Kampala,
October 28, 1998

Mr. Michel Camdessus
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Camdessus:

1.  The attached memorandum of economic and financial policies (MEFP) of the Government of Uganda describes the progress made in implementing the 1997/98 (July-June) program supported by the first annual arrangement under the Enhanced Structural Adjustment Facility (ESAF), which was approved by the Executive Board of the Fund on November 10, 1997, and it sets out the objectives and policies that the Government intends to pursue during 1998/99 for the program for the second annual arrangement under the ESAF, and for the medium term. This program was formulated in conformity with the updated policy framework paper (PFP), which was prepared in collaboration with the staffs of the Fund and the World Bank, and which was transmitted to the Fund and the World Bank today.

2.  In support of these objectives and policies, the Government of Uganda hereby requests the second annual arrangement under the Enhanced Structural Adjustment Facility, in an amount equivalent to SDR 33.48 million (25 percent of quota). The Government will also be requesting support from the World Bank and from bilateral and multilateral donors and creditors.

3.  The Government of Uganda will provide the Fund with such information as the Fund may request in connection with Uganda's progress in implementing the economic and financial policies and achieving the objectives of the program.

4.  The Government believes that the policies and measures set forth in the attached memorandum are adequate to achieve the objectives of the program but will take any further measures that may become appropriate for this purpose. During the period of the second annual arrangement, the Government of Uganda will consult with the Managing Director of the Fund on the adoption of any measures that may be appropriate, at the initiative of Uganda or whenever the Managing Director requests such a consultation. Moreover, after the period of the second annual arrangement and while Uganda has outstanding financing obligations arising from loans under the arrangement, the Government will consult with the Fund from time to time, at the initiative of the Government or whenever the Managing Director requests consultation on Uganda's economic and financial policies.

Kampala
October 28, 1998

Memorandum of Economic and Financial Policies

1.  The macroeconomic objectives under the revised 1997/98 (July-June) program were broadly achieved. Real GDP increased by 5.5 percent, and inflation (as measured by the consumer price index) averaged 5.8 percent. Real growth was above the revised target of 5.0 percent owing to a strong recovery in food production late in the financial year, which contributed to the exceptional inflation performance in the second half of the year.

2.  The program's quantitative and structural performance criteria for December 1997 were met with the exception of net bank claims on government, which was missed owing to a more rapid liquidation of domestic nonbank liabilities than projected. The quantitative benchmarks for end-March 1998 were met; those for June 1998 were met, the main exception being net bank claims on government, which was exceeded both due to a somewhat higher fiscal deficit and a more rapid liquidation of domestic arrears.¹ Performance on structural benchmarks was good, with the exception of privatization.

3.  The fiscal deficit (excluding grants) was contained to 6.4 percent of GDP, compared with the program target of 5.8 percent.² Revenues equaled the program target (11.4 percent of GDP), but were lower than programmed in absolute terms. There were shortfalls in petroleum excises (due to weaker world oil prices and the intensification of smuggling), and in VAT revenues (partly due to higher-than-expected refunds), and some delays occurred in implementing measures to improve tax and customs administration. More specifically, the effectiveness of the Uganda Revenue Authority (URA) has been impeded by poor coordination between departments, limited attention to large taxpayers and collection enforcement, and a lack of a coordinated strategy against smuggling. Taxpayer compliance with regard to VAT has been hindered by cumbersome filing and payment procedures, while the penalty system did not establish strong incentives to comply nor was it fully enforced. However, toward the end of the fiscal year there were indications that strengthened collection efforts at URA were beginning to bear fruit.

4.  Total expenditures (including net lending) were only slightly above the program in absolute terms, albeit higher in terms of GDP. A strict control of cash releases contained recurrent expenditures at the same time as development expenditures exceeded expectations. In the area of expenditure management, strict control on cash releases remained the primary tool for expenditure containment. The government recognizes the need for improvement of expenditure commitment control and for avoiding the accumulation of new arrears. As of end-June 1998, domestic arrears (excluding arrears to public enterprises) were tentatively estimated at about U Sh 150 billion or 2.2 percent of GDP, most of which emerged prior to July 1997.

5.  Broad money grew by 21.7 percent in 1997/98. Base money rose by 12.5 percent, but there was an upward shift in the money multiplier. Demand for credit by the private sector stagnated earlier in the year (reflecting weather-related slower economic growth in general, and lower coffee exports in particular), but began to recover in the closing months of the year. The monetary impact of slower growth in private credit was more than offset by higher-than-programmed accumulation of international reserves by the Bank of Uganda (BOU) and lower government savings with the banking system (after applying the adjusters). The combination of slack demand for credit by the private sector and the continued increase in private sector deposits as a share of broad money resulted in an increase in bank liquidity and a steady decline of interest rates on 91-day treasury bills to 7 percent by June 1998. Interest rates on treasury bills have subsequently increased to 9.6 percent by end-September. Only the final legal steps remain for the BOU's recapitalization; it will be provided with a stock of tradable government securities and it will commence open market operations. With regard to the commercial banking sector, the sale of 49 percent of Uganda Commercial Bank Ltd. (UCBL) was completed, and the purchaser has the option to buy a further 2 percent of UCBL. The COOP Bank was fully recapitalized. The performance in the rest of the commercial banking sector was mixed, and some signs of stress became evident. While the capital base of the banking system has generally improved, five smaller banks (accounting for 12 percent of deposits) were not meeting total capital requirements as at end-June 1998. In addition, a few smaller banks have exhibited weak management and have not been meeting some of the prudential regulations. Furthermore, while bank solvency is not currently a systemic issue, owing to weak management some of the smaller banks have been incurring losses that are eroding their capital. The BOU will perform on-site examinations of these banks and will enforce corrective action.

6.  On the external side, the current account deficit was about US$40 million lower than projected, owing to larger private and official transfers. Excluding official transfers, the deficit was somewhat higher, reflecting the deterioration in the trade balance--the weather-related sizable shortfall in both coffee and noncoffee export volumes, and higher imports. A major step was taken in March 1998 with the lifting of the bans on imports of beer, soft drinks, and automotive batteries; as planned, temporary specific duties were imposed on imports of these products in addition to the standard import duties. Net private transfers were substantially higher than projected. At the same time, as the capital account surplus was larger than projected, the overall balance of payments surplus was about US$65 million larger than projected. As a result, the BOU was able to increase gross international reserves to 4.9 months of imports of goods and nonfactor services, compared with 4.7 months under the program. Paris Club creditors agreed in April 1998 to provide Uganda with an 80 percent NPV stock-of-debt reduction under the HIPC Initiative, and the government has initiated contacts to finalize the bilateral agreements.

7.  With regard to the exchange rate, the Uganda shilling depreciated by about 13 percent against the U.S. dollar (on an end-year basis), reflecting both the strengthening of the U.S. dollar against most major currencies, and the shortfall in coffee export proceeds. The nominal effective exchange rate depreciated by 7.1 percent, and the real effective exchange rate depreciated by about 11.5 percent, both measured on an end-year basis. On a year-average basis, the nominal effective exchange rate was unchanged.

8.  Notwithstanding progress made with regard to the government's public enterprise divestiture and reform program, the number of actual sales were less than planned in the second half of 1997/98. This reflected technical and other difficulties outside the control of government (for example, nonpayment of the agreed price by the buyer); delays in getting the necessary political consensus on privatization; and a change in focus to preparation of high impact public enterprises for divestiture. Furthermore, the privatization process has become complex and the government is taking action to streamline the process and make it more transparent. The benchmarks for privatization were missed by substantial margins in both March 1998 and in June 1998. Thus, 85 enterprises were divested by end-June 1998 compared to a benchmark of 95; of those divested in 1997/98, three were large enterprises (with assets valued at more than U Sh 5 billion) compared to a benchmark of seven. Of the high impact public enterprises, 16 were in advanced stages of divestiture and 5 were in the process of final agreements. There were some positive developments, such as the use of independent arbitration to resolve problems arising from the exercise of preemptive rights of joint shareholders, a clearer policy on the recovery of arrears, and preparation of a comprehensive divestiture procedures manual. Net proceeds (excluding predivestiture, caretaking and preparation costs for the public enterprises not yet sold) from the divestiture program are estimated at U Sh 20.5 billion in 1997/98, bringing the total cumulative net proceeds to U Sh 36.9 billion. The asset value of public enterprises divested was in excess of U Sh 300 billion--a significant figure in relation to asset values of previous divestitures. These figures indicate an increasing impact from the program, although the proceeds have been significantly depleted by predivestiture costs in care-taking and preparation, leaving only a surplus balance of U Sh 2.1 billion at end-June 1998. In mid-August, parliament passed a resolution calling for the suspension of the privatization program pending investigation of procedures followed in some recent divestiture cases. The government is taking steps to address these concerns.

9.  Staff retrenchment at the Uganda Electricity Board (UEB) proceeded on target, and the benchmarks on staff reduction were met. A new management structure is expected to be put in place in October 1998 in preparation for the separation of the internal functions into separate profit centers: generation, transmission, projects, finance, and distribution. General managers were appointed for four of five posts by February 1998, but progress has been slow in appointing the fifth, contributing to delays in internal preparations for the privatization of distribution. The long-term strategic plan for the energy sector (clearly defining the regulatory framework and the extent of private sector participation) remains to be finalized. Progress was disappointing with regard to restructuring of the Uganda Railways Corporation.

10.  In the area of public service reform, a major ministerial restructuring exercise was initiated. The size of the number-limited staff (excluding primary school teachers) on the payroll was substantially reduced, thereby meeting the benchmarks. However, problems persisted with regard to payroll management, and some staff were not placed on the payroll in a timely manner, leading to the accumulation of some U Sh 3 billion in salary arrears in 1997/98. Progress was made in placing school teachers hired under the UPE program onto the government payroll; the use of a transitional supplementary list (of teachers not yet placed on the formal payroll) has enabled the government to become current on salaries, albeit wage arrears pertaining to pre-June 1997 remain. The government conducted a pension census in October 1997 that revealed problems with regard to the pension payroll. The government received technical assistance in the area of public service pension reform, and announced a decision to change the pension formula and move to a contribution-based system.

11.  The government's medium term fiscal program is geared toward supporting the Poverty Eradication Action Plan through increasing expenditures on education, health and rural infrastructure, with emphasis on maintenance and investment projects with low recurrent cost elements. The expenditure program will focus on three main objectives; (i) increasing the incomes of the poor through the provision of roads and support for the modernization of agriculture, (ii) improving the quality of life for the poor through increased provision of health, water, and education services, and (iii) strengthening good governance through transparency and accountability. The government also remains committed to a reduction in the fiscal deficit (excluding grants) over the medium term consistent with the continuation of macroeconomic stability and a sustainable balance of payments. Against the background of the current macroeconomic environment--in particular, the success in achieving low and stable inflation, an adequate level of foreign reserves, and a relatively favorable outlook for the balance of payments--and in conjunction with the increased availability of donor support earmarked for social and priority sectors, the government considers it important not to miss the opportunity to finance its social programs through somewhat higher fiscal deficits relative to the earlier PFP targets. The government is aware that this strategy must not divert attention from a steady buildup of a sustainable domestic revenue base; that the availability of foreign funding needs to be continuously kept under review and associated expenditures scaled down as necessary if it fails to materialize; and that the quality of social and other high priority expenditures needs to be improved and closely monitored so as to achieve the expected returns. The government will continue to implement measures to improve tax and customs administration to ensure that the revenue to GDP ratio rises over time at a rate sufficient to ensure the sustainability of its expenditure program. It has also set up a monitoring mechanism under the Poverty Action Fund to ensure that funds are used as intended.

12.  The overall macroeconomic objectives for 1998/99-2000/01 are: (i) to achieve real GDP growth rates of 7 percent a year; (ii) to hold inflation to 5 percent a year; and (iii) to maintain gross international reserves at around 5 months of imports of goods and nonfactor services (net international reserve coverage would rise to over 3 months). Given the outlook for external resources and world commodity prices, these overall objectives are consistent with a decline in the external current account deficit and the overall fiscal deficit, both excluding grants, to 6.7 percent of GDP and 6.0 percent of GDP, respectively, by the end of the three-year period. These objectives will be underpinned by a strategy to substantially complete reforms in the areas of tax administration, public service, privatization, trade policy, pensions, and the financial sector in the early part of the three-year period, and to make substantive progress in the areas of public utilities and infrastructure. The government will keep this medium-term macroeconomic framework under review; if the prospects for donor financing prove more favorable, the government will consider engaging in higher, donor-funded expenditures on urgent social and priority areas provided that revenue performance is good, inflation remains low, sufficient credit would be available to the private sector, and the higher donor inflows are compatible with external debt sustainability.

Fiscal policies

13.  The government recognizes that an increase in expenditures over the medium term can be sustained only if the revenue effort improves substantially. Hence, revenues will be targeted to increase steadily to 13.0 percent of GDP by the end of the three-year period. An important objective of tax policy will be to eliminate the differential between Ugandan and Kenyan petroleum excise taxes, taking into account the revenue implications. Consequently, bringing about the targeted increases in the revenue ratio would require substantial revenue gains from improved tax and customs administrations. Net external financing and official grants are expected to amount to at least 9 percent of GDP in 1998/99, and gradually decline to 7 percent of GDP by 2000/01. Against this background, it would be feasible to raise expenditure levels for the three-year period 1998/99-2000/01 by about 1 percentage point to around 19.0 percent of GDP annually.

14.  In 1998/99, revenues are targeted to increase to 12.1 percent of GDP. The performance of aggregate revenue collected by the URA and its major components would be monitored on a monthly basis, and cumulative revenue would be subject to quarterly benchmarks and a performance criterion for the test date of the midterm review. Toward this goal, the government will intensify its efforts to improve tax and customs administration. Furthermore, to ensure that public resources are being used effectively, and to avoid the accumulation of new domestic arrears, the government will also implement measures to control and monitor expenditures at the commitment level. Against this background, and supported by the targeted growth in revenues, an expanded program of public expenditures of about 18.8 percent of GDP (including a provision under contingency of 0.4 percent of GDP) has been programmed. The provision under contingency would be released only after an assessment of revenue performance relative to the target at the time of the midterm review, and a determination as to whether additional revenue or expenditure measures are needed to achieve the fiscal target. If released, the bulk of these contingency funds are expected to be allocated to priority program areas. On this basis, the overall fiscal deficit (excluding grants) would be held to 6.7 percent of GDP. This deficit, as well as the planned repayments of domestic bank and nonbank financing (2.3 percent of GDP), would be covered by the projected net external financing (3.3 percent of GDP), and official grants (5.7 percent of GDP). In the event import support is in excess (falls short) of projected levels, projected expenditures would be increased (reduced) by up to U Sh 8.6 billion of the excess (shortfall).

15.  As regards tax measures, no new taxes were introduced in the 1998/99 budget. Specific excises on petroleum products were reduced by about 4.6 percent for petrol, 13.6 percent for diesel, and 11.3 percent for household kerosene. The ad valorem excises on beer and soft drinks were reduced by 7.7 percent and 16.7 percent to 60 percent and 25 percent, respectively, with a minimum specific threshold applying in case the ad-valorem duty is lower. In addition, the maximum import duty was reduced from 20 percent to 15 percent and the number of tariff bands was reduced from four to three. In view of the revenue losses associated with the above measures, the improvement in the revenue effort will depend crucially on improvements in tax compliance and tax and customs administration. Toward this objective, the following measures have already been implemented or planned.

• The 1998/99 budget contains provisions to fund the URA with the material resources needed to fulfill its mandate and meet revenue collection objectives, including U Sh 2 billion for capital improvements.
   
• VAT law has been changed with a view to enhancing incentives to comply. The VAT penalty system has been improved by introducing a nonwaivable penalty tax on late payments, which is set at 2 percent per month on the amounts outstanding, in line with similar provisions in the income tax law. The objective is to ensure that the penalty tax on late payments remains above the average commercial bank lending rate. The fixed penalty for late filing has been replaced by a penalty tax that is set at 2 percent of the tax liability. A general write-off facility for overdue taxes, including penalties that cannot be effectively recovered, has been introduced in the VAT law.
   
• VAT compliance has been made easier by allowing taxpayers to file returns at the same time as they are paying the tax through the banking system. This simplification in administrative procedures has already been implemented for the 100 largest taxpayers, and will be progressively implemented for all taxpayers.
   
• VAT refunds are being expeditiously processed in accordance with the law, giving priority to exporters and to taxpayers making large capital purchases. To reduce audit workload, certain claims for VAT refunds, i.e., from taxpayers that are current with filing and payment requirements, diplomatic missions, and small claims, are no longer subject to automatic audit. A duty drawback desk has been established within the VAT department with the objective to settle complete claims within two months and one month by June 1999 and June 2000, respectively, and to clear the drawback backlog by June 1999.
   
• In order to reduce smuggling, the Customs and Excise Department has installed seals on all petrol station pumps (including those in nonretail outlets), has approved and implemented a new business plan, including an anti-smuggling action plan. Those noncomplying petrol stations that do not currently have tamper proof meters are being closed. To support the anti-smuggling efforts, the URA will complete on-site audits of all retail and nonretail petrol outlets by June 1999; this would constitute a benchmark under the program.
   
• To monitor customs traffic and improve compliance, the customs department has implemented a Wide-Area Network among the six main customs stations and is making preparation to link six smaller entry stations by the end of March 1999.
   
• The recently established Large Taxpayer Unit (LTU), headed by a commissioner, was assigned assessment, auditing, collection, and enforcement functions for the 100 largest taxpayers.
   
• A centralized inventory of all available information on tax arrears by the business sector has been completed, and will be monitored centrally by the office of the Commissioner General. This inventory will be updated on a continuous basis and a report given at the end of each quarter to the URA board.
   
• The Assistant Commissioner for Taxpayer Relations under the direction of the Commissioner General of the URA has intensified efforts to improve customer relations and the URA public education campaign including through radio and television programs. Consideration will be given to creating a Commissioner post for this purpose.
   
• To improve tax collections, the LTU and the income tax department in consultation with the VAT and customs departments, are performing audits on the enterprises whose tax holidays will have expired by June 30, 1999.
   
• The Tax Tribunal has been appointed and has commenced operations.

16.  As a benchmark under the program, the LTU would complete at least 10 comprehensive on-site audits by end-December 1998, and at least another 40 by end-June 1999, for a cumulative 50 for the fiscal year. The VAT register continues to be updated using information from the income tax and customs departments. The URA departments will report quarterly to their Board on the number of penalties imposed and collected, and on the collection of interest charged on outstanding tax payments. The VAT Department will report quarterly on the assessed tax and the collection arising from ordinary audits. The URA will also report on deferred VAT collections. Finally, the URA is developing a medium-term operational strategy for raising Uganda's tax revenue effort, initially with the help of bilateral technical assistance. Based on technical assistance from the Fund, the government will give consideration to contracting out the management of customs to the private sector in order to maximize customs revenues in an efficient manner and to give time to the government for capacity building. In 1999/2000 the Customs Department will adopt a schedule of progressive ad-valorem penalties for shipments valued at US$5,000 or more imported without the preshipment inspection services. To enhance collection of net Appropriations-in-Aid, by end-March 1999, accounting officers in line ministries and departments will produce estimates of their collection for 1999/2000. These estimates will be published in the 1999/2000 budget document.

17.  The expenditure program for 1998/99 incorporates a moderate increase in salaries. Since there has been a 0.4 percent of GDP monetization of in-kind benefits for the army, the wage bill will rise by 0.6 percent of GDP. This monetization will not result in an overall increase in defense expenditures, and is expected to result in savings over the medium term due to the reduction in leakages. The expenditure program would concentrate on increasing resources to education, health, rural infrastructure, and other anti-poverty program areas. For the first time in three years, expenditures in Priority Program Areas (PPAs) will increase much faster than nominal GDP, rising from 1.6 percent to 1.9 percent of GDP. Development expenditures will rise by 0.6 percent of GDP to 7.9 percent. These expenditures are in accordance with the Poverty Eradication Action Plan, and will mainly be channeled through conditional grants to the districts for primary education and health, agricultural extension, and rural feeder roads. The release of these transfers will be conditional to districts meeting accounting and reporting deadlines being developed by concerned line ministries and the MFPED. Conditional grants for rural water supply will be incorporated in the 1999/2000 budget. Non-PPA recurrent expenditures (excluding wages, interest, and contingency) will fall by 0.9 percent of GDP to 3.2 percent. As a benchmark and performance criterion, minimum levels of nonwage expenditures on PPAs (including the UPE component of domestic development expenditures) have been specified. Defense expenditures will rise by 0.3 percent of GDP, reflecting heightened security concerns, a five percent salary increase, an increase in staffing that had been postponed for two years, and the monetization of in-kind benefits for military personnel, some of which had previously not entailed cash budgetary outlays (such as the provision of government-owned housing to military officers). The government will adhere as much as possible to the budgeted outlays for defense; if security concerns make overruns inevitable, the government will endeavor to limit overruns to small amounts, accompanied by offsetting reductions in nonpriority expenditures and/or increases in revenues. The government will keep the Fund staff fully informed on a timely basis about the evolution of defense expenditures.

18.  The MFPED has established an Arrears Monitoring and Reporting Unit (including a Verification Sub-Committee headed by the Auditor General), with the objective of assessing the full extent of existing domestic arrears and proposing a plan for their complete elimination within three years. The accounting officers of line ministries and government agencies had submitted (by September 30, 1998) a report of outstanding arrears at June 30, 1998. The Verification Sub-Committee will verify these claims and submit a report to the Arrears Monitoring and Reporting Unit by December 31, 1998 (a structural performance criterion under the program). The latter will finalize a plan, by end-February 1999, for clearing these arrears (a benchmark under the program). At the same time, it will announce to the general public to submit their claims for settlement of arrears. To assist the government in improving expenditure control, a resident advisor began working in October 1998 to design and implement a Commitment Monitoring and Reporting System in a few key ministries with a history of expenditure control problems. Based on his findings, additional measures would be considered for incorporation into the program during the midterm review. Starting January 31, 1999, accounting officers in these ministries will report monthly the expenditure commitments incurred in the previous month to the Arrears Monitoring and Reporting Unit in the MFPED. Substantial arrears will be cleared this fiscal year and the remaining--including those related to military demobilization and the former EAC workers--will be eliminated over the subsequent two years. A second resident advisor is assisting in the development and implementation of uniform budget preparation and reporting for the districts. In order to enhance transparency and accountability with regard to budget execution, the MFPED has begun reporting both the previous year's budget and estimated outturn in the budget document submitted to parliament for approval, and has for the first time published its three-year budget framework. A report on the utilization of the Poverty Action Fund resources will be presented to donors quarterly.

Monetary policy and financial sector policies

19.  The main objective of monetary policy will be to contain inflation to 5 percent. Broad money growth is projected at 17 percent in 1998/99. On the basis of maintaining reserve coverage at five months of imports of goods and nonfactor services, the monetary program entails a net government savings in the banking system of 0.9 percent of GDP, and provides for a 25 percent growth in credit to the private sector. In the event that import support is higher than programmed, the first U Sh 8.6 billion would not be sterilized, thereby raising broad money growth to 18 percent. In the event that inflationary pressures emerge, the BOU stands ready to tighten monetary policy. The automated book entry system is now fully operational and the Bank of Uganda will begin to execute open market operations using its own stock of tradable government securities. The same system will be used for the electronic transfer of securities in the secondary market and provide for crediting and debiting of commercial bank accounts held at the BOU, thereby reducing uncertainty and risk in the secondary market. A major focus of the BOU will be the strengthening of its bank supervision capacity with a view to developing the capacity within three years to perform on-site examinations of all banks once a year, and the BOU is seeking World Bank support in this regard. The BOU has completed on-site examinations of four commercial banks (that had already been identified in 1996/97 as failing to comply fully with bank regulations), and issued the examination reports to these banks. One of these banks was subsequently closed. The BOU has transmitted letters to the other three requiring all corrective measures needed to bring them into full compliance by end-June 1999, specifying a timetable which identifies those corrective measures that must be implemented by December 31, 1998. As a structural performance criterion under the program, the BOU would conduct follow-up on-site examinations by end-December 1998 of the relevant banks to verify compliance with the timetable of corrective measures proposed by the BOU. As an additional benchmark, the BOU would complete on-site examinations of another four banks by end-June 1999. The government will submit to parliament by end-December 1998 amendments to the Financial Institutions Statute relating to capital requirements and ownership concentration limits, insider transactions, foreign exchange exposure limits, and provisions for prompt corrective action. The government will submit a comprehensive set of amendments to the Financial Institutions Statue in 1999, which will include provisions relating to nonbank financial institutions and licensing requirements.

External sector

20.  Achievement of a sustainable long-term balance of payments position will continue to be the aim of external sector policies. In the medium to long term, donor support is expected to shift from balance of payments support to project financing. Also, further export diversification and foreign direct investment should help strengthen Uganda's balance of payments by reducing its vulnerability to the volatility of coffee prices and the uncertain nature of private transfers. In 1998/99, the external current account deficit, excluding official transfers, is anticipated to widen to 9.2 percent of GDP from 8.3 percent in 1997/98 due to a decline in private transfers, which are projected to fall from their unusually high level in 1997/98. Reflecting better weather conditions, exports in 1998/99 are projected to increase by 16.5 percent, with coffee exports recovering from 2.9 million bags in 1997/98 to 3.6 million bags in 1998/99, and noncoffee exports increasing in real terms by almost 14 percent (after declining by 42 percent in 1997/98). However, with some deterioration in the terms of trade, and continued robust growth of imports, the trade deficit is anticipated to widen. Given the anticipated capital and official transfer inflows, the overall balance of payments is projected to record a surplus of US$47 million. Gross international reserve coverage would be maintained at 5 months of imports of goods and nonfactor services.

21.  The government will continue to pursue a flexible exchange rate policy, allowing the exchange rate to be market determined, and intervening to smooth out seasonal fluctuations, mindful of the impact on its international reserve and inflation objectives. The competitiveness of exports and other relevant indicators, such as the real effective exchange rate, relative prices, profitability, and productivity gains of export sectors, will be assessed on an ongoing basis.

22.  The removal of all remaining controls on international capital transactions in July 1997 has not had any discernable impact on net private capital flows or the exchange rate. Cognizant, however, of the disruptive effects on macroeconomic management of volatile movements of capital, the government will continue to maintain an appropriate macroeconomic and supervisory framework. In particular, all existing and/or anticipated measures to strengthen the financial system will be executed expeditiously. In addition to enforcement of prudential guidelines, this will include improving balance of payments data on private capital flows, private transfers, and trade. Moreover, in the event of substantial unexpected temporary foreign exchange inflows, the government will take advantage of the opportunity to build up its exchange reserves and contain the pressures on the exchange rate to appreciate, mindful of inflation developments.

23.  The new Foreign Exchange Act, which will supersede the Exchange Control Act and formalize the legal framework for the liberalization of international capital transactions, will be tabled in parliament by March 1999. During the period of the second annual program, the government will not impose or intensify restrictions on payments and transfers for current international transactions, introduce or modify multiple currency practices, conclude any bilateral payments agreement that are inconsistent with Article VIII of the Fund's Articles of Agreement, or impose or intensify import restrictions for balance of payments reasons.

24.  In 1998/99, Uganda will continue its efforts to reduce its debt burden. The government has contacted all its multilateral creditors to conclude the modalities and timing of the assistance provided under the HIPC Initiative. The government will make a concerted effort to conclude all bilateral agreements in the context of the April 24, 1998 Paris Club restructuring as soon as possible, and will continue to seek rescheduling terms with its non-Paris Club bilateral creditors on at least comparable terms. These restructurings will regularize remaining external arrears and remove the debt overhang, thus providing a climate more conducive to foreign direct investment and sustainable growth. During 1998/99, neither the government nor the BOU will accumulate any new external payment arrears on nonreschedulable debt. Moreover, the government will continue to seek grant financing to the maximum extent possible. The annual 1998/99 limit on contracting or guaranteeing new nonconcessional borrowing will be US$10 million.

25.  The government took further steps to liberalize the trade regime by reducing the maximum import duty and the number of tariff bands in June 1998. The last remaining import ban (except for those imposed for health and security reasons) will be removed by March 31, 1999. Taking into account revenue developments, the government will consider the phased elimination of the discriminatory excise of 10 percent imposed on selected imports during 1999/2000-2000/01. The temporary additional duties imposed on imports of beer, soft drinks, and automotive batteries will be reduced by one-third by March 1999 and will be eliminated in March 2001. A temporary additional duty will be imposed on imported cigarettes and other tobacco products upon lifting the import ban no later than March 31, 1999. This additional duty will be reduced by 50 percent by June 2000 and eliminated by June 2001. The government is committed to avoid adding any new items to the negative import list. It will continue to strengthen the East African Cooperation with Kenya and Tanzania in the areas of settling transactions, removing various tariff and nontariff barriers to trade, and enhancing cooperation in the areas of transport and communication. Finally, the government has created a duty drawback desk within the URA to expedite refunds.

Other structural reforms

26.  The government, in consultation with parliament, has substantially resumed the privatization program. The government is determined to overcome the impediments to privatization and to simplify the procedures so that results can be delivered in a more efficient, speedy, and transparent manner. To this end, the Privatization Unit (PU) has commenced implementation of a standardized procedures manual which will further increase transparency. In addition, the government will put in place streamlined procedures for approvals for sale. The PU has begun implementing a revised privatization strategy, with assistance by the World Bank, under which highest priority will be given to those enterprises that would have the greatest positive impact on the economy and/or the budget. The government will submit amendments to the Finance Act to strengthen financial oversight over public enterprises by the MFPED. The total number of enterprises to be divested (excluding those public utilities which are to remain in the public sector) stands at 126, of which 85 have been privatized and an additional 23 have been approved for sale by the Divestiture and Reform Implementation Committee (DRIC). In 1998/99, and as a structural benchmark, at least 16 of the remaining public enterprises (and any subsidiaries created therefrom) will be approved by DRIC (approvals of Divestiture Action Plans) and the investor search will begin (in the form of advertisement of sale or negotiations for preemptive rights enterprises). As a prior action for the midterm review, DRIC approvals and the investor search (as defined above) will have been completed for at least 10 enterprises by March 15, 1999, of which at least 5 will be high priority enterprises. The government aims to virtually complete privatization by December 1999. The government will rebid the sale of the Uganda Telecommunications Limited (UTL) in light of unsatisfactory initial offers. The government will closely monitor the disposition of privatization proceeds and use them only for preparing firms for privatization, severance pay for workers, and other expenditures directly related to the restructuring of enterprises to be divested. To this end, the government has defined a restricted list of uses for the divestiture account.

27.  With regard to the UEB, the number of staff will be reduced to 2,000 by December 1998. Furthermore, UEB will become current on debt service due to the government; and in line with this, the government will become current on its obligations to the UEB. The government will finalize its overall strategy for the power sector and utility regulation, incorporating private sector participation in the existing system as well as in the area of independent power production. The government will prepare by March 1999 a program for restructuring the power sector to increase its operational efficiency and performance, and to promote private sector participation. The government will also make all necessary preparations to establish an independent multi-sector regulatory commission. Regarding railways, as a benchmark under the program, Cabinet will take a decision by December 31, 1998 on options for increasing private sector involvement in the operation of the Uganda Railways Corporation (URC). The aim is to increase URC's operating efficiency, either through a short-term management contract or through a longer term concession contract.

28.  In the area of public service reform, the ministerial restructuring program reduced the number of ministries from 22 to 17 and identified further staff positions in ministries that would be divested in the context of decentralization. Weaknesses in payroll management have been identified, and employees (excluding primary school teachers) that are currently working but are pending access to the payroll (numbering 1,817) will be put on the payroll by October 31, 1998. This number will be included in the staff retrenchments to be implemented in 1998/99. As benchmarks under the program, the size of the number-limited public service excluding primary school teachers (and adjusted to include pending cases) as of end-June 1998 stood at 54,982, and will be reduced to 53,190 by December 31, 1998 and to 51,640 by June 30, 1999; in assessing these benchmarks, a margin of 99 will be provided for unintended new pending cases that may arise due to the interval between approval of a new recruitment and placing it on the payroll. The government recognizes the urgent need for improvement of payroll management and has instituted new measures toward this end. In particular, and as a benchmark under the program, with effect from October 1, 1998, the waiting period between the date of reporting to work and being put on the payroll will be strictly limited to no more than four weeks. All primary school teachers under the UPE program will be accurately reflected on the payroll by no later than May 1999. Primary school teachers whose employment documents are in order will access the payroll by October 31, 1998. The government will consider the merits of putting all teachers on a cash-limited payroll, after identification of appropriate establishments for secondary and tertiary teachers. The appropriate establishments for secondary and tertiary institutions would be completed by December 31, 1998. In addition, appropriate establishments would be determined for other number-limited agencies like constitutional commissions, semi autonomous and autonomous bodies, and bodies yet to be divested.

29.  With a view to reducing the replacement rate to international standards and the fiscal burden of civil servant pensions, the government will propose to parliament legislation to reform the public system, replacing the current pay-as-you-go system with a defined-benefit contributory program in which the defined-benefit would be in line with international standards. Toward this end, the government will approve by end-December 1998 a cabinet paper embodying the basic principles of the proposed pension reform, including a specification of the new pension formula as well as the intended adjustment to benefits for persons who retired prior to the monetization of in-kind benefits. Regarding social indicators, the poverty index (the percentage of the population living below the poverty line) has improved (attached table). The preliminary outturn for 1997/98 on selected social outcome indicators (included in the ESAF program) is generally positive, with some exceptions. With regard to education, the net primary education enrollment rate rose more than targeted to 91 percent, and the primary school completion rate also improved; however, the gender ratio remained unchanged. Access in the rural areas to clean water improved. Partial information on immunization rates of pregnant women and children, based on districts' submissions, suggests a deterioration in the past several years. However, other health indicators (such as morbidity rates) have improved. The government will step up efforts to improve the social outcome indicators. There is an urgent need to improve statistics on outcome of social indicators, particularly against the background of the large increases in budgetary resources to the social sectors. More generally, the government recognizes the need to improve the statistical base of the country, particularly in the balance of payments, trade, monetary and the national accounts areas and, for this purpose, adequate funds are being allocated and technical assistance is being received.

30.  To monitor progress in economic policy implementation under the program, quantitative and structural benchmarks and performance criteria under the second annual arrangement of the ESAF are summarized in the annexed tables. These include ceilings on net domestic assets of the banking system, net claims on the government by the banking system, gross issuance of promissory notes by the government, new nonconcessional borrowing, external arrears, outstanding short-term debt of the Bank of Uganda, and a floor on the accumulation of net international reserves. The program also incorporates contingency mechanisms with regard to the impact of additions or shortfalls in donor financing and external debt service payments of the central government. Any excess (shortfall) to domestic nonbank financing compared to the program estimates would result in a corresponding reduction (increase) in the ceiling on net claims on the government by the banking system. These contingency mechanisms are described in the attached tables. Quarterly benchmarks and a performance criterion would apply to cumulative revenues collected by the URA, and to minimum budgetary expenditures on nonwage program priority areas (inclusive of the UPE component of domestic development expenditures). Structural performance criteria would apply to certain measures regarding bank supervision and domestic arrears. Structural benchmarks have been set in the areas of privatization, public enterprises, public service reform, fiscal reforms, and banking supervision. The lifting of the remaining import ban on cigarettes, and divestiture approvals under the privatization program would constitute prior actions for the midterm review. The government understands that the completion of the midterm review by April 30, 1999, together with the observance of the end-December 1998 quantitative performance criteria will be conditions for the availability of the second disbursement under the second annual arrangement of the ESAF.