Uganda - Industrial sector memo

Dam.ui Of The World Bank FOR OFFICIAL USE ONLY Report No. 5633-UG UGANDA INDUSTRIAL SECTOR MEMO September 30, 1986 Industrial Development and Finance Division Eastern and Southern Africa Projects Department I This document has a restriced distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (September 1986) Currency Unit = Uganda Shilling (USh) UShl.OO = USS0.0007 US$1.00 - UShl,400 ABBREVIATIONS AND ACRONYMS ADB - African Development Bank CEM - Country Economic Memorandum CEO - Chief Executive Officer DRC - Domestic Resource Cost EADB - Eastern Africa Development Bank EEC - European Economic Community EPR - Effective Protection Rate GNPR - Gross Nominal Protection Rate &OU - Government of Uganda NNPR - Net Nominal Protection Rate NPR - Nominal Protection Rate PE - Public Enterprises RRP - Revised Recovery Program UCB - Uganda Commercial Bank UDC - Uganda Development Corporation VTC - Vocational Training Center VTI - Vocational Training Institute UEB - Uganda Electricity Board WI - Window I Exchange Rate WII - Window II Exchange Rate FISCAL YEAR Uganda's Fiscal Year runs from July to June. This report is based on the findings of an industrial sector mission which visited Uganda in September-October 1984. The mission members were: Mariluz Cortes - Mission Leader Sven Hegstad - INDRE Anil Kapur - INDRE Hilary Sunman - Consultant Gradimir Radisic - Researcher Mr. Manuel Penalver joined the mission for the second half.  FOR OFFICIAL USE ONLY CONFIDENTIAL UGANDA INDUSTRLAL SECTOR REVIEW Table of Contents Page No. EXECUTIVE SUMMARY AND RECOMMEKNDATIONS ................. *(i) I. EVOLUTION AND STRUCTURE OF THE MANUFACTURING SECTOR ... 1 A. Evolution of the Manufacturing Sector ............. 1 Industrial Growth During the 1960s ................ 1 Industrial Activity in the 1970s .................. 3 B. Industrial Structure ........... ............ . ... 5 Ownership .. 5 Changes in Industrial Employment (1971-1983) .. 6 New Enterprises since 1980 ... 7 Changes in Firm Size .......... . 8 Structure of Output ......... ..................... . 9 Geographical Distribution .... . 9 II. RECENT INDUSTRIAL. PERFORMANCE ...................... .. 10 A. Policy Changes and the Recovery Program ... . 10 B. Industrial Performance (1981-1984) . 11 Growth of Industrial Output . ..11 Capacity Utilization .......13 C. Industrial Investment and Rehabilitation .......... 14 D. Tie Structure of Imports (1980-1984) .... .......... 17 Import Content ....... ........ ....................... 17 Imports of Productive Inputs ..... ................. 18 Annex 1: Investment and the Rehabilitation of industry: Subsectoral Review ..... ............... 22 III. THE POLICY FRAMEWORK: MAIN FEATURES 28 A. Introduction .28 B. Aggregate Demand Management .28 C. PrIce Policies .29 Exchange Regime .29 Interest Rates .31 Wages .32 Price Controls .34 D. Trade Regime ...35 Import Licenses ...35 Import Duties and Indirect Taxes . . .36 Export Taxes and Procedures . . .39 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS (Cont'd) Page No. Ill. THE POLICY FRAMEWORK: MAIN FEATURES (Coat 'd) E. Investment Incentives ........ . ........39 Industrial Licensing .............. .............. 39 Foreign Investment ...Pe...... .................. 39 Financing of SSEs *........................... 41 IV. THE IMPACT OF i3LICIES: PROTECTION AND EFFICIENCY OF THE INDUSTRIAL SECTOR ........................... 42 A. Nominal Protection ............... ....... ........... 42 B. Effective Protection ........ ................ 44 .C. Protection and Efficiency of the Sector ........... 46 D. Efficiency and the Impact of Policies: A Comparison of DRCs and EPH ......... .......... 47 V. CONSTRAINTS TO INDUSTRIAL RECOVERY .... ............... 50 A. Introduction ..................................... 50 K. Government Ownership of Enterprises .... ........... 51 Management Problems associated to Government Ownership ....... ............................... 51 Constraints to the Privatization Process .... ..... j3 Formal Mechanisms for Returning the Expropriated Properties ........ ............................. 53 Bottlenecks in the Privatization Process ......... 55 C. Lack of Creditworthiness .......................... 5b Shortages of Liquidity ........................... 60 D. Low Etfective Demand ...... ........................ 61 E. Kuman Resources Constraints ..... ................. 62 Lack of Managerial and Technical Personnel ....... 62 Lack of Skilled Labor ............................ b3 F. Infrastructural Constraints ..... ................. 64 G. The Security Situation .................. b5 VI. THE KEURGANIZATION OF Thki PUBLIC kNTkKPKISkS SbCI1K.... b5 A. Introduction ........ .............................. b5 B. The Government's Reorganization Program .... ....... ob  TABLE OF CONTENTS (Cont'd) Page No. VI. TE REORGANIZaTION OF THE PUISLIC ENTERPRISES SECTUO (Cont'd) C. Current Institutional Framework .................... 67 Relationships with Central Government ............. b7 Planning and Control System ........... so...*.... O.. b8 Roles and Responsibilities ....................... 69 Financial Management 9..............9a ............... 70 D. Main Issues and Recommendations ................... 71 Management of the Overall Privatization and Rehabilitation Process .99.......9................ 71 Management of Enterprises that the Government Will Retain ..................................... 72 The Role of Individual Ministries ................. 74 The Role of the Uganda Development Corporation (UDC) 74 VII. OVERAFL STRATEGY, AND RECUMMENDATIUNS ................. 78 A. Industrial Strategy . ............................... 78 R. Policy Recommendation . ............................. 82 Aggregate Demand Management ....................... 82 Exchange Rate ......................................* 82 Price Controls ... ..... 83 Interest Rates ....... ............................. 83 Import Duties ..................................... 83 Wages and Labor Policies ........................... 84 Corporate Taxes ........................... 84 Export Incentives ... .............................. 84 Investment Incentives ... .......................... 85 Industrial Licensing ...... ........................ 85 Small Scale Enterprises ...... ...................... 85 C. Iostitutional Reco mendations ..... ................ 85 Privatization and Rehabilitation of Government Industries ...................................... 85 Management of State owned Enterprises .... ......... 80 The Kole of UC .......8............................ .b Rehabilitation of Individual Public Enterprises .... 86 Development of Human Resources ..... ............... 87 Strengthening of the Government's Policy Making Capability . ..................................... 87 Infrastructure .. 87 Annex A Statistical Appendix Annex B Study of Selected Government Enterprises Annex C Methodological Notes on the Analysis of the Structure of Protection in Uganda  PREFACE 1. This report is based on the findings of a Bank mission that visited Uganda In September-October 1984 and on additional information covering up to mid-1985. The internal events in Uganda did not allow the discussion of the draft report with Government officials until mid-1986. In the meantime, the important political and economic events in Uganda substantially affected the industrial sector. These changes notwith- standing, we believe that the main findings and recommendations of the report remain valid. Therefore, no attempt has been made to update the report. This preface briefly reviews the economic impact of the events since mid-1985 and points out the areas where some major changes exist with respect to the situation as presented in the main report. Recent Economic Developments 2. Since the second half of 1984, Uganda faced a growing financial and economic crisis brought about by expansionary financial and credit policies, and by the deterioration of the security situation. Political considerations and the war effort led to increasing Government deficits and borrowings from commercial banks and non-commercial sources. This fuelled inflation which rose from an annualized rate of 22 percent in the first six months of 1984 to 225 percent over the last six months of that year. At the sae time, reduced coffee exports and a slow down in foreign loan disbursements led to a decline in foreign exchange availability. The government started to intervene in the exchange rate auction so as to keep devaluation below inflation, and to limit the amount of non-military imports. Lack of imported raw materials and spare parts, coupled with the informal price controls on industrial goods negatively affected industrial production. 3. The financial and security situation continued to deteriorate in 1985 causing the economy to stagnate (real GDP is estimated to have grown at less than one percent). There was some recovery in coffee exports, and a reduction in Government expenditures, but the fiscal deficit remained high, foreign reserves continuedi to fall and inflation remained unabated, reaching an average of 133 percent for the whole year. Increasing capital flight and reluctance of sellers of foreign exchange to deliver it to the auction market, increased the pressures on the foreign exchange auction in the last quarter of 1985. This prompted further Government interference in the auction system; the official exchange rate was kept at about twice the parallel rate. Industrial Sector Performance 4. The fall in real incomes, coupled with the lack of imported inputs, and the reduction in Government investment (which fell by more than 40 percent) severely inhibited industrial production in 1985. Industrial production also suffered because of the disruption in communications caused by the war, which reduced the supply of agricultural raw materials, and with the looting of factory equipment in the war-affected zones.  -2- 5. Although data on industrial value added indicate that the sector stagnated in 1985, information on capacity utilization shows a sharp contraction in output among large, Government owned enterprises. Production of 10 out of 14 industrial products monitored by the Bank of Uganda (for its GDP calculations) was already lower in 1984 than in 1983; in addition, production of all but one (cigarettes) of those 14 products decline further in 1985. Production of beer, cotton fabrics and footwear in 1985 was only half the maximum level reacbed between 1982 and 1984; production of soft drinks and processed milk dropped by 20 percent in 1985. The output of small enterprises probably also declined, particularly in the war zones, although to a lesser extent because the SSEs are less dependent on imported raw materials. The Bank of Uganda estimates that industry accounted for only 4 percent of monetary GDP in 1985, down from 6.5 percent in 1983 (and 12.4 percent In 1970). Recent Policy Measures 6. Since early 1986, when the new Government took power, the security situation in Uganda improved dramatically. The new Government, however, has not yet fuLly addressed the macroeconomic imbalances it inherited and has taken some policy actions that reduced reliance on market forces. In February 1986, the Government terminated the already inoperative foreign exchange auction and adopted a fixed exchange rate policy, with the official rate at about three times below the parallel rate. The allocation of foreign exchange for imports made on a cash basis was entrusted to the Exchange Allocation Committee in the Bank of Uganda. This Committee allocat!= foreign exchange on the basis of weights (priorities) attached to dIfferent categories of imports. Imports through supplier credits and consignments are approved by a Presidential Committee on Essential Commodities which has a technical office in the Ministry of Commerce. The Government has revoked some import licenses on the grounds that recipients are engaged in speculation and now imports directly some basic products such as sugar, salt, soap, blankets, drugs as well as agricultural inputs such as hoes. Local producers of these products may face negative protection as competing imports remain very cheap as a result of the overvalued exchange rate. Moreover, some of these subsidized imports may be smuggled out of the country in order to cash on the premiums that foreign exchange commands in the parallel market. Since the output of most local industries is subject to reintroduced price controls, subsidized industrial inputs may also end up smuggled out of the country instead of being used in production for the local market. 7. In June, 1986, the Government announced an interim policy package in preparation for further measures to be introduced with the 1986/87 Budget Speech. The main elements of this package included: a) the adoption of a dual exchange rate: a priority rate of U Sh 1,400 per dollar to finance imports of basic consumer goods, agricultural and industrial inputs and petroleum products, for payments of external debt and for converting into shillings export proceeds from coffee and cotton; and a "market exchange rate of U Sh 5,000 per dollar (close to the parallel rate) to finance imports of all other goods and services and for converting into  -3- shillings export proceeds of non-traditional products; b) increases in the producer prices of cotton, cocoa and tobacco; and c) increases in the interest rates payable to investors and chargeable to borrowers. Three months later, however, in the 1986/87 Budget Speech, the Government, abandoned the market- exchange rate and fixed the official exchange rate at U Sh 1,400 per dollar, compared to a parallel rate that was of the order of USh 8,000 per dollar. 8. The producer price increases in the June 1986 package, while steps in the right direction, seem to fall short of whaL. is required. In the case of coffee, despite the June price increase (by 80 percent in the case of robusta coffee with respect to its December level) local producers receive about 10 percent of the current price across the border in Zaire. This pricing policy is a disincentive for coffee producers and has also negative budgetary implications, since the coffee tax is the main source of Government revenues. 9. Similarly, despite the recent increase, interest rates remain strongly negative at the current level of inflation (over 130 percent per year). Firms and individuals are likely to continue choosing other non-financial forms of maintaining the value of their assets, thus reducing the demand for liquidity and further fueling the inflationary pressures. On the other hand, the creditworthiness problems of a large number of enterprises, which are now worse than at the time of the sector mission, continue to limit lending to the industrial sector. The interest rate structure favors lending to commercial enterprises because the same rate applies whether it is a short term commercial loan or a riskier long term -loan to industry. The reduction on corporate income taxes for industrial enterprises from 50 to 40 percent, announced in the Budget Speech, will increase corporate cash flows and help in the rehabilitation efforts of some enterprises. However, in Uganda's economic environment, tax considerations have limited weight an business decisions. 10. The new Government has also taken positive steps towards reducing the Government ownership and management of industrial enterprises. A decision has been made to honor the joint ventures formed by the previous Government and to accelerate the process of privatization, except for a handful of enterprises that the Government considers of strategic nature. In particular the Government wants to close down, as soon as possible, non-viable enterprises which are a drain to the budget. 11. An important step in solving the ownership problem cf Government controlled enterprises is the recent approval by Cabinet of a proposal for the reorganization of the Uganda Development Corporation (UDC). According to this proposal, UDC will receive 20 enterprises managed by the Ministry of Industry in addition to the 15 enterprises it has. UDC is expected to proceed as soon as possible to review these enterprises and decide which of them should be sold (or open to public participation), which ones should be retained, and which ones should be closed down. For this task, UDC will be reorganized and expanded and will recruit executive directors to be in-charge of the enterprises. UDC will be a promoting organization and not  -4- a holding company, the enterprises managed by UDC will be open to public participation (or sold) when they mature (i.e. when they start making profits), and the proceeds used to promote new ventures. The Government is also contemplating the creation of a Public Enterprises Secretariat to manage the rehabilitation of UDC and of several other industrial enterprises that are now managed by the Ministry of Industry and which will not be transferred to UDC (these are firms that have not been subsidiaries or associates of UDC in the past). The Secretariat would decide which of those firms to retain, which ones to sell and which ones to close down. The revitalization of UDC and the delinking of public enterprises from the political sphere through the proposed Secretariat are important steps in the rehabilitation of the industrial enterprises under Governmnt control. 12. Given the recent economic and policy developments in Uganda, the report's diagnosis of the constraints to industrial recovery and its recommendation on bow to overcome them remain valid. The report identified seven major constraints to industrial growth: (a) problems derived from the Government ownership of a majority of large industrial enterprises; (b) inadequacies of the policy environment; (c) lack of creditworthiness of the enterprises; (d) lack of effective demand; (e) scarcity of human resources; (f) poor infrastructure and utilities; and (g) uncertainties related to the overall political and social environment. The latter has ceased to be a major constraint to industrial recovery, but all other constraints remain, albeit in a different order of importance. The problems associated with Government ownership of enterprises appears in the report as the most important constraint to industrial recovery. With the approved reorganization of UDC and the creation of the Public Enterprises Secretariat, this may cease to be a constraint in the near future. On the other hand, policy environment has become once again the most important obstacle to industrial recovery. In the report, the problems associated with the policy environment related to shortcomings in the implementation of a basically sound strategy. At this point, however, the main issue is the need to adopt an adequate macroeconomic strategy. This strategy, the report argues, should be based on a gradual opening of the economy to market forces, particularly in the areas of trade, exchange rate, product prices and labor legislation, and on keeping the budget under control.  Executive Summary and Conclusions A. Historical Background 1. The 1960s was a period of rapid economic growth and rising incomes for Uganda, as the country successfully exploited its agricultural potential. Witlh an agricultural sector growing at 4.5 percent between 1966 and 1970, Uganda was not only self sufficient in food, but also an exporter of considerable amounts of coffee and cotton, as well as tea and tobacco. By 1970, GNP per capita. was US$512 (in 1980 prices), the fourth highest in Eastern and Southern Africa. 2. During this period, a number of industries were established by local and foreign industrialists, many of them of Asian origin, encouraged by rising domestic demand and government support. ihe Government itself established several industries in the form of joint ventures or on its own, through the Uganda Development Corporation. The industrial sector, however, remained mainly privately owned. By the end of the 1960s, the medium and large scale industrial sector, (i.e. firms with 10 workcers or more) including agroindustries, accounted for over 12 percent of monetary GDP and employed over 47,000 people, 17 percent of total monetary employment. The sector produced a wide range of consumer and intermediate goods for domestic consumption and exported sizeable amounts of cotton fabrics and animal feeds to Kenya and Tanzania. Food, beverages and tobacco contributed half of manufacturing value added followed by metal industries (16 percent), non-metallic minerals (8 percent) and textiles and wearing apparel (7 percent). 3. In 1970, the Guvernment of Uganda had started expanding its participation in the industrial sector by acquiring controlling interests (60 percent of equity) in a number of private enterprises. Two years later, the military regime, which took over in 1971, launched the so-called economic war which led to the deportation of 6U,000 non-nationals, mostly Asians, and the incorporation of their industries into the parastatal sector, which became swollen with more than IUU enterprises. 4. What followed was a decade of administrative, social and economic deterioration, aggravated by increasing foreign exchange constraints. Although agricultural production and exports remained steady between 197Z and 1977, the trade balance deteriorated following the 1973 increase in oil prices. The trade balance improved during 1976 and 1977 due to the boom in world coffee prices. By the time coffee prices fell, however, exports other than coffee (cotton, tea, tobacco and textiles) had become marginal because of low agricultural prices, and an overvalued exchange rate. Falling coffee prices and rising import prices, especially petroleum ;.-er the second oil price increase in 1979, produced a 2b per^ent decline in Uganda's terms of trade between 1978 and 1980. 5. Industrial production during the military regime declined through a combination of mismanagement, equipment failures due to lack of techni- cal personnel and maintenance, and scarcity of foreign exchange to import  - li - spare parts and raw materials. Subject to pervasive price controls, all Government owned firms had losses, and acumulated heavy portfolios of unserviceable debts with banks which were obliged by the Government to give them loans. By 1978 industrial production was down to about half the 1971 level. Shortages of consumer and other manufactured goods encouraged the development of black markets and accelerated inflation. Factory looting during the final months of the liberation war, in early 1979, inflicted further damage to the industrial sector. by 1980 manufacturing of food products had fallen 86 percent; crop processing had fallen 62 percent and other manufacturing activities had fallen 57 percent from their 1972 peak level. The share of manufacturing in monetary GDP was down to about 6 percent. The whole monetary sector had contracted by one fourth. By 1980 GNP per capita was US$263, less than half its 1970 level. 6. Despite the precipitous decline in output, industrial employ- ment-in the now nationalized firms-remained remarKably constant. This was accomplished through a tremendous decline in real wages; in eight years, the minimum wage rose by only 54 percent, despite an increase of 11 times in the Kampala low income cost of living. To survive, people combined employment in the monetary sector with work in black market jobs and subsistence agriculture. 7. In the late 1970s and early 1980s, a number of small private firms were set up to provide some of the goods and services that the nationalized industries were not able to provide. Most of these new small firms are resource based, such as grain milling, wood working and brick manufacturing. However, the bulk of industrial employment is still concentrated in 12 large parastatals with more than 500 workers each, which give employment to nearly 18,000 people, half of the people currently employed in manufacturing. B. Recent Industrial Performance S. Policy Changes and the Recovery Program. The mounting balance of payments difficulties experienced by Uganda during the 197Us were the result of a serious imbalance between the level and structure of domestic demand and the country's dwindling productive capacity. Growing public sector deficits since the second half of the 197Us, the main factor behind the growth of domestic demand, were financed by borrowing from the banking system. These deficits had a strong inflationary effect, and left little resources to finance the productive sectors. Negative interest rates hindered the mobilization of domestic resources, further reducing the resources available to the banking sector. On the other hand, serious price distortions in the economy contributed to the contraction of agricul- tural and industrial output. The overvalued exchange rate also undermined the profitability of agricultural exports and weakened the balance of payments, leading to increasing import and exchange controls. 9. In June 1981, the Government adopted a package of policy measures wnich nad the objective of enabling the country to achieve internal and external equilibrium. First, the Government adopted fiscal and monetary policies to bring the growth rate of demand in line with the growth rate of  - iii - productive capacity. These included: (i) reduction of fiscal deficits by eliminating subsidies and increasing tax revenues, and (ii) establishing credit ceilings for Government borrowing. Second, price distortions were reduced in order to improvip the allocation of resources and restore the incentives to the tradeable sectors. These included: (i) a more realistic exchange rate, (ii) increase in agricultural prices; (iii) partial elimina- tion of price controls; (iv) elimination of quantitative restrictions to imports; and (v) increases in interest rates. The Government also adopted the decision to privatize most of the public industrial sector. 10. Following the adoption of the above macroeconomic policies, the Government designed a project specific rehabilitation plan for the economy: the Recovery Program 1982-1984 and the subsequent Revised kecovery Program (KKP). These included a fixed investment program of U$ 437.6 million tor the rehabilitation of the industrial sector, nearly half of which was to be executed over a three year period. The main components of the program were large projects in cement, textiles, sugar, tobacco and beverages, and additional resources to be disbursed through the Uganda Development Bank and the Uganda Commercial Bank to particular industries which were identified as prioritary. This was not a public investment program, but Government estimates of the investments needed to rehabilitate a number of enterprises, many of which have been privatized or are in the process of privatization. To carry out the investments, the firms were to request finarcing trom the financial intermediaries. Pledges by aid donors in support of the RKP are mostly channelled through the financial institutions. 11. The macroeconomic policies adopted by the Government succeeded in reversing the economic decline of the last decade. The sharp licrease in agricultural prices had an almost immediate impact on agricultural produc- tion and exports. Led by the agricultural sector, total GQW, which in 19BU and 1981 had fallen to its lowest level in nearly two decades, grew by d.2 percent in real terms in 1982 and 7.3 percent in 1983. Meanwhile, increased export receipts and moderate increases in imports helped to reduce the current account deficit. Preliminary estimates, however, point to a lower real GOP growth in 19u4 as a result of slower growth of output in the agricultural and industrial sectors. 12. The industrial sector responded initially to the demand expansion generated by higher agricultural incomes, and to the improved toreign exchange availability, by growing by IU percent in 1982. It was unable to sustain such response, however, growing by only 2 percent in 1983. Figures on capacity utilization indicate that recovery was also sluggish in 19b4. Only 6 out of ZZ industrial sub-sectors for which there is information on capacity utilization (comprised mostly of large government owned enter- prises) experienced relatively strong recovery between 1981 and 19*4, going from less than 15 percent of capacity utilization in 1981 to between 30 percent and bO percent capacity utilization in 1984. These are dairy products, soft drinks, cigarettes, fishing nets, leather tanning and corru- gated iron sheets. Three other industrial sub-sectors-i.e., beer, shoes and cement experienced a small recovery, and the other 13 either remained  - iv - at the same level of productioa or contracted even further between 1981 and 1984. Overall, industrial output in 1984 appears to have declined slightly from its 1983 level. 13. Industrial investment has been low in the past three years. by mid-1984 only US$ 92.35 million had been disbursed for the rehabilitation of industries within the RIP, less than half of the originally planned expenditure for the first three years of the program, and only about one third of the funds committed by the Government and the donor community to finance the YAP program, and therefore available for that purpose. Furthermore, a substantial part of these disbursements were used to finance the importation of raw materials and other inputs, rather than rehabilitation investments. The review of industrial investment at the subsectoral level reveals that the bulk of the Government enterprises have not yet made the investments necessary to put their equipment in working order. The consequence is that the majority of installed equipment is still inefficient, dilapidated and unreliable. Some enterprises have rehalilitated only part of their equipment, but production remains constrained by bottlenecks caused by the equipment that has not been rehabilitated. In addition, some of the few enterprises that improved their physical facilities cannot make full use of their new equipment because they have not yet strengthened their organizational structures and management, nor have they established marketing functions within their organizations to identify and expand local and foreign markets. 14. Further evidence of slow and maybe decreasing industrial activity in the last two years comes from the level of productive inputs being imported into Uganda. After a surge of imports in 19l1 and early 1982 associated with the first IDA reconstruction loan, imports of productive inputs in 1983-84 decreased, amounting to only bO percent of their 1962 level. Imports of mineral fuels for industrial purposes in 1983 were still at their 198U level. 15. It is difficult to ascertain the extent to which the private sector experiences the same problems as the public sector. However, a review of the KRP reveals that, within each RRP category, the enterprises that have been returned to their previous owner or converted into joint ventures are performing better than the enterprises that are still owned and managed by the Government. Also, it appears that the small private sector, less constrained by creditworthiness problems, and less dependent on imported raw materials, is responding more effectively to the increase in effective demand for industrial products. There are, however, important linkages between the public and the private sector that limit the response of some parts of the private sector (e.g., the demand for construction materials is limited by the scarcity of cement, which is produced by a Government enterprise). C. Constraints to Industrial Recovery 16. The main constraints to rapid and sustained industrial recovery in Uganda can be grouped in seven categories: (a) problems derived from the Government ownership of a majority of the large industrial enterprises;  v (b) inadequacies of the policy environment; (c) lack of creditworthiness of the enterprises; (d) lack of effective demand; (e) scarcity of human resources; (f) poor infrastructure and utilities; and (g) uncertainties related to the overall political and social environment. Government Ownership of Enterprises 17. A major constraint to industrial recovery in Uganda is related to the Government ownership of a majority of the large industrial enterprises in the country. The Government does not have the human and institutional resources that the rehabilitation efforts require. Although the Government has been quite successful in securing aid funds for its rehabilitation program, the industrial firms have been unable to prepare adequate project proposals (e.g., feasibility studies) and, in some cases where projects were prepared, the financial institutions have been reluctant to lend to Government enterprises due to their poor management and weak financial and accounting structures. Poor management at the enterprise level is exacerbated by the poor organizational structure of the public sector, including a multiplicity of ministries controlling individual enterprises without adequate capacity to do so, the politized boards of Directors, and the difficulties in reversing the low morale and poor business practices inherited from the military regime. The problems described above are compounded in the case of some 5U industrial enterprises where the process of devolution to its previous private owners or UUC is taking a long time to complete. These enterprises are facing an extended period of uncertainty, and the present, but temporary, management does not have the capacity nor the commitment to design and implement a program of rehabilitation. In addition, domestic financial institutions are reluctant to finance investments in enterprises whose future ownership appears unresolved. 1a. The Government has created the institutional basis for the priva- tization process, guided by fair and thorough procedures, and has completed the task of deciding which enterprises out of a group of 172 identified as priority will be returned to their previous owners, which will be made into joint ventures and which will be retained by the Government. After a slow start, the privatization process accelerated in late 1984. by early 1985, the ownership of about 40 percent of these enterprises had been settled in principle, although the question of outstanding liabilities had not been resolved in all of the cases. However, the Government is planning to retain an excessive number of industrial enterprises. In some cases, this is because the Government is reluctant to privatize enterprises with good prospects and in which it has substantial investments; in other cases, because they are in such bad shape that there are no buyers for them. The Policy Environment 19. The industrial strategy adopted by the Ugandan Government in mid-1981, was basically sound and consistent with the overall economic strategy. At the macroeconomic level, the global strategy was based on a rapid move towards reliance on market forces in all major markets in the economy, including the exchange rate. The objective of this strategy was an early elimination of the pervasive price distortions and a major  - vi - improvement in the domestic terms of trade for agriculture, which was seen as the main source of economic growth and of foreign exchange. 20. The macroeconomic strategy succeeded where it counts most, in the agricultural sector which provides a livelihood to the majority of the Ugandan population, as well as the bulk of Uganda's foreign exchange earnings, and for which Uganda enjoys physical and climatic advantages. The strategy did not succeed, however, in improving the productive capacity of the industrial sector because it was not implemented with determination and to its ultimate consequences. The fiscal and monetary policy of reducing fiscal deficits and establishing tight credit ceilings for Government borrowing worked until mid-19d4, and provided growing incomes and demand with declining inflationary pressures. Thereafter, high Government deficits and increased Government borrowing from commercial banks have produced rapidly accelerating inflation. The most successful element of the macroeconomic strategy was the adoption of a realistic exchange rate through an auction system, although here again there were distortions during the period when two rates functioned side by side and, more dangerously, recent developments indicate that the exchange rate has been "managed- to keep devaluation below the accelerated inflation. Despite this inflationary situation, prices of several industrial products have remained de-facto controlled by the iovernment, and the prices of inputs such as electricity and agricultural raw materials are still unrealistically low; the price of labor, on the other hand, doubled in real terms since mid-1984. 21. The above developments resulted in relative prices which are not only distorted, providing wrong signals to producers, but which are also extremely unstable. Instability even more than distortions threatens producers, reducing their ability to adjust to the environment. As a result of this instability, many local producers may have been over- protected at some point during that last two years, and at another point faced with negative effective protection. Currently (early 190S), a number of firms may face negative effective protection, not because of the tariff structure (which is moderate) but because of price controls which keep local products at prices below their cif price plus tariff and because of the renewed overvaluation of the exchange rate. On the other hand, the analysis carried out by the mission on a sample of 44 products manutactured in Uganda showed that a number of economically inefficient producers with negative value added at world prices survive due to infinite protection (e.g. through heavily subsidized inputs) or because their losses and lack of creditworthiness have been compensated by Government guarantees. The persistence of severe distortions in the economy contributed to undermine the private sector's confidence in the business climate. Lack of Creditworthiness of Industrial Enterprises Z2. Throughout the sector, the shortage of working capital is perceived by the enterprises as the most critical problem facing manufac- turing industry in Uganda, whether it is expressed in terms of shortages of spare parts and equipment, of foreign exchange and imported inputs, or of locally available materials. Many firms are unable to borrow their working  - vii - capital requirements from the financial sector because they are not creditworthy. At the core of the crecitworthiness issue, however, is the whole question of managerial weakness of the Government enterprises, and the uncertainty about the future ownership of mny of them. 23. Shortages of working capital have been recognized as a constraint on the sector's recovery since 1980, when the IDA program of reconstruction credits was first conceived. Under the first IDA program, foreign exchange was sold to Government enterprises, against local currency payments, through the Uganda Commercial Bank (UCB). Where companies had no local resources to purchase the foreign exchange, the UCB extended overdraft facilities. For the least creditworthy enterprises, Government guaranteed the necessary overdrafts. Creditworthiness problems are likely to become more acute in the near future as the number of enterprises eligible for Government guarantees under the third IDA Reconstruction credit is reduced. Under IDA III only 20 percent of the funds will be covered by Government guarantees compared with 80 percent under IDA I and 65 percent under IDA II. Furthermore, the rapid devaluation of the Ugandan shilling since 1981 increased the need of working capital, because the shilling cost of imported inputs increased steadily. The rapid devaluation also worsened the creditworthiness of enterprises because they have not revalued their assets and appear to be grossly undercapitalized. Z4. Working capital constraints reflect also a shortage of liquidity within the financial sector. A review of the financial institutions shows that the commercial banking sector has been operating above toe maximum lending ratio of 70 percent required by the Bank of Uganda. If credit- worthiness were not a problem there would not be enough credit available for higher levels of activity. Shortages of liquidity are the result of increased Government borrowing coupled with the failure of the banking system to mobilize domestic savings, as increases in deposit rates have consistently lagged behind the rate of inflation. Also, a large share of domestic credit is tied up seasonally in crop financing. Similarly, if creditworthiness were not a constraint, the toreign exchange available from exports and aid sources would be insufficient to finance the level of imports required to increase the sector's capacity utilization. Low Effective Demand 25. Low effective demand is still an important constraint for many industries in Uganda. The increase in purchasing power generated by higher rural incomes has not translated into higher demand for a number of urban- based industries, even for those catering to the agricultural sector, because of transportation difficulties, cheaper farm produced substitutes, competition from farm inputs received as commodity aid, or low product quality. On the other hand, the low purchasing power of urban workers has been a constraint for some producers of consumer goods until mid-1984, when wages doubled in real terms.  - viii - Human Resources Contraints 26. The years of the 1971 to 1979 military regime severely depleted the country's human capital as the technocratic class which developed in Uganda during the 196Cs fled or was killed. Slowly, this group is now returning, but managers are in very short supply. In 1983 professional and technical personnel still accounted for only 2.6 percent of the labor force employed in industry. The fact that there are only an estimated ZU to 3U certified public accountants gives an idea of the scale of the problem. Similarly, the lack of training and skills development for ten years has weakened the skill composition of the labor force. Less than one fourth of the production workers in the industrial sector can be considered skilled or semi-skilled. The severe shortage of human resources is a problem which will take time to corect but requires urgent and priority attention by the Government, through its educational and vocational training program. Infrastructural Constraints 27. Underlying the problems discussed above are major infrastructural problems which severely impede progress. These include shortages of water, power cuts, and difficulties of transporting inputs and products throughout the country. The Security Situation 28. Finally, a serious factor that has affected the confidence in the business climate is the continuing uncertainty of the security situation. This has wide ramifications affecting the ability of firms to recruit labor or to run more than one shift. It also affects the willingness of foreign investors to invest in Uganda, of expatriates to provide technical assistance and of aid donors to provide funds. D. Overall Strategy and Recommendations 29. The market oriented industrial strategy adopted by the Government of Uganda to rehabilitate the industrial sector is sound, but has been less than fully implemented in practice. Some elements of the policy framework adopted in 1981 were never put in full operation (e.g. price controls were not fully removed) and the overall management of aggregate demand started to deteriorate in late 1983, and resulted in major desequilibrium by mid 19U4. Moreover, the management of the process of privatization and rehabilitation of industry has been slow, although privatization gained momentum after mid-1984. To a large extent, the above problems are the result of the Government's limited ability to implement its policies, due to lack of necessary skinls, or to the Government still unclear position about its role in the rehabilitation process. More than other countries in East Africa, the Ugandan Government needs to turn the Government industries to the private sector and use its limited resources to improve the physical environment and human capital badly depleted by 10 years of deterioration.  - ix - 30. The Government bas an important role to play in the recovery of the industrial sector, not in the planning of individual projects, but in providing a good business environment, in defining policy options for the future and in ensuring a speedy transfer of industrial enterprises to private owners, either totally or by entering into partnership with the private sector. In Uganda, Government partnership is necessary in many cases to solve the problem of outstanding liabilities and to induce private groups to return to what they perceive as a risky business environment.. For similar reasons, Government minority partcership may also be necessary to attract new foreign investment to Uganda. The role of the private sector should be to carry out the rehabilitation of the sector at a project by project level, on the basis of demand, expected profitability and the policy environment created by the Government. Private sector management of the joint ventures in which the Government is a partner is necessary, however, to ensure that the same market criteria apply to the rehabilitation of these enterprises. If this is done, some enterprises will be rehabilitated while others are closed down and, at the same time, new firms will emerge. In the interim period, however, the Government should mobilize and concentrate its best human resources to manage-on a temporary or caretaker basis-the enterprises it now owns and the process of their privatization. Finally. the donor community has an important role to play by making resources available to the industrial sector to carry out the rehabilitation and restructuring process. Donor's support to Government enterprises may be more forthcoming if a private partner with the relevant experience has a meaningful staKe in them. Donors have also an important role to play in providing mu'ch needed technical assistance. Policy Recommendations 31. Aggregate Demand Management. industrial recovery will not occur in the absence of prudent demand management and internal equilibrium. Therefore, the Government should take urgent measures to reduce inflation by keeping the budget under control through a combination of revenue increasing measures (e.g. reducing smuggling) and tighter control of Government expenditure. The balancing of the budget should be accompanied by a redefinition of expenditure priorities. Specifically, there should be a reallocation of funds towards the restoration of the country's damaged infrastructure and human capital. 32. Exchange Rate. Equilibrium in the external sector and an efri- cient allocation of foreign exchange resources is another important pre- condition for 'Lndustrial recovery. The Government snould return to the policy of letting the market forces determine the exchange rate ia weekly auctions. The maintenance of a realistic exchange rate helps curo imports and improves the competitiveness of Uganda's agricultural and industrial products. There should be no interference with the free working of the market, and the recent interventions to keep the devaluation behind the rate of inflation -- resulting in an overvalued currency, once again - should be discontinued. 33. Price Controls. To ensure that efficient investment and produc- tion decisions are taken, industrial enterprises must face a price struc- ture that reflects adequately the demand for, and the supply of, goods and factors. This requires that all price controls be fully eliminated: bocn maximum prices and fixed profit margins. Elimination of price controls is  -x- probably the most important measure to solve the problem of a large number of producers facing negative effective protection. Import competition is likely to be a more efficient regulator of market prices than Government controls. Similarly, utility tariffs should be set at levels that reflect adequately the costs of production. 34. Interest Rates. The interest rate is also an important price indicator in a capital-scarce environment such as the current Ugandan situation. Although ideally interest rates should be deregulated and allowed to settle at the market-determined levels, this may not be feasible in the short term in Uganda because of ongoing hyperinflation. As an initial step, the Government should revise upwards the structure of interest rates while at the same time take measures to curb inflation. However, if hyperinflation develops into a long-term problem, long-term credit may have to be indexed. Interests on deposits should also be increased to attract into the banking system the relatively high sums of money currently outside the banks, particularly in the rural areas. 35. Import Duties. Tariff and other input duties in Uganda are moderate for international standards, with tariff rates on most finisned goods ranging between 20 and 30 perceat, and tarifts for raw materials ranging from 0 in some cases to levels equal to, or sometimes even higher than, those on the corresponding final goods. These tariffs, and all other factors affecting the level of protection result in a wide dispersion of effective tariff rates and a relatively low level of fiscal revenues, which is aggravated by widespread smuggling. 3b. A new structure of tariff rates should be introduced, with the twin objectives of producing a flat and moderate, but positive, level of protection on all industrial activities, and of increasing fiscal reve- nues. This could imply a small increase in the tariff rates on some final goods, but also an increase in the tariff rates on inputs to about 2U percent without exceptions. Where the effective protection rates implied by this structure is insufficient to protect viable companies that are still under rehabilitation, temporary surcharges may be considered. Direct subsidies to the specific firms, however, may be a more efficient way of tackling this problem. 37. Wages and Labor Policies. Industrial enterprises should be allowed to negotiate wage settlements with their labor force without Government participation. Also, both Government and privately-owned enter- prises should be allowed to adjust freely the size of their work force, which in most cases is disproportionately large given their current low levels of activity. In particular, Government pressures to public sector firms to hire additional staff not required by the firms should be discon- tinued. 38. Corporate Taxes. Consideration should be given to reduce the corporate tax rate which is high (50 percent since January 1983). Also, the tax system should be attuned to compensate more adequately for the disruptive effects of inflation so that the real tax burden remains broadly unchanged. The Government should also contemplate the possibility of  - xi - rescheduling firm's debts and arrears and of granting deferrals on duties and taxes to firms that are considered viable once their rehabilitation has been completed. The Government should also take measures to expedite the process of assets revaluation which, together with the removal of price controls, would help to bring cash into the firms through reduced profit taxes. 39. Export Incentives. The rehabilitation of the industrial sector should lead to renewed export potential. To facilitate the reappearance of manufactured exports, an Export Advisory board should be created with representatives of the Ministries of Industry and Commerce and the private sector. The Board should conduct studies on the export potential of Ugandan industries and advise the Government on policies affecting the export sector. A system of duty drawback should be adopted to refund import duties, sales taxes and excise duties levied on materials and compo- nents used in the production of export products. A system of corporate tax benefits to exporters should also be adopted by which the corporate tax rate should be reduced by a specified percentage depending on the share of output exported. 40. Investment Incentives. The investment needed to rehabilitate Uganda's industry has to be financed to a large extent from abrcad. To attract foreign investment the Government has to create a propitious business environWent, free of excessive personal, political and economic risks. In the area of investment incentives, the Foreign Investment Act of 19b4 and the Foreign Investment Decree of 1979 should be revised to: (a) modify the tax holiday scheme to put it more in line with the schemes adopted by other countries; (b) eliminate constraints on minimum size of the initial investment and priority areas; (c) extend the incentives to local investments; and (d) extend the protection againt expropriation without compensation to local investments. 41. Industrial Licensing. Proper guidelines should be adopted to guide the decisions of the Industrial Licensing Board on whether or not to grant an industrial license. Also, approval procedures should be simpli- fied, and a time limit adopted within which the board should respond to any applicant. 42. Small Scale Enterprises. There is evidence that small-scale enterprises, less encumbered by ownership problems and less affected by Government interventions, are performing better than large firms. More resources should be made avaible to this type of enterprises through the financial institutions. Institutional Recommendations 43. Privatization and Rehabilitation of Government Industries. The Government should accelerate the process of privatization by all possible means including securing financial and technical assistance for the Nego- tiations and Verifications committees. The Government should also change its piecemeal approach to the two main tasks of privatization and rehabili- tation by establishing an independent Public Enterprises Unit with respon- sibility and appropriate authority for managing and coordinating both the privatization and rehabilitation processes.  - xii - 44. Management of State Owned Enterprises. Industrial firms that cannot be privatized immediately, or which are to be retained by the Government for other reasons, including UOC, should be overseen by the Public Enterprises Unit which would have responsibility for: (a) appointing board members; (b) establishing financial discipline and objectives; (c) establishing an effective system for performance monitoring and evaluation; (d) in exceptional cases intervening in the management when performance is below acceptable levels; and (e) assuring effective coordination within the Government as it relates to the enterprises. a 45. The Role of Uganda Development Corporation (UDC). UDC should retain the above responsibilities with respect to the enterprises that will remain in its portfolio. The main objective of UDC during the next few years will be the rehabilitation of existing enterprises, a task that will impose great demands on L!DC's managerial and technical abilities. There- fore, UDC should not engage in any new investments before significant progress has been achieved towards the rehabilitation objective. There- after, to preserve its developmental role, UIC should have minority participation Ci.e. no more than 49 percent) in any new corporation; limit the equity investment in any one enterprise to not more than a third of the book value of UDC's total investment; and divest itself of any equity investment when the enterprise has matured. 4b. Nehabilitation of Individual Public Enterprises. A large number of Government enterprises need rehabilitation. However, before embarking in new investments in rehabilitation it is necessary to determine the technical, financial and economic viability of the new investment, and to conduct comprehensive organizational and managerial audits to determine what measures are needed to make the enterprise able to: (a) manage the existing assets in an efficient manner; and (b) manage new investments. 47. Development of Human Resources. The Government has a crucial role to play in the development of human resources. Efforts should be made to increase the budgetary and staff resources of Uganda's only management training institute (the Management Training Advisory Center), to upgrade the quality of teaching personnel and allow it to provide training and consultancy services to industry in a much larger scale. In the more imme- diate future, rehabilitation credits should be complemented with the provision Gf technical assistance in management. 48. More resources and technical assistance should also be channeled to the vocational training institutes and the vocational training centers which are devoted to upgrading the skills of the labor force. Additional funding for these institutions could come from the import tariffs, particularly on capital goods. The study of Technical Education carried out by the Ministry of Education should help the Iovernment to better link the training offered by the training institutions to the needs of industry.  -xiii - 49. Strengthening of the Government's Policy Making Capability. Government should give consideration to setting up an Industrial Policy Unit at the highest level to elaborate and coordinate strategies and policies on the sector. This unii should work in close collaboration with representatives of the relevant ministries (i.e. Industry, Finance, Planning and Economic Development, Commerce). The technical secretariat of this unit should be located in the Ministry of Industry. The effectiveness of policy formolation in Uganda depends to a large extent on the availability of information about industry. The Central Statistical office should be provided with the human and financial resources needed to obtain, process and maintain up-to-date a proper data base. A matter of high priority is the upgrading of the technical capability of the Ministry of Industry to enable it to perform its major functions which are to develop and implement effective sectoral objectives and policies. 50. Infrastructure. The Government needs to devote a larger part of its financial resources to the improvement of the water and power supply, and of the infrastructure for transport. Two recently approved bank Rehabilitation projects in the first two sectors should provide support for the Government efforts in these areas. Also, the sovernment needs to improve the safety and physical conditions of the country's road network.  Chapter 1 Evolution and Structure of the Manufacturing Sector A. Evolution of the Manufacturing Sector 1.01 Industrial Growth During the 1960s. The 1960s was a period of rapid economic growth and rising incomes for Uganda. The rate of growth of GDP was almost 5 percent per annum, substantially higher than the popula- tion growth rate of 2.6 percent. By 1970 GNP per capita was US$512 (in 1980 prices), the fourth highest in Eastern Africa 1/. During this period, the engine of economic growth was the successful exploitation of Uganda's agricultural potential. With an agricultural sector growing at 4.5 percent between 1966 and 1970, Uganda became not only self-sufficient in food, but also an exporter of considerable amounts of coffee and cotton as well as tea and tobacco. By 1970 monetary agriculture accounted for nearly 35 percent of monetary GNP; monetary agriculture together with subsistence agriculture accounted for over 77 percent of total GDP (Table 1.2 in statistical appendix) and gave employment to 93 percent of a working age population of about 5.1 million Ugandans. 1.02 During the 1960s the Government encouraged the development of the industrial sector through a policy of import substitution. A number of industries were established by local and foreign industrialists, many of them of Asian origin such as the Madhvani and Mehta groups. The Government itself established several industries in the form of joint ventures with local and foreign investors, or on its own, through the Uganda Development Corporation (UDC), a Government agency 2J, By 1969, UDC had controlling interests in some 36 enterprises and significant minority shareholding in 22 associated companies including chemical and engineering industries, livestock, metal and steel operations, textiles, air transport, hotels and property development. 1.03 As a result of protectionist policies and high demand for indus- trial goods, the industrial sector, although relatively small, was growing slightly faster than the economy as a whole. Between 1966 and 1970, agro- industries (coffee curing, cotton ginning, sugar and jaggery-unrefined sugar) grew at 4.1 percent per annum; manufacturing of food products grew 1/ After Zimbabve (781), Mauritius (767) and Zambia (730). 2/ UDC was inceorporated in 1952 with an equity of UShs 100 million. UDC received a further capital increase of UShs 38 million in 1958. Through UDC the Government entered in joint ventures with, among others, the Mehta group, the Chillington Tool Company, the Birla Group and Yannato of Japan.  - 2 - at 7.8 percent per annum; and miscellaneous manufacturing at 5.9 percent per annum (Table 1). By 1970 manufacturing accounted for 12.4 percent of monetary economy value added / and 17.3 percent of monetary economy employment. The sector produced a wide range of consumer and intermediate goods for domestic consumption, with a sizeable surplus for exports to Kenya and Tanzania. These exports included 95 thousand metric tonnes of animal feeds and 16 thousand square meters of cotton fabrics (nearly one third of total production of cotton fabrics). Table I UGANDA: Structure of Industry (percentages) Value Added 1966 1970 1983 Agro-industries 19.1 a/ 17.9 14.1 Processed Foods 9.5 10.5 5.9 Miscellaneous Manufacturing 71.4 71.6 80.0 Total 100.0 100.0 100.0 Employment 1969 1971 1983 Agro-industries 32.4 30.0 32.7 Processed Foods 12.6 12.3 9.0 Miscellaneous Manufacturing 55 0 57.6 58.3 Total 100.0 100.0 100.0 Growth Rates 1966-70 1971-80 1981-83 Agro-industries 4.1 -9.3 -1.6 Processed Foods 7.8 -18.1 23.6 Miscellaneous Manufacturing 5.9 -7.4 3.5 Share of Industry in Monetary GDP 1966 1970 1983 Agro-industries 2.3 2.2 0.9 Processed Foods 1.1 1.3 0.4 Miscellaneous Manufacturing 8.6 8.9 5.2 Total 12.0 12.4 6.5 a/ Includes coffee curing, cotton ginning, sugar and jaggery production. Sources: Tables 1.1 and 1.5 in Statistical Appendix. 3/ After agriculture, which accounted for 35 percent of Monetary GDP, trade and transport which together accounted for 23 percent, and services, including Government, which accounted for another 22 percent of monetary GDP.  -3- 1.04 In 1970, agro-industries and food processing accounted for 28 percent of the sector's value added and 42 percent of employment (Table 1). Miscellaneous manufacturing, a subsector that groups the rest of manufacturing activities, accounted for 72 percent of the sector's value added and 58 percent of employment. Within this group, the most important industries in 1971 were: metal products, beverages and tobacco, which together accounted for 50 percent of miscellaneous value added; non- metallic minerals, which accounted for 13 percent of value added; and textiles, wood products, and chemicals, each accounting for about 8 percent of total miscellaneous manufacturing value added (Table 1.4). From the point of view of employment, textiles was the dominant industry, accounting for 40 percent of the employment in miscellaneous manufacturing (Table 1.5). 1.05 Industrial Activity in the 1970s. Even before the military coup of 1971, the Government of Uganda had started expanding its participation in the industrial sector. In May 1970, the Government decided to acquire controlling interests (60 percent of the equity) in a number of private enterprises including commercial, industrial and financial concerns. That year, 17 enterprises were nationalized adding to 23 parastatals which the Government had already established. The Military regime, which took over in 1971, initially reversed these measures, reducing Government's equity participation from 60 to 49 percent in the companies that had been nation- alized. In August 1972, however, the Military Government launched the so- called 'economic war'. This led to deportation of 60,000 non-nationals (mostly Asians) and the incorporation of their industries into the parastatal sector. The Asians had provided most of the skilled management and technical manpower of the country; the people who replaced them had, in most cases, no previous business experience. UDC was initially entrusted with the bulk (about 104) of the abandoned industries. This sudden increase put a heavy toll on the Corporation's managerial and financial resources. In 1974/75 the Military Government reversed this arrangement and created new corporations under various Government Ministries to handle the expropriated properties. 4/ In the process, UDC lost not only the expropriated businesses, but also many of its original subsidiaries such as Nytil (textiles), Uganda Cement Industries, Uganda Hotels and Agricultural Enterprises Limited, which were allocated to new corporations. UDC received no payment for the equity shares lost or for the loans, short term advances, and guarantees given to its former subsidiaries. It was left with 17 companies, most of which were not viable. 1.06 What followed was a decade of administrative, social and economic deterioration aggravated by foreign exchange constraints. Although agricultural production and exports remained steady between 1972 and 1977, the trade balance deteriorated following the 1973 increase in oil prices. After a trade deficit of US$22.6 million in 1975, the trade balance recuperated during 1976 and 1977 due to the boom in world coffee prices 4/ It is estimated that between 1971 and 1979 about 79 industrial, commercial and financial parastatals were created, and to these were added nine corporations reclaimed from the East African Community after it collapsed in 1977.  -4- resulting from the failure of the Brazilian coffee crop. International coffee prices, however, fell afte- 1977, causing a US$30.2 million trade deficit by 1978. By the tlme coffee prices fell, exports other than coffee (cotton, tea and tobacco) had become marginal, as incentives to export were eroded by low agricultural prices and the growing overvaluation of the exchange rate. In 1976 the Government began to default in the service of its foreign debt inducing external suppliers to refuse to further orders. Imports constraints were compounded by the refusal of Kenya Railways to transport without pre-payment, after the break-up of the East African System in 19. 7. A growing proportion of the scarce foreign exchange was being diverted from the importation of productive inputs to the purchase of military equipment. After a short lived recovery in 1979, when the USA lifted its coffee embargo to Uganda, coffee exports declined again reaching only 110,000 tonnes in 1980 compared to 214,000 tonnes in 1972, although coffee was being smuggled to neighboring countries where prices were better, and where consumer goods could be obtained. Falling coffee prices and raising import prices, specially petroleum after the second oil price increase In 1979, produced a 26 percent decline In Uganda's terms of trade between 1978 and 1980. The trade deficit peaked in 1980. In the black market, the shilling fell to less than one tenth the official exchange rate. 1.07 Industrial production during the military regime declined through a combination of mismanagement, equipment failures due to the lack of technical personnel and maintenance, and scarcity of foreign exchange to import spare parts and raw materials. Subject to pervasive price controls, all Government owned firms produced losses, and as the banks were obliged to extend loans to them, they accumulated heavy portfolios of bad debts. 1.08 BN 1978, industrial production was down to little over half the 1971 level /. Basic industries such as Tororo Steel were shiut down for lack of imported materials; while cement production went down from 191,000 tons in 1970 to 73,000 tons in 1978 and then halted, depriving the country of two of the most important building materials. Other industries such as soft drinks, fertilizers, soap, animal feeds, matches, blankets, and fish- nets were producing at between 10 and 20 percent capacity compared to a capacity utilization of about 70 percent in 1971. The only industries still producing at reasonable levels of capacity in 1978 were cigarettes, beer, Uganda waragi (a spirit), paints and textiles. Shortages of consumer and other manufactured goods encouraged the development of black markets and accelerated inflation. Between 1970 and 1978, the consumer price index for the low income group increased at an average of 47 percent per annum, despite price controls. 1.09 The liberation war, which culminated in early 1979, inflicted further damage to the industrial sector: machines were destroyed, raw materials, office equipment, and vehicles were looted. By 1980, manufacturing of food products had fallen by 86 percent, from a peak of 5/ Electricity consumption by industry declined from 277 m. units in 1970 to 161 m. in 1978.  UShs 63 million (in 1966 prices) in 1972 to UShs 9 million In 1980; aiscellaneous manufacturing had fallen by 57 percent, from USha 482 million (in 1971) to USha 209 million; and agro-industries had fallen by 62 percent from UShs 114 million to UShS 43 million (Table 1.1). 1.10 The industrial sector was not the only one to suffer under the Military Government. By 1980 the whole monetary sector had contracted by one fourth: agriculture (which had remained relatively stable until 1977) contracted by 30 percent, mining by 95 percent, and services by 38 percent. Only the Government sector continued growing. In 198L' it was more than double its 1970 level in constant prices (a growth rate of 7.9 percent per year), at the expense of ever increasing budget deficits. During most of this period the subsistence economy (mostly agriculture) continued growing at 3.4 percent per annum, until these activities were also disrupted by the war. In 1980 GNP per capita was US$263, less than half its 1970 level (US$512). 1.11 Despite the precipituous decline in output, employment in the monetary sector remained remarkably constant, at least until the mid 1970s. The last global employment figures are for 1975, when total employment in the monetary economy reached 371,300 people, up by 20 percent from the 1970 level of 312,400. By that time, the composition of employment had changed, as the public sector increased its share from 41 percent in 1970 to 56 percent in 1975. There are no employment figures for subsequent years. Real wages, on the other hand, declined sharply during the military Government. In eight years, the minimum wage rose by only 54 percent, despite an increase of 11 times in the cost of living index for low income groups in Kampala. A minimum wage of UShs 240 per month in 1979 could scarcely buy 10 loaves of bread or two liters of cooking oil. To survive, people combined employment in the monetary sector with work in black market jobs and in subsistence agriculture. B. Industrial Structure 1.12 The last comprehensive industrial survey in Uganda was carried out in 1971. Since then, the only source of information with good coverage of the sector is the 1983 Industrial Directory compiled by the Statistical Office of the Ministry of Planning. The directory provides limited but reliable information on the area of activity, employment, and ownership of nearly 1900 enterprises (not all active) in industry (including agro-'ndustries and manufacturing), mining, and electricity-generation. A comparison between the results of the 1971 survey and the active firms according to the 1983 Directory, provides some insight on the structural changes that took place during the 19?0s. 1.13 Ownership. Most of the nationalized industries became parastatals and were placed under a -parent ministry or UDC. Currently, there are 130 parastatals; 17 of them are managed by UDC and the rest are managed by 14 ministries. About 60 of the parastatals engage in industrial activities. The ministry of Industry is directly responsible for some 45 of them. The ministry of Agriculture and Forestry owns one sugar mill and the Wood Industries Corporation which has eight saw mills under it. The  -6- Grain Milling Corporation has four subsidiaries producing flour, animal feeds aud bakery products. The number of Government owned industries that appear in the 1983 Industrial Directory (not including agro-industries) is 116, includiug 23 statutory corporations, 55 Government owned firms and 14 joint ventures. Employment in Government owned firms had reached about bO percent of total industrial employment in 1963 (see Table i). Table 2 UGANDA: Ownership of Manufacturing Industries (Firms with 1U or more workers) 1 9 8 3 No. of Firms Employment Cooperatives 29 7ii Sole Proprietor 7b Z,b15 Partnership 55 l,1b0 Private Limited 108 4,927 Public Limited 7 1,780 Statutory Corporation 23 3,b15 Governmeut Owned 55 1b,291 Joint Ventures 14 4,U29 Other and Uuknowu 50 4,644 Total 417 39,772 Source: 19b3 Industrial Directory compiled by the Statistical Vffice of the Ministry of Planning and kconomic Development. 1.14 Changes in Industrial Employment (1971-1983). The number of firms aud employment in firms with 10 or more workers increased from 529 firms employing 47,300 workers iu 1971 to bl firms employing 54,500 workers in 1983, despite a drop in output of about 54 percent duriug that period (Table 3). The increase in employment was possible due to the tremendous contraction in real wages aud because of Government ownership. The comparison between 1971 and 1983 also reveals that the economic climate of the 1970s aud early l980s favored the polarization of the industrial sector with employmeut increasing among firms with less than MU workers aud among firms with more than 1,UOU workers at the expense of the medium sized firms.  - 7- Table 3 WANG Nmber of Firm and Ealacmit In a stry (F dus with aL or uze workers) l_Y 1971 1983 .of No. of No. Of mu Fins FiXnI BilDyut FirmB Employmeat Firs Emp t IS W/83 1984 AVvhp3o-iistries 254 14,b55 167 14,218 244 17,813 - - Proessed Food 102 5,703 100 5,846 126 4,92U 15 5 Misc. Mfg. 274 24,875 262 27,272 291 31,796 58 9 Total b3U 45,233 529 47,33b bbl 54,529 73 14 Szce: Table 1.5, Statistical Appeocx 1.15 The major increases in the number of firms and employment during the 1970s occurred among local resources based sectors. The total number of agro-industrial firms went from 167 in 1971 to 244 iu 1983, with au increase of about 3,blW jobs. Most of the uew firms were small and medium sized coffee curers and jaggery producers. The number of cotton ginneries, on the other hand, decreased during this period with a uet loss ot about 3,000 jobs. The uumber of food industries increased from 100 firms in 1971 to 126 firms in 1983 with a loss of uearly 1,000 jobs. The uumber of miscellaneous manufactures, however, increased from 262 to 291 during the same period, with a total increase of over 4,500 jobs. 1.16 New Enterprises Since 1M8U. The comparison between the 1971 survey of industrial production and the 1983 Directory only gives informa- tion on the uet addition of firms and employment between 1971 aud 19a3. It is difficult to ascertain from the data the number of firms that closed and the number of new firms that started operating during this period, and whether the uew firms started before or after 1979. The information on Industrial Licenses granted by the Ministry of Industry indicates that between 1980 and 1983 about 73 new firms started operatious out of 235 new industrial liceuses granted duriag this period (Table 1.5). This seems to indicate that a large proportion of the increase in the number of firms between 1971 and 1963 actually took place after 1979. The uew firms estab- lished after 1979 concentrate in food processiug (20), fabricated metal products (18), wearing apparel (16), chemicals (11) aud wood working (7). An additional 14 firms entered in operation iu the first half of 1984. The more recent figures (not captured by the 1963 Directoryof Industries which began being compiled in 1952) show an increase in the uumber of firms producing wearing rpparel, chemicals, and fabricated metal products. The number of producers of wearing apparel and chemicals (mostly soaps and cosmetics) that started production in recent years may reflect che increase  -8- in consumer demand generated by the reactivation of the economy since the new economic measures adopted in June 1981 (see Chapter 3). Changes in Firm Size 1.17 Many of the new manufacturing enterprises that were created in the late 1970s and early 1980s were small private firms, set up to provide some of the goods and services that the nationalized industries were not able to provide. The number of firms with 10 to 19 workers increased from 93 in 1971 to 188 in 1983 (Table 4). Employment in these firms increased in this period from 1,400 to 2,400 people, increasing this group's relative contribution to manufacturing employment from 4.1 percent in 1971 to 6.6 percent in 1983. Most of these new small manufacturing firms are resource based. They include 45 additional grain millers, 49 additional wood working 6/ firms and eight more non-metallic mineral firms. The number of firms with one thousand workers and above also increased during this period from 4 firms in 1971 to 7 in 1983. Employment in this size group nearly doubled from about 8,000 workers in 1971 to 13,700 in 1983, increasing its contribution to manufacturing employment from 24 percent in 1971 to 37 percent in 1983. However, the number of firms and total employment in all the other intermediate size categories decreased. Table 4 UGANDA: Size Structure of Manufacturing Industry a/ (percentages) Number of Workers Number of Firms Employment 1971 1983 1971 1983 10-19 24.6 45.1 4.1 6.6 20-49 40.2 31.2 14.2 10.4 50-99 16.5 10.1 12.1 7.8 100-199 7.7 6.5 10.9 10.6 200-499 7.2 4.3 22.8 16.8 500-999 1.7 1.2 11.9 10.6 1,000 and above 1.1 1.7 24.0 37.2 Total 100.0 100.0 100.0 100.0 a/ Firms with 10 or more workers Source: Table 1.6, Statistical Appendix. 6/ The average size of wood working firms decreased substantially with a total loss of 1,600 jobs.  -9- 1.18 The increase in employment that occurred among the largest, Government owned firms, reflects in part their better access to scarce foreign exchange to buy inputs and spare parts. However, with falling production levels, the increase in employment in larger industries can better be explained as a Government effort to reduce social unrest in the urban areas where these industries concentrate. 1.19 The Industrial Directory of 1983 also includes 921 firms with less than 10 workers (Table 1.7). It is impossible to ascertain how many of these firms were already in operation in 1971, because the earlier industrial survey did not cover them. However, it is significant that the great majority are in the same subsectors in which new firms with 10 or more workers are most numerous such as grain milling (504 firms), wood products (205 firms), metal products (94 firms) and other food processing (31 firms). The smaller firms' contribution to employment is only 3,900 jobs, less than 7 percent of total industrial employment. 1.20 Structure of Output. The information available on Uganda's industrial production and value added is very limited. Value added is derived from information on physical output of a sample of firms selected in 1981, most of them Government owned. The Statistical Office converts the physical quantities into value added applying 1966 prices, and calcu- lates value added for the whole sector, assuming that the relative weight of the sample within the whole sector has remained constant. As both the value added/gross output ratio and the relative weight of the sampled industries have changed over time, the results may not be very representa- tive. Furthermore, the sampled firms represent less than half the employ- ment in the firms included in the 1983 Directory of Industries. 1.21 The above, limited, data indicate that, between 1971 and 1983, the structure of industrial output changed less than the structure of industrial employment (Table 2.1). Agro-industries decreased their contri- bution to total value added from 18 percent in 1971 to 16.5 percent in 1980 and 14 percent in 1983, despite the increase in the number of firms and employment. Food processing also decreased its contribution to value added from 10 percent in 1971 to 6 percent in 1983 while miscellaneous manufac- turing increased from 72 percent to 80 percent in the same period. As noted earlier, because of the low coverage of the recent official statistics on value added, these structural changes have to be interpreted with caution. 1.22 Geographical Distribution. The geographical distribution of industry in Uganda has not changed substantially since the early 1970s. Manufacturing industry (not counting agro-industries) still concentrates in the Eastern and Buganda Regions (Table 1.9). Over 40 percent of the people employed in manufacturing concentrate in four districts of the Eastern Region (Jinja, Mbale, Njeru and Tororo). Another 30 percent of manufac- turing employment is found in three districts of the Buganda Region (Kampala, Mpigi and Mukono). Lira is the only district outside these two regions with any significant industrial activity. Over 75 percent of the manufacturing employment concentrates in eight of the country's 40 districts.  - 10 - Chapter 2 Recent Industrial Performance A. Policy Changes and the Recovery Program 2.01 The Government that took office after the 1978-1979 liberation war found the economy in ruins. Initial efforts to promote recovery were constrained by the political situation, a weak administration, and severe shortages of foreign exchange (the official foreign exchange reserves were less than three weeks imports when the UNLP took office). In 198U and 1981 monetary GOP fell to its lowest level in nearly two decades as a result of the damage suffered by the industrial sector during the 1979 liberatiou war, low agricultural production and the continuing balance of payment crisis. ILflation during these two years reached lUU percent. 2.02 In mid 1981, the new Government launched a Rehabilitation Program in two complementary phases covering a major macro-economic policy reform and a project-specific rehabilitation plan. The first phase (June 1981 to June 1982) included, inter-alia, the following policy changes: (a) adjust- ment of the exchange rate; (b) increase in producer prices for export crops, (c) elimination of some price controls; (d) introduction of tax reforms to broaden the Government's revenue base; (e) establisflmeut of ceilings for the budget deficit and for Government domestic borrowing. and (f) adoption of a more flexible structure of interest rates 7! 2.03 The second phase, outlined in the Recovery Program 1982-1984, constituted a project-specific rehabilitation plan for 1982/83 and 1983/84. The strategy of the Program was to concentrate resources on the sectors producing tradeable goods and on activities likely to increase production and foreign exchange earnings rapidly by mobilizing under- utilized capacity. In October 1983 the Government published a Revised Recovery Program (RRP 1983-1984) which gave greater strategic emphasis to rebuilding the industrial sector, especially large-scale industries