BANK OF UGANDA STATE OF THE UGANDAN ECONOMY AS AT END MAY Research Department. June 2008

BANK OF UGANDA STATE OF THE UGANDAN ECONOMY AS AT END MAY 2008 Research Department June 2008 Prepared for the meeting of the Board of Directors of the Bank of Uganda

TABLE OF CONTENTS EXECUTIVE SUMMARY...IV 1. INTRODUCTION...1 1.1 MACROECONOMIC OBJECTIVES FOR 2007/08...1 2. DOMESTIC PRICE AND MARKET DEVELOPMENTS...2 2.1 DOMESTIC PRICES...2 2.2 DOMESTIC MONEY AND SECURITIES MARKETS...4 2.2.1 The primary market for Government securities...4 2.2.2 The Secondary Market for Government Securities...6 2.2.3 The Inter-bank money market...8 2.2.3 Commercial Banks interest rates...9 3.3 THE FOREIGN EXCHANGE MARKET AND THE EXCHANGE RATE...10 3.3.1 Exchange rate developments...10 3.3.2 Activity in the foreign exchange market...11 3. MONETARY AND FINANCIAL SECTOR AGGREGATES...11 3.0 BANKING SECTOR HIGHLIGHTS...11 3.1 BASE MONEY...12 3.2 BROAD MONEY...13 3.2.1 Net Foreign Assets (NFA)...13 3.2.2 Net Domestic Assets (NDA)...14 4 DEVELOPMENTS IN THE NON-BANK FINANCIAL INSTITUTIONS...15 4.1 CREDIT INSTITUTIONS...15 PRIVATE SECTOR DEPOSITS...17 4.2 MICRO-FINANCE DEPOSIT-TAKING INSTITUTIONS (MDI S)...17 5 GOVERNMENT FISCAL OPERATIONS...19 5.1 REVENUE AND GRANTS...19 6 EXTERNAL SECTOR AND BALANCE OF PAYMENTS DEVELOPMENTS.21 6.1 OVERALL BALANCE OF PAYMENTS...21 6.2 THE CURRENT ACCOUNT...22 6.2.1 Trade Balance...22 6.2.2 Exports...22 6.2.3 Imports...23 6.2.4 Services account...24 6.2.5 Income account...24 6.2.6 Current transfers...24 6.3 THE CAPITAL AND FINANCIAL ACCOUNT...24 6.4 FOREIGN RESERVES...24 6.5 EXTERNAL DEBT...25 ii

7. REAL ECONOMY DEVELOPMENTS...25 7.1 ECONOMIC GROWTH...26 7.2 STRUCTURE OF THE ECONOMY...27 8 MEDIUM-TERM OUTLOOK AND CHALLENGES...29 iii

EXECUTIVE SUMMARY 1.1 Introduction This paper outlines the macroeconomic framework for the 2007/08 and the performance of the economy over 2007/08. Overall, macroeconomic performance during this period was in line with the benchmarks contained in the Government s Programme of Economic and Financial Policies (EFP), herein after referred to as the Programme. Macroeconomic objectives for 2007/08 For the 2007/08, the main macroeconomic objectives of the Government s Programme were aimed at: Maintaining a GDP growth rate of 6.5 percent per annum by end of the fiscal year Achieving a headline inflation rate of 5 percent or less on average, by end of the fiscal year; consistent with a growth in money supply of 17 percent in 2007/08 The conduct of monetary policy remained focused on promoting price stability to support the broad macroeconomic objectives outlined above. Specifically, Net Domestic Assets visa-vis Base Money: During 2007/08, monetary policy remained anchored on base money though Net Domestic assets (NDA) was adopted as the assessment criterion for the Programme in order to accommodate unexpected shifts in demand for money, including positive shocks to the Balance of Payments. Base money remained an indicative target. Liquidity Management: The Bank of Uganda (BOU) continued to manage liquidity using an instrument mix that took into account the conditions in the financial markets. Open market operations for liquidity management were also used as and when the conditions in the IFEM did not allow sale of foreign exchange. Move to Inflation Targeting: BOU made steady progress with preparations to move to inflation targeting as a monetary policy-monitoring tool given the recent instability in money demand and the need to be more flexible and proactive in the conduct of monetary policy. Towards this end, the Uganda Bureau of Statistics (UBOS) committed to the production of higher frequency data, which is required for better inflation forecasting. At the central Bank level, modeling the transmission mechanism of monetary policy has commenced. iv

Prices and market developments Inflation: During 2007/08, the annual headline inflation averaged 7.3 percent down from 7.5 percent in the previous year. The moderation in inflation was driven largely by easing food prices caused by favourable weather conditions in the first half of the year. Headline inflation was recorded at 5.4 percent in July 2007 before edging up in the second and third quarters to a high of 12.5 percent in June 2008 largely on account of rising fuel and food prices Domestic money market and securities markets: Both the primary and secondary markets were very active during 2007/08. Interest rates on treasury bills were generally higher at the longer end of the market over the period January to June 2008 compared to the rates recorded between July 2007 and December 2007. Foreign exchange market and exchange rate: The shilling has since September 2007 appreciated 7.3 percent from a monthly average of Shs1, 762.8 per US dollar to Shs 1,600.7 per U.S. dollar in June 2008. The strengthening of the shilling was due to the large foreign exchange inflows into the economy and the global weakening of the U.S. dollar Monetary and financial sector aggregates Base money: Base money in gross terms, defined as Commercial Banks deposits at Bank of Uganda, plus currency issued and Commercial Banks holdings of BOU securities, increased by 15.9 percent in May 2008 over the June 2007 level. The May 2008 base money growth was however lower when compared to a growth of 34.6 percent in the same period to May 2007. Increased net foreign assets moderated by Government s savings at the BOU, contributed to base money growth during the period Broad money: Broad Money (M3), comprising of currency in circulation and all private sector deposits, grew by 30.1 per cent from Shs. 3,842.0 billion to Shs. 4,997.7 billion. The growth in M3 was partly explained by the robustness of residents foreign denominated deposits associated with strong balance of payments developments as well as a rather strong growth in the demand and time deposits during the period v

Government fiscal operations Provisional estimates for fiscal operations indicate the following; Revenue: Domestic revenue in the first nine months of 2007/08 amounted to Shs. 2,310.3 billion, which, relative to the program for the first half of 2007/08, was an over performance of 101.8 percent. Domestic revenue for the first nine months of 2007/08 also surpassed that of the corresponding period in 2006/07 by 19.6 percent. This performance is largely attributed to an over performance in URA collections, following stronger demand for imports and increased tax payer compliance coupled with efficiency in revenue collections Expenditure: Total government expenditures and net lending for the first nine months of 2007/08 is estimated at Shs. 3,269.5 billion, reflecting an under performance of 87.5 percent against the programmed level of Shs. 3,734.8 billion. This level of expenditure is however higher than Shs. 2,718.7 billion utilized in the corresponding period of 2006/07. Fiscal balance: The overall budget balance including grants during the first nine months of 2007/08 is estimated to have worsened to a deficit of Shs. 177.3 billion, which is also above the programmed deficit level of Shs. 714.2 billion. This deficit compares to a surplus of Shs. 266.5 billion in the same period a year ago. Excluding grants, the deficit is estimated to have worsened to Shs. 959.2 billion, compared to a deficit of Shs. 1,466.2 billion envisaged in the program and Shs. 787.0 billion realized in the corresponding period of 2006/07. External sector and balance of payments developments Overall Balance: During 2007/08, the overall balance of payments position is expected to decline to approximately US$676.7 million compared to a surplus of US$745.3 million recorded in the previous fiscal year. The expected decline in the overall balance is mainly attributed to the worsened position of the current account balance from the previous fiscal year, despite an improvement in the capital and financial account. The capital and financial account is projected to improve from a surplus of US$1,076.0 million in 2006/07 to a surplus of US$1,234.5 million in 2007/08. Current account: The deficit on the current account is expected to increase from US$330.7 million registered in the previous fiscal year to US$557.8 million this year as a result of higher private sector imports compared to the previous year. In terms of GDP, the current account deficit is estimated to increase to 4.3 percent in 2007/08 from 3.0 percent in 2006/07. Excluding official grants, the current account deficit as a percentage of GDP is expected to be 8.6 percent for 2007/08 compared to 7.9 percent in 2006/07. vi

Foreign reserves: Despite the deterioration of the current account, the foreign reserves at the Bank of Uganda are expected to increase by US$ 615.2 million (excluding revaluation gains and losses) in 2007/08. The reserve growth is due to the higher budget support disbursements observed in 2007/08. By the close of the year, Bank of Uganda s foreign reserves are expected to cover over 6 months of imports of goods and services. Real economy developments Economic growth: Real Gross Domestic Product is estimated to have grown by 9.8 percent in 2007/08, up from 7.9 percent recorded in 2006/07. Gross Domestic Product (GDP) in real value terms was estimated at Shs. 18,236 billion in 2007/08 compared to Shs. 16,610 billion recorded for 2006/07. The performance was largely as result of robust growth in all sectors of the economy. Favourable international commodity prices, installation of thermal power generation to address the energy problems and better heavy rains helped drive growth. Structure of the Economy: The structure of the economy continued to change, with the share of the Agriculture Sector contracting further to 21.4 percent of GDP in 2007/08 from 22.5 percent in 2006/07, while the share of the Services sector continued to expand from 47.4 percent in 2006/07 to 49.0 percent in 2007/08. In line with the world economy where the Service Sector contributes about 60 percent of GDP, a rising dominance of the services sector in the Ugandan economy was observed. Electricity: 2007/08 registered growths in the electricity sector as reflected by the increase in both the number of live customers and consumption. The rains experienced in the first quarter of the year boosted the hydropower generation capacity. Capacity was helped by the raised water levels in Lake Victoria, which feeds into the Owen Falls Hydro-electric power station on the River Nile. To address the current energy shortfall amounting to approximately 200 Mega Watts, work started on the construction of the Bujagali hydropower project while construction of the Karuma hydropower project is expected to begin further downstream from the Owen Falls in 2008/09. Additionally, the recent discovery of petroleum deposits in the country is also expected to enhance thermal power generation in mid 2009. Medium term outlook and challenges Outlook In the medium-term outlook, GDP is projected to grow at least by an average of about 8 percent per year over the next three years. vii

Both annual underlying and annual headline inflation rates are expected to stabilize at or below the 5 percent level. Gross domestic investment is expected to rise to more than 25 percent of GDP, while domestic and national savings will remain within the current range of 10-15 percent of GDP. Revenue performance is also projected to rise to about 15 percent of GDP. Gross foreign exchange reserves are projected to remain at a level equivalent to more than 6 months of future imports of goods and non-factor services. Export receipts are projected to increase by about 10 percent per annum as the drive for increased value addition gains momentum, while the terms of trade are expected to improve. Challenges Risks to appreciation pressures on the exchange rate if the positive shocks to BOP persist. Improving export sector productivity and lowering the costs of doing business as a sustainable measure for continued competitiveness of the sector in the long run. Deepening and strengthening the financial sector to make it more robust and resilient to shocks. The risks to the medium-term macroeconomic objectives posed by energy problems could spill over to sustained inflationary pressures. Notwithstanding the commendable gains made in poverty reduction, poverty still remains a fundamental problem. Reducing poverty and improving social sector indicators will require higher economic growth rates. The challenge of integrating the poor into the growth process thus remains. Enhancing the relevancy of monetary and financial sectors in the context of poverty reduction while maintaining macroeconomic stability remains a big challenge. The pass through effects of the looming economic slowdown in the United States of America following the disturbances arising from the sub prime mortgages sector and the subsequent credit crunch and financial crisis. The challenge is how to deepen the financial sector further and to increase both production capacity and productivity in order to be able to weather the likely shocks to our economy. viii

1. INTRODUCTION This report provides an analysis of the performance of the economy in the first eleven months of 2007/08 against the performance benchmarks of the 2007/08 macroeconomic framework and the performance during the preceding period and the corresponding period of 2006/07. Overall, the developments in aggregates were in line with the performance benchmarks. Economic growth was better than programmed. Domestic prices, exchange rates and interest rates remained relatively stable; the BOP recorded a strong performance while fiscal policy was in line with Programmed levels. The rest of the report is structured as follows: Section 2 provides an overview of the macroeconomic objectives for 2007/08; Section 3 discusses the management strategies and policy actions undertaken during the period under review; while Sections 4-9 provide an analytical assessment of the performance in light of the management strategies undertaken during the period under review. Section 10 provides mid-term outlook and challenges envisaged in the wake of recent economic, political and social developments in the region and the global economy. 1.1 Macroeconomic objectives for 2007/08 For the 2007/08, the main macroeconomic objectives were aimed at: Maintaining a GDP growth rate of 6.5 percent per annum by end of the fiscal year on account of better than expected growth in both the agricultural and industrial sectors, Achieving a headline inflation rate of 5 percent or less on average, by end of the fiscal year, mindful of the pressures from exogenous factors such as rising energy prices, unfavourable weather conditions and the aftermath of the riots in Kenya following the recently concluded elections; Consistent with the above objectives, growth in money supply was projected at 17 percent in 2007/08 while the net change (increase) in Net Domestic Assets (NDA) of BOU was projected to increase by Shs. 207.6 by the end of the fiscal year. Net international reserves of BOU were projected to increase to US$2,600 million by end June 2008. MONETARY AND EXCHANGE RATE POLICY During the first ten months of 2007/08, the conduct of monetary policy remained focused at maintaining price stability to enable the attainment of the overall macroeconomic stability objectives. In addition to maintaining stability, monetary policy was also tailored to provide a conducive environment for financial intermediation. This was done in a cautious manner that could not cause instability in the domestic and foreign exchange markets. Sterilization of excess liquidity was effected through a combination of sales of Treasury bonds, net issuances of Treasury bills and daily sales of foreign exchange. In 1

addition, BOU continued to use the Repurchase Agreements (REPOs) as a flexible finetuning instrument in order to manage the intra-auction liquidity. The liquidity management efforts were supplemented by adjustments of the Rediscount Rate and Bank Rate to ensure a consistent monetary policy stance. During the period under review, authorities continued to operate under the Policy Support Instrument (PSI), an IMF supported, non-borrowing program, which was adopted in February 2006. Overall, the macroeconomic performance during the period was in line with the PSI benchmarks. BOU continued to pursue a flexible exchange rate policy, with occasional intervention in the inter-bank foreign exchange markets (IFEM) to minimise volatility in the market. During 2007/08, appreciation pressures prompted the BOU to halt daily sterilisation sales of dollars in November 2007 so as to restore stability. 2. DOMESTIC PRICE AND MARKET DEVELOPMENTS 2.1 Domestic prices The Uganda Bureau of Statistics rebased the Consumer Price Index (CPI) to 2005/06 from 1997/08 and re-weighted some items in the CPI basket to reflect current consumption patterns of consumers. During 2007/08, the annual headline inflation averaged 7.3 percent, slightly lower than 7.5 percent observed in the previous year. The outturn of inflation during 2007/08 is explained largely by the easing food prices driven mainly by favourable weather conditions that were experienced in the first half of 2007/08. Headline inflation was recorded at 5.4 percent in July 2007 before it edged up in the remainder of the year to close at 12.5 percent in June 2008. The pick up in inflation was largely on account of the rise in fuel and food prices. The annual core inflation, a measure that excludes food crops and energy, fuel and utilities, averaged 7.9 percent, higher than 6.9 percent registered in 2006/07. Annual core inflation maintained an upward trend during the year to a rate of 12.1 percent in June 2008. In the second quarter of the year, developments in core inflation were driven by increased demand for goods and services arising from Common Wealth Heads of Government Meeting (CHOGM) activities in November 2007. In addition, developments in world oil prices also translated into high domestic transport costs. Price developments were exacerbated by the political crisis in Kenya following elections in December 2007. The fall out from the Kenya crisis led to disruptions in movements of goods imported 2

through Mombasa to Uganda. In particular, disruptions in the trade route constrained fuel supplies as well as flow of other goods for about two months. As such, prices of fuel, transport, and other imported goods rose significantly from the months of January and February 2008 onwards. Core inflation thus rose to an average of 9.7 percent for the second half of 2007/08 compared to 6.2 percent, for the first half of the fiscal year. The Energy, Fuel, and Utilities (EFU) inflation averaged 11.6 percent in 2007/08 down from 28.9 percent in the previous year. Though international oil prices and the recent Kenyan crisis impacted negatively on EFU inflation, the stability in electricity tariff following a 40 percent increase in November 2006 helped lower EFU inflation. The food crop inflation averaged about 0.4 percent in 2007/08 from 3.1 percent that was recorded during 2006/07. Prices of food crops declined during the first half of 2007/08 mainly on account of improvement in the supply of most food items following favourable weather conditions that were experienced. Prices however increased moderately during the second half due to the sustained regional demand and reduced supply. However, the impact of the food crop developments did not significantly affect the overall inflation on account of the reduction of the weight of this component in the new CPI basket. Bank of Uganda recognises the potency of the above exogenous inflationary pressures in driving inflation. Going forward, cautious monetary and prudent fiscal policy management will be employed to contain inflation. Policy is expected to continue to respond in a manner that is not fully accommodative. It is envisaged that such a policy stance will help achieve to things. First, it will help us curb the second round effects of the price shocks. Second, and most importantly, it will help to anchor inflationary expectations downwards. The developments in inflation for the period July 2006 to June 2008 are shown in the chart below. 3

Figure 1: Annual Inflation Developments: July 2006-June 2008 Headline & Core Inflation( %) 15.0 10.0 5.0 0.0 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 40.0 20.0 0.0-20.0 Food crop & EFU Inflation (%) Headline Core EFU Food Crops Source: Uganda Bureau of Statistics 2.2 Domestic money and securities markets 2.2.1 The primary market for Government securities (a) Treasury Bills Developments in the Primary Market The primary issuance of Treasury bills remained an important tool for monetary policy management in the financial year 2007/08. The stock of Treasury bills rose by 14.0 percent, from Shs. 1,340.4 billion recorded at the end of June 2007, to a revised Shs. 1,528.5 billion as at end-december 2007. By end-june 2008, this stock had declined slightly by 0.7 percent to Shs. 1,518.3 billion. At this point, Commercial Banks held 46.2 percent of the total stock of Treasury bills compared to a revised 61.8, and a revised 47.7 percent reported in June and December 2007, respectively. The share of BOU holdings increased to 20.5 percent in June 2008 from a revised 16.7 percent in December 2007 and was at a revised 8.2 percent in June 2007. Interest rates on treasury bills were generally higher at the longer end of the market over the period January to June 2008 compared to the rates recorded between July to December 2007. The respective weighted annual discount rates for the 91-day, 182-day, and 364-day bills were 8.3, 13.2, and 13.0 percent in the last auction of June 2008. These rates were higher than the respective levels of 8.0, 11.0, and 11.6 percent in the last auction of December 2007. In the last auction of May 2007, these rates were 9.1, 11.5, and 11.1 percent, respectively. 4

Figure 2: Trend of discount rates on Treasury bills (June 2002 June 2008) 25 Discount Rates (%) 20 15 10 5 0 Jun-02 Oct-02 Feb-03 Jun-03 Oct-03 Feb-04 Jun-04 Oct-04 Feb-05 Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08 Jun-08 91-days 182-days 364-days Source: Bank of Uganda (b) Treasury Bonds 1 Developments in the Primary Market In the five months to May 2008, BOU issued Treasury bonds in 2, and 3-year tenors to support monetary policy implementation and promote market development through the creation of more tradable securities. In addition, these securities assisted in extending both the maturity of the instruments traded and the yield curve. They also provided an additional saving instrument, thereby widening the capital market. Total Treasury bond issues, including one unscheduled issue, in the five months to May 2008 amounted to Shs.292.8 billion at face value. These issues, together with 2-year and 3- year bond maturities totalling Shs. 135.0 billion, brought the outstanding stock of treasury bonds to Shs. 1,414.4 billion by the close of May 2008. In the previous six months to December, and to June 2007, total issues amounted to Shs.448.9 billion, and Shs.207.0 billion, respectively. All Treasury bond issues were listed on the Uganda Securities Exchange. Details of the developments in the primary Treasury bond market activity are shown in Table 2 below. 1 A bond is a market instrument with a maturity term longer than one year. 5

Table 2: Treasury bond volume, cost price and interest rates Tenor/ Issue date Total H2 FY 06/7 Total H1 FY 07/8 2 Year New Issue Jan 09-08 3 Year New Issue Mar 05-08 2 Year New Issue Apr 02-08 3 Year New Issue Apr 30-08 3 Year New Issue May 14-08 2 Year New Issue May 28-08 Total Jan-May 08 Offers (Shs bn) 207.00 457.00 20.000 60.000 60.000 60.000 60.000 60.000 320.00 Total bids (Shs bn) 409.31 707.30 53.539 128.068 62.718 75.592 40.039 88.587 448.54 O/w Competitive 403.26 659.04 53.496 128.030 62.668 75.580 40.025 88.540 448.34 Over (under) subscription Amount sold (Face value) Amount sold (Cost price) 202.31 252.52 33.539 68.068 2.718 15.592 (19.961) 28.587 128.54 207.00 448.89 20.000 60.000 52.718 60.000 40.039 60.000 292.76 199.28 397.58 18.669 55.247 49.094 55.561 36.627 55.506 270.70 Bid-Cover ratio 2.677 2.134 1.045 1.260 0.667 1.476 WAP per Shs. 100 93.345 92.079 93.127 92.601 91.479 92.510 Yield to maturity % Source: Bank of Uganda 13.926 13.550 14.061 13.322 13.815 14.445 The 2-year bond rates rose, while the 3-year bond rates declined gradually in the five months to May 2008, compared to the rates recorded in the first half of 2007/08. As depicted in Table 2, the yield-to-maturity on the 2-year bond that was at 13.9 percent end-december 2007 rose to 14.4 percent by end-may 2008. On the other hand, the yieldto-maturity on the 3-year bond decreased from 14.0 percent end-november 2007 to 13.8 percent by end-may 2008. A total of Shs. 47.6 billion and Shs. 41.5 billion were paid to cover coupon payments on bonds January and May 2008, and between July and December 2007, respectively. 2.2.2 The Secondary Market for Government Securities (a) Treasury Bills Developments In the secondary Market, total trades over the January to May 2008 period were Shs.378.4 billion. From July to December 2007, and these amounted to Shs.444.3 billion, while in the period January to June 2007 total secondary market trades executed were Shs.179.4 billion. Indicators of the secondary market activity in treasury bills are summarized in Table 3. The average indicative rates derived from daily bid and offer yield-to-maturity rate quotations by the primary dealers for secondary trading of Treasury bills realized over the 6

period January to May 2008 were 8.4/8.2, 12.3/12.0, and 13.8/13.5 percent for the 91-days, 182-days and 364-days securities. With the exception of the rates for the 364-day paper, these were lower than the average rates of 9.5/9.2, 12.5/12.3, and 13.2/12.9 percent for the respective papers in the six months to December 2007. In the period January to June 2007, these rates were 9.7/9.4, 11.6/11.4, and 12.3/12.1 percent, respectively. Table 3: Summary indicators from the Secondary Market for Treasury bills (January- May 2008) Yield to maturity rates quotation (%) 91 days 182 days 364 days Bid Offer Bid Offer Bid Offer Minimum 7.35 7.21 10.81 10.53 11.35 11.06 Maximum 10.41 10.20 13.81 13.55 15.49 15.18 Average 8.43 8.17 12.26 12.01 13.80 13.48 Trading activity Transactions (Shs bn) 161.612 66.138 150.667 O/w horizontal repos 39.000 - - O/w transfers - - - O/w outright sales 122.612 66.138 150.667 Av. discount rate (%) 9.72 10.65 11.63 Av. Yield to maturity rate (%) 10.19 11.25 12.68 Source: Bank Of Uganda As shown in Figure 3, the yield curve derived from average yield-to-maturity quotes in the secondary market was upward sloping across the maturity profile, albeit with a steeper slope between the 91-days, and 182-days securities. Figure 3: Securities yield curve for the period July 2007 - May 2008 Annualized yields (%) 16 15 14 13 12 11 10 9 8 91-days 182-days 364-days 2-years 3-years 5-years 10-years Secondary market average Bid quote Secondary market average Offer quote Source: Bank of Uganda 7

(b) Treasury Bonds During the period January to May 2008, the average indicative bid/offer yields-tomaturity in the secondary market were 13.5/13.3, 13.9/13.7, 14.2/13.9, and 14.6/14.4 percent for the 2-year, 3-year, 5-year and 10-year bonds, respectively. This compares with the respective average rates of 12.6/12.4, 13.3/13.1, 13.9/13.7, and 15.1/14.9 percent or the six months to December 2007, and 12.7/12.4, 12.8/12.5, 14.0/13.7, and 15.6/15.3 percent for the same period to June 2007. In the five months to May 2008, a total of Shs. 59.1 billion of the 2-year bond, Shs.88.9 billion of the 3-year bond, Shs.120.2 billion of the 5- year bond, and Shs.3.0 billion of the 10-year bond were traded on the secondary market at respective average yields-to-maturity of 13.4, 12.2, 12.7, and 11.9 percent. A summary of indicators of secondary market activity in the Treasury bond market is provided in Table 4. Table 4: Summary indicators from the Secondary Market for Treasury bonds (January May 2008) 2 years 3 years 5 years 10 years Yield to maturity rates quotation (%) Bid Offer Bid Offer Bid Offer Bid Offer Minimum 12.45 12.20 13.25 12.00 13.80 13.00 13.40 13.20 Maximum 14.25 13.85 14.50 14.25 14.50 14.25 16.00 15.75 Average 13.51 13.27 13.92 13.67 14.16 13.92 14.64 14.40 Source: Bank of Uganda 2.2.3 The Inter-bank money market The weighted inter-bank money market rates increased during 2007/08 from 6.6 percent in July 2007 to 7.8 percent in May 2008 while total volumes traded rose by 12.9 percent to Shs. 5,911.3 billion from Shs. 5,234.7 billion in 2006/07 reflecting the underlying liquidity needs in the domestic money markets All the commercial banks participated in the inter bank market during the year to smooth their daily liquidity fluctuations and to cover their daily liquidity needs. 8

Table 5: Summary of inter bank money market activity July 2007-May 2008 Amount Tenor No. Of transactions (Shs bn) Weighted Rate Overnight 866 2269.24 6.50 2 days 98 252.19 7.30 3 days 156 399.7 7.72 4 days 126 267 7.15 5 days 89 204 7.53 6 days 123 256.4 8.73 1 week 1066 1859.71 8.98 > 1 week 222 389.16 8.75 Total 2726 5911.26 7.79 Source: Bank of Uganda 2.2.3 Commercial Banks interest rates The commercial banks weighted average rates were still high due to structural problems in the economy, although they remained stable through most of the period under review. There was stability in the effective lending rates on loans denominated in shillings and dollars throughout the year in line with the trends in the inter bank market, securities markets and the policy rates. As shown in Table 5, effective lending rates for shilling denominated loans stood at 19.9 percent in May 2008 compared to 18.9 percent in December 2006 and 19.4 percent in June of 2007. Similarly, the lending rates in the foreign currency denominated loans rose to 9.6 percent in May 2008 compared to 9.2 percent obtaining at the end of the end of 2006/07. The rates on shilling time deposits also rose to 11.5 percent in May 2008 compared to the 9.8 percent and 7.6 percent observed in June 2007 and June 2006 respectively. The foreign currency denominated time deposit rate however declined to 3.3 percent from 6.2 percent in June 2007. The May 2008 level however was higher than the rate of 2.9 percent observed in June 2006. The rate on the foreign currency denominated savings deposits remained at the June 2007 level of 1.5 percent while rate on the shilling denominated savings deposits declined to 2.5 percent in May 2008 from 2.8 percent in June 2007. Developments in Commercial Bank lending rate are shown in Table 6. 9

Table 6: Commercial bank lending and deposits rates Jun 2006 Dec 2006 Jun 2007 May 2008 Jun 2006 Dec 2006 Jun 2007 May 2008 Weighted average rates Shilling denominated (%) Foreign currency denominated (%) Lending 18.60 18.91 19.38 19.92 9.92 9.23 9.19 9.58 Savings deposits 2.02 2.02 2.79 2.51 1.45 1.53 1.48 1.51 Time deposits 7.57 9.12 9.80 11.54 2.86 5.25 6.22 3.32 Source: Bank of Uganda 3.3 The foreign exchange market and the exchange rate 3.3.1 Exchange rate developments The exchange rate of the Uganda shilling against the U.S. dollar registered sustained appreciation since 2006/07. Month on month, the shilling appreciated 11.6 percent against the US$ from June 2006 to June 2007. Following the strong intervention by the central bank, the shilling weakened 7 percent from June 2007 to September 2007. The Bank intervened to smoothen the high levels of volatility that characterized the market in this period. The shilling has since September 2007 appreciated 7.3 percent from a monthly average of Shs1, 762.8 per US dollar to Shs 1,600.7 per U.S. dollar in June 2008. The strengthening of the shilling is due to the large foreign exchange inflows into the economy and the global weakening of the U.S. dollar. Foreign exchange inflows are due to favourable terms of trade and higher capital and current inflows. Volumes of trade also show subdued corporate demand in the period under review. Non Bank supply of foreign exchange exceeded demand by US$122.0 million during the period July 2007-May 2008 in the Inter-bank Foreign Exchange Market (IFEM). Net actions (sterilisation and intervention) of the central bank in the IFEM resulted in a net purchase of US$ 68.7 million in the IFEM in the period July 2007, to May 2008. Figure 5 below shows the exchange rate trend from January 2007 to May 2008. Figure 5: Developments in the Nominal exchange market, January 2007- May 2008 Spread(Ugshs) 20 15 10 5 0 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 1,850 1,800 1,750 1,700 1,650 1,600 1,550 Midrate(Ugshs/US$) Average Spread Average Mid rate Source: Bank of Uganda 10

3.3.2 Activity in the foreign exchange market Gross purchases in the inter-bank foreign exchange market increased by 69.2 percent to US$ 7,306.7 million in the eleven months of 2007/08 from US$ 4,319.5 million in the corresponding period of 2006/07. Similarly, gross sales increased by 67.1 percent from US$ 4,300.6 million to US$ 7184.7 million. In July 2007 and November 2007, daily sterilization using foreign exchange was temporarily suspended mainly due to the appreciation pressures on the shilling. The liquidity mopping strategy was resumed on August 07, 2007 albeit with a lower amount of US$0.5 million compared to the earlier amounts of US$0.7 million. Exchange rate volatility occasioned by spikes in appreciation pressures prompted the BoU to intervene in the IFEM to ensure stability. 3. MONETARY AND FINANCIAL SECTOR AGGREGATES This section presents financial sector highlights including the developments in the base money and broader money aggregates, which incorporate the activities of Commercial Banks and non-bank financial sector. 3.0 Banking Sector highlights The banking sector witnessed stability and grew considerably during the year 2007/08 both in terms of size and number of institutions. Following the lifting of the moratorium on the opening new banks by the government of Uganda during the financial year 2005/6, Bank of Uganda received fresh applications for banking licenses during the year and by April 2008, licenses for five banks had been approved. The five banks licensed are Housing Finance Bank (HFB) Ltd., United Bank for Africa (UBA) Ltd, Kenya Commercial Bank (KCB Bank) Ltd, Global Trust Bank Ltd and Fina Bank (U) Ltd. Housing Finance Company of Uganda transformed from a credit institution into a commercial bank. These developments have spurred competition amongst the existing banks resulting into expanded branch network and increase in the range of products offered. All banks remained adequately capitalized observing the minimum requirements stipulated in the Financial Institutions Act 2004 (FIA 2004). There was Sustained public confidence in the banking sector reflected by the growth of 30.1 percent in total deposits of commercial Banks to Shs. 4,116.3 billion in April 2008 from Shs. 3,165.1 billion in June 2007compared to a growth of 17.8 percent in the corresponding period of June 2006-April 2007. 11

The total non-performing loans as a percentage of total advances rose slightly from 2.95 percent in December 2006 to 4.1 percent in December 2007 but nevertheless remained under/well within the prudential limit of 10 percent. Bank of Uganda will continue to improve the degree of surveillance of banks to ensure improved credit risk management in banks. The sector posted a phenomenal increase of 41.9 percent in net after tax profits from Shs.136 billion for the year 2006 to Shs. 193 billion for the year 2007. All banks held ample liquidity to meet ongoing operational requirements with an average ratio of liquid assets to deposits of 46.7 percent, which is well beyond the minimum statutory requirement of 20 percent. The apparent decline in the percentage of liquid assets to deposits ratio from 50.7 percent of the previous year is attributed to increased level of intermediation by banks. In view of strengthening oversight of financial institutions, a set of 3 new regulations on Anti-Money Laundering, Foreign Exchange and External Auditors will soon be gazetted. The process of setting up of a Credit Reference Bureau (CRB) is ongoing. Service Level Agreements have already been signed between the Service Provider- Compuscan (CRB) Ltd and all the participating financial institutions (Commercial Banks, Credit Institutions and Micro-Deposit Taking Institutions). BoU has also launched public awareness campaigns to inform, educate and prepare key stakeholders about the CRB and the Financial Card System (FCS). The FCS is a system that uses biometrics to uniquely identify borrowers. 3.1 Base money Base money in gross terms, defined as Commercial Banks deposits at Bank of Uganda, plus currency issued and Commercial Banks holdings of BOU securities, increased by 18.8 percent in April 2008 over the June 2007 level, lower when compared to a growth of 29.9 percent in the same period to April 2007. Excluding Commercial Banks holdings of BOU instruments, it grew by 30.0 percent from Shs. 1,242.5 billion in June 2007 to Shs. 1,615.5 billion in April 2008. Increased net foreign assets moderated by Government s savings at the BOU, contributed to base money growth during the period. With regard to the components of base money, reserves of Commercial Banks held at BOU increased by 51.8 percent between June 2007 and April 2008 to Shs. 502.0 billion and currency issues grew by 20.0 percent to Shs. 1,177.2 billion. 12

Aggregate Table 7: Monetary Authority Balance Sheet (billion Shs) Jun 2006 Nov 2006 June 2007 Mar 2008 Apr 2008 Total Liabilities 1,061.1 1,290.1 1,360.1 1,554.3 1615.5 Base Money 1,046.1 1,184.3 1,242.5 1,554.3 1615.5 Commercial Banks Holdings of BoU Instruments 15.0 105.8 117.6 0.0 0.0 Total Assets 1,061.1 1,290.1 1,360.1 1,554.3 1615.5 Net Foreign Assets 2,613.9 2,910.9 3,330.9 4,498.6 4451.3 Net Claims on Government -991.3-1,061.0-1,712.7-2,530.8-2348.4 Claims on Commercial Banks 95.5 89.1 113.4 168.9 139.1 Claims on Private Sector 20.78 20.5 20.5 19.2 19.4 Claims on Parastatals 0.9 0.7 4.2 4.1 4.1 Other Items, Net -678.8-670.0-396.3-605.7-650.1 * From June 2004, staff loans at BOU were reclassified from OIN to PSC. Source: Bank of Uganda. 3.2 Broad money Between June 2007 and April 2008, Broad Money (M3), comprising of currency in circulation and all private sector deposits, grew by 27.9 per cent from Shs. 3,842.0 billion to Shs. 4,914.1 billion. This compared to the 18.8 percent growth recorded in the corresponding period of June 2006-April 2007. The growth in M3 was partly explained by the robustness of residents foreign denominated deposits associated with strong balance of payments developments as well as a rather strong growth in the demand and time deposits during the period. Between June 2007 and April 2008, foreign currency deposits grew by 26.9 percent while the US dollar equivalent of the foreign currency deposits grew by 20.0 percent. Currency in circulation grew by 18.2 percent, while demand deposits by 31.5 per cent and time and savings deposits by 33.1 percent. Most of the growth in M3 was on account of a rise in the banking system s net foreign assets (NFA) and growth in private sector credit. Broad Money (M2A), which includes currency in circulation and private sector s shilling deposits, grew by 28.2 per cent during the period to April 2008. 3.2.1 Net Foreign Assets (NFA) The net foreign assets of the banking system increased by 30.7 percent between June 2007 and April 2008 from Shs. 3,835.4 billion to Shs. 5,012.3 billion. This outturn was slightly lower than the growth of about 32.2 percent observed for the corresponding period to April 2007. The net foreign assets of BOU rose by 33.6 percent to Shs. 4,451.3 billion, of which foreign reserves rose by 33.8 percent driven by strong performance of the balance of payments. A major part of the increase in foreign assets constituted BOU intervention in the market as well as net inflows of donor budget support funds. At the level of 13

Commercial Banks, net foreign assets grew by 11.2 percent to Shs. 561.0 billion over the same period. 3.2.2 Net Domestic Assets (NDA) During the period June 2007 to April 2008, the net domestic assets of the banking system (net of revaluation) declined by 31.9 percent from Shs. 490.3 billion to Shs. 334.1 billion. The Government position with the banking system at the end of April 2008 was a saving amounting to Shs. 1,041.4 billion, representing an improvement of Shs. 42.3 percent over the June 2007 position. This was largely due to a rise in government deposits. Claims on the private sector by the banking system grew strongly by 49.4 percent or Shs. 896.0 billion between June 2007 and April 2008. In terms of currency denomination, the highest growth in credit was in foreign currency loans, which grew by 60.9 percent or Shs. 278.3 billion, while Shilling denominated loans grew by 45.5 percent or Shs. 617.7 billion. In comparison with the corresponding period ending April 2007, Shilling denominated loans grew at about 26.1 percent while foreign currency loans grew by 7.1 percent, respectively. The sectoral distribution of credit continued to be heavily weighted in favour of the Other Services, comprising of business services, personal loans and real estate, which accounted for about 45.4percent of the stock of loans in April 2008, the same level as the average for the previous 3 fiscal years. Table 9 summarises the developments in the sectoral distribution of credit. On the liabilities side of the banking system, private sector deposits at Commercial Banks increased by 30.7 percent to Shs. 3,893.4 billion in April 2008, reflecting in part aggressive deposit mobilization amid increased competition by Commercial Banks and the continued improvement of confidence in the Financial sector. Time and Savings deposits increased by 33.1 percent to Shs. 1,333.8 billion, private demand deposits increased by 31.5 percent to Shs. 1,483.2 billion, while foreign currency deposits increased by 26.9 percent to Shs. 1,076.4 billion. Additionally, financial depth as measured by the ratio of financial savings to Broad Money (M2) improved from 33.5 percent in June 2007 to 34.8 in April 2008. 14

Table 8: The Monetary Survey (April 2007- April 2008) (In billion shillings unless otherwise stated) April 2007 Jun. 2007 Sep 2007 Dec. 2007 Mar. 2008 April 2008 Net Foreign Assets (NFA) 4064.0 3834.7 4638.7 4939.7 5157.9 5012.3 Domestic Credit 1235.9 1116.4 1166.3 1152.7 1466.4 1695.9 Net Credit to Government (NCG) - 572.3-731.5-912.7 1094.1-1150.8 1041.4 Claims on the Private Sector 1777.9 1812.9 2037.5 2219.6 2588.4 2708.9 M3 3887.3 3842.0 4185.5 4422.8 4788.7 4914.1 Forex deposits 909.7 848.1 977.6 1034.5 1114.2 1076.4 M2A 2977.6 2993.9 3207.9 3388.3 3674.5 3837.7 Demand Deposits 1138.9 1128.0 1228.4 1264.7 1405.5 1483.2 Term Deposits 1005.0 1002.4 1065.0 1101.3 1275.2 1333.8 Currency 833.6 863.6 914.6 1022.3 993.8 1020.7 Ratios to M3 (Percent) Forex 23.4 22.1 23.4 23.4 23.3 21.9 Currency 21.4 22.5 21.9 23.1 20.8 20.8 Demand Deposits 29.3 29.4 29.3 28.6 29.4 30.2 Term Deposits 25.9 26.1 25.4 24.9 26.6 27.1 Table 9: Sectoral Analysis of Commercial Bank Credit to the Private Sector (%) Recipient Sector Jun 2006 Nov 2006 Jun 2007 Dec 2007 Mar 2008 April 2008 Agriculture 9.1 7.6 6.7 8.8 8.9 8.0 Manufacturing 16.2 15.2 14.1 16.3 13.7 14.1 Trade and Commerce 16.0 17.5 15.6 13.2 13.1 13.0 Transport, Electricity & Water 6.4 6.3 6.5 11.0 9.0 9.1 Building and Construction 5.6 5.0 6.2 5.5 10.0 9.8 Mining and Quarrying 0.1 0.1 2.4 0.5 0.4 0.5 Other Services and Personal Loans 46.7 48.3 48.6 44.7 45.0 45.4 Total 100.0 100.0 100.0 100.0 100.0 100.0 Source: Bank of Uganda 4 DEVELOPMENTS IN THE NON-BANK FINANCIAL INSTITUTIONS This section presents developments in base money and broader money aggregates, which incorporate the activities of non-bank financial sector. 4.1 Credit Institutions During the period under review, credit institutions incurred declines both in terms of balance sheet and volume of business as the number of operating institutions reduced from five to four due to the accession of one of the institutions to a Commercial Bank status. The branch network was maintained at 33 between December 2006 and December 15

2007 as some agencies were formalised into branches while some branches were completely closed. The overall financial condition of the credit institutions was satisfactory despite the significant fall in position with the exception of one credit institution, which was rated satisfactory. Total assets (excluding administered loans) decreased by 64.3 percent from Shs 287.3 billion at the end of December 2007 to Shs 102.5 billion at the end of April 2008. During the same period, total customer deposits decreased by 45.6 percent from Shs 132.0 billion to Shs 71.8 billion. Loans extended by the credit institutions decreased by Shs 77.3 billion to shs 41.7 billion while the ratio of credit institution s non-performing loans to total loans (NPA) increased from 2.7 percent in December 2007 to about 10 percent in April 2008. Three of the four credit institutions maintained adequate capital levels above the minimum requirement stipulated in the FIA, 2004. The Core Capital to Risk Weighted Assets ratio (RWA) declined from 43.7 percent in December 2007 to 19.2 percent in March 2008, but above the required minimum of 8 percent. Paid-up capital of the institutions declined by 79.1 percent from Shs 70.7 billion in December 2007 to Shs 14.8 billion as at 31 March 2008. Overall net income decreased by 97.0 percent, Return on Assets (ROA) ratio deteriorated from 0.6 to 0.2 percent. The stock of outstanding loans and advances to the private sector, which mainly comprised of secured and unsecured loans amounted to Shs. 41.7 billion as at end-april 2008. The trade and commerce sector accounted for 32.9 percent of total CIs advances as at end-april 2008, while the transport and communications sector absorbed a share of 9.8 percent. The construction sector accounted for only 2.8 percent of the stock of outstanding loans, following the transformation of the largest lender into a commercial bank in December 2007. Developments in the credit institutions are summarised in table 10. 16

Table 10: Developments in the Activities of Credit Institutions (Shs Billion) Apr Jan Feb Mar Apr 2007 2007 2007 2008 2008 Total Assets 251.5 103.7 108.2 103.3 102.5 O/w Investments in Government securities 13.5 6.1 7.6 8.2 10.7 Loans and advances 165.2 41.8 42.5 41.5 41.7 Secured & unsecured 46.5 41.8 42.5 41.5 41.7 Mortgage 98.9 0.0 0.0 0.0 0.0 Administered 19.8 0.0 0.0 0.0 0.0 Other c 86.3 61.9 65.7 61.8 60.8 Total Liabilities 251.5 103.7 108.2 103.3 102.5 O/w Deposits Liabilities a 114.4 70.7 75.1 70.6 71.8 Private Sector Deposits 113.1 70.6 74.9 70.4 71.5 Savings 84.6 59.1 63.3 58.3 59.9 Time 28.5 11.5 11.6 12.1 11.6 Agency Funds d 34.6 0.0 0.0 0.0 0.0 Other b 102.5 33.0 33.1 32.7 30.7 Source: CIs monthly reports to BOU a/ Includes accrued interest b/ Includes balances due to commercial banks, administered funds, other liabilities, provisions, capital, and Profit/loss. c/ Includes investments in other stocks and shares, balances with banks, cash, fixed assets, net due from own offices in Uganda for items in transit and other assets. d/ Agency funds were being reported by HFCU which since December 2007 transformed into a commercial bank 4.2 Micro-Finance Deposit-Taking Institutions (MDI s) During the period under review, total assets of the four licensed MDIs grew by 8.2 percent from Shs. 162.4 billion to Shs. 175.7 billion between December 2007 and April 2008. Total customer deposits also increased by 9.5 percent from 39.1 bn to 42.8 billion between December 2007 and April 2008, while total loans more than doubled to Shs. 111.4 billion between April 2007 and April 2008 All MDIs maintained adequate capital levels as required in the MDI Act 2003. The overall core capital stood at Shs 31.6 billion as at March 2008 from Shs 27.3 billion as at end of December 2007. Core capital to risk weighted assets ratio as at March 2008 was at 23.2 17

percent, which was above the required minimum of 15 percent. Portfolio quality of all the MDIs was satisfactory with portfolio at risk ratio of 3.4 percent as at March 2008 compared to 2.8 percent as at 31 December 2007. Total borrowings stood at Shs 46.6 billion up from Shs 49.5 billion between December 2007 and March 2008. The MDIs net profit was Shs 2.1 billion down from Shs 8.2 billion recorded as at December 2007. Return to total assets ratio (ROA) was 4.9 percent as at 31 March 2008 compared to 5.0 percent as at 31 December 2007. Return on Equity improved from 15.7 percent to 15.9 percent between December 2007 and March 2008. Overall, liquidity of the MDIs was satisfactory with liquid assets surplus of 37.4 billion as at 31 March 2008. Table 11: Developments in the Activities of Microfinance Deposit-Taking Institutions (Shs. Billion) Apr 2007 Jan 2007 Feb 2008 Mar 2008 Apr 2008 Total Assets 135.4 166.7 167.0 172.9 175.7 Notes and Coins 3.6 4.5 4.9 4.7 5.2 Balances with financial institutions in Uganda 21.4 24.1 19.7 19.6 17.7 Investments in Treasury bills 11.1 12.5 13.9 25.0 26.4 Net loans outstanding 80.9 103.9 106.6 109.3 111.4 Inter branch/due from own offices 0.5 0.4 0.3 0.0 0.0 Net Fixed Assets 9.8 10.2 10.2 10.2 10.3 Long Term Investments 1.3 1.8 1.9 2.4 2.4 Other Assets 6.9 9.3 9.7 10.6 11.4 Deposit Liabilities 27.1 40.8 39.8 43.1 42.8 Savings Deposits 22.0 31.0 29.5 30.9 31.0 Time Deposits 4.5 9.0 9.2 11.6 11.3 Total Private Sector Deposits 26.5 39.9 38.6 42.5 42.3 Accrued Interest 0.6 0.9 1.2 0.6 0.5 Loan Insurance Fund* 15.8 16.2 16.5 16.3 16.7 Total Borrowing 38.1 47.6 47.1 49.5 50.4 Other Liabilities** 10.1 9.5 9.6 10.9 11.9 Total Liabilities 91.1 114.0 114.3 119.7 121.8 Total Equity 25.1 32.4 32.4 32.9 33.6 Subordinated Debt 15.5 16.5 16.5 16.5 16.5 Preference Shares 3.8 3.8 3.8 3.8 3.8 Total Liabilities and Equity 135.4 166.7 167.0 172.9 175.7 Source: Bank of Uganda 18