Abstract
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.
The Ugandan authorities continue to value the constructive policy dialogue with the Fund. They welcome the insightful and thorough analysis of the country’s macroeconomic policies carried out during the 2015 Article IV consultation and the fourth review of the Policy Support Instrument (PSI) and broadly agree with staff’s assessment.
The Ugandan economy has remained resilient. Sound macroeconomic policies have enabled strong growth and supported adequate buffers to protect the economy against potential shocks. The risks to the outlook arise mainly from geopolitical developments especially in the region, slower recovery in advanced economies and a larger than projected slowdown in emerging markets.
Program Performance
Performance under the PSI has been on track and all end-December 2014 quantitative assessment criteria (QAC) were met. However, there was a breach of the lower inner limit of the band of the inflation consultation clause and average core inflation reached 3.1 percent at end-December, against an inner band of 3.7 percent. The indicative target (IT) on tax revenue was met with a large margin. Although the target on the net change in stock of domestic arrears was missed by a small margin, the annual target is expected to be met, with a large reduction resulting from sustained efforts by the Government to reduce arrears in line with the debt strategy. There is significant progress on structural reforms and most end of March ITs were met. The second phase of the Treasury Single Account (TSA) was partially met in spite of delays due to extended discussions with development partners regarding the inclusion of their accounts.
In light of this performance and the continued commitment to the program, the authorities request the support of Executive Directors for completion of the fourth review under the PSI and the proposed alignment of the program conditionality with the updated macroeconomic framework.
Recent Economic Developments and Outlook
Uganda continues to register strong economic growth, driven by an increase in private sector activity in agriculture, industry and services as well as public infrastructure investment especially in energy and roads. The real GDP growth is projected at 5.3 percent for FY2014/15 and 5.8 percent for FY2015/16. Social services have also expanded significantly in education and health, in pursuit of government’s policy of universal access.
Inflation has remained subdued mainly due to low food and import prices. However, this trend has more recently reversed with inflation gradually rising to 4.9 percent in May 2015. Although the recent oil price decline lowered the import bill, this was partially offset by the exchange rate depreciation, in part due to global strengthening of the US dollar. The exchange rate pass-through and strengthening economic activity are expected to exert further upward pressure on consumer prices over the medium term. The annual core inflation is now projected to rise to 8 – 10 percent by the end of 2015/16, an increase of 1 percentage point compared to the April 2015 forecast. Consequently, the Bank of Uganda (BOU) increased the Central Bank Rate (CBR) by 1 percentage point to 13 percent on June 16, 2015, to ensure that medium term inflation converges towards its policy target of 5 percent. BOU will remain vigilant and take necessary monetary policy actions should the inflation outlook deteriorate.
The current account deficit is projected to widen from 8.5 percent of GDP in FY2014/15 to 10.3 percent of GDP in FY2015/16, due to lower remittances, subdued global commodity prices, lower aggregate demand in key export markets and rising import demand. However, a significant portion of imports is related to public infrastructure and private investment and will boost the long term productive capacity of the country. The current account has been comfortably financed thus far and international reserves continue to be adequate at about 4 months of imports. In addition, the development of Uganda’s oil sector remains positive. To date, there are three active exploration licenses and one production license. Bidding for six new blocks to attract new companies in the exploration phase is ongoing and expected to be concluded in December 2015. Once successful, this is expected to lead to continued strong foreign direct investment and other financial inflows.
Fiscal Policy
Uganda’s fiscal policy focuses on providing sustainable economic and social benefits to the society in the short, medium and long term. In this regard, the budget for FY2015/16 under the theme “Maintaining Infrastructure Investment and Promoting Excellence in Public Service Delivery” seeks to close existing infrastructure gaps, as well as promote socio-economic transformation while taking into account the prevailing macroeconomic conditions and future prospects.
For FY2015/16, the overall fiscal deficit is expected to increase to 7 percent of GDP compared to 4.5 percent for FY2014/15 mainly as a result of the boost in public investment in infrastructure. The infrastructure investment will enhance regional integration, develop Uganda’s oil sector, unlock private sector activity, and generate the much needed tax revenues to finance development. Over the medium term, the deficit will average about 6 percent before it drops to about 4.5 percent in FY2019/20, in line with the East African Community Monetary Union Protocol. The authorities continue to pursue concessional loans as the preferred means of meeting the external financing requirements. Non-concessional external borrowing will be considered only for the financing of highly productive fixed capital investments.
Continuing with the momentum witnessed during FY2014/15, successful implementation of the FY2015/16 budget is expected to yield an increase in the tax-to-GDP ratio of about 0.5 percent. To generate additional revenues, the authorities have proposed amendments to the Income Tax Act and VAT law, including simplification of the presumptive tax regime and specification of the amount of tax payable by small businesses. The government has also made amendments to clarify VAT applications in the oil, gas and mining industry to facilitate investments.
The authorities also intend to focus on increasing non-tax revenues while improving tax administration, compliance and enforcement. They plan to improve the capacity of the Uganda Revenue Authority particularly to combat the challenges associated with international taxation. In line with this, government has ratified various agreements covering double taxation avoidance, prevention of fiscal evasion and collaboration in tax administration with other entities in the region. Furthermore, given the large informal sector, efforts are underway to enhance awareness to bring about a change in the taxpaying culture.
Implementation of public financial management reforms will continue to enhance the efficiency of public expenditures. Following the approval of the PFM Act (2015) in November 2014 and its subsequent commencement in March 2015, the authorities have prepared the PFM regulations which will come into force in July 2015, incorporating recommendations from Fund Technical Assistance. A Charter of Fiscal Responsibility (CFR) which presents the government’s overall strategy on the formulation and implementation of fiscal policy consistent with sustainable fiscal balance and debt paths over the medium term is being finalized. It shall cover the period FY2016/17 to FY2020/21 and will be presented to Parliament for approval according to the timeline under the PFM Act.
Monetary and Financial Sector Policies
The authorities’ monetary policy focuses primarily on the inflation objective. They are committed to keeping monetary policy centered on achieving the medium term inflation target and will continue to carefully adapt monetary policy to changing domestic and external developments. Further, the BOU will continue to strengthen the current inflation targeting framework regime by improving its monetary policy formulation and capacity building.
The financial sector is well capitalized, reasonably liquid and profitable, however, there are vulnerabilities from credit sector concentration and currency mismatches. The BOU is committed to further strengthening its prudential oversight and ensuring adequate provisioning for non-performing loans. As they continue to make progress with the implementation of the FSAP update recommendations, the BOU is carrying out programs to enhance financial deepening and access to bank services by improving financial literacy and consumer protection.
Structural Reforms and Competitiveness
To improve the business climate, the Ugandan government has undertaken legal and regulatory reforms including in land administration, business registration and licensing. A national identification project is being rolled out to support efforts to strengthen revenue collection, promote unique identification of financial sector clients and combat money laundering and terrorism financing. The authorities are committed to addressing the recent Financial Action Task Force’s (FATF) concerns on the shortcomings in Uganda’s AML/CFT. To this end, significant steps have been taken including the passing of the Anti-Terrorism Amendment Bill, 2015 by Parliament on June 18, 2015 which seeks to amend the Anti-terrorism Act, 2002 to include proposals on terror financing. The authorities are also undertaking reforms in the financial sector, including pensions, to create efficient mechanisms to mobilize long term capital.
Progress towards the East African Community (EAC) integration is being made and the first annual Medium Term Convergence Program (MTCP) has been prepared. This outlines the medium-term macroeconomic and fiscal objectives, strategies and policies to ensure that the economy attains a high degree of monetary and economic convergence and compatibility with other EAC partner states and follows a stable and sound trajectory towards meeting the convergence criteria.
Conclusion
The authorities remain dedicated to maintaining economic stability and supporting sustainable and inclusive growth by generating employment and reducing poverty and will continue to strengthen controls and institutional governance. They have noted staff’s concerns on the risks stemming from the upcoming presidential and parliamentary elections in February 2016 and reiterate their commitment to maintaining election-related expenditures to levels contained in the budget.