as did the decline in the real value of exports.

The output gap was also clearly influenced by the Government’s public investment programs. The difficulties in implementing public investment projects and their relation to terms of trade movements can be demonstrated by considering allocations to the Government’s development budget in the second half of the 1970s. After a moderate nominal growth rate of 10 percent during 1975/76-1976/77, development expenditures rose sharply, by almost 70 percent, in 1977/78. This reflected significantly higher revenues from coffee exports accruing from the temporary but significant improvement in the terms of trade in 1977. However, the declining terms of trade, the return of foreign exchange shortages, and the increasing diversion of funds to military activity slowed project implementation considerably. Consequently, development expenditures fell sharply in 1978/79.

The attempt to stabilize and revitalize the Ugandan economy in the early 1980s met with limited short-lived success (Table 5-1). It included the introduction of a more flexible exchange rate policy, decontrol of many prices, and regular review of producer prices. There was a recovery in the growth of real GDP, which averaged about 6 percent a year during 1982–84, but this was not sustained, mainly because of the uncertainty of the political climate caused by the eruption of the civil war in the early 1980s. Gross domestic investment rebounded from its all-time low of 3.9 percent of GDP in 1978 to 9.6 percent of GDP by 1983, but by the end of 1983/84, political instability and the intensification of the civil war led to the collapse of economic stabilization efforts.

Table 5-1.Uganda: Selected Economic and Financial Indicators, 1980/81-1985/86
(Annual percentage change)
Real GDP-
Broad money56.863.847.061.0139.0148.0
(In percent of GDP)
Budget deficit1-4.3-3.2-4.0-2.6-5.2-4.5
Current account2-1.6-2.2-2.30.1-0.9T.I
Gross reserves33.
Source: Data provided by the Ugandan authorities.

Adjustment Policy Mix

The starting point for adjustment in the mid-1980s was characterized by an environment that was unfavorable, both internally and externally. Internally, the civil war devastated transportation, power, and water facilities. Manufacturing plants had either closed or were operating at very low rates of capacity utilization, and much of the formerly productive agricultural sector had reverted to producing for subsistence consumption. The financial sector suffered severe repression, as interest rates were negative in real terms, reflecting inflation rates (on an annual basis) that approached 240 percent by June 1987. Externally, a fixed nominal exchange rate had further eroded Uganda’s competitiveness, leading to a considerable spread between the rates in the official and parallel markets, an acute shortage of foreign exchange, and increasing payments arrears. These developments were made worse by a further steep deterioration in the terms of trade associated with the collapse of the International Coffee Agreement.

The objectives of the adjustment efforts during this period were varied, including the principal task of stabilization and structural reforms. Improving the use of market signals to determine prices, interest rates, and the exchange rate was an important strategic objective. This was seen as critical in providing an environment for enhanced investment and growth. Specifically, the broad policy objectives were (1) the need to stabilize the economy, in part through the restoration of fiscal and monetary discipline, notwithstanding demands for considerable outlays to restore and rehabilitate the devastated infrastructure; (2) the liberalization of consumer and producer prices, with the objective of realigning prices in favor of export-oriented production and import substitution; (3) the progressive movement toward a realistic, market-determined exchange rate within a system free of exchange restrictions; (4) the strengthening of the balance of payments and the normalization of relations with creditors; (5) the removal of trade restrictions; (6) the privatization and rationalization of state enterprises; (7) the downsizing of the civil service and the army; and (8) the liberalization of interest rates within a restructured and more efficient financial system capable of mobilizing savings and increasing investments, with the aim of raising the rate of economic growth.

From the outset, the Government viewed the pursuit of strong macroeconomic policies and structural measures as essential to the attainment of its recovery program. This commitment provided a basis for a coherent set of policy actions and a determination to implement policies consistently. Policy implementation was, however, affected by a marked deterioration in world coffee prices. Although there were slippages in the fiscal area as well as in some important structural reforms in the initial years, consistent application of stabilization policies characterized by a decidedly strong anti-inflation bias met with success in later years. Although difficult to quantify, the credibility of government consistency cannot be overstressed. Additionally, the contribution of the sequencing and pace of the reforms to business confidence is likely to have been significant. These issues are discussed in more detail below.

The outcome is that Uganda achieved stabilization with strong economic growth (Tables 5-2, 5-3). Over the nine-year stabilization period under review, growth averaged 6.4 percent a year, accompanied by rising investment-to-GDP and domestic saving-to-GDP ratios. Despite unfavorable terms of trade for most of the period, the external current account deficit (excluding grants) also declined markedly, from 16.9 percent of GDP in 1988/89 to 5.9 percent in 1994/95, while the exchange rate remained competitive, depreciating from U Sh 100 per U.S. dollar at end-1987 to U Sh 966 at end-June 1995. Although the real effective exchange rate (REER) appreciated somewhat during 1993/94, Uganda’s external competitiveness is now substantially better than it was in 1987 (Chart 5-9). Successes were recorded in many structural areas, notably, marketing, the foreign exchange system, civil service reform, and army demobilization. Progress was also made in financial sector reforms, albeit with delays.

Table 5-2.Uganda: Selected Economic and Financial Indicators, 1986/87-1994/95
(Annual percentage change)
Real GDP3.
Broad money95.0202.9122.456.046.853.442.033.325.3
(In percent of GDP)
Budget deficit1-4.2-4.1-3.5-4.7-3.7-7.8-3.4-4.1-2.6
Current account2-1.0-9.6-9.8-10.5-6.1-4.9-3.7-1.6-0.8
Gross reserves30.
Source: Data provided by the Ugandan authorities.
Table 5-3.Uganda: Annual Growth Rates of Sectoral GDP at Constant 1991 Prices, 1986/87-1994/95(In percent)
Cash crops-
Food crops2.
Forestry and fishing3.
Mining & quarrying-9.7-11.54.473.7106.110.410.63.7-0.3
Coffee, cotton, sugar4.3-0.229.3-0.26.449.4-11.823.819.3
Food products12.339.15.4-9.419.
Public utilities4.
Hotels and restaurants10.812.79.512.314.514.215.021.421.5
Transport & communication5.
Air & support services21.
Community services3.
General government2.
Owner-occupied dwellings2.
GDP at factor cost3.
Source: Statistics Department, Ministry of Finance and Economic Planning, Uganda.

Chart 5-9.Uganda: Real Effective Exchange Rate, 1979–95

(1980 = 100)

Source: IMF Information Notice System.

Fiscal, Monetary, and Debt Policies

Fiscal and Monetary Policies

For Uganda, fiscal performance during the years since 1987 has been important in determining the pace of reforms and the overall savings and investment levels. Not only has strong fiscal adjustment in the last three years affected public savings directly, but it can be argued that it has also had a positive effect on private savings, contrary to the usual Ricardian substitutability theory.4 In 1991/92, the overall fiscal deficit (excluding grants) reached 15 percent of GDP (Table 5-4). Since that time the deficit has been steadily reduced to 8 percent of GDP in 1994/95, reducing the Government’s reliance on credit from the banking system and raising public sector savings. The improved fiscal performance—particularly in the last few years—has been a major factor in building confidence in the economy and achieving stabilization through lower inflation—both of which, it can be argued, have a positive effect on private saving behavior. This commitment by the Government to prudent fiscal policies could have the effect of reassuring private savers that the Government would supplement private saving rather than absorb it, thus increasing individuals’ expectations of a higher return on saving because of lower inflationary expectations, and generally a more optimistic outlook concerning economic growth.

Table 5-4.Uganda: Central Government Budget Operations, 1986/87-1994/95(In percent of GDP at factor cost)
Recurrent revenue and grants5.
Recurrent revenue4.
Tax revenue4.
Nontax revenue0.
Expenditure and net lending19.611.910.713.615.822.619.920.118.7
Recurrent expenditure26.
Development expenditure33.
Overall deficit (commitment)
Excluding grants-4.6-5.8-5.1-6.2-7.8-15.3-12.1-11.2-7.8
Including grants4.
External (net)
Domestic (net)
Of which: banking system(-2.6)(2.1)(1.4)(-1.5)(0.2)(2.0)(-0.5)(-1.3)(-2.0)
Memorandum items:
Primary surplus/deficit4-0.8-
Current budget balance5-1.2-0.6-1.5-0.30.4-5.3-1.2-0.70.7
Source: Department of Statistics, Ministry of Finance and Economic Planning.

In assessing the stance of fiscal policy and its direct impact on investment and aggregate demand/output growth during the adjustment period, one has to consider the degree to which fiscal policies were contractionary or expansionary. In this regard, the adjustment policies faced the task of stabilizing the economy while at the same time preventing a too contractionary impulse from stilling investment and growth. While the achievement of the broad objective of financial stabilization required the pursuit of a restrictive fiscal policy, the desirability of strengthened economic performance necessitated larger outlays on the restoration and the rehabilitation of devastated infrastructure. The authorities reconciled these objectives by focusing on tax reform to augment revenue and by raising donor disbursements. Revenue performance as a percentage of GDP has shown a sharply rising trend under the adjustment efforts in 1987, increasing from 4.9 percent of GDP in 1986/87 to 10.5 percent of GDP by 1994/95. Nevertheless, the ratio is still below that achieved two decades earlier (about 11 percent in 1974/75) and less than half of the average for SSA countries. Of significance is the strong rise in the grant element of budgetary financing, which grew from 0.5 percent of GDP to 5.2 percent of GDP during the same period. This enabled total expenditures to grow from 9.6 percent of GDP to 18.7 percent, having a stimulative effect on the economy.

Thus, although substantial progress has been made in reducing the fiscal deficit before grants since 1992, over the period 1987–95, the deficit worsened from 5 percent of GDP to 8 percent. The high level of foreign financing clearly enabled Uganda to sustain a sufficiently expansionary policy to maintain adequate aggregate demand even while reducing its reliance on the domestic banking system and facilitating the stabilization of the economy. Nevertheless, in recent years a number of aggressive measures have been taken to increase the revenue effort. These include enlarging the coverage of the income tax base, streamlining investment incentives, rationalizing import duties, and improving tax administration. Establishment of the Uganda Revenue Authority (URA) in 1992 was an important factor in the success of these efforts.

The relatively high growth rates achieved in the Ugandan economy over the adjustment period were led by an increase in the rate of investment activity, which responded positively to the fiscal policies described above, as well as numerous structural, price, and exchange reforms. Although the investment-to-GDP ratio has increased substantially, this growth has slowed in recent years raising concerns about bottlenecks, implementation capacity, efficiency issues related to the pace of financial sector reforms, or the possibility that the stimuli provided by reconstruction activities have run their course. A further disaggregation of estimates on capital formation shows that whereas public fixed investment as a ratio of GDP almost tripled from 2.6 percent in 1986/87 to about 7 percent in 1994/95, the private fixed investment ratio increased less sharply, from 6.7 percent to 11.5 percent. Given the implementation capacity constraints on the public investment program in recent years, future increases in gross domestic investment will most likely have to come from the private sector, unless significant bottlenecks reducing the efficiency of public investment programs can be resolved.

Achieving a sustainable deficit is critical to facilitating enhanced growth prospects in Uganda. This is necessary to avoid reverting to destabilizing fiscal policies while providing for rising real levels of outlays on key economic and social services. In this regard, improving further the revenue-to-GDP ratio and reducing the reliance of the budget on donor support are critical. Further rationalization of recurrent expenditures to increase investments in human capital—in particular, education and health—is needed, and though the impact may not be to immediately raise output levels, cross-country analyses have demonstrated that it is significant in the long term.

The reduced reliance of the fiscal position on credit from the banking system through increased donor disbursements and fiscal adjustment efforts has been critical in restraining monetary growth and achieving the Government’s stabilization objectives. Growth in broad money in Uganda declined from a peak of over 200 percent in 1987/88 to 25 percent in 1994/95 (Table 5-5). Over this same period, inflation (as measured by the annual change in the consumer price index) declined from around 200 percent to 3 percent in 1994/95. The impacts of lower money growth and the consequent fall in inflation on the real sector have been several. First, lower inflation has had the effect of raising real interest rates, thus enhancing savings mobilization and increasing the efficiency of allocation of financial resources for investment purposes. Second, by reducing the share of credit to the Government in the supply of money, private sector demand for credit became more easily satisfied. Third, it could be argued that the fall in inflation in Uganda contributed to the increased share of monetary transactions in the economy, thus fostering an environment for investments in formal economic activity. Fourth, the lower inflation has most likely raised investor confidence in Uganda. Fifth, lower inflation has contributed to the maintenance of a competitive exchange rate and therefore enhanced export prospects.

Table 5-5.Uganda: Selected Monetary and Financial Indicators, 1986/87-1994/95
(Annual change as a percent of initial period broad money)
Net domestic assets340.6204.1232.0129.6114.7157.116.7-6.1-3.4
Domestic credit108.0121.7124.352.738.150.48.6-2.7-12.3
Claims on government, net68.323.612.96.3-1.232.0-8.1-17.4-23.8
Claims on the private sector38.898.1111.446.439.318.316.714711.4
(In percent)
Growth of broad money (M2)95.6208.4122.456.046.853.442.033.325.3
91-day treasury bill rate1 (annualized)
Monetization rates
Monetary GDP/total GDP64.265.465.766.369.370.970.373.275.9
Source: Ugandan authorities.

Debt Policies

Uganda’s adjustment efforts have relied to a great extent on disbursements by multilateral institutions. As a consequence, its external debt grew from US$1.3 billion in June 1987 to around US$3.4 billion at end-June 1995, but since the debt is highly concessional, the average interest rate and maturity improved substantially. Nevertheless, the debt-service ratio has been high over the adjustment period, reaching a peak of 128 percent in 1991/92 (Table 5-6), before beginning a falling trend to 28 percent in 1994/95. While manageable, the high level of debt and debt service demonstrates the fragility of the economy and its reliance on the continued financial support of the international community. This high level of debt and debt service also demonstrates the need for continued high growth and substantial increases in export volumes and diversification of the country’s exports. In this regard, Uganda needs to vigorously deepen its structural reforms and raise savings and investment levels. But how has this substantial debt burden affected Uganda’s saving and investment behavior over the adjustment period?

Table 5-6.Uganda: Balance of Payments Summary, 1986/87-1994/95
(In millions of U.S. dollars)
Current account-82-201-230-278-187-132-112-59-44
Trade balance-111-246-281-375-370-279-373-464-504
Exports, f.o.b.383298282210175172157254537
Of which: Coffee(365)(286)(276)(159)(127)(117)(99)(172)(408)
Imports, c.i.f-4945455625845454515317181,041
Nonfactor services-64-11-128-56-102-108-87-96-191
Net interest-47-57-67-77-58-87-49-43-33
Private transfers1001201147881136129312445
Official transfers4092131153262206269250264
Capital account211281332338610103165171
Official (net)11156564812238138179197
Amortization due277-92-125-104-115-96
Private capital (net)3107277185-36-28-34-14-26
Overall balance-61-74-96-45-101-121-8106127
Financing requirement617496451011218-106-127
From monetary authorities22-13182235-5-32-90-150
Change in arrears (net)394718-196598-330-598
Exceptional financing4060421293704315
(In percent; unless otherwise specified)
Memorandum items:
Foreign exchange reserves in months of imports of goods and nonfactor services0.
Current account/GDP-1.0-9.6-9.8-10.5-6.1-4.9-3.7-1.6-0.8
Excluding official transfers-1.5-14.0-16.9-16.7-14.5-12.6-12.7-8.4-5.9
Debt-service ratio before rescheduling (including IMF)54.262.374.081.095.9127.773.853.728.3
Sources: Data provided by the Ugandan authorities; and IMF staff estimates.

A heavy debt burden can potentially impact negatively on saving and investment in a number of ways. First, public investments may be crowded out by resources used to service the public debt, and given the complementarity between public and private investments, the latter may be discouraged. Second, a high debt-service burden may be indicative of a debt overhang that could lead savers to transfer funds abroad instead of saving domestically because of the fear of future tax liabilities to service this debt. This would naturally raise the domestic cost of capital for investments. Third, a high debt burden could discourage foreign direct investment by raising the probability of the imposition of restrictions by the Government on external payment obligations—even for current payments such as investment income.

In Uganda, the heavy debt-service burden may have affected budgetary allocations for investment purposes, particularly in the early years of the adjustment period. However, this does not appear to have been substantial in view of the degree of donor support in the development budget. Thus, it is not obvious that rising debt service has limited public investment outlays, particularly given the implementation constraints of the public sector. Additionally, Uganda has received substantial debt relief in the form of debt reschedulings and write-offs, including being the first country to receive a stock of debt reduction by Paris Club creditors on Naples Terms in February 1995. This would serve to bolster investor confidence. In the absence of solid data, it is also difficult to gauge to what extent private domestic investments or foreign direct investments may have been affected by a debt overhang. The evidence, as demonstrated by rising private investments and unclassified foreign transfers in recent years, seems to suggest that achieving macroeconomic stability was more important in the decision-making process of investors. Additionally, savings behavior seems to have been affected more by the achievement of positive real interest rates and reforms to the financial system. This is not to say that one can continually discount the likely impact of a debt overhang on investor confidence. Whereas the achievement of macroeconomic stability may have been paramount in investors’ minds in the early years of the adjustment period, the sustainability of debt servicing can become increasingly important for future investments in a post-reconstruction Uganda.

Structural and Pricing Policies

The path of output, saving, and investment in Uganda has been influenced by a number of structural distortions in the economy. Substantial progress has been made in correcting these distortions, but in some areas they still present obstacles to higher growth. In addition, at issue is whether reforms could have been more closely coordinated and sequenced to encourage a more timely response by investments, and possibly higher growth.

Agricultural Pricing and Marketing Policies

The return of new investments and growth in the agricultural sector in Uganda has been facilitated by the adoption of market-oriented policies, including the decontrol of food prices and trade. All farmgate agricultural prices in Uganda became market determined during the period of adjustment, although indicative prices continue to be announced for the traditional export crops, such as coffee and cotton, in order to strengthen the bargaining position of producers. The liberalization of agricultural commodity prices and the abolition of various marketing boards have had the effect of increasing revenues to farmers as well as lowering marketing costs, thus significantly raising the profitability of agricultural production and providing the incentives for new investments. Additionally, the positive impact of these policies on investment behavior by producers, processors, and exporters has been bolstered by the progressive liberalization of the exchange system and the abolition of the surrender requirement on export proceeds from traditional crops. However, increased investments and further growth in the food crop subsector are constrained by its reliance on the domestic market. Demand is likely to rise only in relation to population growth rates and, to a lesser extent, increases in income, given the relative inelasticity of food crop demand to changes in income. Higher investment levels and growth rates in food crop production will have to focus on the diversification of export markets and the development of agro-industries.

Traditional agricultural exports have been a key determinant of Uganda’s growth performance. Export growth has not only been significant in the generation of incomes and demand for domestic output but has also eased foreign exchange constraints, making possible higher import levels, which support economic growth. Until recently, declining export prices were a major factor affecting the production levels of the main export, coffee. Coffee exports in 1994/95 totaled about 2.7 million (60 kg) bags, considerably below the peak of 3.5 million bags achieved in 1972/73. The recovery in volume, albeit slow, has been helped by a new system for pricing and taxing coffee adopted in 1991, which allows the producer price, as well as processor and exporter margins, to be determined by market forces. In 1992, in response to the very low levels of world prices, the tax on coffee exports was abolished, and the Government removed the Coffee Marketing Board’s monopoly on buying and marketing. The Board was subsequently converted into a commercial operation in competition with private exporters.

Other traditional exports, such as cotton and tea, remain critical to Uganda’s growth potential. In 1970, Uganda exported 78,000 tons of cotton and earned approximately US$49 million. By 1988, output had fallen to 2,100 tons, with earnings of US$3 million. Over the past several years, all of the ginneries—which are owned by cooperatives—have become heavily indebted and incapable of operating profitably. The greatly improved overall incentive framework and the liberalized environment, together with steps taken by the Government, have improved the outlook for new investments in the industry. The Lint Marketing Board’s monopoly on the export of lint has been removed, and a Cotton Development Statute was enacted in 1994, which abolished the union monopoly over cotton exports, eliminated licensing and other regulatory barriers, and established the Cotton Development Organization to regulate cottonseed production. The cotton industry is far from a recovery, but the decline was arrested during the adjustment period, and production volumes picked up to about 4,000 tons in 1993/94, although there were subsequent declines in 1994/95. With respect to tea, output fell from about 15,000 tons in 1970 to about 2,000 tons in 1987. Reforms in the industry, although limited, have included a shift in policy to allow firms to export directly, and privatization efforts. The result has been a significant recovery in output, to 12,000 tons in 1994/95.

Trade and Foreign Exchange Policies

One of Uganda’s more important and successful external sector reform measures during 1987–95 was the move to a flexible foreign exchange system. This was supported by a continuous effort to liberalize the trade system. The result was the realistic pricing of foreign exchange, which not only gave powerful investment incentives to exporters, but also encouraged the inflow of private capital, which increasingly has become important in financing the balance of payments. Between 1986/87 and 1994/95, private transfers averaged about 6 percent of GDP. The result was the easing of the foreign exchange shortage that had disrupted productive activity in the past. The increased inflow of private transfers has also been significant in raising overall national savings, thus providing a further boost to the economy’s growth potential.

Following an initial 77 percent devaluation in 1987, the Uganda shilling was adjusted periodically through 1989. In 1990, foreign exchange bureaus were licensed, and the spread between the rates in the parallel and official markets narrowed significantly. Finally, the exchange system was unified in November 1993, with the introduction of an interbank system and the abolition of the auction for donor import support funds. The move toward a liberalized trade regime was also fairly rapid, beginning with the open general licensing scheme (OGL) in 1987/88, which focused on allocating donor balance of payments assistance for the importation of raw materials for specified firms. The list of firms and industries was subsequently expanded periodically through 1990. By 1993, this scheme had been phased out, as the payments and foreign exchange system was liberalized and a broadly based import scheme was implemented with a short negative list.

While it is difficult to establish a definitive and quantitative link between investment and growth and reforms in the external sector, Uganda may have benefited from these reforms through the increase in resource accumulation—in particular, foreign exchange. Subjecting the economy to increased external competition may also have had a positive impact on productivity growth and efficiency in the use of resources. Moreover, reforms in trade and foreign exchange policies proved particularly complementary to several of the other key structural reforms. The result was that the efficiency of macroeconomic policies was improved, the supply response of the economy was enhanced, and a clear signal was sent to potential investors that the risks of policy reversals were low.

Public Sector Adjustment

Public sector structural adjustment in Uganda has many facets. Chief among these are the privatization of public enterprises and the improvement of their efficiency, followed by reform and downsizing of the civil service, and demobilization of significant numbers of soldiers. These reforms can have a significant impact on public sector saving rates through reduced expenditures and potentially can have an influence on long-run growth by allowing for a reorientation of expenditure toward the accumulation of human capital through increased allocations for education and social services. Privatization also allows for an improvement in the efficiency of enterprises that previously relied on direct or indirect subsidies from the budget.

Privatization of public enterprises began slowly in the first year after the enactment of the Public Enterprises Reform and Divestiture (PERD) program in 1993, with only two enterprises sold and nine liquidated. The slow implementation of these reforms may have restrained the investment and output response of the economy during the adjustment period, but with the current accelerated efforts in this area, the economy is likely to see significantly higher investment levels in several large enterprises in the coming years. In the second half of 1994, for example, progress in this area accelerated, and eight enterprises were privatized.

Key issues in reforming the civil service have been the rationalization and downsizing of the service, the reform and decentralization of government functions, and the introduction of improved personnel management systems. Since 1992, the Government has been implementing reforms in these areas, with the civil service being downsized from 320,000 positions in 1990 to about 150,000 at end-December 1994. Substantial progress has also been made in simplifying the salary structure by the abolition of a wide range of nonmonetary allowances and their consolidation into a basic salary. The challenges for decentralization are significant, however, since local administrative capacity is either low or nonexistent in key areas. In the area of military demobilization, approximately 38,000 soldiers have been discharged since 1992, reducing the size of the army by over 40 percent from the previous high of around 90,000.

Interest Rate and Financial Reforms

Several issues need to be addressed in assessing the possible role of financial sector performance in enhancing or retarding growth and investment in Uganda. First is the issue of financial repression. The key point here is the extent to which controls on interest rates or directed credit allocation may have distorted the financial sector. As far as the latter is concerned, there is evidence that the allocation of credit to some firms and sectors by political dictate during earlier years—particularly in the 1970s—may have contributed to the current high levels of nonperforming loans in the banking sector. Most of these extensions of credit were made without due regard to creditworthiness and profitability of projects.

Until 1992, the level and structure of interest rates were administered by the Bank of Uganda (BOU), which, in consultation with the Ministry of Finance and Economic Planning, made periodic adjustments. The resulting interest rate policy, combined with a persistently high inflation, led to highly negative real interest rates throughout most of the 1980s, which inhibited savings. The liberalization of interest rates generally resulted in the achievement of positive real rates. Some rates, however, continued to be formally linked to the annualized discount on treasury bills. These included maximum lending rates for term loans, development loans, and agricultural loans. In June 1994, this formal link to a reference rate was abolished, and all interest rates are now freely market determined. The repression of interest rates, however, is only one aspect of the problem. A second issue is the spread between deposit and lending rates, which measures financial intermediation costs. Deposit rates have fallen in response to lower inflation and, most recently, to lower yields on treasury bills, but there has been a general stickiness in lending rates. The result is that the spread has widened, from around 9 percentage points in 1991 (between savings and commercial lending rates) to around 12 percentage points at end-June 1995. The large spread is principally accounted for by the profitability problems associated with the large stock of non-performing assets in the banking system and by the general inefficiency of the banks.

The problems of profitability of the banking system, liquidity management, and capital adequacy have all made it difficult for the financial system to mobilize savings effectively and channel these resources into profitable investments during the adjustment period. The current high real lending interest rates may be constraining investments and can potentially be damaging to further growth in the economy. In this regard, the acceleration of the financial sector reforms is crucial. These reforms include the restructuring and eventual privatization of the Uganda Commercial Bank (UCB) and the reform of several weak banks to achieve stated prudential objectives related to capital and profitability.

Another important issue is the depth of the financial sector. This can be measured by the ratio of the stock of monetary aggregates to GDP. Financial depth can be important, as one would expect a high degree of monetization to be correlated with economic growth by providing greater opportunities for saving and thus investment. In Uganda, the ratio of broad money (M2) to GDP grew from around 7 percent in 1987/88 to around 10 percent in 1994/95. This should be compared with that of Kenya, where the ratio is about 40 percent, or Tanzania, with a ratio of about 30 percent. Although GDP growth may have been facilitated by increasing monetization, this remains a clear obstacle to higher growth.

Reform Sequencing

With any adjustment, the need for appropriate sequencing of reforms in the presence of adjustment costs and political and administrative constraints is unavoidable. Related to the issue of sequencing is the speed of the adjustment. It is difficult to establish principles on the proper sequencing of reforms, and only judgments can be made as to the appropriateness of Uganda’s reform agenda. In assessing this issue, the primary concern is the likely impact on the efficiency of investment and the contribution to growth.

It is generally accepted that stabilization should come first. From the start, this was a primary concern in Uganda’s adjustment efforts and was critical in establishing credibility and in reducing the distortionary effect that high and variable inflation has on potential investors. To enhance credibility, the simultaneous initiation of structural reforms in pricing and marketing was also critical. Given Uganda’s reliance on the export of cash crops, such as coffee, the early attempts to correct the overvaluation of the currency and the reform of the trade regime were also well timed, although delays in this area could have led to some distortionary effects in the allocation of resources away from export crops.

The proper sequencing of the privatization of enterprises should depend on the efficiency gains expected in the short and medium term and the likelihood that a more competitive environment is created. Additionally, early privatization efforts can enhance credibility and improve the Government’s fiscal balance. For Uganda, the slow start of the privatization program may have retarded investment growth and the efficiency of resource allocation. In such key sectors as banking, the delay in completing the restructuring of the UCB and in effecting its privatization may be contributing to the overall weakness of the sector and the difficulty in achieving efficient financial intermediation.

The speed and efficiency of financial sector reforms in Uganda have been constrained by the general weakness of banks and the need to develop an infrastructure that could accommodate market-based indirect monetary instruments. One consequence, as mentioned above, is the continued wide spread in interest rates. This implies that the liberalization of interest rates may have occurred too early, or alternatively, that more effort should have been placed on improving the profitability of problem banks earlier in the adjustment program, as well as on developing the necessary institutions and instruments to influence monetary variables.

Concluding Remarks

Uganda has made impressive strides toward achieving a high and sustained growth in economic activity. This progress has been made possible by the successful implementation of stabilization policies during 1987–95 and by important structural reforms. The evidence from the study of Uganda’s long-term economic performance confirms what is true of other countries, that is, although economic growth is determined by factors such as the accumulation of physical and human capital, these variables can be significantly affected by policy variables. In general, the sequencing and pace of Uganda’s reforms have been appropriate and have elicited the expected responses from investment and saving. Starting from a low base, these variables nevertheless remain inadequate when compared with those of other countries and with Uganda’s potential as demonstrated by past performance.

In addition to mobilizing the resources through higher savings to increase the accumulation of physical capital, Uganda needs to invest more in human capital, which has been shown to be a major influence on economic performance over long periods of time. The consolidation of the fiscal position along a sustainable path is required to allow a greater share of resources in such areas as education and health services to build the human capital of the country. Investment in human capital, together with the growth in physical capital, has the potential to also enhance the technological capability of the country to absorb imported technologies, thus leading to greater dynamism in the growth process.

In the medium term, Uganda’s growth process can be further enhanced through the encouragement of foreign direct investment. This should be given a boost immediately through the various privatization efforts currently under way. However, there is a real potential for sustained inflows of direct investment as a result of the success of the stabilization efforts, the achievement of political stability, the ongoing investments in infrastructure, the liberalized exchange and payments system, and the current reforms being undertaken in the tax and incentive environment.

To achieve a sufficiently higher growth rate and be able to reduce poverty, Uganda needs to accelerate certain structural reforms, primarily in the banking and financial areas. The current weak state of the banking system is preventing the achievement of financial depth and is contributing to distortions in the allocation of resources because of the stickiness of real lending interest rates and the large spread between lending and saving rates. In addition, the economy still remains substantially unmonetized and largely cash based. The achievement of financial depth requires that this situation be improved, including the development of rural finance and the operation of an efficient commercial banking system geared toward mobilization and efficient allocation of financial resources.

A more detailed account of the adjustment efforts during 1987–94 is provided in Sharer, De Zoysa, and McDonald (1995).

All data provided in the text, charts, and tables refer to fiscal years (July-June).

The simplest of these model specifications generally have the form:

where Y is the average annual growth rate of real per capita GDP, INV is the average ratio of investments to GDP, PRIM and SEC are the primary and secondary school enrollment rates at some specified time period t (proxies for human capital). POPG is the average annual growth rate of population, and GAP is the ratio of country i’s per capita GDP at some specified time period t to that of the United States.

See, for example, Asilis and Ghosh (1992) and Leiderman and Blejer (1988). It is argued in some studies that fiscal policies can shift an economy to a higher saving and growth path if individual saving behavior is dependent on aggregate savings.

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