Recent economic developments

The Ugandan economy continues to perform buoyantly as a result of a disciplined fiscal stance, implementation of prudent monetary policy, and strong effort in carrying out structural reforms. Real GDP growth was 7.4 percent in the FY 2006/07 and is projected at 8.9 percent in the FY 2007/08, propelled by expansions in services and manufacturing. The proportion of the people living below the poverty line has declined substantially. Underlying inflation, which edged upwards, was contained at 7.3 percent in 2006/07 and projected at 11.3 percent in 2007/08 against the program target of 8.1 percent and 4.8 percent, respectively. The impact of the political unrest in Kenya in December 2007 was somewhat prolonged with regard to upward pressure on prices, which, together with increased domestic and regional demand for goods and services, higher international oil and food prices and a sharp increase in electricity tariffs, contributed to the higher-than-expected inflation, which stood at 11.8 percent in May 2008. The balance of payments performance and capital inflows have been strong, resulting in modest appreciation pressures on the Uganda shilling against the US dollar. Foreign exchange reserves equivalent to 5.8 months of import cover in 2006/07 are projected to increase to 6.0 months of imports in 2007/08.

The fiscal performance to date and the outlook for the remainder of FY 2007/08 is in line with the Medium-Term Expenditure Framework (MTEF) and program objectives set out in the Memorandum of Economic and Financial Policies (MEFP). The better than expected tax collection in the first half of 2007/08 more than offset the negative impact on customs revenue collection from the unrest in Kenya. Overall, revenues are expected to perform better than targeted. Spending was within the budget envelope despite expenditure pressures arising from hosting the Commonwealth Heads of Government Meeting and the response to emergencies (floods in the North and East, and Ebola outbreak in the West) which were offset by expenditure adjustments in non-priority areas. The lower than expected levels of government implementation capacity, largely contributed to a budget surplus for the first half of 2007/08.

The authorities recognize and remain committed to resolving a number of challenges in order to ensure sustained higher growth performance. These challenges include, expanding the fiscal space to finance domestic infrastructure investment and increased spending pressure arising from reconstruction of Northern Uganda, prudent fiscal management, stemming the growth of domestic arrears, tightening monetary policy in order to bring inflation down to less than 5 percent, prudent management of large foreign exchange inflows, removal of structural rigidities in the financial sector, and managing the macroeconomic consequences of fast rising oil prices.

Performance under the PSI

The authorities remain committed to maintaining macroeconomic stability and implementing structural reforms, which has resulted in all the assessment criteria through end-December 2007 being met. In addition, performance in the first half of 2007/08 was broadly satisfactory, although the indicative target for poverty related spending was not observed because of delays in recruitment of teachers and compliance by spending agencies, even though the required resources were made available. On the structural side, the debt strategy was published in December 2007 and most of the other structural measures were on track. However, four structural assessment criteria for May and June 2008 were missed--delay in issuance of the tender for the national identity card system; establishment of a single regulatory body for non-bank financial sectors for which the authorities opted for specialized regulatory agencies; slight delay in the roll over of the new Integrated Personnel and Payroll System; and budgetary allocation towards the reduction of the stock of domestic arrears. The nonobservance of these structural criteria was mainly on account of improvement in program design in the light of new information, as elaborated in the staff report.

Medium-term outlook and policy objectives

The central objective of the authorities is to raise real economic growth to an average of 8 percent per annum in the medium-term, supported by sound public finances and prudent monetary policy in order to ensure job creation and ‘Prosperity For All’. The focus is to remove constraints affecting private investment while the prevailing peace in Northern Uganda, strong domestic and regional market, as well as peace and stability in the East and Central African regions provide further impetus to growth.

Fiscal policy

The fiscal policy objectives are set in the MEFP and the MTEF. The authorities recognize the need to restrain expenditure and improve revenue collection by 0.5 percent of GDP per year in line with the MTEF for the remainder of FY2007/08 and FY 2008/09. The authorities are committed to taking measures to improve the implementation capacity, including the creation of the Uganda Roads Authority. A comprehensive audit review of the IFMS is to be completed in September 2008 and expenditures contracted outside the IFMS will not be recognized by the Accountant General with effect from July 2008. The authorities are committed to exercising discipline in contracting new loans to maintain debt sustainability. Priority in spending has been directed towards agriculture, infrastructure (energy, roads and railways) human resource development, environment for private sector development--including construction of four industrial parks, and provision of tax incentives to qualifying investors in export business.

The authorities recognize that much more needs to be done to facilitate the flow of commodities in and out of the country in the wake of the recent Kenyan crisis and the increased regional demand for Ugandan goods and services. An additional US$200 million per year for the next 5 years has been budgeted and ring-fenced to upgrade key transport corridors linking the country to Southern Sudan, Eastern DRC, Kenya and Rwanda, while discussions with Tanzania are envisaged to open a sea route through Dar-es-salaam as a viable alternative. The Uganda-Kenya concession agreement for the Rift Valley Railway line is being reviewed. The Bujagali hydroelectric dam and power plant has been under construction for one year and Karuma hydro power project is in the pipeline.

Monetary policy and financial sector

Monetary policy aims at maintaining annual average underlying inflation below 5 percent within the framework of the reserve money target for both FY 2007/08 and 2008/09. The authorities are committed to manage liquidity using an appropriate policy instrument mix without exacerbating market instability and loss of export competitiveness. Sterilization of excess liquidity will continue to rely on both indirect monetary policy instruments and foreign exchange sales. The mix of instruments will be kept under review due to persistent capital inflows to avoid undue pressure on interest and exchange rates. The authorities realize that maintaining low and stable single-digit inflation, stemming financial market instability and minimizing export competitiveness losses, against the back drop of high internal food and oil prices, is a delicate balancing act. They recognize that enhancing the efficiency and productivity of the export sector is key to sustaining the high export growth momentum. Deposit auctions have been introduced to expand the array of monetary policy instruments for liquidity management. The cost of sterilization is being shared between the fiscal and monetary authorities.

The authorities are still reviewing preconditions for, and appropriateness of, an inflation targeting framework in the medium-term. In the meantime, they are continuing with a flexible reserve money growth target range, to take into account shifts in both the velocity and the money multiplier, and the surge in net capital inflows. The base money growth target has been adjusted further upwards by 3 percentage points in view of higher economic growth and increased money demand. Furthermore, the authorities recognize that the high cost of borrowing for small scale enterprises is a serious impediment to attaining higher economic growth performance, employment creation and poverty reduction. In this regard, the authorities are committed to enhancing the development of the financial sector. New commercial banks have been allowed entry to boost competition in the sector. The Uganda Development Bank (UDB) is gradually being recapitalized to ensure availability of long-term financing, which is to be based on internationally accepted best practices. A credit guarantee scheme to cover up to 50 percent of credit risk associated with loans by commercial banks for certain sectors will be introduced.

Structural reforms

The authorities are committed to sustaining the implementation of the country’s economic reform program under the PSI and PEAP. New bodies to regulate nonbank financial institutions (except UDB) are being established. The existing Insurance Commission will continue to regulate the insurance industry. A draft legislation for establishing a regulator for the pension sector and finding an appropriate entity to supervise the other non deposit taking financial service providers, such as leasing companies and microfinance institutions, are underway. The authorities recognize the need to supervise the UDB, which will be done by the newly reconstituted and independent board for the time being. The issuance of a financial score cards and envisaged establishment of the Credit Reference Bureau (CRB) are aimed not only at reducing identity fraud-related losses but also information asymmetry between banks and borrowers.

Measures aimed at improving the efficiency of tax tribunal and its legal capacity to handle cases are being undertaken. The authorities are also considering introducing an electronic tax registry. The BoU, in consultation with the Monetary Affairs Committee of the East African Community, has drafted a comprehensive financial market development plan aimed at enhancing the effectiveness and efficiency of the financial sector, including financial deepening.

The authorities are also updating the national energy policy to ensure that oil revenue is managed and invested prudently, in an accountable manner and transparently. An agreement has been reached on the principles of operating the energy fund.

The introduction of a national identity card system has taken longer than previously envisaged due to high cost but the authorities are taking some interim measures to enhance existing databases.

Conclusion

The authorities have remained steadfast in their commitment to implementing prudent macroeconomic and structural policies under the PSI. All the assessment criteria through end-December 2007 were observed but one structural assessment criterion for end-May 2008 was not met—implementation of a pilot Integrated Personnel and Payroll System in three commissions, four ministries and local governments--and three structural assessment criteria for end-June 2008 were missed—submission to cabinet of a policy paper outlining the establishment of a new regulatory framework for financial institutions, U Sh300 billion for payment of domestic arrears, and issuance of a tender for national identity card system—as a consequence of new information and reassessment of costs and priorities. Accordingly, the authorities are seeking waivers in view of the remedial measures that have been put in place. The authorities believe that the policies set out in the MEFP are adequate to achieve the objectives of their PSI-supported program. They are committed to working with Fund and other development partners in the implementation of the program. The authorities, therefore, request for the completion of the third review under the PSI.