Abstract
Economic growth has recovered, but higher food and fuel prices have sparked a sharp rise in inflation. Monetary policy has been tightened to contain core inflation and effects of the food and fuel price shocks. The government has allowed for scaling up of infrastructure investment spending. The programmed adjustment of fiscal and monetary policies will help put Uganda on a more sustainable medium-term trajectory. Eliminating tax exemptions and incentives will address the revenue gap. The planned oil revenue management framework is encouraging.
1. My Ugandan authorities remain determined to persevere with prudent macroeconomic policies that enabled the economy to recover swiftly from the global economic crisis related downturn. They are also determined to deepen structural reforms to pave way for sustained and broad-based economic growth. With this macroeconomic framework and continued support of the Fund and the international community, my authorities are confident that they stand a good chance of mitigating the effects of the second round of the global commodity price surge and the potential fallout from the sovereign debt risks in advanced economies. To that end, they are committed to strengthen the implementation of their program under the PSI and to continue the track record of macroeconomic stability attained over the years.
2. My authorities are appreciative of the Fund’s constructive engagement and support under the PSI and the related technical assistance packages. Going forward, they are determined to further strengthen their macroeconomic framework, and achieve key national and regional objectives set out in their National Development Plan (NDP) and East African single market protocols that are supported by the PSI.
3. To that end, and in view of the strong performance under the program—with all but two of the end-December 2010 quantitative performance/assessment criteria observed with good margins, and implementation of structural reforms on track—they request Directors’ support for the completion of the second review of the PSI. They also request Directors’ support for the waivers for nonobservance of the two assessment criteria—the NIR and NDA—and agree with staff–s recommendation for the establishment of the end-June 2011 and end-December 2011 quantitative assessment criteria.
Recent economic developments and respective policy environment
4. Uganda’s strengthened economic fundamentals over the years—policy-wise and the broadened economic base—helped the country weather the storm of the global economic downturn and a return swiftly to a growth path. Real GDP growth that had declined from 7.2 percent in 2008 to 5.2 percent in 2009 as a result of deterioration in the external environment, recovered to 6.4 percent in 2010 and is projected to maintain the recent growth momentum in 2011 and in the medium-term. The repetitive drought conditions and the recent spike in global food and fuel prices are exerting pressure on domestic inflation. My authorities are strengthening their monetary policy framework, also in line with staff recommendations, to avert the second round effects of the price surge. They, in this regard, expect inflation to subside to single digits and to revert to the 2009/2010 levels in the medium-term.
5. My authorities’ fiscal policy has in the course of the year progressively shifted towards consolidation as security and elections related spending pressures have abated. The authorities’ fiscal discipline and reallocations of spending among budget lines meant that, overall, the fiscal outturns have remained within the PSI targets. This has enabled them to cut down on the fiscal deficit during the latter part of the year, and to scale back on central bank financing. Nevertheless, the authorities concur with staff over the growing risks of accumulating arrears emanating from the reallocation of spending. To that effect, they are committed to sharpen monitoring of the build-up of arrears within the major spending units.
6. On the revenue front, latest data updates indicate improvement in domestic revenue collection. The authorities are determined to build on the current revenue performance to create additional fiscal space needed for their investment program. They view the recent Fund TA recommendations on tax policy as fundamental inputs into their reform effort.
7. The authorities have made progress in raising funds from external non-concessional borrowing and are confident that they will make use of the entire non-concessional borrowing window for this financial year and express preference for a higher limit than the one proposed by staff of $800 million. In light of the debt sustainability assessment that remains well below the distress threshold, and their strong pipeline of large infrastructure projects, the authorities had, during the discussions with Management at the Spring Meetings, requested a non-concessional limit of $1.5 billion. They are, therefore, disappointed that the proposed $800 million falls well below their financing needs.
8. My authorities’ monetary policy stance has also shifted from being accommodative in response to the growing inflationary pressures. The financial sector has continued to strengthen and profitability remains high, 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. As a result, the non-performing loans (NPLs) have declined substantially. This commendable progress notwithstanding, the authorities are mindful of the remaining risks and stand ready to further support the stability of the financial sector. The recent parliamentary bill that creates an independent regulatory authority for the pension sector is an important step toward strengthening the regulatory framework for the financial sector.
Medium-term policy framework
Fiscal policy
9. My authorities will continue to actively use their fiscal policy to spur economic growth to its potential trajectory and to address the effects of repetitive external shocks. To achieve these objectives, measures including sustaining budgetary spending levels for the priority services, modest scaling-up of investment in infrastructure and primary sectors to shore-up economic growth, and deepening structural reforms to improve the business environment will continue to be prioritized.
10. To maintain prudent spending in these priority areas while embarking on a fiscal consolidation path, the authorities will continue to strengthen domestic and external concessional resource mobilization in the medium-term. Cognizant of the overall resource limitations, they intend to fully utilize this year’s non-concessional financing window—about $0.5bn. As earlier noted, they have requested augmentation of this window. They have also made an undertaking to enhance revenue reforms in line with staff recommendations with the view of raising the revenue yield.
11. The authorities are mindful of the huge potential of oil revenues including the sizable capital gains taxes. They have, in this regard, started with the FY 2011/2012 the process to comprehensively review the Public Finance Accountability Act that will incorporate oil revenue management. They also intend to ring-fence oil revenues for infrastructure investments by establishing a petroleum fund to (i) finance expenditures exclusively through the budget, and (ii) generate revenue savings for future generations. The Bank of Uganda (BoU) will manage the latter component. The authorities also intend to strengthen the ongoing measures aimed at enhancing the public sector’s absorptive capacity.
12. On the expenditure side, the authorities will pursue expenditure streamlining in line with the program while maintaining a clear focus on the priorities of their National Development Plan especially on road and energy infrastructure paralleled by maintaining spending on the MDG clusters to boost growth and reduce poverty. Additionally, they will take steps to strengthen budget execution, and improve the alignment between policy objectives and the budget through prioritization of public investment in line with their NDP.
Monetary and exchange rate policies
13. My authorities’ monetary policy will continue supporting their macroeconomic framework through maintaining sufficient liquidity in the financial system, and low and stable inflation. They will remain vigilant of the inflation pressures arising from the resurgence of global commodity prices and domestic supply shocks. To achieve the objective of anchoring its monetary policy on low and stable inflation, the BoU will further bolster its open market operations, maintain a flexible exchange rate policy, rely on foreign exchange sales for sterilization of liquidity, and continue to improve liquidity forecasting. Meanwhile, they are improving their inflation-specific analytical and forecasting tools, and envisage migrating to an inflation targeting lite framework over the medium-term. The BoU will also continue to review performance of monetary aggregates against their quantitative targets on a monthly basis. They stand ready to intervene regularly with repos and reverse repos to ensure stability in the money markets.
14. The BoU is committed to maintain the transparency of its monetary policy stance and promote orderly financial markets. The authorities will also seek to make progress in the preparation for and negotiations of the East African Monetary Union. To that end, targeted support by the Fund in key relevant areas will be greatly appreciated by the EAC partners.
15. On exchange rate, the BoU remains committed to a flexible exchange rate regime and continue to see this as the first line of defense against external shocks. The BoU will remain vigilant and only intervene occasionally to smooth out excessive volatility. The authorities will also seek to accumulate a high level of international reserves from the current 3.6 months of import cover to the 6 months cover target consistent with the East African Monetary Union convergence criteria over the medium-term.
Financial sector
16. The BoU will continue to enhance its supervisory and regulatory services to the financial institutions to stem further exposure to the new challenges emanating from mobile banking and avert future resurgence of NPLs. Building on the operationalization of the credit reference bureau and the recent increase in capital requirements, the authorities intend to strengthen the regulatory framework for financial institutions to be fully consistent with Basel 1 Capital Accord, and to update the Financial Institutions Act to allow banks to offer additional products. The BoU will also review the regulatory restrictions on lending with maturity of over three years with a view to encouraging longer term lending by banks.
Structural reforms
17. My Ugandan authorities’ commitment to the implementation of a wide range of reforms underpins the NDP objectives. Improving the stock and quality of infrastructure—from road and rail networks to energy and telecommunications and regional infrastructure projects—is a priority with the aim of enhancing productivity in the primary sectors and competitiveness of the country as a whole, and strengthening regional markets. Additionally, the authorities’ pursuit of detailed fiscal management reforms should help create the needed fiscal space to undertake their ambitious investment program including that in the oil sector.
Conclusion
18. The authorities’ macroeconomic fundamentals and continued commitment to strong policies helped the economy restore its growth momentum faster than earlier envisaged. They are aware of the reemerging risks in addition to the regional security threats and are, therefore, prepared to take appropriate measures to protect the gains in the country’s macroeconomic stability. In the near term, and notwithstanding the need for fiscal consolidation, the authorities are determined to ensure that the program focuses on sustaining macroeconomic stability, enhancing domestic resource mobilization, promoting broad-based and pro-poor growth, and increasing investment in infrastructure, primary sectors and core MDG clusters. They are aware of the future 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, restore high growth rates with low inflation for poverty reduction and attainment of the MDGs.