## cr1810 ## Source details **Canonical URL:** [cr1810](https://www.imf.org/-/media/files/publications/cr/2018/cr1810.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr1810.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr1810.pdf.json) --- ### Monetary policy stance and operational framework - CBR announced every two months and maintained at 11 percent following a ½ percentage point reduction in June 2014. - Operational target: monthly weighted average 7-day interbank rate steered within +/- 2 percentage points around the CBR. - Framework: Inflation Targeting Lite (ITL) adopted mid-2011; seven-day REPO used to steer seven-day interbank rate under a floating exchange rate regime. - Macroeconomic context: - GDP growth 2009–14 averaged 5.2 percent. - Core inflation 3 percent in February 2015. - Headline inflation 1.4 percent in February 2015. - Shilling depreciated by 6 percent since end-December 2014. - Main operational challenge: sizable precautionary and involuntary reserves and excessive short-end volatility weakening transmission. ### Liquidity forecasting, reserve maintenance, and fine-tuning - Current forecasting practice: - Hybrid short-term liquidity forecasting plus market analysis; Financial Market Department forecasts and liaises with banks daily. - FMOC convenes every morning; decisions often rely on market intelligence rather than liquidity forecast and mode is often full allocation. - BOU does not publish aggregate liquidity position; market participants lack clear aggregate liquidity view. - Recommendations (short term unless indicated): - Use BOU liquidity forecasts as primary tool for OMOs. - Coordinate closely with MOFPED to improve Government net spending forecasts. - Use ARIMA model to forecast currency in circulation. - Improve communication regarding aggregate liquidity position; publish T-1 daily reserve position and cumulative average fulfillment each morning. - Rearrange 14-day reserve maintenance period to avoid volatile end-of-period and synchronize OMOs with maintenance cycle. - Introduce a new fine-tuning instrument to neutralize unexpected liquidity shocks. - Proposed OMO cadence: - Two 7-day repo/reverse repo operations synchronized with the reserve maintenance period: one on day 1 and one on day 8 of the maintenance period. - T-bill auction outcomes (March 2015): - March 4 Auction: - 91 days Wap Effective yield 12.399; Offered 10,000,000,000; Tendered 10,150,300,000; Accepted 9,389,700,000; Bid to cover ratio 1.076 - 182 days Wap Effective yield 14.991; Offered 20,000,000,000; Tendered 43,400,300,000; Accepted 19,026,200,000; Bid to cover ratio 2.219 - 364 days Wap Effective yield 16.026; Offered 145,000,000,000; Tendered 204,170,800,000; Accepted 141,480,500,000; Bid to cover ratio 1.432 - March 18 Auction: - 91 days Wap Effective yield 14.161; Offered 10,000,000,000; Tendered 9,531,100,000; Accepted 6,531,100,000; Bid to cover ratio 0.983 - 182 days Wap Effective yield 15.087; Offered 20,000,000,000; Tendered 34,907,200,000; Accepted 9,732,200,000; Bid to cover ratio 1.776 - 364 days Wap Effective yield 15.961; Offered 145,000,000,000; Tendered 121,514,400,000; Accepted 6,775,800,000; Bid to cover ratio 0.866 ### Standing facilities: Lombard (Marginal Lending), ILF, Deposit facility - Lombard Facility (current): - Access limited to 25 percent of banks’ reserve requirement; can be used for up to 3 months; administrative burden and stigma attached. - Empirical observation: overnight rate traded close to 25 percent while Lombard rate was 15 percent. - Lombard recommendations (short term): - Define BOU’s LOLR function and distinguish it from monetary policy activities. - Design a separate LOLR framework (More TA needed). - Remove the 25 percent limit on Lombard facility. - Limit use of Lombard facility to overnight. - Communicate to remove stigma; systematize access and remove administrative impediments. - Intraday Liquidity Facility (ILF) (current and recommendations): - Current: non-mandatory, collateralized, free of charge, use requested by bank, penalty for end-of-day shortfall, no automatic conversion to Lombard. - Assessment: not all banks participate; increases demand for excess reserves and overnight volatility. - Recommendations: make ILF mandatory for eligible institutions and banks with lower reserve requirement than their clearing amounts; automatically transform any ILF shortfall at end of day into Lombard facility. - Overnight Deposit Facility: - Currently absent due to cost constraints. - Recommendation (medium term): introduce deposit facility to put a floor on the overnight rate; rate should be below the CBR and sufficiently low to avoid BOU financial intermediation. ### Primary Dealer System and money market development - Current PD system: - Only Primary Dealers have direct access to BOU operations; other banks must route bids via PDs. - Assessment: - PD system creates information asymmetry, constrains interbank activity and BOU absorption capacity, increases demand for excess reserves, and raises intermediation margins (PDs may charge up to 25 basis points). - Recommendation: - Abandon PD system for central bank operations; allow all reserve-maintaining banks access to BOU operations while retaining PDs for MOFPED primary issuance. - Market infrastructure recommendations (medium term): - Develop horizontal repo market with Master Repurchase Agreement (MRA) or localized MRA (GMRA/ localized MRA). - Introduce standardized documentation: Master Swap Agreement or ISDA light; consider Credit Support Annex (CSA). - Re-vamp PD system for debt securities; improve advance auction calendar and re-open long-term T-bonds for full financial year to ensure benchmark liquidity. - Develop “Hand-book on Investment in GOU Securities”. ### Foreign exchange operations, auctions, and FX swaps - FX interventions categorized as: - (i) discretionary interventions to dampen excessive volatility; - (ii) daily purchase program for reserve accumulation; - (iii) targeted interventions for lumpy payments. - Observations: - Accumulation of reserves increased purchases and contributed to structural excess liquidity; modes and instruments used for different objectives caused confusion. - Table of Bank of Uganda FX Market Intervention (USD million) highlights: - 2015 (until March 18): Discretionary -374; Targeted (UETCL) -31; Reserve Build-up 148; Net Intervention -257 - 2014: Discretionary -87; Targeted (UETCL) -164; Reserve Build-up 850; Net Intervention 599 - 2013: Discretionary 42; Targeted (UETCL) -184; Reserve Build-up 633; Net Intervention 491 - 2012: Discretionary -175; Targeted (UETCL) 36; Reserve Build-up 806; Net Intervention 667 - Recommendations (short term unless indicated): - Adopt simplified, prioritized, rule-based intervention framework distinguishing discretionary interventions (to address excessive volatility) from reserve accumulation (rule-based Competitive FX Auction). - Competitive FX Auction design suggestions: - Frequency: initially weekly or twice a week; mid-week standard. - Volume target per auction: range between USD 5–10 million. - Amount accepted: kept closer to announced volume with variance not more than +/-10 percent. - Bid limits: per bid US$0.25–US$1.5 million in multiples of US$0.25 million; max three bids per bank; cumulative bids from any single bank not exceed 25 percent of announced target. - Publish auction results by 3:00 p.m. on auction day on BOU website. - Consider three-month forward purchases in reserve accumulation auctions. - Introduce FX Swap Auctions as additional monetary management tool: - Phase one: weekly (every Wednesday) T+1 settlement; tenors 1 and 3 months; max two bids per bank; allocation variance +/-10 percent. - Phase two: pre-announced monthly volume calendar; consider two-way FX Swap Auctions; cap net outstanding short forward position of BOU within 10 percent of liquid monthly FX reserves (excluding gold). - Use FX Swaps to address short-term liquidity fine-tuning, tackle arbitrages/misalignments in curves, and manage structural excess liquidity. ### Balance sheet composition, income, realized deficits, and recapitalization - Balance sheet foreign and domestic financial assets (UGX (Mil)): - Foreign Financial Assets: - 2009 5,143,471; 2010 5,761,171; 2011 6,896,972; 2012 7,493,808; 2013 8,994,945; 2014 10,165,482 - Domestic Financial Assets: - 2009 2,877,630; 2010 3,576,823; 2011 5,537,737; 2012 6,634,603; 2013 7,266,441; 2014 3,054,684 - Total: - 2009 8,103,945; 2010 9,421,568; 2011 12,541,688; 2012 14,242,370; 2013 16,612,612; 2014 13,677,887 - Foreign assets as percent of total: - 2009 64.12; 2010 61.70; 2011 55.47; 2012 53.04; 2013 55.31; 2014 76.89 - Interest income and expense (UGX (Mil)): - Interest income: 2009 114,804; 2010 38,254; 2011 129,532; 2012 60,773; 2013 82,723; 2014 84,233 - Interest expense: 2009 (1,279); 2010 (1,297); 2011 (2,648); 2012 (1,612); 2013 (37,700); 2014 (59,997) - Interest Expense as percent of interest: 2009 1.11; 2010 3.39; 2011 2.04; 2012 2.65; 2013 45.57; 2014 71.23 - Realized surplus/(deficit) (UGX (Mil)): - Net Interest & Commissions: 2008/09 137,750; 2009/10 62,773; 2010/11 138,156; 2011/12 142,660; 2012/13 65,856; 2013/14 97,283 - Total Operating Expenditure: 2008/09 (138,134); 2009/10 (202,997); 2010/11 (386,477); 2011/12 (241,119); 2012/13 (311,313); 2013/14 (280,876) - Realized Surplus/(Deficit): 2008/09 (384); 2009/10 (140,224); 2010/11 (248,321); 2011/12 (98,459); 2012/13 (245,457); 2013/14 (183,593) - Government loss compensation injections and cumulative deficits (UGX (Mil)): - 2008/09 Realized Deficit (384); Cumulative Deficit (384) - 2009/10 (140,224); Cumulative (140,608) - 2010/11 (248,321); Cumulative (388,929) - 2011/12 (98,459); Cumulative (487,388) - 2012/13 (245,457); Cumulative (732,845) - 2013/14 (183,593); Loss Covering Securities 410,000; Cumulative (506,438) - 2014/15 (-264,858); Loss Covering Securities 250,000; Cumulative (521,296) - 2015/16 (-291,120); Loss Covering Securities 200,000; Cumulative (612,416) - 2016/17 (-106,844); Loss Covering Securities 350,000; Cumulative (369,260) - Key observations: - Even with expected UGX 1,210 (billion) injections from government, BOU projected to continue realizing operating losses through at least 2017. - Target to address realized deficit: additional UGX 160 (billion) of additional income (UGX 200 (billion) average realized deficit reduced by budgeted UGX 42 (billion) noninterest income). - BOU identified chargeable services to government totaling UGX 42 (billion). ### Capital arrangements, accounting treatment, and law amendments - Legal capital constraints: - Literal application provides maximum core capital UGX 90 (billion) (0.68 percent of BOU’s current financial assets). - Law defines maximum authorized capital UGX 30 (billion) of which government issued UGX 20 (billion). - Core capital components (UBX million): - Authorized Capital: 20,000 (each year 2009–2014) - BOU Recapitalization securities: 2013 410,017; 2014 410,017 - General Reserve: 2009 20,175; 2010 20,175; 2011 20,175; 2012 20,175; 2013 257,971; 2014 269,225 - Revenue Reserve: 2009 167,467; 2010 25,834; 2011 (208,546); 2012 (306,713); 2013 (530,357); 2014 (643,532) - Earmarked Funds: 2009 19,072; 2010 21,232; 2011 4,375; 2012 4,375; 2013 0; 2014 0 - Total Core Capital: 2009 226,714; 2010 87,241; 2011 (163,996); 2012 (262,163); 2013 157,631; 2014 55,710 - Modeling and recapitalization proposals: - UGX 800 (billion) additional capital will not cover the realized deficit. - Options include converting UGX 1,200 (billion) of “repo” securities into marketable securities; converting part of UGX 1,700 (billion) UCF receivable into marketable securities; negotiate further tranches of recapitalization bonds. - Recommendations: - Board to classify recapitalization bonds as part of general reserves. - Start accounting interest on recapitalization bonds as interest in profit and loss. - Amend capital disclosures to separate core capital from unrealized revaluation reserves. - Complete development of future capital structure and secure BOU Board and MoFPED agreement; specify new capital arrangements in amendments to BOU law and submit amended law for April 2016 (plan). ### Accounting, FX swaps, PRIR, and financial reporting - Financial statements: - BOU financial statements received a clean audit opinion and reflect IFRS adoption. - Appendix IV provides detailed accounting discussion. - FX swaps accounting and operational guidance: - FX swaps treated under IAS 39/IFRS 9 as derivative financial instruments. - Illustrative sterilization example: USD 500,000 for 30 days with spot and forward rates leading to a swap discount LC 111,959 to be amortized; origination journals and accrual examples provided. - Recommended treatment: view swap as a national currency loan collateralized by FX to avoid realizing gains that would consume unrealized revaluation reserves. - Petroleum Revenue Investment Reserve (PRIR): - PRIR to be managed by BOU as agent; on agency basis the Reserve exists outside BOU balance sheet and should not affect BOU capital requirements. - Outstanding issues: management fees calculation, distributions from Reserve, reconciliation of Articles 59 and 62 regarding transfers to consolidated fund. - Presentation recommendations: - Separate equity into Core Capital and Revaluation Reserves; proposed June 30, 2014 presentation: - Core Capital 19,362; Revaluation Reserves 1,746,410; Total Equity 1,765,772 - Notes: Core Capital components include Authorized capital 20,000; Revenue Reserve (679,880); General reserve 269,225; BOU recapitalization securities 410,017. - Treatment of repo securities: - MOFPED “securities” up to UGX 1,200 (billion) carried no interest, non-tradable; auditors classified as advances from government. - Recommendation: convert repo securities into marketable securities; reconsider accounting disclosures and fair value recognition under IAS39. ### Institutional, legal reform and operational coordination - Key institutional recommendations: - Amend BOU Act to ensure appropriate capital level, clarify LOLR and FSS functions, define distributable earnings, and prevent netting of government advances (temporary advances subject to interest). - Prepare a new MOU between BOU and MOFPED to separate monetary and fiscal instruments and delineate operational arrangements; priority as BOU assumes sterilization costs. - Define price stability target in law (level, time horizon, measure). - Coordination and cash management: - Recommend establishment of a dedicated Cash Management Unit in a new Directorate for Debt and Cash Management within MOFPED Treasury to produce formalized daily projections and improve government cash flow forecasting. - Information exchanged between MOFPED and BOU includes government cash flow (quarterly), treasury auction calendar (monthly), auction performances (per auction), revenue performance (monthly), fiscal operations (monthly), and government position (daily). - LOLR principles (Appendix II highlights): - LOLR for solvent, systemically important institutions; lending temporary and discretionary; collateral and higher haircuts expected; penal interest rates set over overnight facility; supervisory intrusion and conditionality required. ### Implementation progress and action plan status - Progress highlights: - Improved communication under ITL; new Monetary Policy report structure with 12-month policy horizon; distinction clarified between MPC Meeting (policy rate) and MPC Review Meeting. - Accounting procedures amended for realized and unrealized revaluation gains; IMF quota accounting amended. - Recapitalization securities issued (two tranches: 410 bn and 250 bn). - Medium-Term Business Plan developed; UGX 42 (billion) of potential non-interest revenue identified. - Appendix VI action items and status include: - Recapitalization tranches issued; expenditure monitoring and payroll controls implemented; accounting procedures to prevent realized gains remaining in translation reserves implemented since 2012/13; draft law amendment proposals finalized. *IMF TA mission report: PREFACE, EXECUTIVE SUMMARY, BACKGROUND AND INTRODUCTION, and selected chapters (cr1810).* ### PREFACE _________________________________________________________________________________________ 6 ### PREFACE ### Mission context and participants - At the request of the Bank of Uganda (BOU), a technical assistance (TA) mission from the Monetary and Capital Markets Department (MCM) of the International Monetary Fund (IMF) visited Kampala on March 13–25, 2015, to assess and provide recommendations on monetary and foreign exchange operations, Bank of Uganda recapitalization, and Bank of Uganda Act revision (March 13–25, 2015). - The mission comprised Veronica Bacalu (Mission Chief) and Asad Qureshi both from MCM; Alain Vandepeute (Advisor, East AFRITAC); Kenneth Sullivan and Darko Bohnec, both Experts. Ms. Ana Lucia Coronel, Senior Resident Representative (AFR Mission Chief) in Kampala participated in the concluding meeting. Javier Chang from MCMCO provided administrative support. - The mission met with Governor Prof. Emmanuel Tumusiime-Mutebile, Deputy Governor Dr. Louis Kasekende, Executive Directors, and other senior staff of relevant departments of BOU; Director of MoFPED Lawrence Kiiza, senior staff of the Ministry of Finance (MOFPED), chief executive officers and senior staffs of several commercial banks, management of the Ugandan Banking Association, and business representatives. - The mission expressed gratitude to the Governor, BOU staff, the MOFPED, and the Senior Resident Representative Office in Kampala for cooperation and logistical support. ### EXECUTIVE SUMMARY ### Recent performance and framework - The BOU has been successful in guiding core inflation close to target since adopting the Inflation Targeting Lite (ITL) monetary framework in mid-2011. - The BOU uses the seven-day REPO to steer the seven-day interbank rate toward the Central Bank Rate (CBR) under a floating exchange rate regime. ### Main challenges identified - Presence of sizable precautionary and involuntary reserves and excessive short-end volatility has weakened the transmission mechanism. - The key challenge is enhancing monetary and fiscal policy coordination and ensuring institutional and operational arrangements are robust for efficient monetary operations. ### Recommended operational improvements (summary) - Improve liquidity forecasting and communication to market participants on aggregate liquidity positions. - Synchronize required reserves maintenance period and Open Market Operations (OMOs). - Reorganize the Primary Dealer (PD) System to allow all reserve-maintaining banks access to BOU operations. - Modify the Intraday Liquidity Facility (ILF) and the Lombard facility to improve usage. - Introduce competitive FX auctions for reserve accumulation purchases. - Introduce FX Swaps as an alternative monetary management tool to address short-term domestic liquidity and curve misalignments. - Put in place a mechanism for efficient coordination of fiscal and monetary operations given persistent government overdraft and resource constraints. ### Balance sheet and recapitalization issues - The BOU’s ability to sustain operations is affected by its deficit balance sheet position: cumulative deficit from losses since 2009 resulted in monetization of these losses and the need for recapitalization injections. - The government agreed to meet half of the recommended UGX 1,600 (billion) recapitalization injections; this will reduce the cumulative deficit but will not restore the BOU’s capital by the time they are completed in 2017. ### Strengthening capital and governance - Options to strengthen the BOU balance sheet and capital framework include BOU operating expense savings, raising non-interest income, and raising interest from policy-related financial instruments. - Modernizing the BOU Law will strengthen the capital framework and improve capacity to discharge core functions; considerable work remains on the law’s amendment and review process. - Adhering to and publishing the BOU’s medium-term business plan supports transparency and the quest for additional income-generating assets. ### Key Recommendations and Action Plan ### Monetary Operations (Short term unless indicated) - Use the liquidity forecasts of the BOU as the tool to manage open market operations. Market intelligence techniques should only be used to understand the money market dynamics. — Short term - Coordinate closely with the MOFPED to enhance the quality and reliability of forecasts of the Government net spending. — Short term - Use ARIMA model to forecast currency in circulation. — Short term - Improve communication to market regarding aggregate liquidity position. — Short term - Rearrange the 14-day reserve maintenance period to avoid volatile end of period. — Short term - Synchronize OMO operations and maintenance period cycle. — Short term - Introduce a new fine tuning instrument in order to neutralize unexpected liquidity shocks. — Short term - Abandon the PD system for Central Bank operations by allowing all banks access to BOU operations, while leaving the PD’s system to service the MOFPED’s primary issuance of government securities. — Short term - Define the BOU’s Lender of Last Resort (LOLR) function and distinguish it from BOU’s monetary policy activities. — Short term - Remove the 25 percent limit on the use of Lombard facility and limit the use of Lombard facility to overnight. — Short term - Communicate to remove the stigma attached to the use of Lombard facility. — Short term - Systematize the access to the Lombard facility removing administrative impediments. — Short term - Make the use of the Intraday Liquidity Facility mandatory for all eligible institutions and banks with lower reserve requirement than their clearing amounts. — Short term - Transform automatically any shortfall in the Intraday Liquidity Facility into Lombard facility. — Short term - Introduce a deposit facility to put a floor on the overnight rate. — Medium term - Abandon the discount window or change its features to be conducive of the development of secondary Government bond market. — Medium term - Develop the horizontal repo market. — Medium term - Design a separate LOLR framework (More TA needed). — Medium term ### Foreign exchange operations (Short term unless indicated) - Define distinction between modes used for interventions for discretionary purposes and for reserve accumulation. Use discretionary interventions to manage market volatility and establish triggers linked to internally defined volatility thresholds. — Short term - Introduce rule-based Competitive FX Auction mode for reserve accumulation purchases with defined frequency and volume target. — Short term - Introduce three-month forward purchases in reserve accumulation FX auctions to facilitate BOU’s managing the domestic liquidity better, and provide avenue to the exporters to lock in their forward receivable. — Short term - Introduce FX Swap Auctions as an additional monetary management tool to address short-term liquidity fine tuning operations, and also to serve as an effective mode to tackle any arbitrages or misalignment in the market curves. — Short term ### Supporting market development (Medium term unless indicated) - Introduce standardized documentation – Master Swap Agreement or ISDA light. Introduce GMRA or localized MRA for repo market development. — Medium term - For improvement in credit and collateral risk management, consider introducing Credit Support Annex. — Medium term - PD system for Debt Securities needs to be re-vamped. — Medium term - Improve the Advance Calendar of debt securities auction to include volumes, tenors and dates with re-opening of long-term T-bonds for full financial year, to ensure benchmark issues are liquid across sovereign yield curve. — Medium term - Develop a “Hand-book on Investment in GOU Securities” including operational guidelines on types of securities, auction process & pricing methodology, payment & settlement processes and description of debt market structure. — Medium term ### Balance Sheet Management (Short term unless indicated) - Continue to press for government adoption of proposal to introduce direct charging for BOU services provided to government. — Short term - Convert part of the UGX 1,700 (billion) of the Uganda Consolidated Fund (UCF) receivable into marketable securities and issue them to the central bank. — Short term - Negotiate further tranches of “recapitalization” bonds to provide realized income to close realized income deficit. — Short term - Negotiate replacement of “repo” securities with marketable securities for use in market operations. — Short term ### Bank of Uganda Law Amendment (Medium term) - Complete development of the BOU’s future capital structure and gain BOU Board and MoFPED agreement. — Medium term - Specify the new capital arrangements in the amendments to the BOU law. — Medium term - Proceed with completing the proposed amendments to the BOU law, forward it to the Fund’s legal department for final review, and sign off. — Medium term - Plan to complete consultations and reviews to be able to submit the amended law for April 2016 in time for the new Parliament. — Medium term ### Accounting, Capital Structure, and Planning (Short term unless indicated) - Have the Board pass the necessary motions to classify the recapitalization bonds as part of general reserves. — Short term - Start accounting for interest on the recapitalization bonds as interest in the profit and loss. — Short term - Amend capital disclosures in the financial statements to separate core capital from unrealized revaluation reserves. — Short term - Implement the refinements to capital presentations in the financial statements discussed in the report. — Short term - Enhance the presentation of the medium term business plan as suggested and integrate it into the strategic planning process as an annual output. — Short term - Ensure development of the Petroleum Revenue Investment Reserve is consistent with the BOU’s role as management agent. — Medium term ### BACKGROUND AND INTRODUCTION ### Macroeconomic context (as presented) - Economic activity in Uganda remains strong supported by a recovery in private consumption and low international oil prices. - GDP growth over the period 2009–14 averaged 5.2 percent. - At 3 percent in February 2015, annual core inflation remains low within the lower limits of the inner and outer inflation consultation bands agreed under the Fund’s Policy Support Instrument (PSI) in line with the ITL framework adopted in mid-2011. - Annual headline inflation at 1.4 percent in February 2015 was subdued by declining food and oil prices. - The current account has widened recently on account of weaker exports affected by a depressed demand in regional partners and higher dividend payments to foreign shareholders reflecting improved corporate profits. - The shilling has depreciated by 6 percent since end-December 2014, as it came under pressure against the strengthened U.S. dollar, exacerbated by some nervousness over the election cycle. - The BOU kept the monetary policy stance unchanged in February 2015 mainly on account of the expected exchange rate pass-through to domestic prices. *IMF TA mission report: PREFACE, EXECUTIVE SUMMARY, BACKGROUND AND INTRODUCTION (cr1810).* ### 2. The BOU has achieved an impressive progress in developing its monetary operations ### 2. The BOU has achieved an impressive progress in developing its monetary operations framework, but more needs to be done to strengthen it ### Major findings on monetary policy stance and operations - The CBR, announced every two months, has been maintained at 11 percent following a ½ percentage point reduction in June 2014. - The BOU conducts open market operations (OMOs) to steer the monthly weighted average 7-day interbank rate within a band of +/– 2 percentage points around the CBR; this objective has been successfully met, though short-end volatility has been persistent. - The BOU operates in the context of a structural surplus of liquidity resulting from: accumulation of international reserves; persistent government overdraft from its account with the BOU; and a shortage of resources constraining monetary operations choices. - The BOU has taken steps to strengthen its capital position by adopting a medium-term plan of recapitalization and starting its implementation. - The BOU maintains a flexible exchange rate regime and an open capital account; FX intervention has been used actively both to dampen excessive exchange rate volatility and to purchase FX for reserves buildup. ### Financial intermediation and transmission - Financial deepening is increasing slowly; credit to the private sector has been recovering after the GFC, driven mainly by personal and household loans for consumption, but financial intermediation remains low by all measures. - Mid-2014 indicators: credit to GDP ratio stood at 14 percent; M2 to GDP was 16 percent; loan/deposit interest rate margin exceeded 10 percent. - Time deposit rates declined from 20 percent in mid-2012 to 11 percent in January 2015; lending rates declined from 27 percent to 22 percent. - Increases in provisioning to deal with nonperforming loans affected profitability and partly explain weak transmission to lending rates; structural impediments remain in legal enforcement, property registry and verification, collateral enforcement, confirmation of identity, and other areas. - Interbank market transactions remain largely unsecured; the effectiveness of repo and secondary securities market transactions is weakened by a structural liquidity overhang. ### Reducing overnight interest rate volatility - The BOU’s operational target is the seven-day interbank money market rate, but the overnight interest rate is extremely volatile. Since the ITL introduction in July 2011, overnight turnover increased while seven-day transactions decreased; during the mission, overnight volume was much higher than seven-day. - The BOU manages short-term liquidity largely through 7-day repo/reverse repo operations which are not conducted on a regular and systematic basis; repo/reverse repo are always 7-day tenor and there is no fine-tuning instrument. - Before 2012, the BOU absorbed structural liquidity via T-bills; this was abandoned in 2012 when the government drew down the sterilized account. MOFPED then decided government securities would be used exclusively for financing government, leaving BOU without sterilization instruments. - After the 2011 recapitalization plan agreement, MOFPED issued marketable T-bonds amounting to UGX660 Trillion used to replenish the BOU’s capital; the BOU has used outright sales of T-bonds to manage structural liquidity and bought back part of earlier sold bonds. - Overnight volatility can undermine transmission from short-term to longer-term rates; example during the mission: overnight rate traded as high as 25 percent while CBR was 11 percent and Lombard facility rate was 15 percent. ### T-bill auction outcomes (March 2015) - March 4, T-bill Auction: - 91 days Wap Effective yield 12.399 - 182 days Wap Effective yield 14.991 - 364 days Wap Effective yield 16.026 - Offered amount: 91-day 10,000,000,000; 182-day 20,000,000,000; 364-day 145,000,000,000 - Tendered: 10,150,300,000; 43,400,300,000; 204,170,800,000 - Accepted bids: 9,389,700,000; 19,026,200,000; 141,480,500,000 - Bid to cover ratio: 1.076; 2.219; 1.432 - March 18, T-bill Auction: - 91 days Wap Effective yield 14.161 - 182 days Wap Effective yield 15.087 - 364 days Wap Effective yield 15.961 - Offered amount: 91-day 10,000,000,000; 182-day 20,000,000,000; 364-day 145,000,000,000 - Tendered: 9,531,100,000; 34,907,200,000; 121,514,400,000 - Accepted bids: 6,531,100,000; 9,732,200,000; 6,775,800,000 - Bid to cover ratio: 0.983; 1.776; 0.866 ### Liquidity forecasting: assessment and recommendations - Current practice: - BOU uses a hybrid framework: a standard short-term liquidity forecasting exercise plus short-term market analysis; Financial Market Department formally forecasts and liaises with banks daily. - The Financial Market Operation Committee (FMOC) convenes every morning to decide market presence and actions; often decisions rely more on market intelligence than on the liquidity forecast and mode is often full allocation. - The BOU does not publish aggregate liquidity position data; market participants lack a clear view of aggregate liquidity. - Assessment: - A well-designed short-term liquidity forecast should be the main tool for OMOs; central bank has more information than commercial banks and should decide intervention amounts based on its forecasts. - Reliability and robustness of the BOU short-term liquidity forecast need improvement, especially for government net spending forecasts; closer coordination with MOFPED is required. - The BOU should improve forecasting of currency in circulation; current framework does not estimate demand for currency in circulation. In a cash economy, currency demand may be the most important autonomous factor; an ARIMA-type model is recommended to address seasonal demand. - The BOU should account for demand for excess reserves and customary cushion when calculating neutral allotment; identification of demand for excess reserves will evolve with past data analysis and market intelligence. - The BOU should communicate daily information regarding the aggregate liquidity situation; publish each morning the T-1 daily reserve position of banks against CRR amount and cumulative average fulfillment, and detail flows causing changes (central bank operations net, government position net, debt management slicing, revenue and expenditure net flows). - Explicit recommendations: - Use the liquidity forecasts of the BOU as the tool to manage BOU’s open market operations; market intelligence techniques should only be used to understand money market dynamics. - Coordinate closely with the MoFPED to enhance the quality and reliability of forecasts of Government net spending. - Use ARIMA model in order to forecast Currency in circulation. - Improve communication regarding aggregate liquidity position. ### Synchronization of reserve maintenance period and OMOs - Current situation: - Timing of OMOs and the reserve maintenance period are not synchronized; the 14-day reserve maintenance period starts Monday with 50 percent averaging allowed daily; the last day effectively spans three days (ending Friday and including weekend), so liquidity shocks on the last day affect interest rates for three days, contributing to volatility. The end of the period coincides with T-bill settlement, affecting auction outcomes and market volatility. - 7-day repo/reverse repo operations currently overlap between the end of one maintenance period and the beginning of the next, complicating operations and creating unnecessary overnight volatility. - Assessment and proposal: - Rearranging the 14-day reserve maintenance calendar could smooth end-of-period liquidity and stabilize the overnight rate; proposal to start the period on Thursday of T-bill settlement so the period finishes on a Wednesday, limiting end-of-period impact to one day instead of three. - The BOU should have two 7-day repo/reverse repo operations synchronized with the reserve maintenance period: one on the first day of the maintenance period and one on day 8. This would ensure smoother and more predictable liquidity conditions, reduce demand for excess reserves, improve interbank market functioning, and reduce overnight volatility. ### Institutional and legal reform recommendations (selected) - Review the BOU Act to ensure an appropriate level of capital to support the central bank’s operational independence. - Separate and coordinate monetary and fiscal instruments to ensure effective liquidity management. - Ensure FX operations framework and accumulation of reserves are consistent with the ITL objectives. - Take measures to support efficient functioning and development of financial markets. - Improve forecasting of factors driving liquidity conditions, in particular government cash flow and borrowing. ### Implementation progress (Box summary) - The BOU has improved communication with banks, economic agents, and the public under the ITL regime; adopted a new Monetary Policy report structure with a 12-month policy horizon and clarified distinction between MPC Meeting (policy rate set) and MPC Review Meeting (economic developments reviewed). - Accounting procedures amended for realized and unrealized revaluation gains; revaluation reserves reviewed and previously realized gains held with unrealized revaluations identified. - Accounting for Uganda’s IMF membership amended to better reflect membership status. - While short of full recapitalization recommended earlier, authorities issued sufficient securities to slow BOU capital erosion. - BOU developed a Medium-Term Business Plan and identified UGX 42 (billion) of potential non-interest revenue through identification of chargeable services. *Source: IMF mission report to Bank of Uganda (excerpt).* ### 27. The BOU should also consider introducing a new fine-tuning instrument in order to ### 27. The BOU should also consider introducing a new fine-tuning instrument in order to ### Fine-tuning operations: purpose and operational features - Purpose: - Neutralize unexpected liquidity shocks and accumulated forecast errors. - Manage the liquidity situation in the market and steer interest rates. - Smooth effects on interest rates caused by unexpected liquidity fluctuations in the market. - Timing: - Typically conducted on the last day of a reserve maintenance period, though can be conducted as needed to counter liquidity imbalances which may have accumulated since the last OMO. - Desirable operational flexibility due to potential need for rapid action in case of unexpected market developments. - Operational features summarized: - They can take the form of liquidity-providing or liquidity-absorbing operations; - Their frequency is not standardized; - Their maturity is not standardized; - Liquidity-providing fine-tuning reverse transactions are normally executed through quick tenders. ### Recommendations (fine-tuning and OMO/maintenance cycle) - Rearrange the 14-day reserve maintenance to avoid volatile end of period. - Synchronize OMO operations and maintenance period cycle. - Introduce a new fine-tuning instrument in order to neutralize unexpected liquidity shocks. ### D. Marginal Lending Facility (Lombard Facility) — Current situation - Banks’ access to the Lombard facility is limited to 25 percent of banks’ reserve requirement. - The Lombard can be used for up to 3 months. - Additional funding above the 25 percent limits are available but at the discretion of the BOU. - There is an important stigma attached to its access and the administrative process is burdensome. ### D. Marginal Lending Facility — Assessment - The current Lombard facility framework should be improved to better fulfill its function. - Issues identified: - The Lombard facility does not provide an effective ceiling to overnight interest rate. - It does not distinguish the BOU LOLR function from BOU monetary policy activities. - Lombard facility and LOLR are not defined clearly and are perceived to be identical. - Reasons why Lombard does not provide an effective cap to overnight rates: - (i) use limited to 25 percent of banks’ reserve requirement; - (ii) stigma attached to it; - (iii) access is manual and administratively complicated. - Empirical illustration during the mission: - Overnight rate was trading close to 25 percent while the Lombard rate was at 15 percent. - institutional recommendations and context: - FMNPS recommended communicating appropriately on the usage of standing facilities to avoid stigmatizing the use of the facilities, and recommended removal of the stigma attached to its use. - Clear separation between Lombard and Emergency Liquidity Assistance (ELA) framework will help remove stigma. - Automatic conversion of the ILF into Lombard facility will also contribute. - In line with proposed new Article 43 of the Central Bank Act, BOU should establish an appropriate LOLR framework, distinct from its monetary policy activities. - ELA is provided at a rate above the rate of the Marginal Lending Facility (MLF) to solvent but illiquid banks and is used if banks are no longer eligible for operations or do not have eligible collateral. - An LOLR framework should be based on the principles of solvency, viability, supervisory intrusion, and conditionality. - BOU should establish internally clear counterparty and collateral eligibility criteria and appropriate risk control measures, along with defined internal coordination and appropriate binding agreements to allow for increased supervision and conditionality. ### D. Marginal Lending Facility — Recommendations - Define the BOU’s LOLR function and distinguish it from BOU’s monetary policy activities. - Design a separate LOLR framework. - Remove the 25 percent limit on the use of Lombard facility. - Limit the use of Lombard facility to overnight. - Communicate in order to remove the stigma attached to the use of Lombard facility. - Systematize the access to the Lombard facility removing administrative impediments. ### E. Intraday Liquidity Facility — Current situation - The BOU offers a non-mandatory Intraday Liquidity Facility (ILF) to banks. - Current features: - Use needs to be requested by a bank and is not automatic. - Its use is collateralized and free of charge. - There is a penalty for any shortfall at the end of the day. - There is no automatic conversion from ILF to Lombard Facility. ### E. Intraday Liquidity Facility — Assessment - Not all banks participate in the ILF, creating unnecessary queues in the payments system. - Consequences: - Constrains banks’ liquidity management; - Increases banks’ demand for excess reserves; - Results in overnight volatility. - Proposed improvements: - ILF should be mandatory for all eligible institutions and banks with lower reserve requirement than their clearing amounts, automatically opened and backed by a standby pool of collateral deposited at the BOU. - Collateral requirements can be determined based on bank’s historical clearing amounts. - BOU should automatically transform any shortfall in the ILF at the end of the day into Lombard facility to smooth sequencing of payments and liquidity flows and help remove the stigma attached to the Lombard facility. - Note: If non-banks are part of the payment system, they should be eligible for ILF. ### E. Intraday Liquidity Facility — Recommendations - Make the use of the Intraday Liquidity Facility mandatory for all eligible institutions and banks with lower reserve requirement than their clearing amounts. - Transform automatically any shortfall in the ILF into Lombard facility. ### F. Overnight Deposit Facility — Current situation - Due to cost constrains, the BOU does not have an overnight deposit facility. - There is no facility currently putting a floor on the overnight interest rate. ### F. Overnight Deposit Facility — Assessment - Implementing an overnight deposit standing facility would limit overnight volatility by putting a floor on interbank interest rates. - Facility design principles: - BOU should always be willing to accept overnight deposits from commercial banks. - The rate paid for these deposits should be below the CBR. - The rate should not be too close to the CBR to avoid financial intermediation by the BOU; how low must be defined by the BOU based on its experience about the money market. - The better the liquidity forecasts of the BOU, the less commercial banks will use the overnight standing facilities. - Operational timing: - Establish this facility once other proposed measures have been implemented and the demand for excess reserve is reduced. - Under an optimal operational framework, recourse to this facility should be marginal. - To avoid important monetary policy cost, the BOU might only implement the deposit facility once other measures have reduced the current demand for excess reserve. ### F. Overnight Deposit Facility — Recommendation - Introduce a deposit facility to put a floor on the overnight rate. ### G. Primary Dealer System — Current situation - Only Primary Dealers (PDs) in government securities have direct access to central bank operations. - Other commercial banks must put bids through the six Primary Dealers to participate in central bank operations (repo/reverse repo). - This system was created as an incentive for banks to operate as PDs in the government securities market. - Commercial banks deal directly with the PDs and not with the BOU, impacting respective credit lines. ### G. Primary Dealer System — Assessment - Disadvantages for monetary policy and financial stability: - Impacts commercial banks credit lines, reducing scope for interbank activity. - Gives informational advantages to primary dealers, contrary to level playing field; can lead to dominant position in aggregate liquidity positions and pricing power, creating additional overnight volatility. - Contradicts principle that central bank should give direct access to its operations to all commercial banks fulfilling reserve requirements. - In reverse repo, liquidity injection by BOU constrained by PDs credit lines with other commercial banks rather than their collateral. - Limits BOU absorption capacity as non-PDs constrained by credit lines with PDs and PDs constrained by credit line with BOU. - Impedes transmission mechanism and increases intermediation margins as PDs require a margin of up to 25 basis points on the liquidity absorbed or injected. - Increases demand for excess reserve, complicating liquidity management, reducing smooth circulation, and increasing commercial banks intermediation margin. - Recommendation of mission: - Give access to BOU operations to all commercial banks. ### G. Primary Dealer System — Recommendation - Abandon the Primary Dealer system for Central Bank operations by allowing all banks access to BOU operations, while leaving the Primary Dealers system to service the MOFPED’s primary issuance of government securities. ### FOREIGN EXCHANGE OPERATIONS AND MARKET — A. Foreign Exchange Operations — Current situation - De jure exchange rate arrangement: free floating. - Exchange rate management objective: contain inflation and preserve stability of foreign exchange markets. - Vulnerabilities: - Current account deficit and reliance on foreign funding and investments make market susceptible to volatility from shifts in sentiments, flows, and attractiveness of other regional markets. - Recent volatility linked to portfolio shift of around UGX 1.0 trillion by the National Social Security Fund to Kenya and Tanzania during the first quarter of 2015. - BOU actions to improve spot liquidity: - Market making arrangement by BOU between banks for tradeable quoted prices up to USD 0.25 million in spot. ### FOREIGN EXCHANGE OPERATIONS — Assessment of FX interventions - BOU’s interventions classified into three categories: - (i) discretionary interventions, aimed at dampening excessive market volatility; - (ii) daily purchase program of pre-determined amounts to accumulate international reserves; - (iii) targeted interventions catering to specific lumpy payments. - Main thrust: accumulation of international reserves. - Mode of intervention: - Intervenes in interbank FX market at banks’ quoted rates using best bid-ask principle. - BOU publishes information on interventions with a lag in quarterly and annual reports, including discretionary, targeted, and reserve build-up amounts. - Table 5 (Bank of Uganda FX Market Intervention (USD million)) highlighted examples: - 2015: Discretionary -374; Targeted (UETCL) -31; Reserve Build-up 148; Net Intervention -257 (2015 figures until March 18, 2015). - 2014: Discretionary -87; Targeted (UETCL) -164; Reserve Build-up 850; Net Intervention 599. - 2013: Discretionary 42; Targeted (UETCL) -184; Reserve Build-up 633; Net Intervention 491. - 2012: Discretionary -175; Targeted (UETCL) 36; Reserve Build-up 806; Net Intervention 667. - Observations: - UGX followed a gradual depreciation path consistent with fundamentals; discretionary interventions were infrequent until recently. - Amounts of purchases to accumulate reserves have increased recently and remained somewhat inconsistent with communicated amounts to the market. - Recent pressures led to frequent BOU presence in market through discretionary interventions and in a few occasions in the reverse direction during a single day or the subsequent day. - Similar modes and instruments deployed for different objectives caused confusion about BOU’s intervention objectives. - Conduct of FX interventions is not appropriately integrated with domestic currency monetary operations: reserve build-up purchases have contributed to structural excess liquidity and further confused market participants. ### FOREIGN EXCHANGE OPERATIONS — Recommendations (policy and operational) - Adopt a simplified, prioritized, and rule-based intervention policy framework to improve clarity of objectives and effectiveness. - Distinguish approaches for different intervention forms. Example consolidation: - Consolidate modes of interventions into two types: a. Discretionary interventions (less frequent) only directed at managing market excessive volatility; and b. A rule-based Competitive FX Auction strategy with the objective of gradual accumulation of international reserves. - Discretionary Intervention specifics: - Use only under excessive market volatility, which may warrant immediate action. - Modus operandi should be reviewed for effectiveness and provide market space to manage itself. - BOU may continue to intervene at banks’ tradeable quoted rates using best bid-ask principle with standard lot sizes. - An internal intervention policy framework at FMOC level may need to include establishing volatility thresholds consistent with market and de jure exchange rate regime, observed normal bid/ask spreads, and analysis on whether consistent unidirectional pressures are seen. - Factors to refine internal policy framework: a. Institute clear internal distinction between healthy and excessive volatility. In reference to comparable regional and emerging market countries, 4 to 6 percent volatility can be considered healthy and BOU’s intervention internal threshold can be set if market consistently on a close-to-close basis tests this threshold. b. Use several banks and switch among them to help reduce market segmentation, even during closed or announced BOU presence in the market. c. Conduct direct intervention using spot transactions. d. Aim for interventions to convey a clear signal about central bank’s intentions and step up clear communication policy of interventions to influence market participants’ expectations about future development or behavior towards volatility of the exchange rate. *Source: cr1810 - 27. The BOU should also consider introducing a new fine-tuning instrument in order to (cr1810.pdf).* ### 55. A rule-based Competitive FX Auction strategy with clear objective of gradual ### 55. A rule-based Competitive FX Auction strategy with clear objective of gradual ### FX Auction Strategy - Objective: gradual accumulation of international reserves while being market neutral and without having significant impact on exchange rate. - Modus operandi should be: (i) rule based; (ii) follow a consistent approach; and (iii) be market neutral. - Conduct auctions to create competitive price discovery with willing sellers approaching the BOU. - Note: FX Auctions are used by 31 central banks as per AREAER with objectives including (a) FX Intervention vehicle; (b) Vehicle for intermediating or accumulating FX reserves; and (c) Market development and price discovery tool. ### Design Suggestions for Competitive Auctions (best practices) - Frequency: - Standardize auction schedule, initially on a weekly or twice a week basis. - Choose a mid-week day as standard practice. - Volume targets and announcement: - Auction Volume Target and dates should be pre-announced at start of the week on T+1 basis. - Volume target for each auction may be set at a range between USD 5–10 million. - Keep volume targets consistent for each forthcoming auction; later transition to a monthly advance calendar. - Amount accepted: - Amount accepted at auction should be kept closer to announced volume with probable variance of, for example, not more than +/-10 percent. - Bidding mechanism: - Minimum and maximum bid volume limits may be applied. - Example: volume of each bid could range between US$0.25–US$1.5 million, in multiples of US$ 0.25 million. - Each commercial bank may be allowed to propose a maximum number of three bids each at their determined prices. - Cumulative volume of bids from any single bank should not exceed 25 percent of the announced target. - Use of forwards: - Outright forwards in three-month tenor may be used when buying USD from market for reserve accumulation. - Benefits: entice exporter-related forward flows; let market manage interim tenor gap through swaps; reduce need to immediately sterilize UGX liquidity created through purchases. - Transparency: - Bank of Uganda should publish results of these auctions in a standardized format at the latest by 3:00 p.m., on the auction day on its website. ### Annualized Purchase Targets - Determination: - Annualized purchase target needs to be prudently made on basis of realistic BoP projections. - When translating into quarterly or monthly volume targets, seasonally adjust appropriately. - As a rule, targets once derived shouldn’t be significantly adjusted during the financial year. ### FX Swap Auctions (proposal and phased implementation) - Rationale: - FX Swaps used by many central banks; effective for monetary management, addressing short-term liquidity fine tuning, tackling arbitrages or misalignment in market curves, and managing structural excess liquidity from reserve accumulation. - Accounting treatment covered under Appendix IV (in source). - Phase one (implementation basics): - Frequency: standardize to once a week, i.e., every Wednesday with T+1 settlement as standard practice. - Tenors: standardized tenors of 1 and 3 months. - Bids: number of bids allowed per bank may be kept to maximum two in standardized bid lot sizes with multiple thereof. - Volume targets and allocation: keep allocation closer to announced target with probable variance of, for example, not more than +/-10 percent; cut-off consistent with monetary stance. - Transparency: FX Swap Auction results should be announced and disseminated on the BOU’s website. - Phase two (advanced measures): - Pre-announced monthly volume target calendar for forthcoming auctions. - Consider conducting two-way FX Swap Auctions for market development and improved efficiency. - Cap: maximum exposure for net outstanding short forward position of BOU should be capped within 10 percent of liquid monthly FX reserves (excluding gold). ### Market Benchmarks — Assessment and Recommendation - Assessment: - Lack of credible benchmarks across maturities impedes market development; most FX transactions skewed to one month or less. - Distinct misalignment observed between the IR Market Curve and the Swap Implied Curve, creating arbitrage opportunities. - Recommendation: - With introduction of FX Swap Auctions, BOU can introduce market FX swap curve across standard maturities of 1, 3, and 6 months to serve as transparent benchmark and monitor misalignments. - Benefits for banks, non-banks, SOEs: guide hedging decisions and serve as monetary management tool. ### Discount Window — Current situation, assessment, recommendation - Current situation: - BOU has a discount window available to rediscount government securities of 91 day and less; window has not been used but serves as reference for Supervision department. - Assessment: - Limitation to 91 days removes incentive for a discount window as buyer of last resort. - Impact on liquidity coverage ratio: only T-bills of 91-day and less considered liquid assets; international best practice accepts government securities generally up to 1-year tenors for Lombard facility. - Recommendation: - Abandon the discount window or change its features to be conducive to development of the secondary government bond market. - Note: reference to the discount window seems to have been removed from the new central bank act. ### Development of the Horizontal Repo Markets - Current state: - Interbank market active but not vibrant; limited by credit lines and absence of repos as known in international practice; no Master Repurchase Agreement (MRA) in Uganda. - Rationale for true repo: - Provides stronger risk mitigation (credit and liquidity risk) and greater ease of netting in default. - Allows re-use of collateral, circulates collateral, supports money market liquidity. - Supports liquidity in secondary government securities market by providing finance and short-covering for market makers. - Facilitates regional integration (EAC) and cross-border trading by providing outright legal title to collateral. - Implementation needs: - Draft a domestic MRA, staying close to the (International) General Master Repo Agreement. - Consider MRA at level of the 5 EAC countries to aid regional integration. - East AFRITAC to organize a regional workshop on the topic. ### Development of Standardized Documentation - Proposal: - Engage ISDA with Ugandan financial market association to transpose ISDA Swap Agreement for Ugandan market (encompasses swaps, forwards, options). - At inception, adopt ISDA Light or localized Master Swap Agreement with regulatory cover from BOU. - Complement localized agreement with Credit Support Annexure (CSA) for credit & collateral risk management. ### Development of Primary Dealer System for Government Securities - Objectives for revamped PD system: - Improve liquidity and price discovery in secondary debt market. - Improve diversification of investor base and channelize savings to government debt instruments. - Bring efficiency to bank intermediation process. - Gradually narrow gap between savings and lending rates. - Suggested structure of concise regulation (six main sections): - a. Objectives - b. PD Selection Criteria & Process - c. Roles and obligations of Primary Dealers - d. PD Privileges - e. Other Requirements and Obligations - f. Performance Criteria and Reporting Requirements - Handbook: - Develop a “Hand-book on Investment in GOU Securities” separate from PD Regulations covering types of securities, auction process, pricing, payment and settlement, debt market structure, taxation, market conventions, custodial arrangements, and standardized application forms. - Auction and PD rules: - Define minimum/maximum bid amount in competitive and non-competitive bids. - Maximum consolidated total bid amount of any single PD should not exceed 25 percent of the offered amount in that auction. - Rationalize commission, fees and charges for underwriting, client flows, and/or non-competitive bids. - Clearly document underwriting commitments and exposure shares for PDs in case of undersubscription. - Other suggestions: - Define and process reporting of securities held by customers for reconciliation and audit. - Standardize reporting requirements for non-competitive bids and PD activities. - Pace and synchronize auctions of government securities (T-bills and T-bonds) so PDs can buy, hold, and distribute. - Re-open long-term bond issues for full financial year to ensure benchmark issues are liquid across the curve; PDs may be allowed to run short securities positions in long-term bonds between auctions covered through repos. - Manage overall duration of sovereign debt outstanding portfolio in line with regional and global practices, generally observed to range between 3.5 to 5 years. - Introduce advance primary auction calendar, initially one quarter in advance, including volumes, tenors and auction dates. *International Monetary Fund — excerpt from cr1810 chapter on FX auction strategy and market development.* ### 78. The BOU continues the accumulation of foreign currency assets on its balance sheet ### The BOU continues the accumulation of foreign currency assets on its balance sheet ### Balance sheet composition and foreign assets accumulation - Foreign Financial Assets (UGX(Mil)): - 2009: 5,143,471 - 2010: 5,761,171 - 2011: 6,896,972 - 2012: 7,493,808 - 2013: 8,994,945 - 2014: 10,165,482 - Domestic Financial Assets (UGX(Mil)): - 2009: 2,877,630 - 2010: 3,576,823 - 2011: 5,537,737 - 2012: 6,634,603 - 2013: 7,266,441 - 2014: 3,054,684 - Sub total (UGX(Mil)): - 2009: 8,021,101 - 2010: 9,337,994 - 2011: 12,434,709 - 2012: 14,128,411 - 2013: 16,261,386 - 2014: 13,220,166 - Other (UGX(Mil)): - 2009: 82,844 - 2010: 83,574 - 2011: 106,979 - 2012: 113,959 - 2013: 351,226 - 2014: 457,721 - Total (UGX(Mil)): - 2009: 8,103,945 - 2010: 9,421,568 - 2011: 12,541,688 - 2012: 14,242,370 - 2013: 16,612,612 - 2014: 13,677,887 - Foreign assets as percent of total: - 2009: 64.12 - 2010: 61.70 - 2011: 55.47 - 2012: 53.04 - 2013: 55.31 - 2014: 76.89 - Contextual points: - Accumulation consistent with BOU objective of accumulating 4.5 months of imports worth of foreign reserves (EAC common objective). - Costs: greater exposure to low yields of reserve currency sovereign assets and increased valuation volatility from exchange rate movements. ### Impact on Bank of Uganda’s performance - Interest income and expense trends (UGX (Mil)): - Interest income: - 2009: 114,804 - 2010: 38,254 - 2011: 129,532 - 2012: 60,773 - 2013: 82,723 - 2014: 84,233 - Interest expense: - 2009: (1,279) - 2010: (1,297) - 2011: (2,648) - 2012: (1,612) - 2013: (37,700) - 2014: (59,997) - Interest Expense as percent of interest: - 2009: 1.11 - 2010: 3.39 - 2011: 2.04 - 2012: 2.65 - 2013: 45.57 - 2014: 71.23 - Key impacts: - Increased foreign currency exposure reduced interest income (lower yields) while increasing interest expenses (sterilization costs). - Material increase in interest expenses from 2012 to 2013 reflects transfer of sterilization costs from MOFPED back to BOU when MOFPED ceased issuing treasury bonds to absorb excess liquidity and instead offered non-tradable, unremunerated “securities” as collateral. - Convergence of interest income and expenses results from BOU fulfilling its legal policy mandate amid prolonged low yields on reserve currency sovereign instruments and capital inflows requiring sterilization. - BOU has taken significant steps to control operating expenses (discussed in Section VIII of source). - Realized surplus/(deficit) trend (UGX(Mil)): - Net Interest & Commissions: - 2008/09: 137,750 - 2009/10: 62,773 - 2010/11: 138,156 - 2011/12: 142,660 - 2012/13: 65,856 - 2013/14: 97,283 - Total Operating Expenditure: - 2008/09: (138,134) - 2009/10: (202,997) - 2010/11: (386,477) - 2011/12: (241,119) - 2012/13: (311,313) - 2013/14: (280,876) - Realized Surplus/(Deficit): - 2008/09: (384) - 2009/10: (140,224) - 2010/11: (248,321) - 2011/12: (98,459) - 2012/13: (245,457) - 2013/14: (183,593) - Observations: - Sustained series of operating losses since 2009 (realized deficits). - Unrealized revaluation gains (e.g., from weakening UGX) have enabled positive reported operating results in most years but do not affect policy solvency. - Continued realized deficits require monetization to cover shortfalls, increasing excess liquidity and complicating sterilization. - Prolonged realized income shortage raises costs of monetary policy operations and government borrowing as commercial banks demand higher interest. ### Government loss compensation injections and projected deficits - Projected and actual loss-covering actions and cumulative deficits (UGX (Mil)): - 2008/09: Realized Surplus/(Deficit): (384); Cumulative Deficit: (384) - 2009/10: (140,224); Cumulative Deficit: (140,608) - 2010/11: (248,321); Cumulative Deficit: (388,929) - 2011/12: (98,459); Cumulative Deficit: (487,388) - 2012/13: (245,457); Cumulative Deficit: (732,845) - 2013/14: (183,593); Loss Covering Securities: 410,000; Cumulative Deficit: (506,438) - 2014/15: (-264,858); Loss Covering Securities: 250,000; Cumulative Deficit: (521,296) - 2015/16: (-291,120); Loss Covering Securities: 200,000; Cumulative Deficit: (612,416) - 2016/17: (-106,844); Loss Covering Securities: 350,000; Cumulative Deficit: (369,260) - Key points: - Even with expected UGX 1,210 (billion) injections from government, BOU projected to continue accumulating realized operating losses through at least 2017. - Loss-covering injections reduce but do not prevent growth of cumulative deficit. - Longer operation under impaired core capital limits BOU instrument choice and sterilization scale. - Estimates for 2015–17 are BOU’s best projections. - Recommendations and possible balance-sheet/policy options offered in source (list preserved verbatim): - A restitution of MOFPED’s securities purchase program (that program to mop up an agreed pool of excess structural liquidity) would reduce the BOU’s level of interest expense. The parties could schedule this to continue until the earlier of the recovery of yields on the foreign securities or a reduction in the excess liquidity. - Implement charging regime on debit balances on UGF. An amendment in the BOU law prevents netting of government account balances so that any use of temporary advances will incur interest charges. - Convert all or part of the UGX 1,200 (billion) current “repo” securities into marketable securities. MOFPED could treat these securities as a deposit or capital injection. - Convert part of the UGX 1,700 (billion) of the Uganda Consolidated Fund receivable into marketable securities and issue them to the central bank. - Increase the level of planned “recapitalization” securities to generate enough income to close the realized deficit. - Target to address realized deficit: - Target additional UGX 160 (billion) of additional income, or decrease in expenditure if MOFPED resumes bond purchase program. - Note: UGX 160 (billion) derives from an expected average realized deficit of UGX 200 (billion) reduced by the budgeted additional UGX 42 (billion) from an increase in noninterest income. - Non-interest income: - BOU identified chargeable services to government totaling UGX 42 billion; agreement awaiting approval as part of the next budget, 2015/16. - Considerations on outright sale of financial instruments: - Outright sale weakens central bank’s financial strength (removes asset and income stream and reduces sterilization instruments). - BOU repurchase of UGZ of 80 (billion) of previously sold securities supports retention argument. - Mission received late information that “outright sale” may be a form of long term repo as MOFPED will replace bonds on maturity — this changes accounting and long-term effectiveness. - Recommendations (from source): - Continue to press for government adoption of proposal to introduce direct charging for BOU services provided to government. - Negotiate further tranches of “recapitalization” bonds to provide realized income to close realized income deficit. - Convert part of the UGX 1,700 (billion) of the Uganda Consolidated Fund receivable into marketable securities and issue them to the central bank. - Negotiate replacement of “repo” securities with marketable securities for use in market operations. ### Bank of Uganda capital arrangements and reform proposals - Current legal capital framework limitations: - Literal application provides maximum core capital of UGX 90 (billion), which is 0.68 percent of BOU’s current financial assets. - Law defines maximum authorized capital of UGX 30 (billion) of which government has issued UGX 20 (billion). - General Reserve Fund has a non-binding upper level of twice paid-up capital. - BOU has additional capital elements outside narrow legal definition. - Core capital trend (Table 12, Mil of UBX): - Authorized Capital: - 2009: 20,000 - 2010: 20,000 - 2011: 20,000 - 2012: 20,000 - 2013: 20,000 - 2014: 20,000 - BOU Recapitalization securities: - 2013: 410,017 - 2014: 410,017 - General Reserve: - 2009: 20,175 - 2010: 20,175 - 2011: 20,175 - 2012: 20,175 - 2013: 257,971 - 2014: 269,225 - Revenue Reserve: - 2009: 167,467 - 2010: 25,834 - 2011: (208,546) - 2012: (306,713) - 2013: (530,357) - 2014: (643,532) - Earmarked Funds: - 2009: 19,072 - 2010: 21,232 - 2011: 4,375 - 2012: 4,375 - 2013: 0 - 2014: 0 - Total Core Capital: - 2009: 226,714 - 2010: 87,241 - 2011: (163,996) - 2012: (262,163) - 2013: 157,631 - 2014: 55,710 - Proposed new capital structure (high-level features): - Dynamic capital structure defining core capital aligned to balance sheet growth. - Clear separation of realized and unrealized revaluation elements. - Definition of distributable earnings, their calculation, and allocation to core capital or government. - Procedures for central bank recapitalization; increases in capital, distributions and recapitalization to be formulaic, automatic, and non-discretionary. - Appendix III in source discusses details of defining the dynamic capital structure. - Accounting and capital quality: - Robust capital definition requires robust accounting to ensure appropriate recognition and measurement of assets and liabilities and to reflect impaired assets. - Amendments and short-term adjustments under existing law: - External auditors required presentation of recapitalization securities as a separate item in equity in 2013/14 financial statements. - Board motion can allocate these securities to an appropriate element of capital (under existing law, can only be general reserve); once passed, income on recapitalization bonds can be accounted as interest income. - Within existing arrangements, BOU could combine general, revenue and recapitalization bonds into a single general reserve. - Revenue reserve (retained earnings/suspense account) should be cleared to zero at period end. - Equity presentation should separately disclose core capital and revaluation reserves; notes to accounts to disclose individual reserves in each group to illustrate when core capital is negative and trigger recapitalization. - Recommendations (from source regarding capital arrangements and law amendments): - Have the Board pass the necessary motions to classify the recapitalization bonds as part of general reserves. - Start accounting for interest on the recapitalization bonds as interest in the profit and loss. - Amend capital disclosures in the financial statements to separate core capital from unrealized revaluation reserves. - Complete development of the BOU’s future capital structure and gain BOU Board and MoFPED agreement. - Specify the new capital arrangements in the amendments to the BOU law. - Proceed with completing the proposed amendments to the BOU law, forward it to the Fund’s legal department for final review, and sign off. - Plan to complete consultations and reviews to be able to submit the amended law for April 2016 in time for the new Parliament. - Specific legal amendment highlighted: - Prevent netting of any advances to government against other government balances, making temporary advances subject to interest from origination until repayment; serves to remunerate BOU domestic assets and incentivize development of the single treasury account. *Source: Bank of Uganda data and IMF mission analysis as reproduced in the provided content.* ### 104. The BOU financial statements received a clean audit opinion and represent a good ### cr1810 - 104. The BOU financial statements received a clean audit opinion and represent a good ### Financial statements and accounting framework - The BOU financial statements received a clean audit opinion and represent a good example of central bank adoption of International Financial Reporting Standards (IFRS). - Since the 2013 mission the BOU has worked to implement all mission’s recommendations. - Appendix IV presents detailed BOU discussions on accounting and should be read in conjunction with earlier comments on the presentation of capital. ### Medium Term Business Plan and accountability - The BOU developed a four year Medium Term Business that it presented to the MoFPED. - The Medium Term Business proved effective in demonstrating the BOU’s control over its planning and expenditures. - The document lacks formal sign off from the MOFPED, but the department is aware of the document, supporting BOU’s continuation and refinement of the process. - Suggested refinements: - Consider a clearer separation between expenses under BOU internal control and those that are exogenous (split between operational and policy costs). - Integrate the Medium Term Business as an annual output in the strategic planning process. - Provide annual updates showing both forward looking costs and a comparison of actual to project to enhance the document’s integrity. - Footnote observation: In discussions, the MoFPED recognized the BOU’s achievements in controlling its operating expenses and expressed stronger conceptual support for BOU recaptrialization than in previous missions. ### Petroleum Revenue Investment Reserve (PRIR) - BOU management of the proposed Petroleum Revenue Investment Reserve will impact BOU’s balance sheet. - The PRIR should not impact BOU’s capital requirements, but several issues remain outstanding on how BOU will integrate it into its financial structure. - A key issue: the decision that the BOU will manage it as agent — this will determine the accounting framework. - Consequential issues regarding governance and reporting flow from this decision are elaborated in Appendix IV. ### Recommendations (from financial statements / PRIR / medium term plan) - Implement the refinements to capital presentation in the financial statements discussed in the report. - Enhance the presentation of the medium term business plan as suggested and integrate it into the strategic planning process as an annual output. - Ensure development of the Petroleum Revenue Investment Reserve is consistent with the BOU’s role as management agent. ### Coordination between the BOU and MoFPED — government cash management - Close coordination established; information and projections on government cash flows shared in weekly meetings of the Macroeconomic Steering Committee, chaired by MOFPED. - Decentralization of payments has made forecasting cashflows and exact timing of government payments difficult. - Cash planning remains top-down: - Quarterly cash limits allocated based on cash resources (cash rationing principle). - Quarterly plans are sliced into monthly plans; for daily flows affecting bank reserves, BOU estimates daily flows of government sector revenues and expenditures. - Consolidated Fund account role: - All domestically raised revenues and debt financing flow into the Consolidated Fund at the BOU; domestically funded budget releases are made from the Consolidated Fund. - The Consolidated Fund Account is a current account which can be overdrafted by the government according to rules and to an extent not entirely under BOU control. - Treasury Single Account (TSA) framework: - TSA framework introduced with effect from October 2013. - First stage: initial TSA covers only part of operational accounts at the Bank of Uganda; second stage: coverage will be further extended and many existing accounts shall be closed. - Main account in the TSA framework is TSA Holding Account. - GoU has improved capacity to aggregate cash balances and efficiency in transaction costs, control and monitoring of funds released. - Despite improvements, better coordination between fiscal and monetary policy implementation is possible but not enough to achieve clear separation of fiscal and monetary operations. - Net government position: - As presented by the BOU, net government position is in credit, but fluctuates considerably. - It represents the total of government deposits (together with project funds), the balance of Oil Tax Revenue Fund and the total drawdown (most of it relates to the Uganda Consolidation Fund). ### Information exchanged between MOFPED and BOU (by period) - Government Cash Flow—quarterly - Treasury Auction Issuance Calendar—monthly - Treasury Auction Performances—per every auction - Revenue Performance—monthly - Fiscal operations—monthly - Government Position—daily from Accounts Department ### Short term liquidity forecasting and monetary operations - Government daily cash flow projections are important for BOU liquidity projections used by the Financial Market Operations Committee. - Financial Markets Department prepares the “Short Term Liquidity Forecast Report and Proposal” for the day T and presents it to the Financial Market Operations Committee. - The table prepared covers injections to and withdrawals from the BOU’s accounts affecting banking system liquidity and compares projected and outturned amounts for day T-1, stating opening and closing excess reserves position of the banking sector. - A memorandum item calculates the surplus or deficit of the cumulative average reserves position of banks from the beginning to the T-1 day of the maintaining period. - Aggregated anticipated supply and demand for bank balances for day T are derived from individual bank projections. ### Recommendations (cash management) - Establish a dedicated Cash Management Unit in a newly formed Directorate for Debt and Cash Management within the Treasury Department of MOFPED. - The Cash Management Unit should produce on a regular basis (at least on a weekly basis) formalized daily projections of cash flows on government accounts, taking into account revenue and expenditure plans of ministries, departments and agencies. - The Cash Management Unit could improve accuracy of cash flow projections through time under the Cash Flow Committee, including representatives from BOU and MOFPED at the more operational level. - In case of forecasted shortage of cash resources to meet planned expenditures the Cash Management Unit should recourse to the T-bill market to raise needed funds. ### Appendix II — Principles of LOLR (Lender of Last Resort) - Core principles: - LOLR provided by a central bank in exceptional circumstances to systemically important and solvent institutions, in response to idiosyncratic short-term liquidity needs after market-based sources exhausted. - LOLR lending is temporary and at the discretion of the central bank. - Legal basis: - Legal acts should allow lending outside monetary policy framework; some jurisdictions publish guidelines (“rules-based” approach) while others maintain “constructive ambiguity”. - Solvency and viability: - LOLR generally provided to solvent institutions; solvency assessments should be ongoing. - Central banks should avoid lending to nonviable entities; viability assessment should be forward looking. - Access and systemic importance: - Access generally limited to institutions subject to prudential supervision. - LOLR usually provided to systemically important institutions (large, interconnected, difficult to replace); some central banks lend to all banks. - Supervisory intrusion and conditionality: - Recipients should be subject to enhanced supervision and conditionality (management replacement, asset sales, retention of profits, mergers, resolution). - Collateral and risk control: - Collateral will often be illiquid (e.g., loan collateral); collateral must be adequate to protect the BOU from default. - Haircuts expected to be higher and valuations lower than for monetary policy operations collateral. - Penal interest rate and maturity: - Penal interest rates generally set as a fixed spread over overnight lending facility. - Lending is temporary and should last only as long as necessary; prolonged need may indicate insolvency or nonviability. - Other operational points: - LOLR is not a facility and remains at central bank discretion to avoid moral hazard. - Exit plans are required: detailed and binding funding plans showing ability to repay funding. - Internal understanding and coordination across banking, operations, and legal areas is necessary; internal working groups are commonly used. ### Appendix III — Amendments to Bank of Uganda Law Regarding Capital - Objective: update capital framework to provide financial independence for a modern central bank. - Elements of the framework: - (i) the bank’s accounting framework; - (ii) the structure and level of capital; - (iii) the configuration of revaluation reserves; - (iv) the definition of distributable earnings; - (v) the basis for distributions to reserves and stakeholders; - (vi) the arrangements for recapitalization. - MCM preference: strictly limit discretionary powers of the minister and board on capital issues, defining actions as automatic functions of law provisions. - Capital structure: - Central bank capital consists of two elements: core capital (statutory capital) and revaluation reserves. - Core capital consists of realized capital (authorized capital and general reserve formed by retention of realized earnings). - Revaluation reserves may comprise multiple accounts depending on classification of unrealized revaluations. - Core capital design: - Core capital may have a minimum and maximum level applying to a single capital account that combines authorized and general reserves. - Draft law example: maximum core capital proposed at 30 percent of reserve money (the mission endorses the concept but offers advice on constructs). - Denominator definition: - Reserve money may be too narrow as it excludes BOU liabilities issued as part of monetary operations (repos, deposit auctions, FX swaps). - Mission advises broadening the core capital denominator from reserve money to include BOU own liabilities — broadly consistent with MCM definition of monetary liabilities. - Table 1 example and observations: - Table illustrates required core capital under different denominator definitions using assumptions of 10 percent of monetary liabilities (MCM default starting position), proposed 30 percent of reserve money, and 30 percent of monetary liabilities. - Material variances exist between core capital levels under various definitions; BOU needs to justify preferred level as MoFPED will challenge the basis. - Table 1. Examples of Denominators For Determining Core Capital (UBX million) - Monetary Liabilities components by year: - Other foreign liabilities: 2009 94, 2010 94, 2011 94, 2012 94, 2013 6,187, 2014 12,675 - Currency in circulation: 2009 1,468,641, 2010 1,738,981, 2011 2,189,817, 2012 2,204,471, 2013 2,450,857, 2014 2,746,092 - Commercial bank deposits: 2009 506,237, 2010 863,025, 2011 867,982, 2012 828,286, 2013 1,116,386, 2014 1,371,783 - Repos: 2009 -, 2010 -, 2011 69,535, 2012 29,880, 2013 543,101, 2014 910,854 - Total Monetary Liabilities: 2009 1,974,972, 2010 2,602,100, 2011 3,127,428, 2012 3,062,731, 2013 4,116,531, 2014 5,041,404 - 10 Percent of Monetary Liabilities: 2009 197,497, 2010 260,210, 2011 312,743, 2012 306,273, 2013 411,653, 2014 504,140 - 30 Percent of Reserve Money: 2009 592,463, 2010 780,602, 2011 917,340, 2012 909,827, 2013 1,070,173, 2014 1,235,363 - 30 percent of Monetary Liabilities: 2009 592,492, 2010 780,630, 2011 938,228, 2012 918,819, 2013 1,234,959, 2014 1,512,421 *International Monetary Fund — cr1810 chapter content provided in the source document.* ### 8. Table 2 presents the effect on the level of capital shortfall under the various scenarios. ### 8. Table 2 presents the effect on the level of capital shortfall under the various scenarios. ### Core Capital Performance (Table 2) - Table headings and units as presented: - UBX (mls) - Components (by year): - Authorized Capital: 20,000; 20,000; 20,000; 20,000; 20,000; 20,000 - BOU Recapitalization securities: 0; 0; 0; 0; 410,017; 410,017 - General Reserve: 20,175; 20,175; 20,175; 20,175; 257,971; 269,225 - Revenue Reserve: 167,467; 25,834; -208,546; -306,713; -530,357; -643,532 - Earmarked Funds: 19,072; 21,232; 4,375; 4,375; 0; 0 - Total Core Capital: 226,714; 87,241; -163,996; -262,163; 157,631; 55,710 - Actual Core Capital as percentage of denominator (33.3 percent proposed minimum): - 10 percent of Monetary Liabilities: 115; 34; -52; -86; 38; 11 - 30 Percent of Reserve Money: 38; 11; -18; -29; 15; 5 - 30 percent of Monetary Liabilities: 38; 11; -17; -29; 13; 4 - Statutory Capital Shortfall: - 10 Percent of Monetary Liabilities: 29,217; (172,969); (476,739); (568,436); (254,022); (448,430) - 30 Percent of Reserve Money: (365,749); (693,361); (1,081,336); (1,171,990); (912,542); (1,179,653) - 30 percent of Monetary Liabilities: (365,778); (693,389); (1,102,224); (1,180,982); (1,077,328); (1,456,711) *Source: Bank of Uganda and Fund Staff calculations.* ### Modeling capital needs and recovery - Key findings: - The UGX 800 (billion) additional capital will not cover the realized deficit. - Recovery does not need to come entirely from additional capital; modeling should include income generated by assets under different long-term scenarios with normal interest rate assumptions domestically and on foreign reserves portfolios. - Stakeholder behavior: the MOFPED and other stakeholders have shown an indifferent record to ensuring BOU holdings of its obligations are remunerated at market rates. - Policy implication: - BOU must model different scenarios and select one that provides sufficient financial strength to discharge its functions. - BOU should include the MOFPED in its modeling and discussions to secure stakeholder acceptance of any proposed core capital framework. ### Unrealized revaluation reserves - Legal and accounting guidance: - Law should provide for two classes of revaluation accounts: revaluations before profit (IFRS) and allocations from profits. - Law should allow the bank to create sub-accounts; a general provision permitting creation of required unrealized revaluation reserves is sufficient. - Characteristic and practice: - Revaluation accounts should only hold unrealized revaluations. - BOU’s amendment of its policy for realized and unrealized gains implemented since the last mission addresses this condition. ### Distributions (Article 16 amendments recommended) - Issues to address in law: - BOU’s financial reporting framework (identify that BOU prepares annual financial statements in accordance with IFRS). - Definition of distributable earnings (central banks should only distribute realized income). - Basis for allocating distributable earnings to statutory capital and dividends. - Procedure to determine distributable earnings (start with net income under IFRS and apply adjustments): - Transfer all unrealized revaluation gains from foreign currency and fair value price movements from net profit to the relevant unrealized revaluation reserve. - Transfer unrealized revaluation losses to the relevant revaluation reserve until that balance is zero; remaining unrealized losses remain in net profit. - Identify any revaluation gains in the revaluation reserve realized during the year and transfer them back to the current year’s profit. - The adjusted IFRS operating profit represents distributable earnings. - Allocation recommendations: - Allocation between statutory capital and dividends is a matter for agreement between BOU and MOFPED while core capital is between prescribed minimum and maximum. - Below the minimum: MOFPED receives no dividends. Above the maximum: MOFPED receives 100 percent of distributable earnings. - Current arrangement: 75/25 percent in favor of MOFPED. - Mission preference: reverse split retaining 75 percent at BOU to accelerate accumulation of core capital. - Minimum: BOU should retain at least 50 percent of distributable earnings until meeting the limit. ### Recapitalization: Article 14(4) detailed requirements - Recommended recapitalization arrangements: - Trigger point for recapitalization: when sum of all capital accounts reported in audited annual financial statements are less than the authorized capital (i.e., authorized capital is impaired). - Recapitalization Instruments: interest bearing marketable government securities. - Level of recapitalization: make the sum of all capital accounts equal to authorized capital. - Timing of recapitalization: within three months of BOU publishing the financial statements that identify the need. - External investigation: - Government may commission a public inquiry to determine causes; inquiry should not delay recapitalization. - Alternative: BOU may prepare, with external auditor advice, a report explaining causes of capital shortfall and submit it to government. ### Accounting issues — recapitalization bonds and reserves - Treatment of recapitalization bonds: - BOU Board needs to pass a resolution classifying recapitalization bonds as part of equity. - Mission view: allocate value of bonds to offset a negative balance in a realized revenue reserve. - Alternative: allocate balances of both revenue and recapitalization bond reserves to the general reserve. - Income treatment: - Transfer interest income accrued in Other Comprehensive Income (OCI) from recapitalization bonds to the revenue reserve. - Once reclassified, interest on remaining bonds should be recognized as interest income through profit and loss. - BOU should consult new auditors on treatment of interest income accrued in OCI; probable correct treatment is recognition through profit and loss in compliance with the available for sale classification under IAS39. - Distribution concerns: - Distributions to MOFPED should not affect accounting treatment under IFRS. - BOU’s capital position is precarious; distributions are a distant prospect. ### Presentation and rationalization of capital in financial statements - Recommended presentation changes: - Separate equity into Core Capital and Revaluation Reserves. - Proposed Balance Sheet presentation (June 30, 2014 / June 30, 2013) as provided: - Core Capital: 19,362; 161,829 - Revaluation Reserves: 1,746,410; 1,450,980 - Total Equity: 1,765,772; 1,612,809 - Notes presentation of Core Capital and Revaluation Reserves (June 30, 2014 / June 30, 2013) as provided: - Core Capital: - Authorized capital: 20,000; 20,000 - Revenue Reserve: (679,880); (526,159) - General reserve: 269,225; 257,971 - BOU recapitalization securities: 410,017; 410,017 - Core Capital total: 19,362; 161,829 - Revaluation Reserves: - Asset revaluation reserve: 142,405; 143,875 - Post-Employment Benefits: 36,348; (4,198) - Unrealized translation reserve: 1,567,657; 1,311,303 - Revaluation Reserves total: 1,746,410; 1,450,980 - Rationalization: - Board resolution reallocating recapitalization bond account to revenue reserve will simplify disclosures. - Treating revenue reserve as a retained earnings account and closing it annually to general reserve could reduce disclosed core capital accounts to one. ### Treatment of repo securities - Facts and issues: - MOFPED issued up to UGX 1,200 (billion) of “securities” for BOU market operations; they carried no interest flows, had maturity dates, were not tradable, and could not be rehypothecated by commercial banks. - External auditors classified these as advances from government rather than tradable financial instruments. - Mission view: financial statements erred in not recognizing fair value as required under IAS39 and in failing to disclose fair values in note 41. - Economic substance and market effects: - Instruments resemble government guarantees: holders could not sell them; redemption depended on MOFPED discretion and provided no coverage for interest element. - Use of these securities as collateral in sterilization operations limits market development and is unattractive to market participants. - Recommendations: - Convert repo securities into full marketable securities to provide BOU with sufficient financial assets to discharge functions. - Reconsider accounting disclosures to reflect economic substance and disclose fair value under IFRS despite claims of immateriality. ### Petroleum Revenue Investment Reserve (PRIR) - Legal and balance sheet implications: - Public Finance Management Act, 2015 establishes Petroleum Fund and Petroleum Revenue Investment Reserve and specifies BOU’s role as manager. - On an agency basis, the Reserve exists outside BOU’s balance sheet; BOU must present separate financial statements for the Reserve. - Agency treatment implies no direct impact on BOU’s capital requirements. - Issues identified for resolution between BOU and authorities: - Calculation of management fees: agree format including recovery of establishment costs. - Clarification of distributions from the Reserve: PFM unclear on mechanism; investment strategies need clear future inflows/outflows. - Determination of consequences when Parliamentary estimates for receipts exceed actual receipts for the Petroleum Fund. - Reconciliation and clarification of articles 59 and 62 which appear to conflict regarding transfers to the consolidated fund. *Source: Bank of Uganda and Fund Staff calculations.* ### 21. The assumption of the Petroleum Fund and Petroleum Revenue Investment Reserve ### 21. The assumption of the Petroleum Fund and Petroleum Revenue Investment Reserve ### Implications for BOU operational and governance frameworks - Articles 59 and 62 require parliamentary approval to transfer money: - Article 59: requirement for parliamentary approval to transfer money from the petroleum fund to the consolidated fund; Article 59(4) introduces a Petroleum Revenue Holding Account (not defined elsewhere) implying parliament can appropriate money from this account to the consolidated fund, though 59(1) only empowers appropriation from the Petroleum Fund. - Article 62(1): parliament shall appropriate money from the Petroleum Fund to the Petroleum Revenue Investment Reserve. - Article 62(3): any money not appropriated to the consolidated fund shall be transferred to the Petroleum Revenue Investment Reserve. - Petroleum Fund operations: - The Petroleum Fund will be an additional government deposit used to receive and disburse petroleum receipts, managed by the Accounting General. - This should not raise issues for the BOU apart from ensuring it remains excluded from the TSA project. - Petroleum Revenue Investment Reserve (PRIR) implications: - The PRIR carries material management and governance responsibilities for the BOU. - Responsibilities include developing clear reporting and accountability frameworks with: - the Investments Advisory Committee established under the PFM, and - the MOFPED. - The BOU has established a petroleum fund unit working on the operating framework. - The mission supports the BOU’s actions and encourages an early resolution of issues raised in discussions. ### Accounting for FX swaps — recommended adoption and accounting standard - Mission recommendation: - The mission’s report recommends that the BOU consider adopting FX swaps as a policy instrument. - Applicable accounting standard: - For central banks the accounting for FX swaps as policy instruments is the same as for other entities: as specified in IAS 39 or IFRS 9 concerning derivative financial instruments. - Transaction structure: - An FX swap is a two-legged transaction: a spot and a forward. - Typical settlement: spot is purchase/sale on day T (usually Today +2); forward is the reverse at maturity. - Contemporary accounting rules require simultaneous recognition of both transactions in the books of both parties. ### Accounting entries for an illustrative FX swap (sterilization example) - Example transaction: - Central bank sterilizes the local rupee through an FX swap of USD 500,000 for 30 days. - Table data (bid/offer example): - Amount tendered: 500,000 / 500,000 - Spot USD per Local Currency (LC): 0.0819 / 0.0826 - Forward points for one month forward: 18 / 15 - One month forward rate: 0.0801 / 0.0811 - Accounting on origination — spot leg (numbers preserved): - DR Commercial Bank LC 6,053,269 = 500,000 / 0.0826 - CR USD Account LC 6,053,269 (Days spot rate for euro) - Forward leg calculations: - Swaps payable = USD 500,000 converted at forward rate inclusive of swap points = 500,000 / 0.0811 = LC 6,165,228 - Difference (swap discount) = LC 6,165,228 − LC 6,053,269 = LC 111,959 (to be amortized) - Memorandum accounts and origination journal (as presented): - DR USD Receivable LC 6,053,269 - DR FX Swap Point Accrued Expense LC 111,959 - CR FX Swap Payable LC 6,165,228 ### Recognition of swap expenses and valuation changes (accrual example) - Accrual practice: - During the life of the swap the bank must accrue interest and valuation changes via regular recalculations of swap points at each valuation date. - Options for accrual: - Recalculate swap points and recognize difference between origination valuation and latest valuation at each accrual date. - Alternatively, allocate the value of the swap points on a linear basis over the life of the swap (suitable if swap durations are not long). - Hypothetical accrued expense and valuation table (values preserved): - Swap Points / Effective Exchange Rate / Principal / Local Currency / Interest to Accrue / Cumulative Interest - 15.00 / 0.0811 / 500,000 / 6,165,228 - 7 / 11.90 / 0.0814 / 500,000 / 6,141,752 / 23,476 / 23,476 - 14 / 8.90 / 0.0817 / 500,000 / 6,119,202 / 22,550 / 46,026 - 21 / 4.90 / 0.0821 / 500,000 / 6,089,392 / 29,810 / 75,836 - 28 / 1.00 / 0.0825 / 500,000 / 6,060,606 / 28,786 / 104,622 - 30 / 0.00 / 0.0826 / 500,000 / 6,053,269 / 7,337 / 111,959 - Example journal entry for day seven into the swap: - DR Swap Expense LC 23,476 - CR FX Swap Point Accrued Expense LC 23,476 - At maturity, accumulated FX Swap Point Accrued Expense total = LC 111,959. - Closing entries on maturity (as presented): - DR FX Swap Payable LC 111,959 - CR Commercial Bank LC 111,959 - DR USD Account LC 6,053,269 - CR Commercial Bank LC 6,053,269 ### Recognition of exchange rate gains and losses — recommended treatment - Principal observations: - FX unrealized revaluation gains and losses from swaps are essentially the same as those from FX retained in the bank’s portfolio and should be treated the same way. - Frequent processing of swap transactions as realization of FX gains will consume the unrealized revaluation gains reserve buffer, weakening the bank’s ability to withstand future exchange rate shocks. - Economic substance argument: - At end of transaction the central bank ends up with the same amount of foreign exchange as at the beginning; it retains the same exchange rate risk yet may have realized gains/losses on the swap that it did not realize on retained currency. - This asymmetric outcome suggests inappropriate treatment if swaps are treated as realized FX sales. - Recommended accounting view: - View a swap as a loan in national currency collateralized by foreign currency. - Treat the FX leg as exchange of collateral; treat the forward leg as return of collateral matched by repayment of the local currency leg. - Treating both legs as a single transaction avoids treating the forward leg as a sale of FX for national currency receipt, thus avoiding recognition of realized gains. - Operational implication: - On spot leg, central bank does not recognize gain or loss on notional sale of FX. - On maturity, book FX back at the same rate as day of sale, capturing gains/losses in unrealized revaluation reserves. - This requires administrative changes specific to each central bank. - Effect on classification: - This approach does not prevent application of derivative accounting rules but reallocates gains between interest and unrealized revaluation gains to preserve economic substance and the unrealized revaluation reserve. ### Appendix V — BOU: Issues Relating to Amendments of the BOU Law - Process and timing: - BOU is preparing amendments to its law to enhance integrity in the evolving financial market environment. - Mission discussions proceeded on assumption that BOU will send a further draft to the Fund’s Legal Department (LEG) before submitting legislation. - BOU intends not to submit proposed amendments to Parliament until after the 2016 election to reduce political interference risk and allow time to finalize framing, particularly for the proposed financial stability function. - Financial System Stability (FSS) function: - Proposed amendments identify a function to “foster a sound financial system” but lack detail on: - what the FSS contains, - its hierarchy relative to monetary policy, - its interface with other regulatory bodies and MOFPED. - BOU already has FSS elements that require integration into law amendments. - Financial Sector Surveillance Committee (chaired by MOFPED) is defining its role; BOU must ensure law consistency with other regulatory authorities. - The final role of the Surveillance Committee (monitoring, advisory, or directive) affects BOU law design. - FSS developments interface with BOU’s role as lender of last resort (LOLR); BOU must clarify extent and criteria for LOLR role and transfer of liability for loss to MOFPED where applicable. - Mission advises BOU to clarify FSS configuration through consultations with other regulators, MOFPED, and central banks in the EAC or greater Africa. - Defining price stability: - Constitutional and legal framing: - Article 162 of the constitution defines the object of monetary policy as price stability. - Section 28 of the current BOU Act defines instruments for monetary operations. - Preliminaries define price stability as “low and stable inflation over a period of time”. - Missing element: a definition of the target (what price stability means). - Options discussed: minister specifying policy targets or leaving to central bank board; mission provided examples. - Elements a definition should include: - level of inflation (e.g., point or band), - time period targeted (e.g., one year or medium term), - measure of inflation used (statistical basis). - Law may consider specifying accountability for failure to meet the inflation target. - Defining central bank capital: - Preliminaries may need to amend definitions of “capital”, “core capital”, and “monetary liabilities”; add “distributable earnings”; possibly delete “reserve money” if unused. - Possible to delete reference to “capital” and use only “core capital” depending on amendments. - When defining distributions, do not define elements included in profit (IFRS defines profit); reference in law to profit elements could conflict with IFRS. - Defining distributable earnings must identify elements removed from IFRS profits to arrive at realized earnings net of uncovered unrealized losses available for distribution. - BOU law and the Ugandan Constitution: - BOU can accommodate LEG review comments without amending the constitution. - Example: constitution specifies governor as board chair; LEG suggested governor not chair board meetings that consider aspects of his performance — BOU identified solutions consistent with the constitution and LEG concerns. - Temporary advance to government and TSA: - MOFPED and BOU are working to remove government need for short-term financing from BOU by organizing accounts around a treasury single account (TSA). - Once TSA is operational MOFPED can monitor and plan cash flows without recourse to BOU advances. - BOU proposes to ensure any use of temporary advances incurs market-based interest costs by including a clause preventing netting of balances for interest charging purposes — advances will be subject to interest until repaid to encourage substantive move to TSA. - Lender of Last Resort (LOLR): - Proposed amendments to section 43. Credit clarify to whom BOU may act as LOLR: illiquid but solvent financial institutions as defined under the Financial Institutions Act of 2004. - Section creates a tiered approach to collateral and duration to cover critical situations. - BOU must reconcile obligations under this section with those arising from an FSS function. - Other issues: - Discussions covered wording and expression details; BOU will incorporate these in the next draft. - Meetings provided effective forum for BOU legal team to clarify central bank governance and independence issues. ### Box 1. Examples of price stability target definition (examples preserved) - Reserve Bank of New Zealand — policy targets procedure and obligations (text preserved in source). - European Central Bank — quantitative definition: - "Price stability is defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2 percent." - The Governing Council aims to maintain inflation rates below, but close to, 2 percent over the medium term. *Source: cr1810 - 21. The assumption of the Petroleum Fund and Petroleum Revenue Investment Reserve* ### Appendix VI. Status of Implementation of Earlier ### Appendix VI. Status of Implementation of Earlier Recommendations and Action Plan ### Central Bank Financial Strength and Recapitalization: Recommendations and Action Plan - Restoring Income Sufficiency - Agree framework for income restoration and structure and timetable of securities for issue. - Action: BOU/MoFPED - BOU actions: BOU developed a medium term business plan showing how financial viability will be restored. It was submitted to MOFPED. Feb 2013 - Issue first tranche of securities - Action: MoFPED - BOU actions: Recapitalization securities were issued to BOU so far two tranches, 410 bn and 250 bn. February 2013 - Establish process to identify opportunities to charge for BOU services - Action: BOU - BOU actions: Opportunities were identified and documented in the medium term business plan. The aspects that related to charges for services rendered to Government are contingent on signing the MOU between MOFPED and BOU. April 2013 - Establish procedures to further control expenditures, especially payroll - Action: BOU - BOU actions: Done in the medium term business plan. Staff costs were capped and recruitment frozen since 2012. April 2013 - Agree mechanism for monitoring expenditure - Action: BOU/MoFPED - BOU actions: Medium term business plan addresses all major expenditure aspects for the Bank. May2013 - Implement expenditure monitoring process - Action: BOU - BOU actions: Quarterly management reports are prepared and discussed by BOU board and management. May 2013 - Recapitalization - Agree the elements of a new capital framework: statutory capital, revaluation reserves, distributions and recapitalization - Action: BOU/MoFPED - BOU actions: This was agreed under the MAC framework for capital adequacy for central Banks that was approved by the EAC central Bank Governors in January 2015. April 2013 - Develop accounting procedure to identify and capture realized revaluation gains to avoid accumulation in translation reserves - Action: Accounting - BOU actions: Accounting Procedure was developed and has been implemented for the last two Financial years. 2013/14 and 2012/13. This is based on the Modified LIFO framework as advised by the IMF team led by Ken Sullivan. May 2013 - Develop procedure to identify realized gains already held in translation reserves - Action: Accounting - BOU actions: Accounting Procedure was developed and has been implemented for the last two Financial years. 2013/14 and 2012/13 May 2013 - Amend law to reflect new capital structure - Action: BOU - BOU actions: Draft amendment proposals were finalized (LC and EDR can confirm). June 2013 - Implement new law and post realized revaluation gains to general reserve - Action: Accounting - BOU actions: Posting is done although law not yet changed. July 2013 - Implement new accounting procedures to prevent realized gains from remaining in translation reserve. - Action: Accounting - BOU actions: Done on annual basis since 2012/13 as seen in the statement of Changes in Equity. July 2013 - Accounting and Reporting - Agree accounting for increased Quota and reporting of reserve tranche position - Action: BOU/MoFPED - Date: March 2013 - Rename “Statement of Strategic Objectives” to “Statement of Functional Expenditures” in the annual report and present on that basis. - Action: Accounting - BOU actions: Implemented June 2013 - Refine disclosures on expenditure management - Action: Accounting - BOU actions: Implemented June 2013 - Develop a “Statement of Distributions” to present determination and allocation of distributable earnings - Action: Accounting - BOU actions: Will be resolved once the new law is amended to address distribution of earnings. August 2013 ### Establishing the Building Blocks of an Inflation Targeting Regime: Recommendations and Action Plan - I Institutional Framework — Key findings and recommended actions - Finding: The BOU has been constantly subjected to an extreme version of fiscal dominance that could also endanger the implementation of IT, and the coordinating framework has proven not to be sufficiently robust to withstand such pressures. - Mission recommendations: - Amendment of the BOU Act to rule out any advances to the government. In the meantime, all advances should be fully sterilized, and the MoFPED must assume full responsibility for cash flow and public debt management and build capacity in these areas. - Agree on the operational arrangements for the implementation of a separation between monetary and fiscal policy instruments. This requires that BOU is fully recapitalized. - Draw up and design of a new Memorandum of Understanding between the BOU and the MFPED as a matter of urgency to establish a set of operational arrangements for the coordination of macro policies under the new framework. - BOU actions / assessment: - Work on amendments of the BOU Act is already in progress. - Since July 2012 MFPED & BOU agreed to use treasury securities in the primary market for only fiscal policy purposes. Monetary policy is conducted through the secondary market. - A revised MOU between BOU and the MFPED was drafted by BOU and is currently before the MFPED for review. - II Central Bank Communication Policy — Findings and recommendations - Finding: BOU has significantly improved its communication in some aspects, but it needs to do further work to support the new IT regime. - Mission recommendations: - The MPS’ should be structured to be more effective: - Improve the structure of ideas/paragraphs; - Inclusion of signals of possible future monetary policy movements. - The MPR or the future Inflation Report should consider: - The report should be released on a quarterly basis; - The inflation projection should not consider a “passive projection”; - The time horizon of the inflation projection should be consistent with the policy horizon; - At the end of the horizon (in the fan charts), the projection should be equal to the target of 5 percent; - The risk balance analysis should be better explained. - Economic agents would benefit from active communication (website focus on monetary policy; conferences/seminars; regular speeches; off the record meetings with journalists and economists; publication of a light brochure; activities for students; regular publication and dissemination of working papers). - BOU actions / assessment: - This is work in progress. - A new structure of the Monetary Policy Report (MPR) was adopted. The report is forward looking and with a clear policy horizon of 12 months. - The frequency of the MPR was reduced to bi–monthly in line with the announcement of the new policy rate. - BOU continues to disseminate information to the general public to improve their understanding of monetary policy in line with the approved communication strategy of the BOU. This has been done through, press briefings, media houses, the website, social media and school seminars. - III Monetary Policy design and Implementation — Findings and organizational recommendations - Finding: The decision making process in the MPCMs is based on the discussion only among the Governor, Deputy Governor and the BOU staff. The MPCMs should be refined for higher effectiveness. - Mission recommendations: - MPCMs should be renamed to differentiate between the monetary policy meetings and the other ones. - The MPCMs should be scheduled in an annual rolling basis. To avoid any uncertainty related to monetary policy decisions and its implementation the BOU should release annual rolling calendars. - Adjust organizational structure and adopt an allocation of the key monetary policy functions better aligned with the demands of its new monetary framework. Suggested allocation: - Operations Department: responsible for all activities having to do with the financial operations undertaken by the central bank including (i) short term liquidity forecasting. - BOU actions / assessment: - The MPC meeting to set the policy rate are known as MPCs while the weekly meetings to review economic developments are named MPCR i.e. MPC review. - A 12 month’s rolling calendar for the Issuance of the MPS is published on the BOU website. - The Financial Markets Department does the daily liquidity forecasting. The Economic Research Department continues to provide any additional information to FMD for the short term liquidity forecasting. - IV Foreign Exchange Policy and Operations — Findings and operational recommendations - Finding: Interventions in the forex market need to be formalized to ensure full consistency with the ITL regime. - Mission recommendations to strengthen the flexible exchange rate regime and make FX operations more transparent and market oriented: - The BOU should publicly announce the main objectives of its forex interventions (e.g. to accumulate international reserves or to dampen exchange rate volatility), the duration of the program, the amount of US Dollars to be brought on a daily basis and the specific rules that will trigger an intervention. - The rules-based mechanisms for forex intervention should be executed through interactive competitive auctions where banks can change their initial bid/offer to make it more competitive to assure that they receive an allotment. - Results of the forex auctions, once finished, should be published on BOU’s website. - The BOU reserves the right to realize unannounced interventions in the forex market. However, these interventions should only be used under very extreme circumstances and, once executed, should be explained to the public (the explanation can be done with a time lag). - BOU actions / assessment: - The recommendations were adopted by the MPC and continue to be implemented. - V Monetary and Fiscal Policy Coordination — Findings and recommended operational measures - Finding: The BOU has not yet developed a robust macro modeling capacity. There is still need. The BOU has not been sufficiently capitalized to face a framework in which it has to pay the cost of sterilization. The BOU lacks longer-term instruments to accommodate changes in the structural liquidity of the banking system. - Mission recommendations and operational guidance: - During the transition, the authorities should still rely on the financial programming exercise to coordinate macro policies. - It is suggested for the BOU to conduct empirical evaluation of the relevance of broader monetary aggregates as information variables for monetary policy conduct. - To improve economic analysis and forecasting the Directorate is in its final stages of adopting the Forecasting and Policy Analysis System (FPAS) Tool. FPAS provides an environment for collecting, analyzing, and processing information and assumptions for policy formulation using models, forecasting processes, and software. - Under a framework in which the BOU will be the institution facing the sterilization costs, it is strongly recommended to sign a MoU between the BOU and the MFPED to address the problem. Further technical assistance is recommended to address the specific details of this issue. - At the operational level MFPED and the BOU have to decide which instruments will be used for fiscal financing needs, and for sterilization purposes for BOU: - First best option: BOU to auction government securities to sterilize excess liquidity. - Second best option: BOU to issue its own securities. To avoid market fragmentation, the BOU and the MoFPED should coordinate the main characteristics about the securities (e.g., terms, amounts, type of interest rates, etc.). - BOU actions / assessment: - To date the Government has issued recapitalization securities worth Shs. 660 billion. - MCM has made arrangements for a follow-up mission by Kenneth Sullivan on the BOU recapitalization during January 23–February 5, 2013. *Appendix VI. Status of Implementation of Earlier Recommendations and Action Plan — Central Bank Financial Strength and Recapitalization; Establishing the Building Blocks of an Inflation Targeting Regime (as presented in the source).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1810.pdf_