A Budget for Energy

An op-ed by Peter Allum
Advisor, African Department
International Monetary Fund
Published in The New Vision (Uganda)
June 25, 2006

Last Thursday's budget was not only the first Kisanja budget, but also the first since Uganda moved into the group of countries that no longer need to borrow from the International Monetary Fund (IMF). Tanzania has also made this transition. Instead of new loans, the government has asked the IMF to monitor its macroeconomic policies, and conduct semi-annual economic "check-ups" under its Policy Support Instrument (PSI) facility. This is a new program through which the IMF provides technical advice to its member countries.

It is common for governments to launch new policies at budget time, but they often face funding constraints. Uganda's budget rests on the twin pillars of domestic revenues and donor funding (in about a 60-40 proportion). For the 2006/07 fiscal year, donor funding is expected to total roughly $870 million in grants and net loans, matching the record levels of the previous year.

But stable funding, even at record levels, is not good enough when the value of Uganda's economy is expanding 12-15 percent each year on account of price increases, population growth, and improved productivity. Despite continued high dollar inflows, donor funding has fallen substantially in relation to GDP since 2003/04. Projected inflows in the coming year are projected to fall nearly one percent of GDP.

To make up for the decline in donor funding relative to GDP, efforts are underway to boost domestic revenue collections by modernizing the Uganda Revenue Authority (URA) and improving tax efficiency. Over time, the goal is to raise revenue collections from the current 13 percent of GDP to 15 percent or more. But this will take some years, and the government can achieve quick revenue increases only through new taxes.

The measures which Finance Minister Suruma announced to raise revenues will only compensate for only a fraction of the large decline in donor funding relative to GDP. As a result, domestic revenues and donor funding, taken together, are expected to decline by perhaps 0.8 percent of GDP in 2006/07. This is almost equal in size to the entire budget of the ministry of health. In addition to challenges on the funding side, the government faces difficult spending decisions. A clear priority is to address the power crisis. Electricity generation plummeted 28 percent between early 2005 and early 2006. This reduced economic growth to around 5 percent in 2005/06, down from almost 6 percent in earlier years.

Given the extent of the load-shedding, things could have been much worse. Indeed, production by Uganda's largest manufacturers, surveyed by Uganda Bureau of Statistics, rose 4 percent between early 2005 and the same period this year. Evidently, these companies kept going through a combination of more flexible work hours and the use of back-up generators. There are no statistics on the smaller, informal manufacturing operations, and they have probably fared less well, since they do not have the same access to bank financing or alternative power supplies.

But even if the immediate impact of the power crisis has been less than might have been feared, corporate profitability has undoubtedly taken a hit. Unless the power crisis is rapidly addressed, falling investments could well lead to larger declines in production, employment, and incomes.

The 2006/07 budget provides funding of over 2 percent of GDP to address the energy sector crisis, more than four times the allocation in 2004/05. These resources, funded by donors and from domestic revenues, will partly fund the installation and operation of new petroleum-based power plants over the coming year, and cover government costs relating to the future Bujagali and Karuma hydro facilities.

Without the recent electricity tariff increases, the cost to the budget of the power crisis would have been even larger. Indeed, electricity tariff policy is currently more important for sound public finances than tax policy. Electricity tariffs that appropriately reflect the cost of power generation will provide critical funding for new power capacity while also encouraging energy saving.

As it grapples with a tight budget, the government's most trying challenge is how to fund the country's energy needs. It has sought to do so in part by maintaining a very tight rein on spending outside the energy sector.

Consequently, other sectors received little or no increase in funding in 2006/07, other than a few priority areas like education, where funds were specifically allocated toward a salary increase for primary school teachers. Indeed, the government is introducing some of its priority programs, such as universal post-primary education and the rural development strategy, in a phased manner to reduce their upfront costs. Despite this challenging prioritization, the relatively tight limits on non-energy spending have not compensated for the decline in budget funding and expansion of energy-related spending.

As a result, the budget deficit is now projected to increase in the coming year, in contrast to the decline that was anticipated when the government's macroeconomic program was approved for support under the IMF's PSI facility. Given Uganda's strong track record of macroeconomic management and the nature of the energy crisis, the IMF may consider, later this year, adjusting the targets under the PSI program to reflect these new realities.

The larger fiscal deficit is not, however, entirely without consequences. In the past, donor funding adequately covered the gap between spending and domestic revenues. This allowed the government to save a small amount each year, by paying off some of its treasury bill debts. In the coming year, donor funding will no longer be large enough to close this gap, and the government will need to borrow rather than save (that is, issue new t-bills or bonds). This risks putting upward pressure on interest rates, and may encourage banks to invest in government securities rather than productive private sector loans. The Bank of Uganda will need to manage this shift toward government borrowing, and the domestic debt situation, very carefully to limit any adverse impact on private sector credit.

The coming year is one of tough choices, given the decline in donor funding in relation to GDP. The sudden and costly emergence of the energy crisis has made a difficult situation even more so. Allocating scarce funds to energy has left resources for other programs severely limited. On the positive side, however, the cost to the budget from the energy sector is likely to diminish in future years. The company responsible for energy distribution, UMEME, will benefit from higher tariffs and is planning to reduce the transmission and distribution losses that it inherited.



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