This note describes the main tools for. Uganda: macroeconomic policy co-ordination and management SUMMARY COUNTRY LEARNING NOTES

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1 REPUBLIC OF UGANDA MINISTRY OF FINANCE, PLANNING AND ECONOMIC DEVELOPMENT Uganda: macroeconomic policy co-ordination and management COUNTRY LEARNING NOTES Maris Wanyera and Fiona Davies * December 2012 SUMMARY Macroeconomic policy co-ordination in Uganda aims to ensure that the Government budget is financed in a way that is compatible with low and stable inflation. There are two main phases of macroeconomic policy coordination: the first, during budget preparation, is coordinated through the Macroeconomic Framework; and the second, during budget execution, is co-ordinated through management of Government cashflow and by setting quarterly limits on Government expenditure. The close working relationship between the Central Bank, Uganda Bureau of Statistics and the Ministry of Finance has been an essential component of Uganda s success in macroeconomic policy co-ordination and management over the past 18 years. This relationship between the Ministry of Finance and each of the other institutions which establishes the basis for their co-ordination across a range of macro and fiscal issues. This note describes the main tools for macroeconomic policy co-ordination and management in Uganda and how they have evolved. The Macroeconomic Framework ensures that projections for the coming budget year are consistent with the Government s macroeconomic policy objectives across the real, external, monetary, and fiscal sectors of the economy. Ultimately, the framework places a limit on the resources available to finance the budget that is consistent with low and stable inflation. Once the budget has been approved, the Central Bank and the Ministry of Finance monitor fiscal performance (Government revenues and expenditure performance) on a weekly and monthly basis. This ensures that spending does not exceed levels set in the budget and that Government s net liquidity injections remain within the planned levels. Quarterly limits are placed on Government expenditure consistent with projected resource inflows and the target for the Government s borrowing from the Central Bank. If the Government receives less domestic revenue than planned, expenditure is cut to ensure that borrowing remains within the limit agreed to in the Macroeconomic Framework. If donor budget support inflows are delayed, expenditures are not cut. In this case, the Government draws from its foreign currency reserves to finance priority spending. However, this adjustment is supposed to be restored by the Government making equivalent savings from future donor disbursements. * Maris Wanyera is Acting Commissioner Macroeconomic Policy Department at the Ugandan Ministry of Finance, Planning and Economic Development. Fiona Davies is an advisor at ODI s Budget Strengthening Initiative.

2 THE EVOLUTION OF MACROECONOMIC POLICY CO-ORDINATION AND MANAGEMENT When the current Government of Uganda came into power in 1986 it inherited an economy devastated by years of mismanagement. From the time of Idi Amin s coup in 1971, Gross Domestic Product (GDP) per capita had almost halved in real terms and exports had all but collapsed (with the exception of coffee). The country was plagued by chronic shortages of both foreign exchange and essential goods. Fearing that a devaluation of Uganda s currency would prove inflationary, the Government initially tried to stabilise the economy by fixing the exchange rate at an appreciated nominal rate. The fixed exchange rate was not effective in stabilising prices. Between 1986 and 1989, annual inflation averaged over 150 percent as the Government repeatedly financed budget shortfalls by borrowing from the Central Bank (i.e. printing money). At the same time the fixed exchange rate stifled growth in exports. This perpetuated foreign exchange shortages and led to a parallel black market for foreign exchange which sold Ugandan currency significantly below the official exchange rate. In 1990, after considerable internal debate, the Government realised that artificially fixing the exchange rate was not stabilising prices and was instead distorting economic growth. It took the bold decision to devalue the official exchange rate and legalise the parallel market. This helped to rapidly boost exports the value of non-coffee exports in dollar terms increased 500 percent in the space of just four years and reduced the rationing of imported consumer goods which had arisen from chronic foreign exchange shortages. By the mid-1990s the two rates had been merged into a single, floating exchange rate and the currency reform process was complete. However, it soon became clear that there was more to macroeconomic stability than just currency reform. Even after the devaluation of the official rate in 1990, and the legalisation of the parallel market, the economy continued to be dogged by high inflation. This was on account of the Government borrowing from the Central Bank to finance budget shortfalls. Between 1991 and 1992 the Government experienced a budget funding crisis that triggered a renewed spike in inflation. This persuaded the President that fiscal discipline was essential to macroeconomic stability. He responded by merging the Ministry of Finance and the Ministry of Planning and made fiscal discipline the cornerstone of the Government s macroeconomic policy. This marked a turning point in Uganda s management of macroeconomic policy, which has since been characterised by close coordination between the Central Bank and the Ministry of Finance. This has ensured that the direction of fiscal policy supports the Government s primary macroeconomic objectives of low and stable inflation, private sector-led growth, and a sustainable balance of payments position (characterised by foreign exchange reserves equivalent to at least five months of import cover). The results have been impressive: inflation has averaged less than 7 percent per annum for the past 18 years (barring occasional food price shocks); and GDP per capita has more than doubled. THE IMPLEMENTATION OF MACROECONOMIC POLICY CO-ORDINATION AND MANAGEMENT Macroeconomic policy co-ordination between the Bank of Uganda and the Ministry of Finance falls into two distinct phases during the budget cycle: the budget preparation phase; and the budget execution phase.

3 During the budget preparation phase macroeconomic policy is coordinated through the Macroeconomic Framework. During the budget execution phase it is co-ordinated by monitoring Government cashflow and setting quarterly limits on Government expenditure. The two management tools share the common objective of ensuring that Government expenditure can be financed without resorting to levels of domestic borrowing from the Central Bank (known as Net Credit to Government ) that are incompatible with low and stable inflation. The Macroeconomic Framework brings together all four sectors of the macroeconomy real (growth, inflation, exchange rate), external (Balance of Payments), monetary (the banking system), and fiscal (government revenue and expenditure). Its primary objective is to ensure that projections across all four sectors for the coming budget year are consistent with one another, and with the Government s macroeconomic policy objectives. Specifically, the Macroeconomic Framework determines the level of Government borrowing from the banking system that is consistent with the Central Bank s desired path for growth in money supply and foreign reserve coverage, in order to meet the Government s policy targets for growth and inflation. As such, it sets a limit on the amount the Government can spend BOX 1: THE RATIONALE FOR LIMITING GOVERNMENT BORROWING FROM THE CENTRAL BANK The rationale for limiting Government borrowing from the Central Bank to meet the Government s macroeconomic policy objectives is best illustrated by a summary of the monetary sector balance sheet in the Macroeconomic Framework set out below: Equation 1: Money Supply = Foreign Reserves + Net Domestic Assets (1) Net Domestic Assets are primarily comprised of Commercial Bank lending to the Private Sector (Private Sector Credit) and Central Bank lending to the Government (Net Credit to Government). Thus: Equation 2: Money Supply = Foreign Reserves + Private Sector Credit + Net Credit to Government (2) Of the four components of the equation, the projections for Money Supply, Private Sector Credit and Foreign Reserves are all linked to the realising the Government s macroeconomic policy objectives. The Central Bank sets the money supply projections at a level consistent with growth in aggregate demand to deliver the Government s objective of low and stable inflation. It targets a level of Private Sector Credit that can support the Government s objective of private-sector led growth. And finally, it has to keep the level of foreign reserves at least five months of import cover, to meet the objective of a sustainable balance of payments position. Thus it becomes inevitable that Net Credit to Government acts as the residual in the monetary equation, its level determined by the three other components: Equation 3: Net Credit to Government = Money Supply Foreign Reserves Private Sector Credit (3) The limit placed on Net Credit to Government directly feeds into the calculation of resource availability for financing the Government budget, as calculated in the fiscal sector of the Macroeconomic Framework: Equation 4: Budget Resources = Revenue and Grants + Net External Financing + Net Domestic Financing (4) Net Domestic Financing comprises Net Credit to Government and Non-Bank financing. This latter is negligible in Uganda, given its underdeveloped financial sector, so Net Domestic Financing is effectively determined by the level of NCG set by the Central Bank as a part of its projections for the monetary sector. This in turn means that the resources available for Government spending are primarily dependent on the projected level of inflows from domestic revenue, donor grants, and external loans net of repayments.

4 in any given year and determines the size of the budget. Co-ordination of macroeconomic and fiscal policy between the Central Bank and the Ministry of Finance through the Macroeconomic Framework means that printing money is no longer an option for financing Government expenditure. Given the constraints placed on resource availability (and consequently domestic financing) by the limit in Net Credit to Government it may seem like it would be tempting for the Ministry of Finance to inflate the size of the budget through unrealistic (overly optimistic) projections of domestic revenues and donor grants. However, inflating estimates of donor grants would simply raise the level of foreign reserves in the monetary sector and further reduce the Net Credit to Government. This would lead to no net gain in resources (see Equation 3 in Box 1). While inflating estimates for domestic revenues would increase resources available for financing the budget on paper it would not translate into an increase in actual spending. This is due to the imposition of cash limits on Government expenditure during budget execution. The second phase of macroeconomic policy coordination between the Bank of Uganda and the Ministry of Finance happens during budget execution. Once the budget has been approved the Central Bank and the Ministry of Finance monitor Government cashflow the aggregate inflow and outflow of government resources - on a monthly basis. This ensures that spending stays within the levels set in the budget and that Net Credit to Government does not exceed the approved level for the year. Quarterly limits are placed on Government expenditure consistent with projected resource inflows and with the Net Credit to Government target. If the Government experiences a shortfall in domestic revenue relative to budgeted levels, expenditure is cut to ensure that the level of Net Credit to Government remains within the limits agreed in the Macroeconomic Framework. The closeness of the working relationship between the Ministry of Finance and the Central Bank is an essential component of macroeconomic policy co-ordination in Uganda. The Ministry of Finance takes overall responsibility for maintaining the Macroeconomic Framework and Government cashflow using data supplied by both institutions. The Central Bank takes the lead in providing the monetary survey, which presents the government s financial positions with the monetary authorities and the commercial banks, as well as exchange rate and balance of payments data; while the Ministry of Finance is responsible for managing data on domestic revenues, donor grants, net external financing and Government expenditure. Both institutions use outturn data on inflation and growth produced by the Uganda Bureau of Statistics, and jointly agree on the forecasts for these aggregates. The working relationship between the Central Bank and the Ministry of Finance is governed by a Memorandum of Understanding which sets out Terms of Reference for key co-ordination committees on macroeconomic monitoring, cashflow management, liquidity forecasting, debt management and external flows. The Research and Macro Departments of both institutions hold weekly meetings throughout the year. ISSUES IN CURRENT PRACTICE The reforms that Uganda implemented in the 1990s proved highly successful in attracting aid over a fifteen year period aid trebled in dollar terms and an increasing proportion was channelled through the Treasury as budget support rather than allocated to projects. During this time, Government expenditure rose from around 17 percent of GDP to almost 25 percent. And it became increasingly clear that absorbing significant increases in aid had implications for macroeconomic stability, even as Net Credit to Government remained low and stable. As aid was mainly being used to finance

5 domestic expenditures (i.e. teachers and health workers wages) it led to an increase in fiscal liquidity (i.e. expanded the money supply) in the domestic economy. To keep inflation in check the Central Bank had to sterilise this increase in liquidity. Its two main options for doing so were to sell foreign exchange or to sell domestic securities. To avoid discouraging exports by appreciating the exchange rate, the Central Bank mainly opted to sell domestic securities. This squeezed the credit available to the private sector, jeopardising the macroeconomic objective of private-sector led growth. To address this problem, the Government has adopted a strategy of limiting the overall level of donor aid it spends in a given year to levels that are compatible with liquidity management. The Government is also gradually reducing its long-run dependency on aid to finance expenditure and uses the Macroeconomic Framework to ensure that budget financing is compatible with these objectives. In recent years the Government has made significant efforts to increase tax revenue collections with a target to increase tax revenues by 0.5% of GDP each fiscal year. Another issue has been the capacity of the economy to respond to supply-side inflationary shocks, such as an increase in food prices. While Uganda s macroeconomic policy co-ordination has been highly successful in ensuring that Government expenditure is not inflationary, it has not been a useful tool for helping the economy weather supply-side shocks. This has to be dealt with through the direction of Government s budget policies. Government spending to date has focused more on service delivery than on developing the productive capacity of the economy. As a result growth has primarily been driven by the service sector. If the economy is to develop greater capacity to respond to food price shocks, greater priority needs to be placed on spending that can help boost production, particularly in agriculture and infrastructure. BIBLIOGRAPHY Kuteesa, Tumusiime-Mutebile (2010) Uganda s Economic Reforms. Oxford: Whitworth and Williamson, Oxford The Country Learning Notes series is intended as a tool for policy makers and practitioners to learn from the experiences of other countries. Each note focuses on a specific country and a particular policy area, documenting the challenges faced and decisions taken to overcome them. The series can be freely downloaded from For more information please contact bsi-research@odi.org.uk. Readers are encouraged to reproduce material from the Country Learning Notes series for their own publications, as long as they are not being sold commercially. As copyright holder, ODI requests due acknowledgement and a copy of the publication. For online use, we ask readers to link to the original resource on The views presented in this paper are those of the author(s) and do not necessarily represent the views of ODI. Overseas Development Institute 2012 Budget Strengthening Initiative Overseas Development Institute 203 Blackfriars Road London, SE1 8NJ