Uganda: Staff Report for the 2015 Article IV Consultation and Fourth Review Under the Policy Support Instrument

KEY ISSUES Backed by sound policies, economic performance since the 2013 Article IV Consultation has been positive. In response to fiscal stimuli and credit recovery, growth is picking up from the low levels that followed the credit-boom-and-bust-cycle. Careful central bank policies kept inflation low and the financial sector stable, despite shilling volatility. Lower export demand and high infrastructure-related imports widened the current account deficit, but reserves and debt remain at comfortable levels. Performance under the PSI is on track. All end-December 2014 quantitative assessment criteria and most indicative targets and structural benchmarks were met. Key highlights include an exceptionally strong revenue performance and progress in public financial management. The inflation targeting mechanism triggered consultations with staff as average core inflation fell below the inner limit of the band. Risks to the program stem from the upcoming election, regional unrest, and capacity constraints. The envisaged policy mix should achieve further economic gains in the fiscal year starting in July. Despite the election, the authorities are committed to keeping fiscal policy within a budget that favors large infrastructure investment and sustains tax revenue collections in the context of low inflation. They also intend to closely oversee the spillovers and feedback loops between the real economy and the financial sector.1 The planned oil production, infrastructure upgrades, and regional integration bring encouraging medium-term prospects for growth and employment. The strategy will be supported by foreign direct investment; enhanced domestic revenue mobilization through additional tax collection and efforts to improve access to bank services; and increased borrowing at non-concessional but favorable terms. Staff recommends conclusion of the 2015 Article IV Consultation and supports the authorities’ request to complete the fourth PSI review. It also supports the authorities’ decision to modify two end-June 2015 ACs and to increase the continuous ceiling on the contracting or guaranteeing of new nonconcessional debt.


KEY ISSUES Backed by sound policies, economic performance since the 2013 Article IV Consultation has been positive. In response to fiscal stimuli and credit recovery, growth is picking up from the low levels that followed the credit-boom-and-bust-cycle. Careful central bank policies kept inflation low and the financial sector stable, despite shilling volatility. Lower export demand and high infrastructure-related imports widened the current account deficit, but reserves and debt remain at comfortable levels. Performance under the PSI is on track. All end-December 2014 quantitative assessment criteria and most indicative targets and structural benchmarks were met. Key highlights include an exceptionally strong revenue performance and progress in public financial management. The inflation targeting mechanism triggered consultations with staff as average core inflation fell below the inner limit of the band. Risks to the program stem from the upcoming election, regional unrest, and capacity constraints. The envisaged policy mix should achieve further economic gains in the fiscal year starting in July. Despite the election, the authorities are committed to keeping fiscal policy within a budget that favors large infrastructure investment and sustains tax revenue collections in the context of low inflation. They also intend to closely oversee the spillovers and feedback loops between the real economy and the financial sector.1 The planned oil production, infrastructure upgrades, and regional integration bring encouraging medium-term prospects for growth and employment. The strategy will be supported by foreign direct investment; enhanced domestic revenue mobilization through additional tax collection and efforts to improve access to bank services; and increased borrowing at non-concessional but favorable terms. Staff recommends conclusion of the 2015 Article IV Consultation and supports the authorities’ request to complete the fourth PSI review. It also supports the authorities’ decision to modify two end-June 2015 ACs and to increase the continuous ceiling on the contracting or guaranteeing of new nonconcessional debt.


1. A challenging geo-political situation over the last two years has not disrupted economic and financial stability. Security concerns following unrest in neighboring countries and terrorist attacks in the region have weighed on Uganda’s spending needs, exports, and remittances. Declining donor support in reaction to concerns about governance and human rights and reduced development partners’ aid budgets have spurred domestic borrowing requirements. Moreover, the proximity of the February 2016 presidential and parliamentary elections has generated uncertainty. Despite these challenges, the authorities have succeeded in preserving economic and financial stability, helped by a resilient economy—characterized by low inflation, sustainable debt, and ample international reserves.

2. Economic developments and performance under the PSI have been positive. During a period of moderate growth, inflation has come down significantly from its 33 percent peak in 2011; and despite a decline in international reserves and a pickup in public debt, both remain at comfortable levels. Policies have strongly responded to the last Article IV recommendations (Box 1). Recent program performance has been positive, with all end-December 2014 quantitative assessment criteria (QAC) met. However, the lower inner limit of the inflation consultation clause was breached triggering consultations with staff. The indicative target (IT) on tax revenue was met by a substantial margin. The reduction in the stock of domestic arrears was smaller than targeted reflecting a decision to backload intra-year repayments, but the annual target is expected to be met. Contracting of nonconcessional borrowing (NCB) for hydropower plants (HPPs), roads, and electrification was within the $2.2 billion limit. Most end-March ITs were met.

3. Structural reforms have progressed steadily. The approval of the Public Financial Management (PFM) Act in November 2014 was a major milestone, and structural benchmarks on finalizing preparation on its regulations and the Charter of Fiscal Responsibility (CFR) were observed. The Treasury Single Account (TSA) set-up has laid the stage for improved cash management although more time will be needed to eliminate movements of cash and incorporate donor accounts in the system. The submission to parliament of amendments to the Bank of Uganda (BoU) Act was postponed.

4. Over the medium term, the government is committed to boosting sustainable growth to generate employment. This will require bolstering public and private investment with a more targeted focus on inclusiveness. To this end, the government has started the implementation of an ambitious investment package aimed at narrowing the infrastructure gap, enhancing regional integration, and preparing for oil production. The acceleration of private investment is expected to entail PPP schemes for strategic projects; and reforms to deepen financial markets, encourage credit growth, and make bank credit more accessible and affordable. Improvements in governance and the business environment are set to support this framework.

Response to 2013 Article IV Consultation’s Key Recommendations

Preserving macroeconomic stability. Moderate growth, low inflation, and comfortable reserves have underpinned favorable economic conditions.

Strengthening public financial management. The legal framework for improving budget credibility and execution, and a TSA to boost cash controls were set up. Payment and payroll systems were upgraded. Domestic arrears are declining.

Enhancing tax revenue. The authorities eliminated many tax exemptions, and efforts are ongoing to modernize tax administration. Additional action is needed to raise tax collection.

Refining the inflation targeting framework. With the use of better forecasting techniques, monetary policy formulation has improved. The government has recapitalized the BoU with marketable securities reinforcing its instrument independence. Further operational and institutional reforms are being considered.

Improving the business environment to better prepare the economy for oil production. Public sector operations are more transparent. Clearer tax and licensing rules bring favorable oil production prospects. Shortcomings in doing business and governance indicators remain.

Strengthening implementation capacity. Capacity constraints still limit execution of public investment projects, and delays are frequent. Guidelines to improve investment decisions are being prepared.

Deepening the financial sector and making it more inclusive. The system is sound and dominated by banks. Private sector credit has recovered, but a structurally low deposit base is insufficient to contribute to development financing.

Recent Developments

5. In the context of moderate growth and exchange rate depreciation, inflation is coming up from depressed levels:

  • According to rebased estimates (Box 2), realGDPgrowth was 4½ percent in FY2013/14, driven by services, trade, construction, and manufacturing—below the estimated potential of about 6 percent.2 More recently, economic activity is picking up, led by public investment and a recovery in private consumption driven by higher real incomes and stronger credit growth.

  • The nominalexchangerate against the US dollar appreciated by 7 percent in the year through February 2014, and since then depreciated by 20-25 percent. Sharp pressures were felt in early 2015 reflecting 1) a portfolio rebalancing in response to the dollar appreciation; 2) increased foreign exchange demand from corporations to repatriate their profits; 3) lower exports to and remittances from South Sudan; 4) some decline in FDI linked to oil investment plan deferrals; and 5) election-related market nervousness as memories of the 2011 elections—when rapid credit expansion and expenditure overruns drove inflation out of control—reverberated. The real effective exchange rate appreciated by about 4 percent in 2014, mainly reflecting the weakening of Uganda’s main trading partners’ currencies, and it is close to the level implied by the estimated current account norm (Annex I).

  • Inflation has been contained in the context of declining food crops and oil prices, the 2013 shilling appreciation, and moderate economic activity. Nonetheless, the recent exchange rate depreciation has started to pass through to core inflation despite the mitigating impact of declining fuel prices (Box 3). Annual core inflation fell to 2.7 percent in December 2014 and rebounded to 4.8 percent in May 2015.

Effects of Rebasing Gross Domestic Product

The rebasing exercise. In November 2014, the Uganda Bureau of Statistics rebased the GDP series from calendar year 2002 to FY2009/10 to better reflect the dynamism of economic activity and improve the quality of statistics. The new estimates incorporate more comprehensive survey data; compile production by industry supply and use tables; and introduce methodological changes to improve accuracy and coverage (e.g. compilation of intermediate consumption, and inclusion of the informal sector and nonprofit institutions in the national accounts). GDP was revised upwards by 17¼ percent in FY2009/10, the base year. The services sector and to a lesser extent the agricultural sector increased their share in GDP, while the share of industry and construction declined.

Implications for economic analysis. Some indicators experienced significant change, including the debt-to-GDP ratio, almost 4 percentage points lower, at 29 percent in FY2013/14; and the tax-to GDP ratio, about 1 percentage point lower, at 11½ percent. There are also implications for policy analysis. The impact of the credit boom-and-bust cycle that started in 2011, for example, looks now more pronounced, with GDP growing by almost 10 percent in FY2010/11 (6½ percent estimated earlier) and decelerating more significantly in the following years. The slower economic recovery looks now more consistent with the behavior of banks’ nonperforming loans (NPLs) and tax collections of the past two years.


Real GDP Growth


Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Source: Uganda Authorities

Impact of the Decline in International Oil Prices

In the short term. Lower oil prices represent a positive supply shock, resulting in foreign exchange savings and a slight growth stimulus. A one percent reduction in international oil prices is estimated to lead to a 0.2 percent decline in total nominal imports in US dollars, implying that the expected average price for the current fiscal year would lead to a 10 percent reduction in the total import bill. With pump prices fully liberalized, lower prices allow consumers to divert income to other purposes. In the absence of fuel subsidies, the fiscal impact is also positive, as the government saves in the energy bill and collects slightly higher excise taxes (which are based on quantities and not prices). In the first nine months of the fiscal year, revenue from petroleum duties increased by around 18 percent compared to the same period in the previous year. The decline in oil prices is also expected to feed into lower electricity prices.

Short-term benefits of the oil price decline have been less pronounced in Uganda than in other countries in the region.1 In the past nine months, petrol average pump prices have declined by 10 percent in domestic currency (21 percent in US dollar terms) on account of the shilling depreciation; the taxation modality; the oligopolistic nature of suppliers; and the lags between purchases and distribution.


Pass-through of Changes in International Fuel Prices

(June 2014 to January 2015)

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Country authorities; and IMF staff calculations.

In the medium term. The impact would likely be less benign. Oil investments might be delayed in the context of lower profitability. Moreover, many interrelated investment decisions are dependent on the oil price, including granting production licenses; signing commercial and financial arrangements; developing engineering, procurement and construction plans; and agreeing on transnational infrastructure works.


Monthly Variation of Petrol Prices (USD and Ush)1

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

1. Average in 8 locations.Source: Uganda Bureau of Statistics.

Imports of Petroleum Products

(in millions of US$)

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Source: Bank of Uganda (preliminary data the most recent)
1 According to standardized calculations for the whole sub-Saharan region, the pass-through from the oil price decline to pump prices in Uganda was about 14 percent, compared to a regional average of about 36 percent (IMF Sub-Saharan Africa Regional Economic Outlook, Spring 2015).

6. International reserves declined reflecting the spike in dollar demand for financial transactions in the context of depressed exports, but continue to be adequate. The current account deficit remained large owing to structurally high trade deficits. Imports of capital goods and petroleum products are increasing, while both coffee and non-coffee exports have stagnated since mid-2013 reflecting depressed food exports to South Sudan. Temporarily, strong travel receipts partially offset the impact of the large trade deficit. FDI, loans, and portfolio inflows have financed the deficit. However, since late 2014 total net financial inflows have slowed down.

7. Recent indicators show that the banking sector remains sound. Banks are well capitalized, liquid, and profitable. As of March-2015, the core capital-to-asset ratio averaged 20.8 percent, well above the minimum requirement of 8 percent. At over 29 percent, the statutory liquidity requirement (minimum 20 percent) was met. Consistent with the rebound in private sector activity, NPLs declined from the March 2014 peak of 6.2 percent to 4.2 percent of total loans in March 2015—getting closer to the 5-year historical average of 3.8 percent—boosting average profitability. Credit and liquidity risks related to loan quality and currency mismatches remained low.

8. Private sector credit recovered as lending rates declined and credit risks dissipated. The strong monetary tightening that followed the 2011 credit boom led to a sharp decline in credit and growth as lending rates picked up with a short lag. Once inflation stabilized, the significant drop in the central bank rate (CBR) in 2013 led to a similar fall in interbank rates (reflecting the functioning first stage in the interest rate transmission mechanism), although the decline in lending rates was more sluggish, revealing a longer lag in monetary transmission than in the tightening period, leading to a gradual credit recovery. The monetary policy transmission asymmetry is explained by the banks’ cautious focus on loan recovery and their high operating costs, coupled with some crowding out effects as government’s domestic borrowing requirements increased at that time. Now at 16 percent year on year, credit growth—mainly to manufacturing, trade and construction—is significantly higher than the 10 percent average of the previous two years, reflecting an improvement in the bank lending monetary transmission channel. However, lending rates remain relatively high.

Text Table 1.

Key Interest Rates


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Data from Mar-15 used when Apr-15 unavailable.

Source: Bank of Uganda

9. Despite significant banking sector growth, financial intermediation is limited and access to bank services low. The number of commercial banks has increased from 14 to 25 with a large influx of foreign banks, which currently hold 80 percent of assets. However, the system is small (total assets equal 27 percent of GDP) and highly concentrated, with the three largest banks holding 50 percent of assets. In a cash-based economy that suffers from a low savings rate, the deposit base (about 18 percent of GDP) is limited, and credit to the private sector stands at just 14 percent of GDP. Financial access is low with only 28 percent of adults owning a formal bank account.

10. Over the last year, economic policies had to respond to volatile foreign exchange flows, declining commodity prices, and the complex geopolitical environment.

  • On monetary policy, the BoU kept a tight policy stance, holding the CBR constant at 11 percent from June 2014 to April 2015, and then raising it to 12 percent, on account of global developments and the ongoing and expected exchange rate pass-through. The BoU’s intervention in the foreign exchange market has been focused on its program of announced dollar purchases for reserve build-up, but in the last few months it has been intervening on the sale side to smooth the fast-paced shilling depreciation. This intervention, along with increased infrastructure-related government imports, drove reserves down from $3.2 billion in end-December to $2.9 billion in mid-May (about 4 months of imports).

  • Regarding the financial sector, to shield banks’ balance sheets from the impact of ongoing shocks and mitigate short-term liquidity risks, the BoU further integrated risk-based analysis into its supervision work; introduced a liquidity coverage ratio to ensure that banks hold sufficient high quality liquid assets to cover 100 percent of net cash flows over a 30-day period (well above international standards); and advanced efforts to improve regulation of mobile money payments and financial literacy.

  • On fiscal policy, in FY2014/15 the authorities embarked on an ambitious revenue enhancing program that yielded tax revenue beyond expectations, and kept expenditures below the budget level due to delays in external disbursements for HPPs. A supplementary budget, needed to reallocate resources, did not add expenses to the budget, but together with the delays in HPPs, tilted it towards current spending.

Text Table 2.

Uganda: Fiscal Operations of the Central Government, FY2012/13–2015/16

(Percent of GDP1)

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Sources: Ugandan authorities and IMF staff estimates and projections.

All figures are based on the rebased GDP, except the 3rd review “old GDP” column.

Other spending includes contingency reserve and repayment of domestic arrears.

The authorities follow this definition to better assess the impact of the fiscal stance on domestic demand.

Figure 1.
Figure 1.

Uganda: Recent Economic Developments

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Bank of Uganda, World Bank, and IMF staff calculations.

Economic Outlook and Risks

11. The outlook is broadly favorable underpinned by consistent macro-financial policies. Real GDP growth is projected at 5¼ percent in FY2014/15, 5¾ percent in FY2015/16, and an average 6¼ percent over the medium term, driven by scaled-up public investment and a rebound in private sector demand. Public investment financing, alongside weaker exports and tourism receipts, will drive the current account deficit up while preserving reserves at 4 months of imports. The rebound in private activity will be supported by an expected expansion in credit to the private sector of about 10 percent per year in real terms—gradually boosting the credit-to-GDP ratio to about 17 percent by FY2019/20. This pace—expected to prevent a reoccurrence of credit boom-and-bust cycles and preserve economic stability—is consistent with real GDP, consumption, and investment growth estimates, as judged by observed trends in other low-income countries.3 Low consumer prices—with average core inflation projected to remain within the PSI consultation inner band at 3½ and 6¼ percent for end FY2014/15 and FY2015/16—will underpin the encouraging outlook.


Distribution of Macroeconomic Outcomes


Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Source: IMF Staff Calculations
Text Table 3.

Macroeconomic Outlook

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The authorities follow this definition to better assess the impact of the fiscal stance on domestic demand.

Sources: Ministry of Finance, Planning and Economic Development of Uganda, Bank of Uganda, and IMF staff calculations.

12. Risks to the outlook reflect economic and political vulnerabilities. Uganda has ample buffers and a flexible policy framework to respond to potential shocks—including low inflation, healthy international reserves, low levels of debt, a resilient financial system, a flexible exchange rate, and an improved PFM system. Nonetheless, the economy is vulnerable and risks are tilted to the downside. In the short run, expenditure overruns could materialize in the pre-electoral environment, potentially leading to a hike in inflation or to tight domestic credit conditions that could crowd out the private sector, affect banks’ balance sheets, and hamper growth. Slower growth in key trading partners and further spillovers from lower global liquidity could trigger capital outflows, squeezing liquidity and generating currency mismatches for banks and corporations. In the medium term, the complex commercial and legal aspects surrounding FDI in the oil sector could delay the planned investments. Other risks stem from postponements or cost overruns in the planned infrastructure projects. Security issues in the region pose additional challenges (Annexes II and III).

Supporting Medium-Term Growth

13. The authorities are committed to supporting sustainable growth and socioeconomic transformation. Key objectives of their medium-term development plan include enhancing sustainable production and productivity; strengthening public service delivery; improving education and health; and reducing the infrastructure deficit to strengthen competitiveness. The latter has been at the center of the authorities’ economic agenda as infrastructure investments of around $11 billion—including PPPs—are expected over the next ten years (Box 4). Discussions centered on policies to support the medium-term strategy, including by preserving the hard-won price and financial sector stability; increasing revenue collection; improving spending efficiency; enhancing financial intermediation and access to bank services; and ensuring a stable regulatory environment, in which contracts and medium-term commitments are fully honored and procurement rules are transparently observed.

14. Oil production will be an important component of the medium-term economic horizon. With recoverable crude oil reserves of 1.7 billion barrels out of potential reserves of 6.5 billion, oil production would start in FY2020/21 under a model that entails a crude export pipeline and a domestic refinery. While the government has identified a lead investor for the refinery, decisions on the pipeline’s route are still subject to economic and geopolitical considerations. Significant steps have been taken to speed-up investments in the sector including (i) granting one of the production licenses; (ii) announcing a bidding process for operations in six new blocks; (iii) starting to set up the institutions that will govern oil operations; and (iv) proposing parliament to remove the value-added tax (VAT) on capital equipment used in exploration and production activities. Despite the oil price decline, companies remain optimistic about the medium-term prospects. While operations will be largely externally financed, their domestic content is expected to have positive spillovers on employment and domestic banks’ operations.

Developing Infrastructure

Overview. In line with the National Development Plan (NDP II), the government has embarked on an ambitious infrastructure investment program to revamp the transport network and alleviate bottlenecks emanating from electricity shortfalls. The program will be gradually implemented during the next 10 years; financed through NCB, PPPs, and use of government savings (the oil, energy, and infrastructure funds): and accompanied by capacity building in project preparation, appraisal, monitoring, and execution. Key projects include:

  • Electricity projects. A total of $4.6 billion is estimated. Besides the Karuma and Isimba dams and related substations—already under construction and financed by China’s Export Import Bank with government’s contributions—other plans include the construction of smaller HPPs and several transmission lines for rural electrification.

  • Oil and oil-related infrastructure. The plan includes the construction of the Hoima oil refinery and a product pipeline to Kampala to be run as a PPP, and the Albertine region airport and roads, with a total investment of $1.8 billion. The crude oil pipeline is not included in these estimates, as it is expected to be privately financed.

  • Transport infrastructure. Projects, worth $4.7 billion, include (i) the Kampala-Jinja highway and several other roads serving the Greater Kampala area under PPP arrangements; (ii) the upgraded Entebbe International Airport, financed by China’s Export Import Bank; and (iii) the initial phase of the standard gauge railway from Kampala to the Kenyan border.

Economic Impact.

  • A multiplier analysis points to a positive impact on growth during construction—about 1½ percent over the next five years—and an increase in potential output once projects come on stream.

  • The projects are expected to have an import component of about 80 percent, thus limiting their impact on aggregate demand and inflation.

  • Private sector credit growth will not be compromised because current spending and domestic borrowing will remain constrained, providing space for credit expansion.

  • Capital spending is set to pick up by an average 4¼ percent of GDP during the period.

  • Imports are expected to rise by about 3½ percent of GDP per year, leading to an equal expansion of the current account deficit over the period.

  • The impact on reserves is determined by the domestic component of the financing, which amounts to $515 million over the construction period.

  • The total impact on external debt will be about 14 percent of GDP.

15. Progress towards East African Community (EAC) regional integration is gradually taking place and has the potential to further enhance trade and structural transformation. Uganda ratified the Monetary Union Protocol, and has been actively participating in work to establish EAC regional institutions and to create a fiscal surveillance process. The Ugandan authorities plan to achieve greater integration by continuing progress towards the reduction of non-tariff barriers; implementing common-market agreements; integrating payment systems; and harmonizing policies in the context of the medium-term convergence program. These improvements would allow Uganda to reap its comparative advantages and maximize efficiency of production, raising prospects for attracting investors.

16. Financing the medium-term development strategy requires domestic revenue mobilization and external borrowing.

  • Domestic revenue mobilization will entail gains in public and private savings.

    • On the public sector side, the government plans to use savings in the oil an energy funds to finance part of the infrastructure program. Bold action is needed, however, to raise tax revenue as this is the most sustainable and reliable source of development financing. Welcome steps are being taken by the Uganda Revenue Authority (URA) to improve enforcement and compliance, but a sustained increase in the ratio will require incorporating the large informal sector into the tax-paying portion of the economy and ensuring that large taxpayers comply with their obligations—no simple task. Although many statutory tax exemptions were removed, loopholes remain on the policy front. Taxpayer-specific exemptions still exist, and the government is under near constant pressure to provide tax breaks (Box 5). Continued diligence is required to resist these pressures and create a tax system that is efficient and fair for everyone.

    • On the private sector side, deepening the financial sector and improving bank access are essential for making private sector credit an engine for growth. Sustainable financial deepening will largely rely on making steady progress on financial inclusion, which will in turn depend on actions to boost the bank deposit base; enhance the intermediation role of non-bank financial institutions, including the National Social Security Fund (NSSF); and develop the money and capital markets. To this end, there is scope for simplifying procedures to open bank accounts, locating outlets in remote areas, upgrading trading and settlement systems, improving investors’ literacy, and leveraging regional opportunities for the local stock exchange. The current massive use of mobile money is a clear demonstration of the population’s demand to move away from cash transactions (Annex IV). FDI flows will add to domestic credit within this financing strategy.

  • External borrowing will complement the financing needs. With insufficient domestic savings and ample space for borrowing, external financing is a key requirement. The authorities remain committed to pursuing concessional loans as the preferred means of financing, when available. For infrastructure projects, however, they have started to secure NCB, still on favorable terms, within levels that would allow total debt to remain at low risk of distress. Staff’s debt sustainability analysis, which includes the infrastructure package as a whole, concludes that the public and publicly guaranteed external debt-to-GDP ratio in net present value (NPV) terms would peak at about 25 percent in FY2020/21. Even combined with domestic borrowing plans, total public debt would remain well below the benchmark associated with heightened vulnerabilities. Nonetheless, the relatively short average maturity of domestic debt and the high debt service-to-revenue ratio are matters of concern (Debt Sustainability Analysis).

Enhancing Tax Revenue

Weak tax performance. The tax-to-GDP ratio in Uganda was one of the lowest in the region prior to the GDP rebasing and is definitely the lowest afterward. Over the past ten years the ratio only increased by 0.2 percentage points per year, on average. This weak performance was due to a combination of ineffective tax policy and poor compliance. On the policy front, the Income and VAT Acts contained many exemptions. On the administrative side, a VAT gap analysis showed that 60 percent of the gap was due to compliance, partly related to deficiencies in data integrity and operational weaknesses in tax administration.


Tax Revenue to GDP Ratios

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Source: IMF staff calculations.

Successful concerted efforts. Many statutory VAT and income tax exemptions were eliminated in FY2014/15, and improvements in coordination between the URA and local governments have paid off. As a result, the tax-to-GDP ratio is projected to increase substantially. An additional increase is expected next year as focus begins to shift from tax policy changes to tax administration improvements. Planned improvements include URA’s efforts to assess income from rental properties and identify businesses that are accessing local services but not filing national tax returns. Use of enhanced controls and creation of a single central processing center for all customs clearances should boost customs revenue.

Changing the tax-paying culture. As part of the EAC convergence criteria, Uganda has targeted a tax-to-GDP ratio of 25 percent by 2021. Although some of the increase is expected to come from oil revenues, an effort far beyond what has been achieved in the last ten years is needed. While URA’s audit and enforcement efforts—an expensive way to collect taxes—will bear fruit, sustained improvement in tax collections will only be possible if the citizens of Uganda pay tax voluntarily. For this to happen, they need to be convinced that their tax payments are being put to good use and that corruption is being eliminated.

17. Strengthening social protection is another key ingredient for accomplishing the medium-term development agenda. Although progress on poverty reduction has been significant, inequality remains high, suggesting that investments in infrastructure and service delivery are not sufficient for attaining inclusive growth. While there is evidence that fiscal policy has played a key role in boosting growth and addressing inequality, there is a clear need for enhancing the social support system (Box 6 and Annex V).

Strengthening Social Protection

Poverty and vulnerability. Uganda has made impressive progress on poverty reduction over the past two decades, with poverty declining from 56 percent in the early 1990s to 19.7 percent in 2013, allowing for early achievement of the Millennium Development Goal (MDG) of halving poverty by 2015. However, vulnerability remains widespread, rural and urban inequality has increased, and still about 7 million Ugandans live below the poverty line. While accelerating growth and upgrading infrastructure will contribute to further reductions of poverty and vulnerability, the most vulnerable segments of the population are not likely to fully share the benefits. Furthermore, the traditional social protection system (family support and other community self-help initiatives) has weakened in the last few decades.

Benefits of well-targeted protection. Experience in other countries in the world and the region show that the establishment of a comprehensive, well-targeted, and well-defined social protection system can improve productivity through health and education enhancements; function as a shock-absorber to various forms of economic instability; benefit the wider local economy; and contribute to achieving inclusive growth, creating employment, and building community assets. Social protection systems do not have to be costly. Average spending in safety nets in low income countries in Africa is 1.1 percent of GDP, and 2.8 when considering social protection in a broader sense1. Donors finance almost 75 percent of social safety nets in low income Africa.

Revamping social protection in Uganda. Social protection in Uganda is entrenched in the Constitution, Vision 2040 and the NDP II. Interventions have nonetheless been limited and fragmented—with only 0.4 percent of GDP a year devoted to direct income support and 1.2 percent of GDP to total social protection—and donors played an important role. A new policy framework is being developed to scale up interventions, covering the areas of direct income support, contributory social assistance, and social care services.

1 Monchuk, Victoria (2013). “Reducing Poverty and Investing in People: The New Role of Safety Nets in Africa”. Directions in Development. Washington, DC, World Bank.

Maintaining Fiscal Restraint While Raising Public Investment

18. In the last few years, the fiscal deficit has widened and has been largely domestically financed. The overall deficit increased by 2 percent of GDP between FY2011/12 and FY2014/15. While grants declined by ¾ percentage points, tax and non-tax revenue picked up by 1¾ percentage points, and total spending by 3 percentage points (with significantly larger increases in capital than current outlays). Given the substantial decline in concessionally financed external loans, the deficit was financed almost exclusively from domestic sources, mainly through issuances of securities in the market and use of government savings. This illustrates the falling importance of external support in deficit financing. Only 12 percent of total expenditure and net lending is expected to be financed by loans and grants this year, compared to 45-50 percent a decade earlier.

19. Over the medium term, the deficit is set to expand further, with spending tilted more towards capital outlays, and the bulk of financing coming from external sources. The overall deficit is projected to increase by an additional 2½ percentage points by FY2017/18 fueled by a continued expansion in capital spending (3¾ percentage points) and a small increase in current spending (¼ percentage point), and curtailed by a further improvement in revenues of at least ½ percent of GDP each year. Financing of the deficit is expected to pivot away from domestic sources towards external borrowing on non-concessional but favorable terms. Staff welcomed the changing deficit structure and financing, which will result in a higher fiscal multiplier, and will create space for private sector credit growth.

20. For FY2014/15, buoyant revenues, savings from the elimination of ghost workers, and delays in HPP implementation should keep the overall deficit well below the budget limit. The strong revenue measures, alongside tax administration enhancements, are likely to result in a 1 percent increase in the tax-to-GDP ratio (½ percent in the program), a significantly better than expected outcome. At the same time, spending on HPPs was almost 2 percent of GDP lower than originally anticipated, as delays in negotiating loan repayment mechanisms slowed progress. Against this backdrop, the supplementary budget used part of the windfall revenue and expenditure savings to cover operational shortfalls at several ministries, and Electoral Commission outlays, among other pressing needs. All in all, the overall fiscal deficit is now projected to reach 4½ percent of GDP (6¾ percent in the program) and issuances of securities in the domestic market should remain within the target4. While supporting efforts to keep domestic financing contained, staff expressed concern about investment delays, which can be costly, and about reallocating spending away from development expenditure. The authorities indicated that more time was needed to get assurances on the commercial viability of the projects, and committed to preserving spending in social sectors in the future.


Fiscal Revenue and Expenditure

(percent of GDP)

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Source: Bank of Uganda and IMF Staff Calculations

21. The FY2015/16 budget will increase the overall fiscal deficit to 7 percent of GDP, largely financed by NCB on favorable terms. The budget was approved on May 30 in line with the provisions of the PFM Act that call for approval before the fiscal year starts. The deficit expansion is explained by the boost in public investment, mainly for infrastructure financed by NCB with a grant element of about 11½ percent, and an increase in interest payments, partially offset by additional tax revenue gains. The revenue-to-GDP ratio is set to rise by 0.6 percentage points through policy measures and efficiency gains, including an increase in excise taxes (0.2 percent); an expansion in the scope of withholding taxes (0.1 percent); the imposition of the VAT on discounted taxable supply of services at fair market value (0.1 percent); an increase in fees and stamp duties (0.1 percent), and improved use of compliance data and better collaboration among ministries and the private sector (0.1 percent).

Figure 2.
Figure 2.

Uganda: Fiscal Developments and Outlook

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Bank of Uganda and IMF staff calculations.

22. Staff urged the authorities to resist current spending pressures and implement infrastructure investment efficiently. The FY2015/16 budget is consistent with program objectives, but its successful implementation would require strong efforts to keep current expenditures within the budgeted amounts and proceed without further delays with the infrastructure plan. The contingency provision was reduced by 0.2 percent of GDP at the time of budget approval to facilitate one-off spending on police activities linked to the election and allowances to parliamentarians, leaving little budget flexibility and requiring prudent execution in the year ahead. The authorities agreed that the projected deficit expansion will be contingent on the materialization of the planned infrastructure projects, and committed to refrain from substituting them by other types of spending in case of delays. On the infrastructure program, staff reiterated the need to properly sequence projects while ensuring that they are selected on the basis of commercial viability and with awareness of implementation constraints. The authorities agreed and are developing new public investment management guidelines and procedures for this purpose.

Protecting the Inflation Objective

23. The inflation targeting framework has been successful, although a few challenges need to be addressed to ensure its long-term efficiency. Underpinned by a strong commitment to the inflation target, clear arrangements for monetary policy formulation, revamped policy instruments, and continuous learning from past experiences, the framework has been effective in keeping inflation low. The monetary transmission has worked well in spite of the shallowness of financial markets. Nonetheless, some challenges remain, including insufficient institutional arrangements to prevent government’s use of deposits in BoU accounts beyond agreed levels, and shortcomings in inflation forecasting capabilities and fiscal-monetary policy coordination (Annex VI). The authorities have committed to taking action to address these shortcomings, including by agreeing on a floor below which the balances in the Uganda Consolidated Fund—the main government’s account—would not decline, and upgrading the BoU’s technical capacity. Both will result in improved decision making.

24. Recent inflation volatility has complicated monetary policy decisions. Inflation and inflation expectations have fluctuated over the last 18 months in response to sharp variations in the shilling (a fast depreciation following a significant appreciation); the food price evolution (not only seasonal but also related to weather conditions), and fiscal uncertainties. This volatility generated an understandable monetary tightening bias. Staff conducted consultations with the BoU on the factors behind the fall of average core inflation (3.1 percent in December 2014) below the inner band of the inflation consultation clause (3.7 percent). The authorities explained that prospects for loosening the stance in the first half of 2014 were constrained by (i) the start of a shilling depreciation trend that threatened to persist in the context of weakening trade; (ii) an expected increase of food prices; and (iii) unclear fiscal prospects amid mounting spending promises by politicians.


Core Inflation Forecast

(annual average percent change)*

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

* This is calculated as the 12-month average of the y-o-y percent change of Core CPISources: Bank of Uganda and IMF Staff Calculations

25. The depreciation risk materialized, at higher-than-anticipated rates, driving the BoU’s decision to tighten the stance by 100 basis points in April. Given the high share of imported goods in the CPI, import prices play a key role in inflation behavior, with an estimated pass-through factor of 0.4-0.5. In view of this and of the narrowing output gap, the authorities’ decision to tighten the stance was appropriate. Staff inquired whether some monetary easing last year could have possibly helped reduce inflation volatility and limit the interest rate hike given the monetary transmission lags. The authorities indicated their preference not to allow for swings in the policy stance, as frequent changes could jeopardize signaling and confuse the markets. Going forward, the BoU intends to continue to adapt monetary policy to evolving conditions to ensure that core inflation remains within the target range.

26. The BoU has managed the tradeoffs between interest rates and exchange rate behavior well, but has faced difficulties in times of market turbulence. Since the adoption of inflation targeting, the BoU has let the shilling find its market price while preserving international reserves. Foreign exchange interventions have been limited to smoothing excessive variations that would generate unfounded nervousness or threaten the inflation objective, and have been sterilized. In mid-March, however, the BoU intervened strongly on the sale side (gross sales amounted to $375 million in the first quarter of 2015 compared to around $10 million in 2013 and $140 million in 2014). In doing so, the BoU was successful in calming the markets, but to stop speculation, it intentionally allowed a liquidity shortage for a few days (by incomplete sterilization), temporarily pushing the 7-day interbank rate above the upper 3 percent band around the CBR, and forcing banks to borrow needed liquidity (through the Lombard facility) at high rates. Staff recommended dealing with speculation by building policy credibility rather than by allowing discrepancies between the CBR and the 7-day interbank rate. Fully sterilizing all market interventions will provide clear monetary policy signals, while ensuring that price stability remains the BoU’s primary objective.

27. The authorities’ program of foreign exchange reserve build up will continue albeit with a different modality. Relatively high FDI and portfolio inflows, partly related to the presence of foreign-owned businesses in Uganda’s banking, telecommunications and retail sectors, allow for continued reserve accumulation in preparation for the expected rise in government’s import needs. Until April, the BoU carried out a program of pre-announced BoU purchases through daily auctions, which was only interrupted during days when the BoU intervened on the sale side. More recently the BoU reached agreement with seven banks to buy a fixed daily amount from each of them. Staff expressed preference for market-based competitive foreign exchange auctions to allow for clarity of objectives, promote market deepening, and prevent market distortions. The authorities explained that the new system is well understood by all parties, introduces predictability, and is being used on a pilot basis to assess its effectiveness.

Figure 3.
Figure 3.

Uganda: Monetary Sector Developments and Outlook

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Bank of Uganda, Bloomberg and IMF staff calculations.

28. Several actions to improve monetary policy effectiveness are underway. The BoU has taken steps to reduce volatility in overnight market rates by allowing all banks (previously only primary dealers) to access BoU operations. It is also strengthening its inflation forecasting skills, institutionalizing procedures to improve the decision making process, and studying the possibility of rearranging the reserve requirement cycle to smooth liquidity conditions. The latter would enhance operational effectiveness, potentially reducing speculation exacerbated by insufficient BoU short-term liquidity management facilities.

Securing a More Effective Contribution of the Financial Sector to Growth

29. The banking sector is broadly resilient to key adverse shocks. Stress tests regularly conducted by the BoU and those carried out with staff—including one to assess resilience to a combination of shocks—confirm the banking sector’s relative strength. Specifically, the system can tolerate shocks such as increased NPLs, deposit withdrawals, and a large shilling depreciation, suggesting that credit, liquidity, and foreign exchange risks are well contained (Box 7). The BoU does not stress test banks’ resilience to lending rate hikes because of insufficient data availability. Staff welcomed ongoing efforts to collect granular data on interest bearing assets and liabilities classified by maturity buckets, which would allow better measurement of the impact of interest rates changes on banks’ solvency.

30. Despite bank stability reassurances, there are some sources of vulnerability that call for caution. Staff acknowledged that existing prudential requirements and risk-based supervision provide assurances of banks’ strength to deal with shocks. Noting that stress test results usually mask diverse impacts on individual banks, the authorities agreed that further efforts to deter any negative impact of real sector developments on bank balance sheets—mainly due to potential interest rate and exchange rate volatility—are needed. Discussions covered the following issues:

  • High dollarization. 37 percent of deposits and 43 percent of loans are denominated in foreign currency. These shares have increased, possibly reflecting depositors’ inclination to protect the real value of their funds and borrowers’ preference for lower financing costs. Regulations in place—banks’ required net open position in foreign currency is 25 percent of capital; foreign exchange loans are mainly granted to hedged borrowers; and an 80 percent loan-to-deposit ratio is in place for operations in foreign currency—mitigate risks associated with foreign currency operations. Staff acknowledged that liquidity risks from banks’ balance sheet mismatches seem to be contained, but called for guarding against credit risks associated with possible currency mismatches in borrowers’ balance sheets. To complement current assessments on the effects of shilling depreciation on banks’ net open positions and transaction costs, it would be advisable to revamp on-site inspections to examine more closely the quality of foreign currency loans.

  • Concentration and related-party risks. Given that the largest borrowers operate with all systemic banks, their default would seriously harm the system’s capital. There is a need to strengthen data verification and monitoring, and ensure strict compliance with the regulations to avoid the risks posed by credit concentration.

  • Provisioning of bad loans. Provisions as a share of NPLs stand at 55 percent, and the general provisioning ratio for watch loans—those that have been past due for 30 to 89 days—at 1 percent. While the loan write-off and collateral policies are strict, staff encouraged the authorities to consider an increase in the general provisioning ratio for watch loans as recommended in the 2011 FSAP update.

  • Cross-border transactions. The dominant presence of subsidiaries of foreign banks in the system involves transactions with nonresidents. While risks of cross-border flow reversals do not seem too high—a sudden withdrawal of nonresident funds would only affect 1.5 percent of bank liabilities—more detailed monitoring of offshore investor activities is warranted.

  • Consolidated supervision. Cooperation with foreign regulators through supervisory colleges with regional presence is gradually enhancing the quality of consolidated supervision. Nonetheless, further efforts are needed to exchange information, address financial group issues more systematically, and prevent regulatory arbitrage.

31. While financially sound, the banking system’s role in credit intermediation is weak, hampered by high operational costs, insufficient competition, and low policy credibility. The recent recovery in credit is welcome and its sectoral distribution does not raise credit risk. However, at about 11 percent, spreads between time deposit and lending rates in domestic currency are high by international standards. The low deposit base and elevated overhead costs (40 percent of income) hinder economies of scale gains in bank operations. Profits are high suggesting insufficient competition.5 Moreover, banks’ business models, with a large share of assets devoted to investments in Treasury bills, reflect cautious risk taking, as well as curtailed policy predictability given the large swings in interest rates, thus jeopardizing credit growth. Although there is some evidence that the lending channel is functioning well, improved bank efficiency and competition would result in better monetary policy transmission.


Decomposition of Bank Interest Rate Spreads


Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Source: Bank of Uganda

32. The BoU has made progress in implementing the FSAP update recommendations, but many are waiting for the approval of supporting legislation (Text Table 4). Reforms contained in the Financial Institutions Act (FIA), currently before parliament, (i) require banks to maintain a capital buffer in addition to the minimum capital requirements; (ii) allow for agent banking (licenses to carry out financial institutions business through an agent); and (iii) permit operations of Islamic banking (license to operate financial businesses under Islamic procedures).

Text Table 4.

Uganda: Implementation of 2011 FSAP Recommendations

(April 2015)

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Sources: Bank of Uganda and IMF staff.

Uganda: Banking Sector Stress Tests

Based on the Cihak model, the BoU regularly conducts stress tests (STs) to measure credit and liquidity risks on the banking sector and publishes the results annually. In its most recent STs exercise, the BoU assessed sensitivity to single-factor shocks on the basis of end-2014 bank-by-bank data. In addition, BoU and IMF staff carried up ad-hoc STs to assess foreign exchange risk and to test the system’s sensitivity to a combined set of shocks.

On credit risk, the BoU assesses the impact on the core-tier-1 capital adequacy ratio (CAR) of a deterioration in loan quality by applying:

  • A uniform shock to total performing loans: a “breaking point” approach is used to find the NPL ratio that would trigger a large bank to fail CAR compliance. The trigger is then applied to all other banks.

  • A uniform shock to sectoral performing loans: the same “breaking point” approach is used to find the NPL ratio that would trigger a large bank to stop complying with the CAR due to the portfolio deterioration of business sectors exceeding 25 percent of the total loan portfolio.

  • A proportional increase in NPLs to large borrowers (concentration risk): to measure the impact on the CAR of the default of three or the five largest borrowers of each bank.

Results suggest that the first large bank’s CAR would fall below the required level when 19.6 percent of its loans become nonperforming. A total of seven banks would get undercapitalized, with the system’s CAR falling from 19.7 percent to 12.6 percent. When the five largest borrowers of each bank default, the system’s capital would fall to 11.6 percent. In both cases, the CAR would remain above the threshold.

On liquidity risk, BoU’s simulations to measure the impact on the liquidity ratio include:

  • A bank run with daily deposit withdrawals of 6 percent of total deposits for five consecutive days.

  • A sudden withdrawal of all deposits of the NSSF, a big player in the market.

  • A sudden withdrawal of all funds held by offshore clients.

Results suggest that the liquidity ratio would decline from 43 percent to 26, 41, and 37 percent, respectively, as a result of each of the above shocks. Therefore, the system as a whole would continue to meet the threshold of 20 percent even though for a few banks, the ratio would fall below the floor.

On foreign exchange (FX) risk, BoU and IMF staff analyzed the impact on the net open foreign exchange position from:

  • A depreciation of the shilling against US dollar by up to 50 percent.

Results show that both the net open position in foreign currency and the system’s CAR would remain within the required thresholds after the shock.

On combined credit, liquidity, and FX risks, BoU and IMF staff measured the impact on solvency and liquidity of:

  • The NPL ratio rising to 19.6 percent (consistent with the trigger to assess credit risk) combined with 50 percent depreciation, and 3-day successive withdrawals of 6 percent of deposits.

Results show that banks’ capital is vulnerable to multiple risks. The system’s core CAR would fall to 11.9 percent with seven undercapitalized banks presenting a capital shortfall equivalent to 1.8 percent of GDP. Further, the system’s liquid asset ratio would fall to 18.2 percent (below the regulatory requirement of 20 percent), and five banks would suffer liquidity shortages.

Figure 4.
Figure 4.

Uganda: Financial Sector Developments and Outlook

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Bank of Uganda, World Bank, and IMF staff calculations.

Building Institutions and Improving the Business Environment

33. Progress on PFM reforms has been strong and is set to continue. The reduction of the stock of domestic arrears to a projected ½ percent of GDP by the end of the current fiscal year—about a third of the June 2013 level—is welcome. The new PFM Act incorporates good budget practices; prepares the economy for oil revenue management; and institutionalizes the preparation of a fiscal risks statement and the CFR (Box 8). Staff urged progress on issuing the PFM Act regulations and eliminating cash movements within the TSA sub-account structure.

Enacting the Charter of Fiscal Responsibility

The authorities are working on the enactment of the CFR, which in line with the PFM Act needs to be published at the start of each new parliamentary cycle. The CFR has the following main features:

Core fiscal targets. These targets are based on the EAC convergence criteria, and consist of an overall deficit target of 3 percent of GDP by FY2020/21 and an annual debt ceiling of 50 percent of GDP in NPV terms. The targets enjoy political support; are clear and simple; are achievable under the current medium-term framework; and provide ample scope for avoiding pro-cyclicality. Pursuing a gradual and sustainable convergence path will be important to avoid the need for unrealistic adjustments to meet the targets.

Interim targets. To counterbalance the need for flexibility with the risk of unsustainable deficit and debt paths, potential interim targets will be introduced, including on the tax-to-GDP ratio and net domestic financing.

Deviations from fiscal objectives. Although the PFM Act specifies circumstances under which the government can deviate from fiscal objectives, the CFR will establish strict and transparent procedures for when these ‘escape clauses’ can be used and how objectives will be reestablished afterwards.

Management of oil revenues. Fiscal objectives should govern outflows from the oil fund and their use. This would require building capacity in oil revenue forecasting and public investment management.

Fiscal reporting requirements. To strengthen the budget process, the CFR will provide definitions and data sources for key fiscal objectives and establish robust and transparent forecasting practices including the provision of a fiscal risk statement.

34. The completion and approval of several pieces of legislation will be crucial in moving reforms forward. The submission to parliament of the planned amendments to the BoU Act to improve central bank governance and independence has been delayed, but the authorities are confident they will be able to do so immediately after the election. Similarly, the FIA and the Microfinance Development Institutions (MDI) Act, which allow for important improvements in supervision of financial institutions and create the legal framework for development of non-banks, have been before parliament for a long period. Staff encouraged their prompt approval.

35. Staff called for strengthened communications between the Ministry of Finance, Planning and Economic Development (MoFPED) and the BoU and with market players. Aware that policies have been misunderstood by economic agents and opinion makers, MoFPED authorities agreed to overhaul their communication strategy to better influence economic expectations, and prevent market confusion or misperceptions. They also agreed to coordinate policies more closely with the BoU, so that messages from the fiscal authorities and central bank policy statements are better aligned. While credibility will be strengthened by continuous sound policy implementation, better communication would facilitate closer alignment of banks’ and households’ behavior with the economic incentives.

36. The authorities need to take further steps to address Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) shortcomings. The Financial Action Task Force has included Uganda in its list of jurisdictions with serious deficiencies in the AML/CFT framework and placed the country under its review process. The authorities have designed an action plan to address deficiencies, but its implementation has been slow, posing risks to Uganda’s business climate. The Board of Directors of the Financial Intelligence Unit has been constituted, which will allow its functioning, and procedures to secure approval of the Anti-Terrorism Act (ATA) are being advanced. Further actions to be taken include (i) compelling financial institutions to file suspicious transaction reports (a stipulation to this end is included in the FIA); (ii) properly criminalizing terrorist financing (a provision for this included in the ATA before parliament); and (iii) enforcing adequate and effective AML/CFT supervisory and oversight program for all financial sector institutions.

37. Further upgrades of statistics compilation and dissemination remain a critical objective. On the real sector, staff discussed planned efforts to improve the quality and coverage of surveys—including compiling GDP from the expenditure side and on a quarterly basis. In the fiscal area, staff emphasized the importance of overcoming the coordination difficulties that prevent the straightforward collection and dissemination of arrears data.

Staff Appraisal

38. Supported by comfortable buffers and a sound policy mix, Uganda’s economic performance over the last two years has been favorable. Real GDP growth has gradually rebounded from a low of 3.3 percent in FY2012/13 slowly narrowing the output gap. The BoU has reigned in inflation while keeping a comfortable international reserve level, preserving financial sector stability, and encouraging credit recovery. Nonetheless, the external current account deficit has widened reflecting stubbornly high negative trade positions. Fiscal policy has stimulated growth with an emphasis on public investment, unprecedented action to boost tax collections, and maintenance of debt at low risk of distress. Monetary policy formulation and implementation have noticeably matured with improved forecasting techniques, revamped policy instruments, and more professional policy signaling.

39. Program performance has been positive. Key program objectives have been accomplished, notably by maintaining inflation within the outer bands of the consultation mechanism; eliminating many tax exemptions and improving tax administration; prudently managing domestic debt issuances; and reducing domestic arrears. Progress in PFM has been impressive and is already bearing fruit. The upgrade in payments and payroll systems and the TSA set-up are generating savings through the elimination of ghost workers and pensioners and better cash controls. The authorities are to be commended for these achievements.

40. Maintaining fiscal discipline in the pre-electoral period will be essential. The expected growth recovery is critically contingent on the maintenance of price stability, which is being threatened not only by the decline in the shilling and possible increases in food prices, but by unanchored expectations related to perceived election-related spending. Reassuring the markets soon—through an overhauled communication strategy—that fiscal policy decisions will be strictly aligned to the budget is essential to influencing banks’, corporations’, and households’ behavior. Even more critical, however, is that policy implementation adheres to the budget to build a track record of fiscal discipline during pre-electoral periods and preserve the economic objectives. The authorities are therefore urged to keep the overall deficit and domestic financing within the planned limits, find savings to replenish the upfront appropriation of the contingency provision, and refrain from reallocating expenses to less productive activities.

41. Monetary policy needs to remain vigilant of evolving conditions. Against the backdrop of the dollar appreciation, depressed exports and remittances, and impaired policy credibility, the BoU was effective in calming the markets and preserving low inflation by tightening policies and stepping up interventions. Nonetheless, the associated decline in international reserves to deal with this temporary shock was sizeable. A build up of this critical buffer is ongoing, and should help address the projected government import needs. Preserving low and stable inflation will require a monetary policy stance that continues to carefully calibrate trade-offs between interest rates and exchange rates, and allows the shilling to reflect market conditions. The inflation targeting framework, which has been successful to date, should support these efforts. The approval of the amendments to the BoU Act; and additional operational and institutional improvements to upgrade the inflation forecasting quality, enhance policy coordination with the government and fully insulate the BoU against fiscal dominance, and further improve the monetary transmission mechanism are critical actions to improve the inflation targeting framework.

42. The banking system’s stability needs to be maintained, while increasing its contribution to growth. The credit-to-GDP ratio needs to increase over the medium term by improved bank efficiency and higher access of the population to bank services. An expanded deposit base along with lower operational costs, and enhanced policy credibility will be necessary to achieve the needed contraction in bank spreads and lending rates, and foster financial deepening. Bank regulation and supervision have been effective, and would be further enhanced by the prompt approval of the FIA and MDI Act. To deal with ongoing vulnerabilities while preserving bank soundness, the BoU is encouraged to further strengthen its risk assessment of foreign currency lending and credit concentration, and revamp its loan provisioning policy. Interest rates and exchange rates are subject to volatility in Uganda—as in any small and open economy with large current account deficits and a focus on targeting inflation—and their impact on banks’ balance sheets should be continuously assessed.

43. Sustaining recent gains in domestic revenue mobilization and PFM reform and securing efficient infrastructure spending will be critical priorities. Despite an increase of 1½ percent of GDP in the past two years, the tax-to-GDP ratio remains low by international and regional standards. Its further improvement critically depends on securing the political will for removing the remaining discretionary tax exemptions, ensuring taxpayer compliance, and bolstering government efforts to enforce obligations. PFM reforms need to be complemented by the enactment of regulations to implement the new law, improvements in cash management, enactment of a CFR, and continued reductions in the stock of arrears. The infrastructure investment program needs to be based on good project selection to ensure commercial viability, and efficient implementation to avoid overheating or cost overruns.

44. Supported by oil production, infrastructure upgrades, and regional integration, medium-term growth prospects are encouraging. The weak export performance in the context of structurally large external current account deficits is a matter of concern, and needs to be addressed by improvements in productivity and competitiveness. Future oil production, infrastructure upgrades, and regional integration will support these efforts, particularly if accompanied by stronger governance, improvements in conditions for doing business, addressing AML/CFT shortcomings, and a decisive fight against poverty and inequality. Financing of the development strategy comprises higher domestic revenue mobilization and prudent borrowing. A more targeted focus on employment creation and inclusiveness, including by strengthening social protection, would raise policy efficacy.

45. Staff recommends completing the fourth review under the PSI-supported program. The attached LoI and MEFP outline policies for the rest of FY2014/15 and propose alignment of program conditionality with the updated macroeconomic framework. In particular, the authorities propose reductions in the end-June 2015 ceiling on net domestic financing of the central government in line with the lower-than-projected deficit, and in the reserve accumulation target to take account of the impact of shocks, which staff support. The planned start of a few key infrastructure projects—including the Entebbe Airport rehabilitation, the purchase of road construction equipments, and other electricity and rural electrification projects—underpins the request to raise the NCB ceiling from $2.2 to $3.0 billion. Finally, the authorities also request incorporating a new overall deficit IT in preparation for the transition to the application of the new debt limits policy expected at the time of the fifth PSI review.

46. It is proposed that the next Article IV Consultation be held in accordance with Decision No. 14747, as amended.

Figure 5.
Figure 5.

Economic Indicators in EAC Countries

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Bank of Uganda and IMF staff calculations.
Figure 6.
Figure 6.

Financial Sector Indicators and Prudential Requirements in EAC Countries

Citation: IMF Staff Country Reports 2015, 175; 10.5089/9781513572413.002.A001

Sources: Bank of Uganda and IMF staff calculations.
Table 1.

Uganda: Selected Economic and Financial Indicators, FY2011/12–2019/201,2

(Annual percentage change, unless otherwise indicated)

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Sources: Ugandan authorities and IMF staff estimates and projections.

Fiscal year runs from July 1 to June 30.

All figures are based on the rebased GDP, except 3rd PSI review figures.

The CBR was introduced following the start of Inflation Targeting in July 2011. End of year CBR.

Capital expenditures include net lending and investment on hydropower projects.

The public external debt is different from the Public and Publicly Guaranteed Debt reflected in the DSA, which covers also publicly guaranteed debt.

Table 2a.

Uganda: Fiscal Operations of the Central Government, FY2011/12–2019/201,2

(Billions of Uganda shillings)

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Sources: Ugandan authorities and IMF staff estimates and projections.

Fiscal year runs from July 1 to June 30.

All figures are based on the rebased GDP, except 3rd PSI review figures.

Include mainly HIPC-related grants from FY 2013/14 onwards.

Expenditure categories in FY2013/14 include clearance of arrears totaling Shs. 544 billion, mainly in Government of Uganda investment and other current spending.

Reflects actual and projected issuances for the recapitalization of Bank of Uganda.

Net financing from the Bank of Uganda includes resources freed by MDRI relief.

Public domestic debt has been revised following methodological discussions, and new information, on intra-public sector transactions.