Abstract
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.
Introduction
1. My Ugandan authorities have persevered with strong macroeconomic policies that have enabled them to emerge from a succession of adverse external shocks relatively intact. They are appreciative of the policy support provided under the Fund’s PSI, particularly in facilitating the implementation of their structural reform agenda. Going forward, my authorities are determined to preserve Uganda’s hard-earned record of macroeconomic stability, while striving to achieve key national objectives set out in their recently launched National Development Plan (NDP). The NDP will guide the policy thrust of the new PSI.
2. The authorities believe that addressing infrastructure bottlenecks—one of the most binding constraints to growth—while maintaining a sound macroeconomic environment should help Uganda attain a satisfactory sustainable growth path. It is against this backdrop, that they are requesting a new PSI to be aligned with the NDP objectives and annual budget cycles. They request the conclusion of the seventh review, a new three-year arrangement under the PSI, and cancellation of the current PSI that was due to expire at the end-2010.
Program performance, recent economic developments and prospects
3. Performance under the PSI through the seventh review has remained strong and, like in the previous reviews, all end-December assessment criteria have been met. Building on that record, the authorities affirm that all the structural benchmarks with deadlines in 2010 are expected to be met. While some weaknesses in budget execution and spending controls lingered, their impact on the program objectives has been contained.
4. Real GDP growth, which had remained broadly resilient to the global economic downturn, slowed down in the first half of 2009/10 1 due to drought and delays in the implementation of government spending. Annual consumer price inflation decelerated sharply during the same period, from 11 percent in June 2009 to 7.4 percent in December 2009, mainly due to slower consumer spending and appreciation of the Uganda shilling. The outlook on aggregate demand is projected to increase in the second half of 2009/10 on account of recovery of consumer spending and better execution of capital expenditures. Likewise, real GDP is expected to rebound towards its potential growth trajectory in the medium term.
5. The fiscal stance in the first half of 2009/10 has been tighter than programmed because of delays in the implementation of capital expenditures. Though revenue overperformed in some categories of direct and indirect domestic taxes, total revenue underperformed on account of the weakness in imports.
6. The Bank of Uganda (BOU) has pursued an accommodative monetary policy to stimulate domestic demand, especially private spending. However, due to market rigidities and tightening of lending standards by commercial banks, lending rates declined only marginally. As a result credit to the private sector remained unchanged.
7. The financial sector has remained resilient to the global financial and economic crisis on account of the limited exposure of the banking system to the toxic assets and the strength of the regulatory framework. Additionally, the banks have generally increased their liquidity buffers and tightened their lending standards. These commendable developments notwithstanding, non-performing loans (NPLs) have increased -- though from a low base -- with the slowdown in economic activity. The extension of the financial sector to include mobile banking may also have created new strains and operational risks, especially those related to transfers and the regulatory framework.
Policy framework under the new PSI
Fiscal policy
8. My Ugandan authorities are resolved to maintain a modest expansionary fiscal strategy in the near to medium term, geared to scaling up infrastructure investment while maintaining spending on the MDG clusters, to boost growth and reduce poverty. To achieve these objectives, the authorities are aware that they need to create adequate fiscal space and address weaknesses in the public sector’s absorption capacity. Against this backdrop, they are determined to restrain expenditure growth in non-productive activities, while at the same time focusing on revenue-enhancing measures.
9. Cognizant of limited options with respect to new sources of tax revenue in the near term, my authorities’ efforts to increase revenue will focus on improving enforcement and the collection of non-tax revenues. In the same vein, they would be taking steps to strengthen budget execution (absorption) capacity through the deployment of external technical assistance on contracting and procurement, and training of accounting officers on preparation of work plans, execution and reporting.
Monetary and exchange rate policies
10. The BOU’s monetary policy framework in the near to medium term will focus on supporting growth. The authorities would, however, remain vigilant and monitor the inflation risks closely and stand ready to tilt the policy stance when warranted. Lack of high frequency activity indicators has constrained the efficiency of monetary policy. In this regard, the BOU is committed to developing a set of high frequency indicators that would capture the level of activity and demand in the economy. The BOU will also continue to review its quantitative targets for monetary aggregates on a monthly basis, based on the latest available macroeconomic data, to check for stability. They stand ready to intervene on a daily basis with repos and reverse repos to ensure stability in the money markets.
11. On exchange rate, the BOU remains committed to a flexible exchange rate regime and sees it as a key line of defense against external shocks. The BOU will only intervene occasionally to smooth out excessive volatility. The authorities will also seek to accumulate a level of international reserves consistent with the East African Monetary Union convergence criteria over the medium term.
Financial sector
12. The BOU will continue to strengthen its supervisory and regulatory services to the financial institutions to stem further exposure to the new strains emanating from mobile banking and the rise in NPLs. Further, the authorities intend to strengthen the regulatory framework for financial institutions, by updating the Financial Institutions and Microfinance Deposit-taking Institutions Acts. The new framework will include an upward revision of minimum and paid-up capital requirements; provisions to cover Islamic banking products, regulations to cover insurance products offered by banks and other non-bank financial institutions, and bring the large savings and credit unions under the financial sector regulatory framework.
Structural reforms
13. Through the recently launched NDP, my Ugandan authorities have reaffirmed their commitment to the implementation of a wide range of reforms. The authorities’ drive at addressing the infrastructure deficit underpins the NDP objectives and the thrust of the structural reforms in the medium term. Improving the stock and quality of infrastructure—from road and rail networks to energy and telecommunications—is a priority with the aim of enhancing productivity in the primary sectors and competitiveness of the country as a whole. The authorities are also considering participating in regional transportation projects infrastructure in the East African Community (EAC) to strengthen regional markets. To finance these investment priorities, the authorities will implement both allocative and technical efficiency improvements and other measures—including the use of PPPs—in order to create the needed fiscal space. Although they have maintained the current ceiling for non-concessional borrowing in the new PSI-supported program, the authorities may request an increase when the need arises after appropriate due diligence.
14. The authorities reaffirm that the imminent exploitation of oil and gas resources would present opportunities as well as challenges to the Ugandan economy in terms of substantive revenue base and high start-up infrastructural and operational costs. In this regard, they are focused on developing an oil and gas intervention plan, setting up a sound legal and institutional framework for the oil sector, and strengthening their resource management capacity. They also intend to foster regional cooperation in terms of key infrastructure for energy supply and security. To that end, they would welcome Fund TA and continued engagement in the assessment of the macroeconomic impact of oil and gas exploitation on the rest of the economy, including the Dutch disease effects.
15. In light of the future increase in public investments in the oil and gas sector, the authorities remain committed to fast-track the strengthening of their Public Financial Management (PFM). Also reforms will be undertaken to improve the pension sector, including liberalization to allow entry of private pension providers that will compete with the National Social Security Fund (NSSF). A Bill to establish a regulatory framework for the pension sector and other retirement benefits schemes will be submitted to Parliament at the start of the 2010/11 financial year, and the new regulator put in place soon after the enactment of the law.
16. On the regional front, the authorities consider the deepening of the EAC regional integration framework as an important catalyst to enhance Uganda’s medium-term growth. They, therefore, view progress in the implementation of the Customs Union and Common Market protocols as key to advancing the EAC’s integration agenda. They are committed to make progress in the harmonization of monetary and fiscal policies, and the ultimate EAC monetary union.
Conclusion
17. Uganda’s strong macroeconomic fundamentals and policy framework has helped the economy to weather the storm of the global crisis. The authorities are committed to continue with the implementation of sound macroeconomic policies and a broad range of structural reforms. They also remain committed to advance the EAC integration agenda.
18. My Ugandan authorities are aware of the opportunities and challenges arising from the imminent exploitation of the oil and gas resources. They, therefore, request continuous support of the Fund, other international financial institutions, and development partners in their effort to strengthen macroeconomic stability, and restore high growth rates with low inflation for poverty reduction and the attainment of the MDGs.
Fiscal year runs from July 1 to June 30.