Seventh Review Under the Policy Support Instrument, Request for a New Policy Support Instrument and Cancellation of Current Policy Support Instrument: Staff Report; Staff Supplements; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Uganda.

This paper discusses key findings of the Seventh Review Under the Policy Support Instrument (PSI) for Uganda. The medium-term outlook for Uganda remains favorable but risks are on the rise. Growth is expected to rebound to its potential in the coming two years on the heels of a supportive fiscal stance and higher global and regional growth. It remains vulnerable to exogenous shocks as well as to election-related uncertainties. IMF staff supports the authorities’ request for a new three-year PSI to anchor their near- and medium-term policies.


This paper discusses key findings of the Seventh Review Under the Policy Support Instrument (PSI) for Uganda. The medium-term outlook for Uganda remains favorable but risks are on the rise. Growth is expected to rebound to its potential in the coming two years on the heels of a supportive fiscal stance and higher global and regional growth. It remains vulnerable to exogenous shocks as well as to election-related uncertainties. IMF staff supports the authorities’ request for a new three-year PSI to anchor their near- and medium-term policies.

I. Background

Uganda has shown firm commitment to prudent macroeconomic policies throughout the PSI-supported program. A strong policy framework has helped make the economy more resilient to exogenous shocks; robust growth, moderate inflation, and a sustainable fiscal and external position have prevailed.

1. The Ugandan economy performed strongly during the first three years of the PSI even in the face of exogenous shocks and the global financial crisis. Real GDP growth averaged around 8 percent, and monetary policy was successful in containing inflation after a spike following the rise in world food and fuel prices. The fiscal position remained sound, and debt low. The external position strengthened, with international reserves growing to over $2 billion, or about 5 months of imports.

2. Nonetheless, uneven progress in structural reforms hampered policy implementation (Box 1). An important objective of the PSI was to create the fiscal space necessary for scaling up public investment in infrastructure. Tax revenue increased, thanks to notable improvements in tax administration, but capital spending was repeatedly below budget, due to pervasive absorptive and capacity constraints. At the same time, persistent weaknesses in public financial management led to the accumulation of new domestic arrears.

3. The authorities are requesting a new three-year PSI to support their near and medium-term policies and reinvigorate the structural reform agenda. The current PSI was approved by the Board on December 14, 2006 and extended by one year in December 2009. The authorities are requesting the cancellation of the current PSI and the approval of a new PSI that will be more closely aligned with the budget cycle. Its objectives dovetail with those of the recently-adopted National Development Plan (NDP).1 With its longstanding track record of prudent macroeconomic policies, ample foreign exchange reserves, and low external debt, Uganda remains well positioned for continued engagement under the PSI.

4. The near-term political environment will be dominated by the preparations for the 2011 presidential and legislative elections. President Yoweri Museveni and his ruling National Resistance Movement (NRM) are widely expected to win a fourth term. However, political and ethnic tensions are flaring up and governance issues are being exacerbated by the prospects of large fiscal revenues once identified oil reserves are brought to commercial use.

The 2006-2009 PSI—Achievements and Challenges

  • The 2006 PSI aimed to build on the achievements of an impressive decade of macroeconomic consolidation and structural reforms supported by a series of Fund programs and HIPC and MDRI debt relief. As a “mature stabilizer” with no immediate need for balance of payments support, Uganda easily qualified for a non-financial instrument, and its PSI was one of the first in the Fund.

  • The main objectives of the 2006 PSI were to create the fiscal space to enable a rapid scaling up of public sector investment and encourage private-sector-led growth. Fiscal policy targeted an increase in revenue and a rationalization of current spending. Monetary policy aimed at keeping inflation at around 5 percent through increased foreign exchange sales from aid inflows to reduce interest rates and encourage private sector credit growth. Second-generation structural reforms were designed to improve tax collection, strengthen public financial management (and in particular control spending arrears), and develop the financial infrastructure to support financial deepening.

  • The program was largely successful in maintaining macroeconomic stability. Both core and headline inflation declined to 5 percent in 2008, before rising subsequently due to high world food and fuel prices, and later a regional drought. Real GDP growth peaked at 9.5 percent in 2007/08 before declining again to 7 percent the following year. Gross international reserves increased markedly, and as portfolio inflows increased, the shilling appreciated.

  • Lack of progress in public financial management and weak implementation capacity constrained the scaling up of the public investment program. While reforms in tax administration led to a steady increase in the tax-to-GDP ratio, at least through 2007/08, execution of public investment repeatedly fell short of program targets due to a combination of persistent spending inefficiencies, operational capacity constraints and delays in donor disbursements. Weak expenditure commitment controls led to continued accumulation of arrears, undermining budget execution and efforts to strengthen implementation capacity.

  • Exchange rate appreciation raised new challenges for monetary management. Following a surge in portfolio inflows beginning in 2007, concerns about real exchange appreciation and loss of competitiveness led to a reduction in forex sales in the monetary policy mix. The BOU maintained a relatively tight monetary stance, allowing exchange rate flexibility to dampen external shocks and using intervention judiciously to smooth exchange rate volatility. In this context, the monetary program was adjusted to allow more flexibility.

  • Observance of program conditionality was mixed. Adherence to quantitative targets was impressive, with all the quantitative assessment criteria observed in all the six reviews—except for the ceiling on the increase in base money missed in the second review. Compliance with the ambitious structural conditionality weakened over the course of the program reflecting technical and political limitations as well as ‘reform fatigue’. Overall compliance has declined to 40 percent, compared to 80 percent (with 70 percent on time) under previous Fund programs, and 50 percent in other PSIs. The highest number of missed conditions related to public financial management (PFM), and particularly the reforms aimed at avoiding the accumulation of new domestic arrears.

II. Recent Developments and Program Performance

Growth is slowing on account of global uncertainties and the regional drought but external and financial indicators remain robust. Structural rigidities continued to prevent delivery of the intended monetary and fiscal stimulus. All program targets have been met.

5. The first-round impact of the global financial crisis in Uganda was relatively limited. The sudden reversal of portfolio inflows and lower foreign direct investment in the second half of 2008 led to a tightening of liquidity conditions, a rise in interest rates and a rapidly depreciating shilling. But economic growth (7 percent in FY2008/09) remained robust by regional and international standards, buoyed in part by strong cross-border exports, particularly of agricultural products.2

6. Activity decelerated more markedly this fiscal year. Subdued import growth, underperforming VAT receipts and weakening credit growth suggest a significant slackening in private demand in the first half of FY2009/10. The sharp deceleration in core inflation (to a 12-month rate of 6.5 percent in March compared to 9.9 percent in September 2009) may also reflect falling consumer demand. Causes for the slowdown include a prolonged drought (which adversely affected agricultural output) and lingering uncertainties regarding the path of the global recovery. Growth is expected to rebound in the latter part of the year as weather conditions improve and government spending accelerates, and reach 5.6 percent for FY2009/10 as a whole.

7. The external position has remained strong. Exports continued to expand while import growth slowed markedly with the downturn, leading to a narrowing of the trade deficit. The small increase in the external current account (to a projected 5 percent of GDP in FY2009/10, largely on account of lower official transfers) should be readily covered by higher FDI and multilateral disbursements. The rebound in capital inflows pressured the shilling, which appreciated by 19 percent between June and November 2009. Gross international reserves (including the SDR allocation) stood at the equivalent of about 5.1 months of imports in December.

8. The policy response to the slowdown has been constrained by pervasive structural rigidities. Prudent economic policies of the past gave Uganda scope to implement counter-cyclical policies. From the last quarter of 2008, monetary policy was gradually eased while the fiscal authorities took steps to raise investment spending and provide a positive impulse to growth. However, in both cases the intended stimulus failed to materialize.

  • The transmission mechanism from monetary policy to real sector activity has been weak. The large injections of liquidity by the Bank of Uganda (BOU) prompted a sharp fall in interest rates on government securities, but lending rates did not come down as banks moved to a more conservative risk stance. As a result, private credit growth slowed markedly and only trended up marginally by the end of 2009. Reserve money, broad money and private sector credit all grew below program levels in the year to December 2009.

  • Budget under-execution prevented the delivery of the expected fiscal stimulus. On the revenue side, receipts from VAT, personal income taxes and import duties grew more slowly than in previous years, reflecting softer economic growth and declining import volumes. However, the stimulus effect of lower revenue collections was more than offset by significant under-execution of capital spending, due to a combination of longstanding weaknesses in investment planning and teething problems as new procurement procedures were being introduced to ensure ‘value for money’.

9. The BOU has used foreign exchange management operations more actively to smooth out excessive volatility and support activity. While remaining committed to a flexible exchange rate, the BOU intervened sporadically in the foreign exchange market to limit volatility including at the onset of the global financial crisis. More recently, the BOU stepped up its foreign exchange purchases in response to the sudden appreciation of the shilling. It also shifted the distribution of its monetary interventions from November 2009, reducing its regular daily sales of foreign exchange while maintaining the stock of domestic securities broadly unchanged. The shilling subsequently depreciated by around 9 percent between November 2009 and March 2010.

10. The financial system remains sound, but pockets of vulnerabilities may be emerging. In light of global and domestic uncertainties, banks have generally increased their liquidity buffers and tightened their lending standards. The system’s capitalization levels remain adequate in the aggregate, and although NPLs have increased, the overall level is still low. Yet, new strains seem to have emerged, as reflected in the decline in overall bank profitability, with some banks, particularly smaller ones, registering losses and periodic liquidity stresses. Operational risks may also have increased, as new financial products such as mobile banking have spread rapidly.

11. Financial sector structural reforms are progressing, albeit at a slow pace. Recent advances in this area include, in particular, the near-complete rollout of the credit registry system and the development of a BOU-based settlement system to support secured transactions in the interbank market (as a way to reduce transaction costs and market segmentation). However, progress with other legal and institutional reforms has been slower and a number of laws to support the development of financial markets are yet to be enacted.

12. Program performance in the first half of FY2009/10 has been strong in spite of a weakening of spending oversight. All end-December assessment criteria and indicative targets have been met. No structural benchmarks were due for this review, but the authorities are making progress towards the completion of two measures: the submission to Parliament of a draft regulatory framework for pension funds and the rolling out of the Integrated Personnel and Payroll system. Latest figures from the auditor’s office confirm, however, an upward drift in domestic arrears, with arrears accumulated since FY2004/05 through January 2010 estimated at around ½ percent of GDP. There is also evidence of a weakening in budget management, with unspent balances equivalent to about ½ percent of GDP being carried forward from the previous fiscal year to the next one outside of established budget procedures.

Figure 1.
Figure 1.

Recent Economic Developments

Citation: IMF Staff Country Reports 2010, 132; 10.5089/9781455204366.002.A001

1 Outturn at December 2009Source: Ugandan authorities and IMF staff estimates

III. The New PSI

The objectives and policies of the new PSI-supported program will largely be guided by those set out in the National Development Plan (NDP). Beyond maintaining macroeconomic stability, policies will continue to seek to alleviate constraints to growth through a build-up in public infrastructure while giving new impetus to structural reforms, particularly in the fiscal area. The government program will also aim at strengthening institutions ahead of expected oil production and lay down the grounds for Uganda’s participation in the future East African Monetary Union.

13. The new PSI will be guided by the objectives and policies outlined by the new NDP. The NDP, approved by the cabinet in February 2010, broadens the policy focus from ‘poverty reduction’ to ‘structural transformation’.3 It gives the government a strategic role in this process through the elimination of growth constraints and the promotion of private investment in selected priority targets (Box 2). Government action is to be centered on four main areas: human resources development (health, education and skills building); physical infrastructure, particularly in energy and transportation; science, technology and innovation; and facilitation of private access to critical production inputs, particularly in agriculture.

Uganda: Constraints to Growth

The National Development Plan identifies the following as the main impediments to economic growth and poverty reduction:

  • Weak public sector management and administration: despite years of reforms, PFM slippages affect the efficiency in absorbing public funds. Insufficient funding of spending agencies remains a key constraint for effective performance of public institutions and delivery of public goods and services.

  • Inadequate financial services to the private sector: availability and access to financial services is limited by the lack of financial services infrastructure across the country, high cost of financing, and an underdeveloped capital market.

  • Weak infrastructure: with the exception of a rapidly expanding telecommunications sector, the state of Uganda’s infrastructure is poor. Transport costs remain a significant trade barrier, equivalent to effective protection of over 20 percent and an implicit tax on exports of over 25 percent. Road density indicators are at par with the average for Sub-Saharan Africa but a much smaller fraction is paved. The existing railways are in poor shape and carry a negligible volume of freight. Electricity supply lags far below demand, with only 11 percent of the population having access to power from the grid. The internet infrastructure is also nascent with most concentration placed in the capital, Kampala.

  • Insufficient production inputs: farm inputs and irrigation are costly and not widely employed, increasing agriculture vulnerabilities.

14. Accordingly, the PSI-supported program will continue to target infrastructure development while ensuring a stable macro-economic environment. The investment drive will maintain a focus on transport and energy. As donor assistance is likely to decline over the medium term, the increase in public spending will require higher mobilization of domestic revenue and access to new financing sources, including on less concessional terms. The fiscal and debt positions will however remain sustainable. Monetary policy will anchor inflationary expectations while a flexible exchange rate regime will help maintain competitiveness and a comfortable level of international reserves to cushion against exogenous shocks. The authorities will seek to continue to improve the living conditions of the poorest segments of the population through targeted programs in health and education as described in the NDP.

15. The new PSI also aims at breathing new life into the structural reform agenda. After a commendable start at the beginning of the previous PSI, progress in structural reforms has slowed and new weaknesses have emerged, particularly in public financial management. Over the last few years, the authorities embarked—with the support of donors—on a large number of initiatives in this area. The multiplicity of objectives and lack of prioritization has tended to overwhelm the local implementation capacity and at times overshadowed narrower, more functional reforms. In the event, progress in addressing longstanding problems such as the accumulation of domestic arrears and weak account management practices has been limited.

16. Structural conditionality will be more narrowly focused on specific, incremental steps that can bring quick results in macro-critical areas and ensure a more satisfactory implementation of reforms. It will continue to straddle the fiscal and financial sectors, both key to increase policy effectiveness and raise future growth. Staff and the authorities agreed on a set of actions to be implemented promptly and also identified follow-up and consolidation measures. The authorities noted that in many cases, external technical support would be needed to assist with implementation.

  • On public financial management, there was broad consensus that weak implementation capacity and spending controls bear even more heavily on the public finances in the context of scaled-up infrastructure investment, and that strengthening account management and controlling the accumulation of domestic arrears—an area where performance has fallen repeatedly short—was an immediate priority.

  • Tax policy reforms, together with continued improvements in tax administration, will raise domestic revenue and create fiscal space for the public investment push over the medium term.

  • Financial sector reforms will continue to be two-pronged, aiming on one hand at consolidating banking stability and on the other at facilitating financial deepening, including through institutional and legal reforms.

17. The PSI-supported program begins to lay the ground for two momentous events, the commercial exploitation of oil and the establishment of the East African Monetary Union (EAMU). Although dates for both are uncertain and in any case still years away, both will raise multiple macroeconomic policy challenges for Uganda. The policies in the program will help reach consistency with EAMU requirements over the medium term (including with respect to the international reserve cover and the fiscal deficit) and strengthen competitiveness and fiscal transparency in preparation for the oil era.

18. The macroeconomic outlook over the period of the new PSI remains broadly positive although risks are on the rise. Growth is expected to rebound to its potential in the next couple of years on the heels of the supportive fiscal stance and higher global and regional demand. Inflation is projected to hover around 5 percent and international reserves to rise above 5 months of imports. Risks, however, are mounting, mostly on the downside. The region remains vulnerable to severe security and weather-related shocks as well as unexpected shortfalls in aid. Domestically, election related tensions and resistance to the ambitious structural reform program could put pressure on Uganda’s fiscal position and undermine donor and investor confidence. The authorities expressed their commitment to maintaining macroeconomic stability in the face of external and domestic shocks, as they have in the past.

A. Fiscal Policy

19. Fiscal policy will continue to target a bold scaling up of energy and transportation infrastructure. Public investment is targeted to increase from 6 ½ percent of GDP in 2008/09 to 8 percent by 2011/12—a path that is scaled down slightly compared to previous forecasts in view of implementation and absorptive capacity constraints.

20. Reaching this ambitious investment target will require, first and foremost, more efficient budget execution. Staff encouraged the authorities to step up capacity building in relevant spending agencies. Recent efforts to that end—most with support from donors—augur well for the future. The expanded use of Public Private Partnerships (PPPs) could also help alleviate implementation bottlenecks. Staff strongly support ongoing work to establish a sound legal and monitoring framework for PPPs (MEFP ¶23).

21. Spending controls will also be strengthened. As public investment spending is slated to increase significantly over the next three years, effective oversight mechanisms become even more critical. Procedures will be set to ensure the transparent treatment of unspent budget balances (Box 3). Regarding arrears, narrowly focused measures seem to have achieved some degree of success. For example, the establishment of a centralized payment system appears to have stemmed the increase in pension arrears. Staff and the authorities identified a set of similarly targeted actions that could be implemented quickly and complemented by follow-up and consolidation measures over the rest of the program (MEFP ¶26).

Measures to Strengthen Spending Controls

Strengthening account management

  • Report to Parliament of unspent budget balances at the end of each fiscal year will become mandatory and their subsequent use will be allowed only with new Parliamentary appropriation.

  • The authorities will undertake a thorough review of all existing government accounts and close promptly those not associated with a legitimate government activity (structural benchmark).

  • Relevant financial legislation will be reviewed and amended as needed to ensure it does not leave scope for diverting budgetary funds.

Controlling domestic arrears

  • The centralized payment procedure will be extended to utilities and rents in the next budget cycle (structural benchmark).

  • More realistic budget projection mechanisms will be introduced to prevent under-provisioning of recurrent spending in key areas, an important source of arrears accumulation in recent years.

  • A mandatory rotation of accountants and procurement officers will also be introduced to reduce opportunities for collusion (structural benchmark).

  • The government will continue to expand use of integrated management and payroll systems across government entities to improve oversight (structural benchmark).

22. New financing sources will need to be tapped to fund the public investment drive. Current financing plans show that aid flows, and particularly grants, are expected to decline in coming years. Donor support has also tended to trend down in previous election periods because of governance and transparency concerns. Under conservative projections, grants would decline to about 1½ percent of GDP by the end of the program period (from 3½ percent in FY2008/09). In that context, raising the public investment ratio to 8 percent of GDP will require mobilizing additional financing equivalent to about 3½ percentage points of GDP.

23. There is significant scope to raise domestic revenue. Uganda’s tax-to-GDP ratio is low by international and regional standards, including in the EAC. So far, efforts to boost tax receipts have largely relied on improvements in revenue administration. The forthcoming introduction of a national identification system will also help reduce tax evasion. While welcoming these efforts, staff argued that additional tax policy measures are needed to raise the tax ratio in a more decisive manner. In view of the forthcoming elections and the still subdued level of activity, objectives for the first year of the program are relatively modest (a review of all existing tax incentives and exemptions—many of which may have been granted in an ad hoc fashion to individual sectors and firms—and recommendations for their streamlining) (MEFP ¶14). The authorities agreed to consider additional tax policy measures in subsequent years (MEFP ¶21). These could include broadening the coverage of taxes on property, capital gains or informal activities. The program targets an increase in tax collections of 1½ percent of GDP over the coming three years.

24. The shortfall could be financed in part by non-concessional borrowing. Uganda has maintained a very cautious borrowing strategy since debt relief, and its risk of debt distress is low.4 The authorities intend to continue to rely on concessional resources to the extent possible to fund their investment program, and to rely on non-concessional borrowing only to the extent that a shortfall materializes (MEFP ¶24). The debt sustainability analysis shows that measured amounts of non-concessional borrowing could be contracted without endangering debt sustainability. Domestic financing could also be increased as long as it does not endanger monetary stability and inflation targets. In practice however, Uganda’s limited absorptive capacity and its still budding procedures for public investment selection and implementation set constraints on the size of a manageable borrowing envelope.

25. The PSI includes a ceiling of $500 million on non-concessional borrowing for the duration of the program. This borrowing, equivalent to about 0.7 percent of GDP a year, on average over the PSI period, would leave all debt indicators well below the DSA thresholds. It is consistent with the authorities’ preliminary investment program. It could be revisited once investment plans are better specified and financing options have been more closely assessed, including in particular those related to the development of regional infrastructure in the context of the EAC.

B. Monetary and Financial Sector Policies

26. Monetary policy will aim at keeping annual underlying inflation at 5 percent on average, using base money as an operating target to that end. The exchange rate will remain flexible, with only sporadic intervention from the BOU to smooth out undue volatility. In addition, the authorities will seek to build up international reserves in the context of the EAC.

27. Monetary management will continue to rely on a mix of foreign exchange and domestic securities operations. With technical assistance from MCM, the BOU will continue to enhance the flexibility of its short-term liquidity management. The absence of high-frequency activity indicators has complicated monetary decisions in the recent downturn, and staff welcome the steps taken by the authorities to fill that gap (MEFP ¶15). Staff emphasized that closer coordination with the Ministry of Finance on near-term cash flow projections is also critical to ensure the effectiveness of liquidity management.

28. Staff support the authorities’ objective of maintaining comfortable international reserves. Uganda’s vulnerability to sizable external shocks (including to aid flows) and uncertainties related to the future development of the oil sector justify keeping a solid reserve buffer. Shortfalls in donor aid, particularly in the coming election year, may dampen reserve accumulation. Also, the large public investment drive may put pressure on the reserve cover target, in as far as these investments entail a large increase in imports. Against that backdrop, reserve accumulation is projected to slow in the near term before regaining steam in the outer years. Staff continue to see merit in targeted intervention in the foreign exchange market to smooth out excessive exchange rate volatility.

29. A new, comprehensive financial markets development plan is being prepared. The plan, developed under a common EAC framework, aims at harmonizing the legal and regulatory infrastructure in the region. It will include a roadmap of reforms to increase access to financial services (including in rural areas) and reduce borrowing costs for smaller enterprises. A deeper financial market should make monetary policy more effective over the medium term. The plan, expected to be finalized in June 2011, could form the basis for structural reform agenda in this area to be included in the PSI’s later years. The authorities indicated that external technical expertise, including from the IMF, would be desirable to assist in implementing this plan.

30. Finalizing the reform of the pension sector remains an objective of the PSI-supported program. The bill establishing a pension fund regulator—a key requirement for sound liberalization of the sector—was approved by Cabinet in December 2009 and is on track to be submitted to Parliament before year end. Staff welcome progress in this area and support the authorities’ intent to conduct, preferably with external technical assistance, an assessment of the viability of the National Social Security Fund and other existing pension schemes (MEFP ¶25).

31. The BOU will pursue its efforts to raise the quality of its oversight of the banking system. A financial stability department has been established, and the first Financial Stability Report was published in January 2010. Steps are being taken to increase minimum bank capital requirements, in line with the practice in other EAC members, and to extend regulatory coverage to large deposit-taking microfinance institutions (MEFP ¶17). Staff welcomed these advances and recommended continued watchfulness, particularly of the few small banks that have suffered a recent deterioration of their balance sheet. Staff also encouraged the authorities to review their crisis preparedness and build capacity for contingency planning and crisis resolution, to ensure that the BOU has the legal tools and appropriate human resources to intervene quickly if the need were to arise.

C. Management of Oil Resources

32. Large-scale oil production will pose significant macroeconomic policy challenges for Uganda. It is not yet possible to estimate precisely the impact of oil on the Ugandan economy as the timing, scope and pace of oil production remain contingent upon the results of ongoing exploration activity and technical analyses. However, with reserves potentially as large as 2 billion barrels and oil revenues likely to exceed one third of total government revenues, oil can be expected to alter meaningfully Uganda’s productive, fiscal and financial landscape (Box 4).

33. Staff commended the authorities for their early commitment to establishing a sound legal and institutional framework for the management and use of oil revenues. The authorities are eager to preserve Uganda’s hard-won record of macroeconomic stability while maximizing the opportunities offered by oil for development and income growth. They are initiating the expert review of relevant public finance legislation and stand ready to introduce all necessary amendments to provide a robust and transparent regulatory environment for oil, preserve budget integrity and limit unintended leakages (MEFP ¶29). The authorities are appreciative of the technical assistance provided by the Fund and other development partners in this area and hope it will be continued. Staff and the authorities agreed that a fiscal ROSC would provide a particularly timely assessment of the quality of their fiscal institutions.

34. The PSI-supported structural reform agenda will help prepare Uganda for the oil era. Stronger public financial management systems are crucial to the efficient spending of oil revenues. Higher non-oil tax collections will help ensure post-oil fiscal sustainability and offset any retrenchment in overseas aid. The current drive to improve public infrastructure and increase financial access will help overcome, at least in part, the strains on competitiveness that could arise from oil-related appreciation pressures. These first steps could be usefully complemented by more forceful efforts to promote a more fluid and supportive investment climate and reduce transaction costs—policies that take time to bear fruit and should be initiated now. A transparent and well-focused public communication strategy with investors, donors and civil society would also help in keeping private expectations in check.

The Macro-Economic Implications of Oil

Preliminary estimates suggest that oil could account for around 8 percent of Uganda’s GDP, and up to one third of government revenues. Oil reserves are currently expected to last for around 25 years and offer a unique opportunity to raise income levels. However, the substantial size of oil revenues combined with their short duration and inherent volatility will pose significant challenges for macroeconomic management.

Figure 2.:
Figure 2.:

Uganda’s oil revenue will be large but temporary

(percent of GDP).

Citation: IMF Staff Country Reports 2010, 132; 10.5089/9781455204366.002.A001

The first and most widely documented risk is to competitiveness. Demand for non-tradables can be expected to rise in line with government spending and private expectations. The resulting appreciation of the shilling (either through inflation and/or through the nominal exchange rate) cannot be avoided, but well-designed policies can increase productivity and preserve competitiveness. There is considerable scope, for example, to lower production costs through investment in public infrastructure, skills training, and reforms to land and other input markets.

Money and foreign exchange markets will also face major structural shifts. Oil export earnings will increase their size in an abrupt manner. Oil price movements will feed through the foreign exchange market and increase exchange rate volatility. Asset bubbles will be a risk as oil wealth prospects attract private financial inflows. In that context, monetary policy alone is likely to be insufficient to address both appreciation and inflation pressures stemming from oil resources, and fiscal policy will take an even more central role in maintaining macroeconomic stability.

A fiscal rule can help govern the accumulation and spending of oil wealth. The rule would respond to at least three objectives: (i) preserving a share of oil wealth for future generations; (ii) smoothing spending to insulate the non-oil economy from volatile oil revenues; and (iii) mitigating the deterioration in competitiveness (as public spending usually features a large component of non-tradables). Countries such as Timor-Leste and Chile offer examples of well functioning commodity funds underpinned by relatively complex fiscal rules. Uganda may consider a simpler fiscal rule initially, with sufficient flexibility to adapt to the country’s circumstances. The authorities expressed interest in anchoring fiscal policy through a ceiling on the public spending-to-GDP ratio. Technical assistance may be useful in this respect

The fiscal rule should also take into account Uganda’s participation in the future East African Monetary Union. Uganda is the only prospective EAMU member with large proven oil resources. In the future, its business cycle would not be fully synchronized with those of other oil-importing EAMU members. Monetary policy in the EAMU will be set based upon economic conditions in the union as a whole. It would likely be loosened during oil price booms, to support growth in oil importers, fueling further inflationary pressures in oil-exporting Uganda. The monetary union will thus place an additional burden on fiscal policy as a counter-cyclical policy instrument in Uganda. In anticipation, the authorities could consider measures to strengthen automatic stabilizers (through an increased tax effort and the development of social transfers). Consideration could also be given to a fiscal rule that weakens the link between oil prices and domestic activity—for instance, a savings rule that places a relatively low discount rate on the consumption of future generations.

IV. The Program for the Remainder of 2009/10 and 2010/11

In light of the slowdown in economic activity, near term economic policies will aim at reviving growth back to its potential. An ambitious, upfront effort at fiscal structural reforms will help address recent shortcomings and set the stage for more efficient fiscal spending in the years to come.

35. Growth is expected to remain below potential in the near term. After a weak first half of FY2009/10, activity is projected to recover gradually on the heels of higher public spending and a weather-related rebound in agriculture. Overall, growth in FY2009/10 will only reach 5.6 percent, rising moderately to 6.4 percent in 2010/11. Inflation is expected to ease to about 5 percent at the end of the fiscal year but pressures may arise from the recent depreciation of the shilling. Gross international reserves are projected to remain at a comfortable level, reflecting, inter alia, the positive impact of the SDR allocation, which provides an additional buffer against shocks and downside risks.

A. Fiscal policy

36. Public spending is being accelerated in the second half of FY2009/10 to provide stimulus to domestic demand. Expenditure worth around ½ percent of GDP is being reallocated from development to current items. Reallocated resources will be used to address humanitarian emergencies and provide for under-budgeted pensions. In addition, unspent balances from the FY2008/09 development budget are being carried forward, for an amount equivalent to another ½ percent of GDP. Assuming full execution of this revised budget, the fiscal stance will be roughly neutral for the year, but strongly expansionary in the second half (Table).

Uganda: Fiscal Impulse of the Central Government, FY2007/08–2010/11

article image

The impulse is calculated as the change in the primary balance with respect to the preceding year; (-) = fiscal withdrawal

The adjusted fiscal impulse is equal to the fiscal impulse, adjusted for the fiscal impact of the deviation of growth from potential; the calculation assumes an elasticity of 0.2 and a potential GDP growth of 7 percent.

37. A range of structural measures are being introduced to ensure that the additional resources are well spent. Staff noted in particular that the carry-forward of unspent balances from 2008/09 without Parliamentary re-appropriation creates serious potential for leakages and ineffective spending. The authorities agreed to move quickly to tighten the relevant legislation (MEFP ¶27) to avoid recurrence of this practice. Staff also underscored that reallocated items should be subject to the same budgetary discipline as items approved in the original budget.

38. The fiscal stance will remain slightly expansionary in FY2010/11. Investment spending is scheduled to increase by around 1 percentage point of GDP as spending agencies gain familiarity with planning and procurement procedures. Tax revenue will rebound reflecting the pick-up in economic activity together with renewed efficiency gains, but this will be insufficient to cover the expected shortfall in grants. To avoid squeezing public infrastructure investment and dent the emerging recovery, the program envisages a temporary increase in domestic financing of the government budget (0.6 percent of GDP, year-on-year) and a small dip in the reserve cover. These are upper bound estimates, as a less-than-complete execution of the budget, and higher donor disbursements, would reduce the financing needs.

B. Monetary and Exchange rate Policies

39. Monetary policy in the near term will be cautiously accommodative. Reserve money is projected to grow by 19 percent in FY2009/10 so as to cover shortfalls in budget financing while providing enough room for private sector credit growth. This stance is not expected to generate inflationary pressures given the weak economic activity. However, the authorities should remain vigilant to inflation risks and stand ready to tilt the policy stance as demand picks up.

40. The monetary policy stance in FY2010/11 will be driven by the pace of the economic recovery and inflation developments. Reserve money growth (of about 14 percent, consistent with a core inflation target of 5 percent) is predicated on a pick-up in economic activity and full execution of the planned fiscal stance. The authorities viewed the development of high-frequency activity indicators as key to enhancing the efficiency of monetary policy.

41. International reserves are not expected to come under strain in the near-term. In FY2009/10, muted import growth is expected to lead to an additional build-up of reserves despite weaker capital inflows. However, the expected shortfall in budget support may constrain the authorities’ ability to increase reserves further in the following year. Even though this could delay the desired accumulation path, the authorities and staff agreed that a drawdown in reserves to cushion a temporary shock was appropriate.

C. Program Monitoring

42. For monitoring performance under the three-year PSI, quantitative assessment criteria, quantitative indicative targets, and structural benchmarks have been proposed (MEFP Tables 1 and 2). The quantitative targets will be monitored on a semiannual basis and include net credit to the central government from the banking system, net domestic assets of the central bank, and net international reserves of the BOU. Targets to be monitored on a continuous basis include nonaccumulation of external arrears, contracting or guaranteeing of new nonconcessional external debt, and new short-term external debt. The standard provisions on the exchange system and trade issues that apply to the use of the Fund’s financial resources will apply as continuous assessment criteria under the PSI. The assessment dates for the first year will be end-June 2010 and end-December 2010.

V. Staff Appraisal

43. Prudent macroeconomic management has allowed Uganda to emerge from a succession of adverse external shocks relatively unscathed. Although growth has slowed, it remains enviable by international standards and is set to rebound quickly. The authorities' focus on closing the infrastructure gap—one of the most binding constraints to growth—while maintaining a sound macroeconomic environment should help raise potential output and future income levels.

44. Persistent structural rigidities continue to hamper policy implementation. Financial sector segmentation together with fiscal capacity constraints have prevented the delivery of intended fiscal and monetary stimulus, and weaknesses in public financial management bear on the efficient use of scarce public resources. Revamping and refocusing the structural reform program on these hurdles is an important priority. Well-targeted external technical assistance can go a long way in helping the authorities reach that goal.

45. Staff recommend completion of the 7th review under the PSI. All quantitative assessment criteria have been met. The impact of emerging weaknesses in budget implementation and spending controls has been limited and has not jeopardized program objectives. Staff welcome the authorities’ determination to take early action to address these shortcomings head-on in the requested successor PSI.

46. Staff support the authorities’ request for a new PSI. The agreed program aims at continued infrastructure build-up to support private investment and growth. It will give new impetus to structural reforms in the fiscal and financial sectors through structural conditionality that is more narrowly focused to enhance the prospects of success. The PSI-supported program will help maintain macroeconomic stability through the forthcoming election period. It will also help Uganda prepare for East African integration and the oil era, when they come.

47. There are risks to the program but they appear manageable. The first would be a loss of investor and donor confidence due to uncertainties in the run-up to elections. Against that backdrop, the program is predicated on conservative financing assumptions. Regional shocks are also a risk given the fragile security situation in some of Uganda’s neighbors. The authorities have a solid track record of maintaining macroeconomic stability in the face of adverse domestic and external shocks, and staff trust that they will be able to continue to do so if the need were to arise.

Table 1.

Uganda: Selected Economic and Financial Indicators, FY2008/09–2013/14 1

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Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

Percent of M3 at start of the period.

Percent of exports of goods and nonfactor services.

Including Fund obligations; reflects actual debt service paid, including debt relief.

Table 2.

Uganda: Fiscal Operations of the Central Government, FY2007/08–2013/14 1

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Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

Includes arrears.

Spending related to unused balances carried over from FY2008/09.

Table 3.

Uganda: Monetary Accounts, FY2007/08–2013/14 1

(U Sh billions; end of period, unless otherwise indicated)

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Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins in July.

The public sector includes the central government, the public enterprises, and the local government.

Including valuation effects and the BOU's claims on the private sector.

4 Reclassification of non-bank institutions in FY2007/08 added approximately Ush 250 bn to the stock of private sector credit. Excluding this amount, credit to the private sector grew by 40 percent.

Table 4.

Uganda: Balance of Payments, FY2007/08-2013/14 1

(US$ millions)

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Sources: Ugandan authorities; and IMF staff estimates and projections.

Fiscal year begins on July 1.

Table 5.

Uganda: Quantitative Assessment Criteria and Indicative Targets for December, 2009 1

(Cumulative change from the beginning of the fiscal year, unless otherwise stated) 2

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The assessment criteria and indicative targets under the program, and their adjusters, are defined in the TMU.

Fiscal year begins on July 1.

Cumulative changes are from June 2009 (averages for NDA and BM) as defined in the TMU.

Continuous assessment criterion.

Cumulative change from December 1, 2006.

Excluding normal import-related credits.

Arrears incurred after end-June 2004. Excludes new arrears accumulated during the current fiscal year.

Table 6.

Uganda: Structural Benchmarks 1

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Benchmarks also apply on a continuous basis to the standard provisions on the exchange and trade issues that apply to programs supported by the Fund’s financial resources.

Table 7.

Selected Banking System Indicators, 2006–09

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Kampala, Uganda

April 25, 2010

Mr. Dominique Strauss Kahn

Managing Director

International Monetary Fund

Washington, DC 20431

Dear Mr. Strauss Kahn:

On behalf of the Government of Uganda, I wish to provide you with an update on the progress we have made under our program backed by the IMF’s Policy Support Instrument (PSI). Further, I would like to request continued cooperation through a new three-year PSI.

Performance under the PSI through the 7th review has remained strong and all end-December assessment criteria have been met. Our strong policy framework enabled us to limit the impact of the global financial crisis on our economy. Growth has slowed but remains robust and is set to recover quickly, and inflation has been kept under control. Although there have been some delays in reforms, particularly in public financial management, we have made advances in other areas and we remain committed to strengthening the structural reform agenda.

We recently launched our National Development Plan (NDP) aimed at sustaining long-term economic growth, promoting economic transformation and wealth creation. To better align program targets with our medium-term development plans, the Government of Uganda wishes that the current PSI be canceled immediately upon conclusion of the seventh review, and that a new three-year PSI commence immediately thereafter.

The attached Memorandum of Economic and Financial Policies (MEFP) sets out the Government’s objectives and policies derived from our NDP. Specific emphasis is placed on infrastructure investment to address critical constraints to growth in a coherent and consistent framework. The new PSI also seeks to rejuvenate the structural reform agenda.

The Government of Uganda believes that the policies set forth in the attached MEFP are adequate to achieve the objectives of our PSI-supported program but will take any further measures that may become appropriate for this purpose. We stand ready to work with the Fund and other development partners in the implementation of our program and will consult in advance should revisions be contemplated to the policies contained in the PSI.

The Government of Uganda authorizes publication of this letter, its attachments, and all reports prepared by IMF staff for the 7th review under the PSI and the request for a new PSI.



Ms. Syda Bbumba

Minister, Ministry of Finance, Planning, and Economic Development

cc: The Governor, Bank of Uganda

Attachment 1. Uganda: Memorandum of Economic and Financial Policies

April 25, 2010

I. Introduction

Purpose of MEFP

1. The Government of Uganda (GOU) requests a new Policy Support Instrument (PSI) for the period 2010 to 2013, to be aligned with the recently-adopted National Development Plan (NDP). The NDP, which covers the period 2010/11-2014/15, identifies four priority objectives: human resource development through health and education; eliminating infrastructure bottlenecks to growth, particularly in energy and transportation; supporting science, technology and innovation, and facilitating private access to critical inputs to production, especially in agriculture. Economic policies under the new PSI will also be framed to be consistent with the requirements of the transition to a monetary union in East Africa.

2. This memorandum outlines the performance of the economy in the first half of 2009/10, discusses the projections and policy stance for the remainder of the fiscal year and then sets out the policy objectives for the 2010/11 fiscal year and the medium-term.

Performance under the PSI

3. All of the six quantitative assessment criteria for end-December 2009 were met, as were the two indicative targets. Both structural benchmarks under the PSI have 2010 deadlines which Government expects to meet.

II. Economic and Policy Developments

Outturn in the first half 2009/10

4. There have been indications of slowdown of real GDP growth in H1 2009/10 because of drought in the first quarter of 2009/10, and delays in the implementation of government spending. Core consumer price inflation fell sharply in H1 2009/10, from an annual rate of 11 percent in June 2009 to 7.4 percent in December 2009, because of the slow growth in consumer spending and the exchange rate appreciation in the first half of the year. A sharp rise in food crop prices in Q1 2009/10, attributable to the drought, drove up annual headline consumer price inflation from 12.3 percent in June 2009 to 14.6 percent in September 2009, but the recovery in food supply in the second quarter together with the continued fall in core inflation brought down headline inflation to 11 percent in December 2009.

5. The fiscal stance in H1 2009/10 was tighter than programmed because of delays in implementing public expenditures, especially capital expenditures. Total expenditures were Shs 246 billion lower than budgeted in H1. Revenues underperformed by Shs 85 billion, on account of the weakness in import growth. There was, however, an over performance in several direct and indirect domestic tax handles, including excise taxes and VAT on domestic goods, as a result of stronger enforcement efforts by the Uganda Revenue Authority.

6. Monetary growth was lower than projected in H1 2009/10, reflecting weak money demand as a result of subdued private sector consumption. Reserve money was 2.4 percent lower than programmed. To stimulate stronger private spending, the Bank of Uganda (BOU) sought to boost liquidity and reduce interest rates, with the yields on 364 day Treasury Bills falling from 14 percent in June 2009 to 9 percent in December 2009. The fall in securities yields, alongside lower money market rates, reflected both the stance of monetary policy and falling inflationary expectations. However, thus far lending rates have only declined marginally, reflecting market rigidities and a tightening in lending standards.

7. The BOP, which had recorded an overall deficit in 2008/09, improved in the first half of 2009/10, with an overall surplus leading to a net accumulation of international reserves of US$ 93 million. The improvement in the BOP, which was due to weaker import growth and a recovery of foreign investment, led to an appreciation of the nominal exchange rate, which on a trade weighted basis, appreciated by 8.2 percent between June and December 2009.

Projections for the second half of 2009/10

8. Aggregate demand is projected to pick up in H2 2009/10, boosted by recovery of consumer demand and a more rapid implementation of budgeted public expenditures. This is expected to result in real GDP growth for the fiscal year of 5.6 percent, 0.7 percentage points lower than had been programmed. Despite the recovery in H2, output will remain below potential and hence inflationary trends are expected to remain subdued. Although monthly core inflation will begin to accelerate in H2 in line with consumer demand (from around zero at the end of H1), annual core inflation is projected to decelerate to 3.9 percent in June 2010. Annual headline inflation is projected at 5 percent in June 2010.

9. The fiscal outturn for 2009/10 is projected to be slightly less expansionary than projected at the time of the 6th Review, largely due to the underperformance of development expenditures (by 1.6 percent of GDP). This is for two reasons. First, reallocations from capital expenditures to current spending, including increased provision for pension payments, and for emergency spending and road maintenance through supplementary appropriations, will raise current expenditures above programmed levels by 0.5 percent of GDP. Secondly, expenditures amounting to 0.5 percent of GDP, mainly pertaining to roads projects, will be implemented from budgetary resources carried forward from the previous fiscal year. Revenues are projected to underperform but only by 0.3 percent of GDP. With grants being approximately in line with programmed levels, the overall fiscal deficit, both including and excluding grants, is projected to be lower than programmed by 0.2 percent of GDP and 0.3 percent of GDP, at 2.3 percent and 4.7 percent of GDP, respectively. The fiscal deficit is projected to be financed by net external borrowing of 2.0 percent of GDP and net domestic financing of 0.3 percent of GDP, the latter being 0.2 percent of GDP higher than programmed.

10. Monetary policy will continue to be cautiously accommodative. Money demand is projected to pick up in H2, lifting annual broad money growth for the fiscal year to 19.3 percent and reserve money growth to 19.1 percent. Private sector credit is projected to grow at 17.1 percent in 2009/10.

11. The BOP is projected to record an overall surplus of US$ 291 million in 2009/10, in line with the programmed level. The current account deficit is projected to widen as a percentage of GDP, from 4.8 percent in 2008/09 to 5.3 percent in 2009/10, despite a lower trade deficit, because of higher services and lower official transfers.