Uganda: Staff Report for the 2017 Article IV Consultation and Eighth Review Under the Policy Support instrument
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International Monetary Fund. African Dept.
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Publication Date:
12 Jul 2017
eISBN:
9781484309322
Language:
English
Keywords:
ISCR; CR; core inflation; rate; report; headline inflation; exchange rate; monetary policy; money multiplier; development spending; Arrears
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2017 Article IV Consultation and Eighth Review Under the Policy Support Instrument-Press Release; Staff Report; and Statement by the Executive Director Uganda

Abstract

2017 Article IV Consultation and Eighth Review Under the Policy Support Instrument-Press Release; Staff Report; and Statement by the Executive Director Uganda

Context

1. Uganda has made remarkable achievements over the past decades. Growth averaged 8 percent per annum during 1992–2010, tripling per capita GDP and more than halving poverty to 35 percent (20 percent based on the national poverty line)—one of the strongest performances in sub-Saharan Africa over this period (see Annex 1).1 The performance was underwritten by sound macroeconomic policies and institutions and a reliance on the private sector as the engine of growth. In the early years, Uganda also benefited from a peace dividend and increasing labor force participation.

A01ufig1

Poverty and Inequality

(in percent)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

sources: Ugandan authorities and the World Bank.

2. The challenge going forward is to rebuild momentum for continued high and inclusive growth. Average growth slowed around 2010, reflecting negative productivity growth in agriculture and industry, as well as investment that is heavily concentrated in real estate.2 Notwithstanding the strong gains in poverty reduction, a third of the population is still below the poverty line, and some 40 percent of the population are vulnerable to falling below the poverty line (2013 data). Income inequality has declined over the last decade and is lower than in many peers in sub-Saharan Africa, but is still somewhat higher than in the 1990s.

3. The government’s focus is squarely on promoting growth. President Museveni has put his fifth and possibly final term in office—given a constitutional age limit—under the theme “Hakuna Mchezo” (“no jokes”). The main objectives of his administration include commencing oil production and achieving middle-income status by 2020. Government has scaled up infrastructure investment to address key bottlenecks in electricity and transport. The authorities, parliament, and civil society are concerned about problems in public investment management and the build-up of debt.

4. Uganda now hosts over one million refugees, with an integrative approach that is praised internationally as best practice. Arrivals over the last year are concentrated in northern Uganda where refugees make up more than half the population in some districts. The influx from conflict-torn South Sudan strains local service delivery systems and has raised inter-communal tensions. Emergency needs are estimated at about US$1.4 billion this year, but UNHCR has recently announced that there are significant shortfalls in assistance. By government estimates, Uganda has spent the equivalent of ½ percent of GDP on refugees in 2016. This includes the provision of land and access to local services (e.g., health, education). A solidarity conference in June aims to raise international assistance for the refugees.

5. The authorities welcome the Fund’s advice and the engagement through the Policy Support Instrument (PSI). The authorities have implemented key recommendations from the 2015 Article IV consultation (Box 1). The PSI has been instrumental in developing macroeconomic policies and moving the structural reform agenda forward, though implementation has suffered from delays.3 The Ugandan authorities also rely on the Fund’s technical assistance, and have achieved notable progress, e.g. in public financial management, inflation targeting, and designing a fiscal regime for natural resource taxation.

The Authorities’ Response to 2015 Article IV Recommendations

Fiscal policies. The authorities raised domestic revenue mobilization and strengthened PFM institutions while scaling up infrastructure investment, some slippages notwithstanding. They completed regulations to implement the Public Financial Management Act, the Charter of Fiscal Responsibility and advanced the introduction of the treasury single account. The authorities made progress with the reconciliation of domestic arrears, but new domestic arrears occurred.

Monetary policy. The BoU successfully kept core inflation within the target band, maintained a flexible exchange rate regime, and maintained reserves at appropriate levels. BoU recapitalization progressed as envisaged.

Financial sector. Financial inclusion improved largely via mobile money, but formal bank access remained low. The authorities passed the Amended Financial Institutions Act that allows for Agency Banking, bancassurance, and Islamic banking. Basel III capital standards are being implemented with delay.

2011 FSAP. Most FSAP recommendations have either been implemented or are still in train. However, a few key recommendations, pertaining to strengthening regulation and supervision are outstanding—such as the recommendation to amend regulatory requirements on classification and provisioning in respect of “watch loans (Annex 2).

Recent Developments

6. Growth slowed during the first half of FY16/17, reflecting domestic factors and external headwinds.4 The drought in the Horn of Africa is likely to have reduced growth by about ½ percentage point, mainly in the agricultural sector and food processing industry, exposing some 11 million Ugandans to food insecurity. In addition, subdued credit growth was a significant drag, and the slow execution of externally-financed public investment and the impact of spillovers from regional conflict also had a negative impact on growth. The initial estimate from the Ugandan Bureau of Statistics has growth at 1.6 percent in H1-FY16/17. Leading indicators suggest a pickup in economic activity in the second half of FY16/17, following a resumption of normal weather patterns. Projections assume that the fall armyworm infestation can be controlled, and renewed momentum in the growth of services. With this, the authorities and staff estimate growth of 3.9 percent for the year (about ½ percent in per-capita terms), down from 4.7 percent in FY15/16. This assumes that the initial H1 estimate will be revised up.

A01ufig2

Composite Index of Economic Activity

(index, leading indicator)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

sources: Bank of Uganda and IMF staff calcultions

7. Macro-financial linkages explain part of the growth slowdown. Non-performing loans (NPLs) have become elevated (6.3 percent at end-March), and banks have tightened lending standards in response. As a result, real private sector credit growth (adjusted for valuation effects) turned negative in late 2016, and is recovering only slowly. NPLs are concentrated in agriculture, construction, and trade and commerce. A BoU survey suggests that NPLs arose from government domestic arrears in FY15/16, diversion of borrowed funds and fraudulent activities, the effect of political instability in South Sudan, and the impact of the economic downturn and recent exchange rate and interest rate volatility.

8. Headline inflation has edged up, mainly reflecting the effects of the drought. Food price inflation rose from 5 percent year-on-year in September 2016 to 23.1 percent in May 2017. With this, headline inflation registered 7.2 percent year-on-year in May. Core inflation was 5.1 percent year-on-year in May, in line with the BoU’s 5 percent target.

9. The current account deficit narrowed. The deficit dropped to an estimated 2 percent of GDP in H1 FY16/17, driven mainly by lower investment-related imports. Financial inflows remained broadly stable. The overall balance of payments registered a surplus of 0.6 percent of GDP. The Ugandan shilling has stabilized against major currencies, while the real effective exchange rate depreciated by 2 percent since July 2016.

10. Implementation of the FY16/17 budget has been mixed. Revenue collection in nominal terms was slightly lower-than-projected through March, reflecting lower nominal growth than underlying the program. Policy and administration measures have performed well, yielding a near ½ percent of GDP increase in the revenue ratio. Recurrent expenditures were ¼ percent of GDP ahead of program projections at end-March—broadly corresponding to additional domestic arrears clearance—and the government had prepared two supplementary budgets to meet the additional needs, including for drought-related food relief.5 Domestically-financed development spending is on track, but there was significant under-execution of the foreign-financed development budget and construction of the two hydropower dams.6 Given the slow pace of public investment execution, the overall fiscal deficit for Q1-Q3 FY2016/17 was 3 percentage points of GDP lower than anticipated, and is projected at 3½ percent of GDP for the year, compared to 6 percent at the time of the seventh review.

11. With only a few weeks to go in the fiscal year, the authorities revised their financing strategy, relying again on BoU advances. The government decided to curtail domestic securities issuance compared to the program, given concerns over the pace of debt accumulation. They also decided against repaying the BoU advances taken in FY15/16, contrary to their original intentions of repaying in full. Instead, the government again took recourse to BoU advances as defined under the program, though in their interpretation it is a drawing down of government deposits at BoU. Given that BoU had already issued securities in line with the program, all June auctions were cancelled, entailing a large injection of liquidity that subsequently had to be mopped up with costly repo issuance.

Performance Under the PSI

12. Performance under the PSI through March 2017 has been broadly satisfactory. The authorities met the cornerstones of their quantitative program, but missed several supporting targets (see Table 1.1 of the authorities’ letter of intent). Specifically, the authorities met all end-December and continuous quantitative assessment criteria (QAC), including the overall deficit, net international reserves, and non-accumulation of external arrears. The BoU achieved its inflation target in December 2016 and March 2017. The indicative targets on poverty alleviating expenditures were met and preliminary data indicate that the target on domestic arrears clearance was met at end-December. However, the indicative target on revenue collection in December and in March was narrowly missed, reflecting muted economic activity, and the government issued two guarantees for Uganda Development Bank to allow the bank to pick up its lending activities. The IT on repaying BoU advances was missed in December and March, and the government subsequently reversed the repayments that had been made under the program so far.

Table 1.1.

Uganda: Quantitative Assessment Criteria and Indicative Targets for December 2015–March 20171

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

article image

Defined in the Technical Memorandum of Understanding (TMU). Values for December 31, 2015, June 30, 2016, and December 31, 2016 are quantitative assessment criteria except as marked. Values for other dates are indicative

Proposed targets are measured as the change from June 2015, except as marked.

Proposed targets are measured as the change from June 2016, except as marked.

Assessed on a continuous basis.

The NIR outturn is assessed using program exchange rates.

As the issues regarding this target have been addressed by the Amendments to the PFM Act (2015), the target was set up until June 2016, but it was then reinstated at the seventh review.

The outturns are not available because a reconcilation process has not been completed yet. This target will be measured semiannually for quarters ending June 30 and December 31 since the seventh review.

Annual percentage change, twelve-month period average core inflation.

13. The authorities have made some progress on structural reforms. One structural benchmark was met on time, three have been implemented with delay, and the remaining six have not been met, though the authorities intend to implement them going forward (see Table 1.2 of the authorities’ letter of intent). Most notably, the authorities approved the AML/CFT legislative agenda that will support Uganda’s exit from the Financial Action Task Force “grey” list. The Ministry of Finance, Planning, and Economic Development published reconciled reports on the stock of outstanding domestic arrears at end-June 2016 (3.2 percent of GDP). Looking ahead, continued capacity building and a focus on prioritization and selectivity should facilitate reform implementation. Pending reforms include:

  • Sending the BoU Act Amendments to Parliament: it took longer than expected to agree on some technical aspects between the Ministry of Finance, Planning, and Economic Development and the BoU. An understanding has now been reached, and the draft amendments are about to be shared with cabinet.

  • Finalizing and publishing the report on end-December unpaid bills: the authorities have compiled information on gross settlements of domestic arrears in the first half of the year. Capacity constraints have slowed the reporting on unpaid bills, and further work is needed to strengthen domestic arrears monitoring within the fiscal year.

  • Publication and issuance of the Appraisal User Manual: expected by end-June. The Manual has been finalized, but the actual printing and distribution has been delayed.

  • Sending to cabinet a policy for regulating mobile money: the authorities are revisiting the best course of action to provide for a sound regulatory framework.

Table 1.2

Uganda: Structural Benchmarks

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Figure 1.
Figure 1.

Uganda: Real Sector Developments

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda, Uganda Bureau of Statistics, and IMF staff calculations.
Figure 2.
Figure 2.

Uganda: External Sector Developments

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda and IMF staff calculations.
Figure 3.
Figure 3.

Uganda: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Ministry of Finance and IMF staff calculations.
Figure 4.
Figure 4.

Uganda: Monetary Sector Developments

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda and IMF staff calculations.
Figure 5.
Figure 5.

Uganda: Financial Sector Developments

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

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

Uganda: Other Financial Sector Developments

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda, Uganda Stock Exchange, and IMF staff calculations.

Economic Outlook and Risks

14. With sound and steadfast policy implementation, Uganda’s economic outlook is broadly favorable. If weather conditions continue to improve, private sector credit recovers, and the public investment program is implemented as planned, growth could accelerate to 5 percent in FY17/18. Over the medium term, infrastructure and oil sector investments could yield growth rates of 6 to 6 ½ percent (Box 2). Such growth rates would require private sector credit to grow by 10-11 percent per annum in real terms. The authorities broadly agree with the outlook, while anticipating a somewhat higher growth dividend over the medium term from the planned infrastructure and oil sector investments.

15. The current account deficit will be driven by developments in the oil sector in the coming years. Initially, the deficit is projected to widen, driven by investment-related imports. Once oil exports start, the current account is projected to gradually improve and turn into a surplus. International reserves are projected to remain at around 4½ months of prospective imports.

16. Risks are tilted to the downside (see Annex 3). Weak implementation of public investment and regional developments (conflicts, possible disruptions during upcoming elections), could undermine growth, as could a slowing of global trade. Renewed accumulation of government domestic arrears would aggravate banks’ NPL problem, and hit growth via the credit channel. Uncertainty persists over when oil production will commence and the phasing of investment in the sector. The agricultural sector remains exposed to climate conditions and pest infestations, with the spread of the fall armyworm posing an immediate danger. A large shilling depreciation could impact foreign investor holdings of government securities and contribute to rising NPLs. Tightening global financing conditions could hold back portfolio inflows and reduce offshore participation in Uganda’s Stock Exchange. Lastly, cuts in aid flows would undermine the sustainability of spending, particularly in the social sectors.

Managing Oil Wealth

Uganda has approximately 1.7 billion barrels of recoverable oil reserves, the fourth largest in sub-Saharan Africa. The authorities aim to have oil production commence in 2020. Production would continue for over 40 years. During this period, the government expects to receive between 0.5-4 percent of GDP in oil-related revenue per year.

Oil Extraction: A joint venture of three international companies and a government owned oil company (Uganda National Oil Company, UNOC) will carry out upstream oil extraction. The international joint venture partners are expected to make final investment decisions by end-2017. Production could commence as early as 2020 and quickly rise to a peak of 200,000 barrels per day. The total investment cost of upstream extraction is approximately US$8 billion. The international oil companies will bring external financing, and the investment will be associated with increased imports. The government, through UNOC, has a carried interest share, and is fully involved in all commercial decisions. Additional blocks that could yield further proven reserves and thus additional revenues are set to be auctioned in the near future.

Pipeline and Refinery: There will be two outlets for extracted crude oil:

  • (i) A pipeline to be constructed by a joint venture of the above-mentioned international companies, a subsidiary of UNOC and the government of Tanzania (costing US$4-5 billion) will transport oil from Uganda to a sea port in Tanzania, allowing crude oil to be sold on international markets.

  • (ii) A domestic oil refinery (with initial capacity of 30,000 barrels per day) will be constructed by a joint venture consisting of a UNOC subsidiary and other partners yet to be identified. Refined petroleum products are expected to be sold domestically and in the region at market prices.

Regulatory and Fiscal Regime: A Petroleum Regulatory Authority was established in 2015 to oversee the entire oil sector. The Public Financial Management (PFM) Act of 2015 requires all oil revenue to be deposited in a Petroleum Fund. Tax arrangements for upstream oil production are governed by Production Sharing Agreements (PSAs) between the government and joint venture partners that provide for: (i) royalties; (ii) distribution of ‘profit oil’ between the government and the joint venture partners according to the daily rate of production (where ‘profit oil’ is the surplus of oil over the amount needed to cover the royalty and other costs); (iii) corporate income tax (30 percent rate); and (iv) state participation, so that development costs owed by the government as a joint venture partner are initially covered by the private partners and then later repaid out of the government’s share of profits.

Outstanding Issues: Construction of the pipeline must be completed before oil production commences, and the authorities also aim to have the refinery operational in time. The tax regime for the pipeline is under negotiation between the governments of Uganda and Tanzania, while that for the refinery is also still to be determined. Public road infrastructure is required to allow access to oil fields and the government is seeking external financing to commence road construction as soon as possible. A policy on the use of oil revenue deposited in the Petroleum Fund needs to be developed, to ensure an appropriate balance between investment and saving. For now, withdrawals from the Petroleum Fund are limited to infrastructure spending. However, when the previous Oil Fund was closed, its resources were pooled in the Consolidated Fund, and the ringfencing of the saved oil revenue for infrastructure was dropped.

Text Table 1.

Uganda: Macroeconomic Outlook, FY2015/16 – 2021/221

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Sources: Ugandan authorities and IMF staff estimates and projections.

Fiscal year runs from July 1 to June 30.

Policy Discussions

17. Against this backdrop, the 2017 Article IV consultation centered around the macroeconomic framework underpinning the authorities’ development strategy. Specifically, discussions focused on: (i) balancing infrastructure investment, social spending needs, and debt sustainability; (ii) macro-financial linkages and growth prospects; and (iii) other policies to foster inclusive growth. With fiscal policy mainly focused on the development strategy, monetary policy is the main instrument for counter-cyclical policy. In the near term, high NPLs impede credit and weigh on activity. Over the medium term, financial sector deepening is needed to promote sustained and inclusive growth.

A. Macroeconomic Policies for FY17/18

Fiscal Policy

18. The FY17/18 budget seeks to create space for priority public investment expenditures through revenue mobilization and recurrent expenditure restraint. The authorities plan to increase development spending to allow for constructing roads needed for the oil sector. They acknowledge that this will require enhanced project implementation. The budget envisages a further ½ percent of GDP increase in the revenue ratio. Current expenditure is to be compressed and decline by 0.4 percent of GDP compared to FY16/17. In particular, allocations for social spending are budgeted to stay broadly unchanged relative to FY16/17 in Shilling-terms, and thus decline as a percentage of GDP from 6.3 percent of GDP in FY2016/17 to 5.7 percent in FY2017/18 (Box 3). The authorities believe that the allocations are adequate, if tight, and warranted to create space for their development spending priorities. They do not see a faster pace of revenue mobilization as an option as this could hold back the recovery of growth. Staff notes that strong expenditure control will be needed to avoid a recurrence of domestic arrears or the need for a supplementary budget, and that social spending is important for achieving inclusive growth.

19. The authorities’ FY17/18 revenue target continues the path of strengthening domestic resource mobilization. The target is consistent with the policy of increasing the revenue to GDP ratio by about ½ percent of GDP per year. At 14 percent of GDP in FY16/17, revenue collection remains at the lower end of regional peers and severely constrains the scope for social and development spending. The budget includes specific tax raising measures, including a base expansion of the infrastructure levy. The remainder would have to come from administrative gains such as intensifying risk-based audits of large and medium taxpayers. Staff cautions that the measures may not be sufficient to achieve the targeted revenue gain, and suggests that the authorities consider, e.g. reducing corporate tax exemptions. In addition, the budget also introduce new tax exemptions intented to promote investment and reduce the cost of electricity. Staff notes that general tax exemptions have a poor record of attracting investment and that accelerated depreciation allowances are a better targeted and effective option. Moreover, staff believes that a direct subsidy to the Bujagali power station instead of a tax exemption would be a more transparent measure to reduce the cost of electricity that would facilitate an informed discussion of budget priorities.

A01ufig3

Total Revenue (excl. Grants)

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Country Authorities and IMF Staff Estimates

Growth, Inequality and Poverty in Uganda: The Impact of Taxation and Social Spending

Inequality in Uganda remains high with a Gini coefficient of around 0.4. Recent research by the Commitment to Equity (CEQ) Institute indicates that fiscal policy reduces inequality in Uganda, but the effect is small, given the low levels of public expenditure and revenue collection1/ The impact of fiscal policy on poverty is negligible.

Higher income inequality can make growth less durable. IMF research shows that income inequality is associated with shorter growth spells, preventing significant reductions in poverty (October 2015 Regional Economic Outlook for sub-Saharan Africa; Berg and Ostry, 2011). Redistribution of income by fiscal policy has been found to be generally benign or beneficial for growth (Ostry, Berg and Tsangarides, 2014). Redistributive policies can include public spending on health and education, pensions and cash transfers. Improving financial inclusion has also been found to reduce inequality in emerging market and developing countries (Dabla-Norris et al, 2015).

Fiscal policy reduces inequality in Uganda, but only by a small amount. Research by the CEQ Institute based on the latest available household survey finds that the net impact of fiscal policy (taxation and spending) yields a reduction of the Gini coefficient by 0.03 points. The modest impact on inequality appears attributable to the low level of social spending in Uganda, compared with regional peers, rather than stemming from inefficiency of social spending. For example, direct transfer programs in Uganda are found to operate effectively, but reach only a small fraction (around 3 percent) of Ugandan households in a given year.

The impact of fiscal policy on poverty appears to be neutral. This partly reflects the design of the tax system, with the very poor falling below the lowest personal income tax thresholds and benefiting from VAT exemptions on essential items.

On-budget social spending in Uganda has recently declined as a share of GDP and is below the EAC average. Education spending has declined from a peak of around 5 percent of GDP in the mid-2000s to roughly 2 percent of GDP in 2013. Health spending has also declined to around 2 percent of GDP from a peak of 3 percent of GDP in 2010, the result of a build-up in spending from 1½ percent of GDP in the mid-1990’s. Pension spending has been flat at ½ percent of GDP since 2010. Compared to peers, social spending (including pensions and social assistance payments, such as cash transfer programs) is below the average of the other EAC countries. When looking at these numbers, it is important to keep in mind that donor spending in the social sectors also occurs outside the budget, so that budget allocations do not necessarily reflect the total spending in a sector. For example, off-budget donor spending is estimated at 25-30 percent of total spending in the health sector and about 10 percent in the education sector in Uganda. However, data on donor activity is difficult to compile in a comprehensive and consistent manner, making cross-country comparisons difficult.

RA01bx3ufig1

Social Spending, 2014*

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

* Data are for 2014 or latest year available in each country over 2009-2014Sources: IMF and World Bank calculations
Sources: UNESCO; WHO; IMF; World Bank and government data; IMF Staff Discussion Notes SDN/11/08 and SDN/15/13; and Commitment to Equality (CEQ) Institute Working Paper No. 53 1/ Jellema and others (2016) use the FY2012/13 Uganda National Household Survey to analyze the impact on inequality and poverty of Uganda’s various taxes, as well as government spending in the form of in-kind transfers (health, education spending), direct transfers and water/electricity subsidies.

Monetary Policy

20. The BoU’s inflation targeting framework has served Uganda well (Box 4). The BoU has appropriately reduced its policy rate by 600 bps since April 2016 to 11 percent, guided by its core inflation forecast, and considering the weak growth outlook.7 Headline inflation is projected to increase over the next few months, reflecting the drought-related spike in food prices. The BoU assesses the increase to be temporary, given the return of normal climatic conditions and does not see notable second-round effects, with the still weak economy and absence of demand pressures. As such, the BoU projects core inflation to remain within its narrow band of +/- 2 percentage points around the 5 percent target. Staff believes that remaining on hold for a while would allow the BoU to confirm that second-round effects from food price inflation remain limited.

Inflation Targeting Has Served Uganda Well

The BoU introduced inflation targeting (IT) in July 2011, replacing its monetary targeting framework. Money demand and the money multiplier had become unstable, and the monetary targeting framework was proving ineffective in bringing down high inflation. Under the IT-lite framework, the BoU began targeting core inflation of 5 percent with a band of ±3 percent over a 12 months’ horizon. The BoU uses open-market operations (repos or reverse repos) to steer the 7-day interbank rate to be aligned with the announced Central Bank Rate which is set every other month by the Monetary Policy Committee. In support of the IT approach, the BoU committed to a flexible exchange rate regime, with interventions limited to volatility smoothing.

The authorities have continuously enhanced their capacity since the introduction of IT. The BoU has strengthened its forecasting, operational, and communication capacity, and developing monetary policy instruments, also with support of IMF technical assistance. The authorities’ macroeconomic framework under the PSI has been instrumental in strengthening fiscal discipline, constraining BoU advances and creating channels for fiscal-monetary coordination, some recent problems notwithstanding. Reforms such as the drafting of amendments to the BoU Act, the adoption of the Charter of Fiscal Responsibility and the Public Finance Management Act, as well as the introduction of a Treasury Single Account have strengthened the basis for effective IT.

With its IT framework, the BoU has successfully steered core inflation close to its target. At inception in 2011, core inflation was reduced within a year from a peak of over 30 percent to about 5 percent. In 2015, guided by its core inflation forecast, BoU raised its policy rate early and decisively, keeping core inflation within a narrow band around its target. When the inflation outlook improved, the BoU started easing again in April 2016. Inter-bank rates and treasury security rates have followed the policy rate, but bank lending rates have responded less, particularly during easing episodes. Market participants widely acknowledge the BoU’s credibility.

These achievements have been supported by the BoU’s independence and a strong political commitment to the primacy of the inflation objective. Uganda’s constitution contains stipulations to support the operational independence of the BoU. Initial reforms separated domestic financing in primary auctions from monetary policy operations in the secondary market. In addition, the success in controlling inflation consolidated support for additional institutional reforms to reinforce IT. Remaining challenges include maintaining fiscal discipline, strengthening fiscal-monetary coordination, and developing the still shallow financial market to improve monetary policy transmission.

Sources: IMF (2015) and E. Tumusiime-Mutebile (2014). “The elements of a modern monetary policy framework.”

21. The BoU is enhancing the financial market architecture to facilitate liquidity management. The BoU has introduced deposit auctions as an additional tool for managing the banking system’s structural excess liquidity.8 Work is ongoing to develop a master repo agreement that would facilitate banks’ liquidity management via the interbank market. The BoU is enhancing trading in government securities by giving all banks direct access to the central depository system, and considers replacing the current over-the-counter trading with a trading platform, to enhance market efficiency. In addition, the authorities could consider introducing a standing facilities corridor that would delink liquidity provision from emergency liquidity assistance which currently are both provided under the BoU’s Lombard facility.

B. External Sector Assessment

22. Uganda’s external position was broadly consistent with fundamentals and desirable policy settings in calendar year 2016 (Annex 4). The net international investment position stood at −56 percent of GDP at end-2016, and the current account deficit narrowed to 4.4 percent of GDP. Continued scaling-up of infrastructure investment and the development of the oil sector are expected to temporarily widen the current account deficit. To maintain external sustainability, achieving the envisaged growth dividend of these investments will be critical. The EBA-Lite methodologies do not indicate significant misalignments, while international reserves exceed the assessed adequacy level. Going forward, the BoU should maintain reserves in line with the EAC convergence criterion of at least 4½ months of imports. The flexible exchange rate regime continues to serve Uganda well. The authorities agree with staff’s assessment.

C. The Medium-Term Fiscal Framework

23. Government debt is projected to peak at 42 percent of GDP in FY19/20 when the scaling up of infrastructure investment is completed. The projected debt trajectory is broadly unchanged from the latest Debt Sustainability Analysis (DSA) (IMF Country Report No. 17/7), which found the risk of debt distress to be low, but noted that risks had increased.9These risks can also be illustrated with a fan-chart that assesses the probability of different debt trajectories given the past shocks to key macroeconomic aggregates.10 The fan chart for government debt shows that the probability of exceeding 56 percent of GDP—the NPV threshold in the public debt DSA—is negligible, given past shocks to growth, inflation, or the primary deficit. However, the fan chart also shows that a potential breach of the 50 percent of GDP line—the NPV ceiling in Uganda’s Charter of Fiscal Responsibility—is within the 90 percent confidence interval.

A01ufig4

Uganda Central Government Debt

(percent of GDP)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Note: The green shaded area is a 90 percent confidence interval around the baseline projection (black line), capturing uncertainty about future realizations of growth, interest rates and the exchange rate.Source: IMF Staff Calculations.

24. The authorities confirmed that fiscal policy is anchored by their Charter of Fiscal Responsibility. The Charter requires keeping government debt below 50 percent of GDP in net present value terms and achieving an overall fiscal deficit of no more than 3 percent of GDP by FY20/21—consistent with the EAC convergence criteria for monetary union. Fiscal projections are consistent with the Charter’s deficit target and keep government debt below the Charter’s ceiling. Staff welcomes this framework and notes the authorities’ commitment to safeguarding debt sustainability. Staff suggests that the authorities consider adopting the projected debt trajectory as an operational ceiling which would provide a buffer to the Charter’s debt ceiling in case of adverse shocks.

25. The success of Uganda’s fiscal strategy depends on continued revenue mobilization and strong public investment management. The authorities remain committed to increasing the tax-to-GDP ratio by ½ percent of GDP per year over the medium term. Past Fund technical assistance has provided options for tax policy and revenue administration measures to achieve this objective. The authorities are considering to adopt a medium-term revenue strategy in collaboration with the G20 initiative, with the IMF possibly taking the lead. In parallel, the authorities are focusing on strengthening public investment management to ensure that development spending is cost-effective and yields the envisaged growth dividend. A recent IMF technical assistance report emphasized the need to undertake: (i) an annual review and prioritization of the project pipeline to ensure consistency with the medium-term fiscal framework for cabinet approval; and (ii) phased development of an integrated project database to track all completed and planned projects, containing information on appraisal, financing, monitoring and evaluation of project outcomes. Staff welcomes the ongoing efforts to enhance project selection, implementation, and monitoring.

26. The budget process could be strengthened to better align spending with policy priorities and plan for financing. The 2015 Public Financial Management Act provides a sound legal framework for budget preparation and execution. However, ambitious plans for foreign financed development spending have typically not been realized, given numerous implementation challenges, while tight envelopes for recurrent spending have had to be revisited through supplementary budgets. Indeed, the National Planning Authority notes that the FY16/17 budget is only 59 percent aligned with the National Development Plan (68 percent in FY15/16) with adverse implications for growth—the misalignment also reflects that some spending entities have not spelled out sector plans consistent with the National Development Plan. Moreover, supplementary budgets have complicated financing since they do not have to be accompanied by the legal authorization to raise the necessary domestic financing. Therefore, as FY16/17 demonstrated, supplementary budgets can lead to a financing gap that is then closed through ad hoc measures— including the use of BoU advances—which create volatility.

27. The authorities remain focused on fighting corruption. In this year’s state of the nation address, President Museveni again emphasized his government’s attention to reducing corruption, and there have been several recent high level arrests, including at the Ministry of Finance, Planning, and Economic Development. Uganda ranked 151 out of 176 countries in the 2016 Transparency International Corruption Perception Index. Corruption was cited as one of the most problematic factors for doing business in the World Economic Forum’s 2016 Global Competitiveness Report where Uganda ranks 113 out of 138 countries. Based on the World Bank’s 2015 Governance Indicators, Uganda is ranked below its EAC peers Rwanda, Tanzania, and Kenya.

28. The authorities seek to settle existing domestic arrears and prevent accumulation of new arrears. The FY16/17 budget prioritized settlement of outstanding domestic arrears, but at the same time, there are reports of new domestic arrears being accumulated—only the end-June 2017 report on the stock of domestic arrears will provide a clear picture. Given the total outstanding stock of domestic arrears, the government could consider securitization which would, for example, help in the case of government suppliers that need to service bank loans. The government has also tightened commitment controls, moved regular payments such as utilities onto pre-paid schedules, and has announced that accounting officers would be personally held responsible for accumulating domestic arrears. However, as long as budget envelopes are overly tight, pressures for renewed domestic arrears accumulation are likely to persist.

29. The authorities have launched a local content policy aimed at supporting domestic companies and service providers. The Buy Uganda, Build Uganda (BUBU) policy aims to promote production of local goods and services. To increase local content in government procurement, new guidelines require that at least 30 percent of procurement goes to local companies in specific sectors. In parallel, plans are under way to enhance the capacity of local service providers and producers and to develop a brand and marketing strategy for Ugandan goods and services. Staff cautions that initiatives in this field would need to be carefully designed to avoid discretion and ensure quality and cost effectiveness, to minimize any associated compliance costs, and to be consistent with commitments at the EAC level.

D. Financial Sector Stability, Inclusion and Development

Financial stability

30. The authorities note that the banking sector is well-capitalized overall and liquid, notwithstanding the recent failure of Crane Bank. Most banks meet or exceed Basel III capital requirements and already comply with the liquidity coverage ratio which the authorities expect to make binding by end-2017. Profitability in the sector has declined, reflecting the rise in non-performing loans and provisioning costs. The increase in non-performing loans in 2016 from 8.3 percent in June to 10.5 percent in December 2016 was largely driven by developments at Crane Bank, which was taken over by the BoU in October 2016 (Box 5). However, NPLs remain elevated at 6.3 percent at end-March which no longer includes most of Crane Bank’s toxic assets. The authorities pointed to the watch list remaining high, and expect that NPLs could rise further in the next two quarters. Staff notes the initiative by the Uganda Bankers’ Association to set up an asset recovery company that would purchase bad loans from commercial banks. While this would still imply a write-off for banks, it would free them to refocus on new lending. The authorities have requested a Financial Sector Stability Review which could be initiated later this year.

31. BoU stress tests suggest that the banking system remains resilient to shocks (Annex 5). The BoU performs quarterly top-down stress tests that cover single-factor credit and liquidity stress tests. For the purposes of this Article IV consultation, the BoU has also carried out more stringent ad hoc tests, including interest and foreign exchange risk and combined stress test scenarios. Staff agrees that the stress tests suggest that the system can weather credit shocks, but notes the risks from deposit concentration. Staff also notes that the quality of banks’ reporting is a risk to the validity of the stress test results, as the Crane Bank episode has illustrated. The authorities agree that the experience calls for more intrusive supervision, and explained that they are also focusing on banks’ risk management frameworks.

Resolution of Crane Bank

In October 2016, the BoU appropriately took over management of Crane Bank, which had become undercapitalized and encountered liquidity problems. The bank was the third largest domestic bank, accounting for just under 10 percent of total credit to the private sector, and 7.5 percent of total banking system assets.

Crane Bank had underreported its NPLs, and there were other problems with its financial reporting. Facing a steady deposit outflow, the bank was close to being illiquid, with signs of asset stripping. The ensuing corrections to the financial statements contributed to the worsening of financial soundness indicators of the banking sector. BoU intervened and placed the bank in receivership, appointing a statutory manager and suspending the bank’s Board of Directors. BoU commissioned financial and forensic audits which are still in progress.

In January 2017, the Development Finance Corporation of Uganda (DFCU)—a domestic bank with foreign ownership—was chosen to acquire most of Crane Bank’s balance sheet. BoU took over some of the non-performing assets.

32. The BoU is strengthening its financial surveillance toolkit. With support from the World Bank, the authorities are: (i) mapping the interconnections within the Ugandan financial system to strengthen consolidated supervision; (ii) developing a contagion matrix, encompassing cross-border exposures; and (iii) establishing three financial stability indices to better monitor financial stability risks. A real estate price index is also being developed that could form the basis for counter-cyclical provisioning. In response to NPLs in foreign exchange denominated mortgages, the regulator has introduced a maximum loan-to-value ratio and required that banks extend these mortgages only to borrowers that have foreign exchange income. Staff cautions that in the case of real estate, rents may be denominated in foreign exchange, thus documenting the income of the borrower, but tenants may ultimately only have shilling incomes so that the foreign exchange risk is simply pushed to another balance sheet, but not eliminated. Staff encourages the authorities to consider imposing loan-to-value ratios on all real estate lending, including in shilling terms. A second credit bureau has been established to improve on the quality of service delivery. Both credit bureaus should look beyond loan repayments to other payment obligations to derive credit scores.

Financial inclusion and development

33. Mobile money has greatly expanded access to financial services, although access to credit remains low. Credit to the private sector has averaged only 11 percent of GDP over the past decade—about half of its estimated benchmark potential.11 The private sector views high lending rates as one obstacle to investment, while banks point to credit risk and their high funding costs—a few large depositors command returns that are close to the yields on government securities. Mobile money has significantly narrowed the access gap. With half of Uganda’s population using mobile money, transactions amounted to 44 percent of GDP in 2015, but so far there is only one provider that offers credit services. The authorities agree with the need to make continued progress on financial deepening and point to the introduction of agency banking and Islamic banking, as well as the growth of micro banking as avenues for further financial deepening and improved access to credit. Staff welcomes these initiatives, and encourages the authorities to ensure that their regulatory framework keeps pace with these innovations. Access to collateral, in particular land titling, remains a problem for borrowers to access loans at competitive rates. The nonbank financial sector is small, and reforms under consideration to open the mandatory pension system could provide an impetus.

A01ufig5

Sub-Saharan African Countries: Financial Inclusion

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Source: Finmark Trust, Finscope Survey.

E. Inclusive Growth

34. The authorities are keenly focused on policies to reinvigorate growth. Their strategy emphasizes infrastructure investments that appropriately tackle bottlenecks in electricity and transport and provide the space for industry to develop. In parallel, the authorities are promoting agriculture where about 70 percent of the labor force is employed. They point, for example, to the free distribution of coffee seedlings that is expected to boost production further. In addition, enhancing agricultural extension services would likely help to improve productivity and job creation.

A01ufig6

Primary School Completion Rate

(percent of relevant age group)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: World Bank World Development Indicators.

35. Staff analysis suggests that these efforts should be complemented with improved skill formation. Despite having achieved nearly universal primary enrolment, completion rates have recently declined and lag those of regional peers. The government’s reforms to strengthen vocational education are steps in the right direction, while private sector participation in curriculum design, skill certification, and practical training would improve the delivery and outcomes. Emphasis on empowering women to be economically active is equally important. This includes addressing obstacles to women accessing land or inheriting assets and improving fertility choices. The authorities agree that skill formation and social protection are important, but note that their tight envelope requires prioritization, including over time.

36. In addition, Uganda has scope to facilitate private sector activity. While Uganda’s business environment has improved in absolute terms, the country has lost ground relative to its peers. Enhancing Uganda’s competitiveness requires faster progress in supporting business creation and growth, facilitating trading across borders (e.g., raising awareness of relevant regulations and promoting cross-country harmonization within the EAC), and reducing corruption. In this context, advancing EAC integration could further support Uganda’s exports and structural transformation by providing improved access to a larger market.

A01ufig7

Relative Scores of Doing Business

(higher value indicates better business environment)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: World Bank Doing Business database and IMF staff calculations. The years refer to the publication time.

F. Regional Integration

37. The authorities remain committed to the process of economic integration within the East African Community (EAC). EAC partner states announced that a Single Customs Territory (SCT) system will take effect on July 31. The SCT is intended to harmonize and electronically connect EAC countries’ customs clearance systems to reduce the number of customs checkpoints and clearance delays at borders, and thereby reduce the costs of doing business. The harmonization of customs systems under the SCT is likely to gradually reduce customs delays and operational disruption along transport routes, by facilitating the clearance of goods and the remittance of customs fees charged at the port of entry to the relevant country. Implementation of the SCT is also likely to reduce customs-related corruption risks, through the digitization of systems, simplified procedures, and enhanced transparency.

38. Work is also advancing to achieve regional harmonization objectives, in keeping with the East African Monetary Union Protocol objectives. This includes key fiscal priorities such as: harmonization of domestic taxes and the approach to international tax treaties and negotiations, to help ensure a level playing field in the EAC common market, and strengthen tax administration through efforts to reduce tax expenditures and broaden the tax base. Efforts are also ongoing to strengthen harmonization in other areas, including: regulatory and prudential frameworks, systemic risk analysis, and monetary policy implementation and operations. Also important is the adoption of common principles and rules for payments and settlements and eventual harmonization of payments and settlements systems and the harmonization of monetary and financial sector statistics, balance of payments, government finance statistics and price indices; and improved data quality. The IMF is providing extensive technical assistance in these areas.

Staff Appraisal

39. Uganda’s economic conjuncture is challenging. Per-capita growth averaged about 5 percent for two decades, but has slowed to ½ percent in FY16/17. Uganda has realized notable progress on poverty reduction, but vulnerability remains high and income inequality has increased in parallel. The cyclical slowdown is partly driven by exogenous factors such as the drought and spillovers from regional conflicts. However, the slowdown in credit growth, inter alia linked to domestic government arrears, also played a role. Boosting trend growth requires a mix of infrastructure investment, strengthening skill formation, enhancing the business climate, and further financial deepening. Uganda’s external position is broadly consistent with fundamentals and desirable policy settings in calendar year 2016. Policies to support growth, including infrastructure investment and enhancing the business environment, would also support Uganda’s external position over the medium term.

40. Over the next 3-5 years, infrastructure and oil sector investments can become the key drivers of growth. The authorities’ strategy appropriately focuses on tackling bottlenecks in electricity and transportation, as well as on developing Uganda’s nascent oil sector. Significant improvements in public investment management are required to achieve the envisaged scaling up of development spending and realize the targeted growth dividend. In parallel, attention to social spending is needed, including on health and education, to invest in Uganda’s citizens and help them acquire the skills needed to leverage the opportunities from improved infrastructure and the oil sector. Likewise, enhancing the business environment can empower the private sector to take advantage of the opportunities opening up, also from further EAC integration. With the right policy mix, Uganda can achieve high and inclusive growth that contributes to poverty reduction and equality.

41. Execution of the FY16/17 budget points to strengths and weaknesses. The muted economic activity notwithstanding, the authorities achieved another ½ percent of GDP increase in the revenue-to-GDP ratio. Domestically-financed development spending was executed as budgeted, and the government started settling domestic arrears. However, the execution rate of externally-financed development spending, including the hydropower projects, was only 35 percent. Two supplementary budgets were introduced—without a corresponding authorization to raise debt—and overall, spending was poorly aligned with the National Development Plan priorities. Insufficient coordination between the Ministry of Finance, Planning, and Economic Development and the BoU resulted in uncertainty over the government’s financing needs and the amount of domestic issuance. It is regrettable that the government stepped away from its commitment to repay in full the BoU advances taken in FY15/16 and instead relied again on central bank financing when the domestic market could have easily absorbed government securities. This practice is not consistent with an inflation targeting framework. The government should settle outstanding advances from the BoU as a matter of urgency.

42. The FY17/18 budget accommodates infrastructure investment needs, but implies a very tight current expenditure envelope. The targeted increase in tax collection by another ½ percentage point is welcome, though specific measures still need to be firmed up. Capital spending plans will require improved project implementation capacity which may take more time to build. Strong expenditure control for recurrent spending is needed to avoid renewed domestic arrears or the need for a supplementary budget. The tight social spending allocations require efficiency gains to protect the level of service delivery. Once growth has recovered, the authorities could consider additional revenue measures to create space for higher social spending which has declined in recent years and is below the EAC average.

43. The BoU’s inflation targeting framework has served Uganda well. Since its introduction, the BoU has successfully steered core inflation within the band around the 5 percent target. With the drought-related spike in food prices, headline inflation is projected to increase over the next few months, while core inflation would remain close to target. Remaining on hold for a while would allow the BoU to confirm that effects from food price inflation on core inflation remain limited. Ongoing financial market architecture reforms should ultimately strengthen the monetary transmission mechanism.

44. The Charter of Fiscal Responsibility provides an appropriate anchor for fiscal policy. The key to safeguarding debt sustainability is continued domestic revenue mobilization and sound project implementation to realize the envisaged growth dividend. The authorities should consider targeting the projected debt trajectory—peaking at 42 percent of GDP in FY19/20—which would provide a buffer relative to the Charter’s debt ceiling in case of adverse shocks. Local content requirements for government procurement need to be carefully designed to ensure quality and cost effectiveness. Close monitoring and adopting a comprehensive domestic arrears clearance and prevention strategy is essential for preventing a recurrence of domestic arrears with their negative macro-financial spillovers on credit and growth.

45. Financial sector stability and deepening are down payments for growth. Supervision needs to become more intrusive, scrutinizing banks’ reporting, and the BoU is appropriately focusing on banks’ risk management frameworks. Microprudential regulations could be tightened in some areas. Mobile money has greatly enhanced access to financial services, and the sector offers opportunities for deepening financial inclusion and access to credit. The regulatory framework must keep pace with this rapidly developing segment.

46. Staff recommends completion of the eighth review of the PSI for Uganda. The attached Letter of Intent provides a brief synopsis of the authorities’ achievements and macroeconomic objectives and policies for the period ahead. The authorities have managed macroeconomic policies well in a complex environment for most of the fiscal year. However, the continued reliance on BoU advances complicates the implementation of the inflation targeting regime. Adopting AML/CFT legislation to support Uganda’s exit from the FATF grey list is a major milestone. The slow progress on some of the other structural reforms, including the BoU Act Amendments and domestic arrears monitoring—reflecting inter alia extra time needed to agree on certain provisions and capacity constraints—is regrettable. Going forward, better prioritization and selectivity combined with a sharp focus on capacity building should help structural reform implementation.

47. It is proposed that the next Article IV consultation with Uganda take place on the 12 month cycle. The authorities have requested a successor PSI, and discussions could commence this fall.

Table 1.

Uganda: Selected Economic and Financial Indicators, FY2012/13–2021/221,2

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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 2009/10 rebased GDP provided by the authorities.

The Central Bank Rate (CBR) was introduced to start Inflation Targeting in July 2011. Data refer to end-year CBRs. The CBR was at 11 percent in April 2017.

Capital expenditures include net lending and investment on hydropower projects, and excludes BoU recapitalization and other spending.

Based on revised figures after the 2014 census by UBOS.

Table 2a.

Uganda: Fiscal Operations of the Central Government, FY2012/13–2017/181,2

(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 2009/10 rebased GDP provided by the authorities.

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.

The overall deficit excluding large infrastructure projects financed by nonconcessional external borrowing (e.g. HPPs), BOU recapitalization, and oil

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

The balances of the Oil Fund were transferred to the UCF and in line with the PFM Act, a new Petroleum Fund was opened with balances from recent oil revenue deposits.

Excluding externally financed spending.

Table 2b.

Uganda: Fiscal Operations of the Central Government, FY2012/13–2017/181,2

(Percent of GDP)

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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 2009/10 rebased GDP provided by the authorities.

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

Expenditure categories in FY2013/14 include clearance of arrears totaling 0.8 percent of GDP, mainly in Government of Uganda investment and other current spending.

The overall deficit excluding large infrastructure projects financed by nonconcessional external borrowing (e.g. HPPs), BOU recapitalization, and oil revenue.

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

The balances of the Oil Fund were transferred to the UCF and in line with the PFM Act, a new Petroleum Fund was opened with balances from recent oil revenue deposits.

Excluding externally financed spending.

Table 2c.

Uganda: Quarterly Fiscal Operations of the Central Government, 2015/16–2016/171,2

(Billions of Ugandan 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 2009/10 rebased GDP provided by the authorities.

Include mainly HIPC-related grants from FY 2014/15 onwards.

The projections for the overall balance in FY17 are consistent with the adjusted ceiling on the overall balance, as defined in the TMU of the Staff Report for the Sixth Review of the PSI.

The overall deficit excluding large infrastructure projects financed by nonconcessional external borrowing (e.g. HPPs), BOU recapitalization, and oil revenue.

Table 3.

Uganda: Monetary Accounts, FY2012/13–FY2017/181,2

(Billions of Ugandan Shillings 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 2009/10 rebased GDP provided by the authorities.

Starting on June 2013, the Bank of Uganda expanded the reporting coverage from Monetary Survey to Depository Corporations Survey.

The public sector includes the central government, public enterprises, other financial corporations and local governments.

Including valuation effects, the Bank of Uganda’s claims on the private sector and Claims on Other Financial Corporations.

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

Inclusive of foreign currency clearing balances.

Table 4.

Uganda: Balance of Payments, FY2012/13–FY2021/221,2

(Millions of US dollars 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 2009/10 rebased GDP provided by the authorities.

Table 5.

Uganda: Banking Sector Indicators, March 2013–March 2017

(In percent)

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Source: Bank of Uganda.

Under new rules, effective in December 2016, designed to ensure compliance with Basel III financial standards, tier one capital requirements were raised to 10. 5 percent from 8 percent, while the total regulatory capital ratio was raised to 14.5 percent from 12 percent. However, Systemically Important Banks (SIBs) will be required to maintain tier one capital of 11.5 per cent and a total regulatory capital ratio of 15.5 per cent percent respectively. The cash reserve requirement for banks is 5.25 percent, and the liquidity coverage ratio is at 20 percent.

Annex I. Progress in Achieving Millennium Development Goals

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Sources: World Bank Development Indicators, TAC mdgTrack, and Ugandan authorities.

Annex II. Implementation of 2011 FSAP Recommendations

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Annex III. Risk Assessment Matrix (RAM) 1

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Annex IV. External Sector Assessment

Uganda’s external position is broadly consistent with fundamentals and desirable policy settings in calendar year 2016. The current account balance improved and is consistent with the estimated norm. The real effective exchange rate does not seem to be misaligned. Reserve coverage is above the assessed adequacy level.

1. External sustainability is not a major concern. One indicator of external sustainability is the net international investment position (NIIP), which at end-2016 stood at −56 percent of GDP. External liabilities consisted mostly of FDI and debt, while international reserves constituted the bulk of external assets. The FDI stock is concentrated in the mining sector, most of which is oil-related investment and expected to improve the current account balance once oil exports start. Public sector loans accounted for almost three-quarters of external debt. The last debt sustainability analysis indicated that external public debt remains at a low risk of debt distress, though risks have increased.1

2. The NIIP is projected to improve in the long run, though risks remain. In the medium term, the NIIP is projected to deteriorate further, before an expected turnaround once infrastructure and oil sector investments start bearing fruit. Over the next few years, significant FDI inflows are expected to finance the development of the nascent oil sector. The continued scaling-up of infrastructure investment will involve additional external public sector borrowing. This is expected to increase investment-related imports and thereby widen the current account deficit. Over the medium to long run, these investments are expected to produce a growth dividend, reduce the current account deficit, and thereby improve the NIIP outlook. Achieving this growth dividend is essential for maintaining external stability.

A01ufig8

Net International Investment Position (NIIP)

(in percent of GDP)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda, Uganda Bureau of Statistics, and IMF staff calculations.
A01ufig9

FDI stock by sector 2015

(in percent)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda and IMF staff calculations.

3. The current account remained in deficit, though it narrowed as imports slowed. After reaching a trough in 2011 at −9.7 percent of GDP, the current account has gradually improved, reaching −4.4 percent of GDP in 2016, driven by the trade balance. While exports remained relatively stable as a share of GDP, imports declined, mostly related to FDI and other investment activities. Going forward, the current account deficit is projected to widen again, as the development of the oil sector and continued scaling up of infrastructure investment are expected to increase imports.

A01ufig10

Current Account Balance

(in percent of GDP)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Bank of Uganda, Uganda Bureau of Statistics, and IMF staff calculations.

4. The 2016 current account is consistent with the level implied by fundamentals and desirable policies. Using the EBA-Lite current account model, Uganda’s norm is estimated at −4.4 percent of GDP in 2016.2 This compares to an actual current account balance of −4.4 percent of GDP, implying no current account gap. The current account gap is contained by a large policy gap of 1.5 percent of GDP, driven mostly by an overly loose world fiscal policy. Put differently, a tightening in global fiscal policy in line with desirable policy settings and, thereby, higher savings in the rest of the world, allow Uganda to borrow more to finance a higher current account deficit than economic fundamentals would suggest. No adjustment in the real exchange rate is therefore needed to align the current account with its norm.

A01ufig11

Current Account Balance: Actual, Fitted, and Norm

(in percent of GDP)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Ugandan authorities, WDI, and IMF staff estimates.

Current account and real exchange rate assessment

(in percent)

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Source: IMF staff estimates.

Positive numbers indicate overvaluation. Elasticity of current account to real exchange rate is 0.15.

5. The real effective exchange rate (REER) does not seem misaligned. The panel regression model for the REER index indicates an undervaluation of the real exchange rate of about 9 percent. In 2015, the exchange rate depreciated sharply, driven partly by external factors, while domestic factors related to election uncertainties also contributed.3 This sharp depreciation seems to have had a lasting impact and a full reversal is not expected. These factors are not captured by the model. The staff-assessed REER gap is around zero, which is consistent with the staff-assessed current account gap. Using a simple linear trend line for the REER supports this assessment.

A01ufig12

Real Effective Exchange Rate (REER): Actual, Fitted, and Norm

(natural logarithm)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Ugandan authorities, WDI, and IMF staff estimates.
A01ufig13

Real Effective Exchange Rate Index

(2000=100)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: INS, and IMF staff calculations.

6. International reserves are higher than the adequate level. The availability of external buffers is another important aspect of external sustainability. At end-2016, gross international reserves stood at US$3 billion, covering about 5 months of next year’s imports of goods and services. The IMF’s metric to assess reserve adequacy in credit-constrained economies, which explicitly weighs the cost and benefits of holding reserves, indicates that a reserve coverage of 3 months of imports would be adequate for Uganda, even when assuming a very low opportunity cost of holding reserves.4 The current stock of reserves exceeds this metric, as well as standard rules of thumb (3 months of import coverage, 20 percent of broad money, and 100 percent of short-term external debt at remaining maturity), by comfortable margins. Going forward, the Bank of Uganda can purchase reserves opportunistically and would meet the EAC convergence criterion of 4½ months of imports.

A01ufig14

Reserve Adequacy Assessment

(in months of current year’s imports of goods and services)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Source: Bank of Uganda, Uganda Bureau of Statistics, and IMF staff calculations.
A01ufig15

Gross International Reserves

(in billion of US$)

Citation: IMF Staff Country Reports 2017, 206; 10.5089/9781484309322.002.A001

Sources: Ugandan authorities and IMF staff calculations

Annex V. Stress Test Results

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Appendix I. Letter of Intent

Kampala, Uganda,

June 20, 2017

Ms. Christine Lagarde

Managing Director

International Monetary Fund

700 19th Street, N.W.

Washington, DC 20431

USA

Dear Madame Lagarde:

On behalf of the Government of Uganda, we would like to provide you with an update on the progress we have achieved under our economic program under the Policy Support Instrument (PSI) for Uganda in the context of the current eighth and last review.

Over the course of this program, we have maintained stability in a complex international and regional environment. We have scaled up our infrastructure investment while keeping debt on a sustainable path. We further strengthened our inflation targeting framework and are in the process of finalizing the development of a master repo agreement. We advanced key structural reforms including the adoption of the PFM Act and its Regulations and the Charter of Fiscal Responsibility; we expanded the Treasury Single Account (TSA) framework to local governments; and ensured the adoption of key amendments to laws which will help secure Uganda’s timely exit from the FATF Gray list. Government established and issued National Identification Cards under the new national identification system, which will support efforts to strengthen revenue collection, promote the identification of financial sector clients, and combat money laundering and the financing of terrorism.

In the current fiscal year, economic growth has slowed. Following the 4.8 percent recorded in FY15/16, the difficult global and regional environment, compounded by a drought that affected agriculture and subdued credit growth. are likely to result in growth of 3.9 in FY16/17. Low credit growth to the private sector, at an average of only 6.4 percent as of Q3 FY16/17, is a result of the tightening of lending standards by banks. In its turn, the tightening of standards is reflective of banks’ risk aversion towards lending following a rise in non-performing loans (NPLs). The gradual reduction of the Central Bank Rate (CBR) to 11 percent in April 2017 is likely to lend support to increased credit to the private sector.

The current account deficit is projected to narrow to 4.7 percent of GDP in 2016/17, owing mostly to increased receipts from exports and decreased expenditure on both Government and private sector imports. Although export receipts increased to 11 percent of GDP, they remain constrained, partly as a result of lower than expected agricultural output. The external capital account was financed by surpluses in the financial accounts of the balance of payments. FDI rose by USD 61 million and portfolio flows recorded a net inflow of USD 11 million.

The prolonged drought which started around October 2016 to the end of February 2017, and the Fall Armyworm attack resulted in severe crop failure in several parts of the country. The Government intervened by providing food relief to households in the affected districts. The Government also allocated resources for the procurement of fast maturing seed and plantlets for the March - May planting seasons to address the short-run food security concerns. To control the spread of the Fall Armyworm and to mitigate its negative effects on crops in the affected areas, Government constituted a National Inter-agency Task Force and provided funds through supplementary funding of Shs. 2.1 billion to procure pesticides and provide necessary technical backstopping to the farmers. Government is also undertaking research into the control of the pest, and has allocated Shs 168 million to the National Agricultural Research Organization for this purpose.

The banking sector remains sound and resilient with banks well capitalized and liquid. Despite reducing from 10.5 percent in December 2016 to 6.3 percent in March 2017, mainly due to writeoffs and debt restructuring, NPLs remain high, and are likely to weigh on bank capital and financial intermediation in the near term. Nevertheless, stress tests show that the system remains strong. We continue to monitor developments closely.

Against this challenging backdrop, we have made good progress on our economic and financial program. We have observed all end-December quantitative assessment criteria and the majority of indicative targets through March. The reserve accumulation floor was exceeded and the inflation consultation clause was respected. We have also made progress on key structural reforms, including preparations for the amendments to the Bank of Uganda Act and for adopting a manual setting out national parameters, shadow prices and conversion factors to be used in all economic project appraisals prior to admission into the Public Investment Plan. These will be completed in the coming months.

On the fiscal side, we continued our efforts to enhance domestic revenue mobilization. In the first three quarters of the year, we mobilized Shs 9,277 billion, which is a remarkable amount given the lower-than-projected economic growth. Still, the indicative target setting a tax floor for end March 2017 was missed by a small margin. Our efforts focused on improving compliance, with measures including implementation of the Taxpayer Registration Expansion Program (TREP) to increase compliance in the informal sector; tax audits and collection of arrears; implementation of the Regional Electronic Cargo Tracking System (RECTS) to improve on customs enforcement; and tax education, among others. The tax measures introduced in the FY16/17 budget have been particularly useful, especially the excise duty on petrol & diesel, ready-to-drink spirits, sugar and VAT on bulbs other than fluorescent bulbs.

Expenditure was lower than projected due to the under-execution of externally financed projects, largely as a result of capacity constraints in project implementation, challenges with land acquisition and delays in the procurement process. The need for food relief, among other pressing needs, led to some increase in current spending towards the end of the fiscal year.

As a result of the revenue collection progress and under execution of externally-financed expenditure, we met the deficit quantitative assessment criteria (QAC) in December 2016, and expect the deficit to be 3.5 percent of GDP at the end of the current fiscal year.

In the context of a complex situation of muted private sector credit growth, concerns about the rate of increase in our debt obligations, and given the fact that there are available resources in the Consolidated Fund, we decided to stick to the budget’s original legal authorization in terms of issuance of domestic debt. To accommodate revenue shortfalls and domestic spending pressures above the original budget embedded in the supplementaries we decided to draw down our available resources with Bank of Uganda in the Consolidated Fund. Unfortunately, we will thus not be able to repay the advance taken from BoU last year, as contrary to our original plans. We understand that this financing decision makes monetary policy management difficult. Bank of Uganda will manage the complex situation using available instruments. Going forward, we plan to continue strengthening fiscal-monetary policy co-ordination, in particular ensuring more certainty around the treasury issuance schedule. We are committed to ensure that financing of the fiscal deficit does not result in money creation.

The granting of two government guarantees to the Uganda Development Bank (UDB), however, resulted in a breach of the IT on issuance of guarantees. The guarantees were necessitated by the need to recapitalize the UDB to lend at affordable rates to priority sectors, particularly in light of sluggish growth in private sector credit.

On the monetary side, core and headline inflation reached 5.1 percent and 7.2 percent respectively in May 2017. The increase in headline inflation was largely on account of a food price spike related to the widespread drought that occurred in the first half of the year, whose adverse effects on the food supply have persisted to date. However, lower international food prices and weak domestic demand partly offset the food price effect on headline inflation and second-round effects are not expected to be significant. BoU continued its easing cycle that started in April 2016, and since then the CBR was reduced by 600 bps to 11 percent, successfully keeping inflation within the bands of the inflation consultation clause. International reserves remain at adequate levels, with the net international reserves floor exceeding the agreed floor by US$147.43 million.

On structural reforms, we continued to make progress, although there were some delays. We made progress on improving our AML/CFT regime with the approval of the Anti-Terrorism (Amendment) Bill 2017, Capital Markets Authority Act (Amendments) and the Insurance Bill. These laws will facilitate the speedy tracing, identification and freezing of terrorist assets and pave the way for exiting the FATF gray list, which is due for consideration in the next International Cooperation Review Group (ICRG) meeting planned for June 2017. The report on the stock of domestic arrears as at June 2016 (Shs 2,701 billion) was published. According to preliminary calculations, the stock of domestic arrears was reduced to Shs 2,300 billion in December 2016 resulting from clearance of outstanding payments by Ministries, Departments and Agencies (MDAs). Accounting officers were asked to migrate all electricity and telephone utilities from the post-paid to the prepaid systems by 30th June 2017 to prevent reoccurrence of utilities arrears and thereafter, no funds will be released to non-compliant Ministries and Agencies.

On Public Investment Management (PIM), the Appraisal User Manual and Development Committee Guidelines have been completed while the manual setting out national parameters, shadow prices and conversion factors is still being developed. We did not meet the benchmark follow-up on value-for-money audits by March 2017 as consultations on the Treasury instructions, which provide for procedures for follow up and reporting on progress of the recommendations by Auditor General, took longer than anticipated. However, they have since then been finalized and will be issued to MDAs by June 2017. On the other hand, the process to put in place a regulatory system for mobile money has commenced with the preparation of a policy framework and the principles on the national payments system, which will be presented to cabinet for consideration. The amendments to the BoU Act were not presented to Parliament by March due to extensive consultations among stakeholders. We plan to present to Cabinet the proposed amendments by end June 2017. In addition, the National Risk Assessment has been concluded by the Financial Intelligence Authority, and is expected to be submitted to Cabinet in May 2017.

Looking ahead, for FY 2017/18, we expect real GDP growth to rebound to 5 percent, supported by the contribution of large infrastructure investments, strengthened credit growth (which is expected to reach 12%), and the end of the drought. Inflation is projected to remain in line with its medium-term target. The current account deficit is likely to increase reflecting 6.8 percent of GDP. The level of international reserves will remain adequate at around 4.0 months of future imports. However, risks would continue to be to the downside, including weak implementation of public investment and regional developments; tightening global financing conditions, including the slowdown of growth in China.

On the fiscal side, in next years’ budget we will continue our efforts to increase the tax to GDP ratio by at least ½ percentage points through tax measures and enhanced compliance. In this regard, we are preparing a medium-term national revenue mobilization strategy, and aim to take advantage of the G-20 Medium-Term Revenue Strategy initiative, together with the IMF, DFID, WB and other key players. We also plan to increase development expenditures to accommodate US$ 303.3 million for oil roads, while maintaining social spending at appropriate levels and ensuring that the borrowing levels remain reasonable to avoid crowding out the private sector or increasing the risk of debt distress. We expect the deficit to rise to 5.6 percent of GDP in FY17/18.

On the monetary side, we continue enhancing our inflation-targeting framework and stand ready to adjust the CBR depending on the inflation expectations. We shall continue reforms to improve our operations both for the conduct of monetary policy and government securities, particularly with regard to primary dealership reforms. We will also continue strengthening our oversight and supervisory frameworks through consolidated supervision, setting up a contagion matrix to monitor risk, and adopting Basel III among others, and will continue to monitor developments in the financial sector closely.

Based on our program performance, we request the completion of the eighth and last review under our PSI. We plan to request a successor PSI agreement in the fall to continue to strengthen our economic performance. We consent to the publication of the staff report and the letter of intent for the 2017 Article IV consultation and the Eighth Review of the PSI.

Sincerely yours,

/s/

Honorable Matia Kasaija

Minister of Finance, Planning, and

Economic Development

/s/

Prof. E. Tumusiime Mutebile

Governor Bank of Uganda

Attachments:

2 tables (Quantitative Assessment Criteria and Indicative Targets; Structural Benchmarks).
1

The national poverty line ranges from US$0.88 to US$1.05 in 2005 PPP terms, depending on the region. The international poverty line is set at US$1.90 per day in 2011 PPP terms.

2

See Selected Issues Paper “Growth Diagnostics,” IMF Country Report No. 17/207.

3

See Selected Issues Paper “Uganda’s Experience under the 2013 PSI,” IMF Country Report No. 17/207.

4

The fiscal year runs July−June.

5

The latest comprehensive arrears data is for end-June 2016. The report on outstanding bills for end-December 2016 is pending. The next comprehensive arrears data would be for end-June 2017.

6

Construction of the Isimba and Karuma Hydro Power Projects (HPPs) is approximately 70 percent and 50 percent complete respectively. The projects have been subject to delays due to technical difficulties, including a crack in the Karuma dam wall.

7

The staff report was finalized before the June 19, 2017 Monetary Policy Committee meeting. A staff [statement/supplement] will provide an update on the decision.

8

The certificates of deposit with tenors of 28-day and 56-day are auctioned weekly to banks.

9

Uganda owes a small amount in pre-HIPC Initiative arrears to non-Paris Club debtors, which continue to be deemed away under the revised arrears policy for official creditors, as the underlying Paris Club agreement was adequately representative and the authorities continue to make best efforts to resolve the arrears.

10

See Selected Issues Paper “A Medium-Term Fiscal Anchor: Managing Debt as Public Investment is scaled up”.

11

See Selected Issues Paper “Financial Inclusion and Development”.

1

IMF Country Report No. 17/7.

2

Based on the External Balance Assessment (EBA-Lite) methodology (IMF Working Paper 13/272) and the Methodological Note on EBA-Lite (IMF Policy Paper; February 5, 2016).

3

See IMF Country Report No. 15/321.

4

Assessing Reserve Adequacy (ARA) board papers (IMF 2011, 2013, 2014).

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Cover IMF Staff Country Reports
Uganda: 2017 Article IV Consultation and Eighth Review Under the Policy Support Instrument-Press Release; Staff Report; and Statement by the Executive Director for Uganda
Author:
International Monetary Fund. African Dept.
Volume/Issue:
Volume 2017: Issue 206
Publisher:
International Monetary Fund
ISBN:
9781484309322
ISSN:
1934-7685
Pages:
79
DOI:
https://doi.org/10.5089/9781484309322.002

Poverty and Inequality

(in percent)

Composite Index of Economic Activity

(index, leading indicator)
Figure 1.

Uganda: Real Sector Developments
Figure 2.

Uganda: External Sector Developments
Figure 3.

Uganda: Fiscal Sector Developments
Figure 4.

Uganda: Monetary Sector Developments
Figure 5.

Uganda: Financial Sector Developments
Figure 6.

Uganda: Other Financial Sector Developments

Total Revenue (excl. Grants)

(percent of GDP)

Social Spending, 2014*

(percent of GDP)

Uganda Central Government Debt

(percent of GDP)

Sub-Saharan African Countries: Financial Inclusion

Primary School Completion Rate

(percent of relevant age group)

Relative Scores of Doing Business

(higher value indicates better business environment)

Net International Investment Position (NIIP)

(in percent of GDP)

FDI stock by sector 2015

(in percent)

Current Account Balance

(in percent of GDP)

Current Account Balance: Actual, Fitted, and Norm

(in percent of GDP)

Real Effective Exchange Rate (REER): Actual, Fitted, and Norm

(natural logarithm)

Real Effective Exchange Rate Index

(2000=100)

Reserve Adequacy Assessment

(in months of current year’s imports of goods and services)

Gross International Reserves

(in billion of US$)