Uganda - Towards stabilization and economic recovery

Report No. 7439-UG Uganda Towards Stabilization and Economic Recovery September 26,1988 Eastern Africa Department Africa Region FOR OFFICIAL USE ONLY Document of the World Bank 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 VVorid Bank authorization.  CURRENCY EQUTVALENTSal Currency Un it End December Shillings Dollars per Exchange Rate per doliar Shilling 1981 0.852 1.174 1982 1.058 0.945 1983 2.400 0.417 1984 5.200 0.192 1985 14.000 0.071 1986 14.000 0.071 1987 60.000 0.017 End August 1988 150.000 0.007 Average Annual Exchange Rate 1981 0.501 1.996 1982 0.940 1.064 1983 1.539 0.650 1984 3.597 0.278 1985 6.720 0.149 1986 14.000 0.071 1987 42.841 0.023 a/ Central Bank midpoint rate through July 1982, and from June 1984 through April 1986; fixed priority rate 'hereafter; midpoint rate in the first market (Window One) from August 1982 through May 1984. GOVERNMENT OF UGANDA FISCAL YEAR July 1 to June 30 ABBREVIATIONS AND ACRONYMS ADB - African Development bank BOU - Bank of Uganda c.i.f. - cost, insurance and freight CMB - Coffee Marketing Board CPI - Consumer Price Index EAC - East African Community EAU - Economic Analysis Unit of the Ministry of Finance EEC - European Economic Community ERC - Economic Recovery Credit ERP - Ecdnomic Recovery Program ESAF - Enhanced Structural Adjustment Facility f.o.1 - free-on-board FRG - Federal Republic of Germany GDP - Gross Domestic Product GNP - Gross National Product ICO - International Coffee Organization IDA - International Development Association IMF - International Monetary Fund MCH - Maternal and Child Health MOF - Ministry of Finance MOH - Ministry of Health M&LT - medium and long term MPED - Ministry of Planning and Economic Development MPU - Ministry Planning Unit MUV - Manufacturing Unit Value NGO - Non Government Organization NRA - National Resistance Army NRM - National Resistance Movement ODA - Official Development Assistance OECD Organization of Economic Cooperation and Development OGL - Open General Licensing PFP - Policy Framework Paper PHB - Produce Marketing Board PSIP - Public Sector Investment Program PTA - Preferential Trade Area RB - Resource Balance RP - Recovery Program SAF - Structural Adjustment Facility of the International Monetary Fund UCB - Uganda Commercial Bank UNDP - United Nations Development Programme  FOR OMCIAL USE ONLY FOREWORD (i) This report, Uganda: Towards Stabilizatio' and Economic Recovery, provides an evaluation of Uganda's renewed pursuit of economic stability and growth. It sets the Economic Recovery Program launched by the Government in May 1987 in the context of the shattered economy inherited by the National Resistance Movement, evaluates the experience with the Program in its first year (1987/88) and in particular, the progress in the real sectors and the failure of stabilization measures. It describes the corrective measures announced for the second year (1988/89), and analyzes the factors that will determine the outcome of the Government's rededication to stabilization with growth, including the volume and nature of external financing. (ii) The Statistical Appendix pres.nts a time series of key economic data for Uganda. The appendix draws on diverse sources: official data, both published and unpublished, and IMF and Bank Staff estimates. (iii) The report is based on the findings of a mission which visited Uganda in February 1988. The mission was led by Paulo Vieira da Cunha, and comprised Young Kimaro, Oey Meesook, Gianni Zanini, K. M. Vijayalakshmi, Charles Harvey (Consultant), and Glynn Cochrane (Consu]tant). Sanjay Pradhan contributed to the finalizatior, of the report and participated in discussions of the report with Government officials in Kampala in September 1988. Alan Isaak (Consultant) prepared, at headquarters, a background paper for the report. In addition to the members of the main mission, sectoral contributions were received from S. Dhingra, Mohamed Faisel, and Hillegonda Goris. Kathleen Jordan, Anna Muganda and Margaret Lynch also contributed to the Report at Headquarters. (iv) Background papers for this report (available on request) include: (a) The Coffee Marketing Board, Financing requirement and impact on the banking system; (b) Civil service employme;.t and pay policy; (c) A macroeconomic model of the Ugandan economy. 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.  UGANDA TOWARDS STABILIZATION AND ECONOMIC RECOVERY Table of Contents Page No. COUNTRY DATA SUMHARY AND CONCLUSIONS .... .................................... . i I. DEVELOPMENTS LEADING TO THE ECONOMIC RECOVERY PROGRAM. 1 A. Background... 1 Agriculture ............... .... ...................... 2 Industry ........................ 2 Transport ........................ . 3 Health and Education . . ...................... 4 B. Recent Economic Developments ............................. S C. The Crisis of the Mid-1980s .............................. 6 D. The NRM in Command ....................... 12 E. The Government's Economic Measures in 1986. 13 II. THE ECONOMIC RECOVERY PROGRAM. 17 A. Objectives ..17 B. The 1987/88 Stabilization Program . .17 C. Macroeconomic Performance in 1987 . . .20 Output and Investment. 20 Balance of Payments ... 21 Exports .21 Imports .24 D. Fiscal Performance. 25 Revenues. 25 Expenditures. 25 Deficit Financing .27 E. Money and Credit .28 Domestic Credit and the Commercial Banks .30 F. Coffee Stocks and Financing Requirements ... 31 G. Inflation ...33 H. Conclusions: The Lesson in 1987/88 ..................... 38  III. THE 1988/89 PROGRAM AND THE MEDIUM-TERM OUTLOOK A. Challenges for the New Program .. 40 B. Key Elements of the Program .. . 40 C. Exchange Rate Management and Trade Liberalization ... 42 D. Issues in Demand Management ............................. 43 Issues of Fiscal Adjustment .......................... 43 Monetary and Credit Issues ........................... 47 E. Supply Side Policies ................................ . 50 Agriculture ................................ 50 Industry ................................ 52 Infrastructure and Energy ............................ 54 F. Institutional Strengthening ............................. 55 G. Short- to Medium-Term Macroeconomic Scenario ............ 57 Long-Term Scenario . ........................... .64 IV. EXTERNAL ASSISTANCE NEEDS ........ 65 Recent Aid Trends....... . 65 Aid Requirements in 1989-1991 . . ......................... 66 Recommendations for 1989 and 1990 ... 66 The Debt Burden ................ 70 Aid Coordination .............. 70 ANNEX I The Planning and Management of Public Expenditure .......73 STATISTICAL APPENDIX ....... . 83  List of Text Tables and Figures Tables 1-1 Real Growth in Gross Domestic Product ........................ 7 1-2 Nominal Gross Domestic Product by Expenditure ................ 7 1-3 Selected Economic and Financial Indicators ....... ............ 8 1-4 Balance of Payments ........................ . 10 2-1 Balance of Payments, 1987 .................................... 22 2-2 Exports and Imports, 1985-1987 ....... 23 2-3 Central Government Operations (July-December 1987) . . 26 2-4 Growth in Tax Revenues, 1987/88 .. 26 2-5 Recurrent Expenditures, First Half of Fiscal FY88 ............ 27 2-6 trends in Monetary Aggregates - 1987 .... 29 2-7 Base Money - 1986 and 1987 .... 29 2-8 Factors Affecting Change in the Money Supply: 1987 ........... 30 2-9 The Coffee Marketing Board's Financing Requirements March to December 1987 ....................... .33 3-1 Government Budget ........... . 45 3-2 Monetary Sector ....................... , 48 3-3 Gross Domestic Product by Origin .............. ......... 57 3-4 Investment and Savings ......................... 60 3-5 External Balances .......... ................. .62 4-1 Exterral Financing Requirements, 1987-1991 ................... 67 4-2 Overall Aid Pipeline 1988-1991 ................ 68 4-3 External Debt Service on Government and Government- Guaranteed Debt ... ............. . 71 FiRures 1-1 Coffee Producer Price and Export Share ....................... 15 2-1 Low and Middle Income CPI .................................... 34 2-2 Components of Low-Income CPI ................................37 2-3 Components of Food Index ........................... 37 2-4 Money, Inflation and Exchange Rates ................ ..........39 3-1 Investment External Balance . ......... ........ 59 MAP  Page I of 2 paes Ugarnda - Data Sheet Area: 241 Population: 15.7 Density: 118 ('000 Sq km) (mill. 1987) (Per sq km) Rate of growth: 3.1% (1980- 1987) Population characteristics Health Crude birth rate(per 1000): 50 Infant mortality(per 1000 live Crude death rate(per 1000): 18 births): 108 PoPulation per physiclan: 21270 Population per hospital bed: 700 Income distribution Dlstributlon of land onership % of national income,highest quintile: n.a. % Owned by top 10% of owners: n.a. lowest quintile: n.a. % owned by smallest 10%: n.a. Access to safe water Access to electricity % of population - urban: 45 % of population - urban: n.a. - rural: 12 - rural: n.a. Nutritlon Education Calorie Intake (per day): 2483 Adult literacy rate(X): n.a. Per capita protein Intake(g/day): 55 Primary school enrollment: 57 GNP per caPita(US$,1987)1/: 260 GROSS NATIONAL PROOLCT ANNUAL RATE OF GROWH(%.constant prices) 1986 UgSh Mln % 1983-86 1987 Est. GNP at Market Prices 61627 100 -4 4 Gross Domestic Investnent 5044 8 -7 54 Gross National Savin,g 5038 8 -1 73 Current Account Balance -417 -1 Export of Goods,NFS 5873 10 -2 8 Import of Goods,NFS 7494 12 0 6 OUTPUT.EMPLOYMENT AND PROOUCTIVITY IN 1986 Value Added Labor Force 2/ US$ Mln % MIn X Agriculture 2516 76 86 Inidustry 3/ 199 6 4 o\w manufacturing 166 5 Services 596 18 10 Total 3310 100 100 GOVERNMENT FINANCE (In Fiscal Years) Central Government UgSh MIn Xof GOP 1986/87 1986/87 1981/82 Current Receipts 5870 5 7 Current Expenditure 6788 6 9 Eurrent Surplus/Deficit -918 -1 -2 Capital Expenditures 4705 4 8 1/ Calculated In accordance with Atlas methodology. 2/ Data for 1980. 3/ Where significant and available,separate manufacturing mining construction.  Pae 2 of 2 pags Uganda - Data Sheet MDNEY,CRiEDIT & PRICES 1983 1984 1985 1986 1987 (millions of UgSh outstanding end of period) Money Stuply '(M2) 543 1115 2620 7242 18204 Bank Credit to PubIl.Sector 405 662 1425 2470 3349 Bank Credit to Priv.Sector 352 540 1148 2983 7575 (Percentage or Index Numbers) Money asX of GOP 9 11 10 12 11 CPI - Mid inome Grouv 249 350 788 2218 7514 (April 1981 . 100) Anra i percentag changes In: Genral Price Index 41 125 181 239 Bank Credlt to Ptbiic Sector 64 115 73 38 Bank Credit to Private Sector 54 112 10 154 BALANCE OF PAYMENTS RCWAISE EXPORTS(AVERAGE 1984-87) Estimated Proj. USS Mln S 1984 1985 1986 1987 Coffee(beans 350 94 - - -- - & soluble) (miltlons of USS) Cotton 8 2 Eports of Goods,NFS 443 360 419 359 All other commodities 15 4 Inports of Goods,WFS 450 483 535 620 Total 374 100 (of vihich Petrol. 1/) 75 77 54 68 Resource Gap(deficit * -) -7 -123 -116 -261 Interest Payments(net) 62 50 40 57 Other Factor Paments(net) Ngt Transfers 97 92 155 194 Balance on Ourrent Aco.mt 28 -81 0 -124 EXTERNAL DEBTLDECEMER 31,1987(Prei II.) (IncI.grants) - - U Direct Private Foreign investment 1 0 0 1 No3t MLT Borrowing. 40 89 53 101 Pi,lic Debt,incl.Guaranteed 1281 DnisbursEoents 2/ 1C0 Ise 136 193 Non-&zaranteed Private Debt n.a. Amortizatlon 59 79 83 92 Total Outstanding & Dlsbursed 3/ 1261 &ubtotai 69 8 52 -23 Other Capital(net) NET DEBT SERVICE RATIO FOR 1987 4/ F,J Capital n.e.l. -16 -1 -22 -47 % Overall Balance 53 7 30 -71 Pub ilc Debt, lm .Guaranteed 55 Flnanoing -53 -7 -30 71 Non-Guaranteed Private Debt n.s. 0/w Increase In Recarves(M) -23 -30 3 15 Total Outstanding & Dlsbursed 55 Gross Reserves(end year) 53 24 27 42 IBRO/IDA LEMING(12/31/87)(hiliions of US$): RATE OF WIANGE(SELLING) IBPD IDA kai Averages End Period Os i & Dsburs 50 534 1988 1987 Jan-J.r 1988 July 1988 Undisbursed 0 284 - - Outstanridng Incl. ihdlsbursd 50 818 USS1.00D. USi 14.00 42.84 60.00 150.00 U0Shl.OW - U 0.07 0.02 0.02 0.01 1/ Crude and derivatives. 2/ Includes East African Comfity payments. 3/ Includes IW. 4/ Debt ServICe, net of Interest earned on iorelgn exchange reserves, as a percentage of Export of Goods & WFS.  SUMMARY AND CONCLUSIONS Introduction 1. When the National Resistance Movement assumed power in Kampala in January 1986, it inherited a nation torn by ethnic and religious conflicts, and an economy shattered by years of civil war, political instability and physical insecurity. Severe macro-economic imbalances fuelled inflation and contributed to acute foreign exchange scarcity. Industrial enterprises lay alandoned. Even the remarkably resilient agricultural sector had been disrupted in some areas as farmers fled thi r farms in search of refuge. Uganda's once impressive economic and social infrastructure lay devastated by war and lack of maintenance. Its skilled personnel and experienced administrators, terrorized by successive repressive regimes, had fled to safer pastures. Those less fortunate and forced by circumstance to remain were deep ! demoralized by physical in&ecurity and declining real incomes. 2. It was an unenviable inheritance. To its credit, the new Government has faced its responsibilities with remarkable courage and persistence. Its first priority was to restore law and order and civil liberties, overcome remaining insurgencies in the North and East, and begin once again the long and difficult task of nation building. With the establishment of a broad-based Government, and the gradual improvement in the security situation, the attention of policy makers shifted to the economy. After some initial hesitations and false starts, the Government developed a bold and sweeping program of reforms. These reforms, launched in May 1987, were aimed at restoring economic stability, establishing more realistic relative prices, and initiating the rehabilitation of the country's productive and social infrastructure. The reforms were supported by resources from the World Bank, the IMF and other donors. 3. The results during the first year (1987/88) have been mixed. While there has been encouraging progress in many areas, the stabilization goals proved illusive. This was due to a number of factors, including unanticipated external shocks, a slower than anticipated response from external donors, an overestimation of the speed with which the country would return to normalcy, and monitoring and implementation difficulties, all of which contributed to the substantial deviation from the fiscal and monetary targets the Government had set itself. Reflecting its strong commitment to the reforms, and drawing on the lessons learnt from the first year's experience, the Government has taken a number of corrective actions as part of a revised medium-term program. Uganda's economic situation remains fragile. The outcome of this renewed effort depends as much on the speed and determination with which constraints to growth and macro-economic stability are alleviated as it does on timely and sizable external assistance. 4. This report provides an evaluation of Uganda's renewed pursuit of economic stability and growth. Chapter I describes in detai' the government's economic inheritance, and the experience with earlier stabilization programs. Chapter II outlines the 1987/88 recovery program and draws lessons from the experience of this first year. Chapter III describes the program for 1988/89 and the medium term, and assesses the  - ii - factors that will determine its outcome. Chapter IV examines the role of external assistance and assesses financing needs in the short to medium term. The Inheritance 5. At Independence, Uganda had been one of Africa's most prosperous countries. The rapid momentum generated in Uganda's economy in the early years of Independence was, however, quickly reversed during the eight years of despotic military rule beginning in 1970. Acute economic mismanagement resulted in a 42 percent decline in per capita incomes during the decade of the 1970s. Export voumes fell by 60 percent, dragging down import capacity; savings and investment levels also fell sharply. The Government's budget became increasingly untenable as the revenue base was undermined and controls on spending collapsed. The resultant growing deficits were financed mainly by domestic bank borrowing, fuelling the excessive expansion in money supply and rapid inflation (74 percent per annum between 1971 and 1979). To survive, most Ugandans reverted to subsistence activities or participated in the pervasive parallel market. The shock to a young and fragile nation's economic, political and administrative capacity from this mismanagement and the subsequent war of liberation was severe. Subsequent efforts to revive the economy were greatly constrained by these initiel conditions and the political instability that followed Amin's regime. 6. In mid-1981, with the return to power of Obote, a number of economic measures were taken. The 1981 Recovery Program (RP) sovt' ht to stabilize the economy and restore growth through fiscal and monetary restraint, the establishment of a dual exchange rate regime (with a managed and an auction determined floating rate), associated major adjustments in relative prices, trade liberalization and removal of price controls. The initial response to these reforms and the considerable external assistance that accompanied it, was encouraging, with a quick increase in output, a substantial reduction in the budget deficit and a marked decline in inflation during late 1982 and 1983. This recovery, however, proved both transient and partial, with infrastructure improvements lagging behind. A fall in agricultural output, induced by weather and civil war caused a 5 percent drop in GDP in 1984, initiating a period of steady decline that by 1986 had wiped out the gains since 1981. The fires of inflation were stoked once again by large bank-financed fiscal deficits reflecting the parallel deterioration in the political and security situation and the consequent increases in military spending and public sector employment. Rapid monetary expansion caused a sharp depreciation in the exchange rate under the second auction window, further feeding inflation. 7. Ui_able to consolidate its political or military position, the Obote regime ended abruptly with a military coup in July 1985. This did not end the civil war which kept many of the key coffee producing areas outside Kampala's control. Non-eubsistence agriculture stagnated at a low level, and what little marketed surplus there was could not be moved as the roads were in disrepair and the country's transport fleet was stolen or destroyed. With the sharp decline in foreign exchange earnings, severe restrictions were imposed on the auction, which virtually stopped operating. Lack of foreign exchange and physical insecurity brought  - iii - industrial production, which was alread' nperating at a low level of capacity utilization, virtually to a halt. 8. When the National Resistance Army (NRA) occupied Kampala and established a government, its first preoccupation was with consolidating the military position, while restoring law and order and a sense of normalcy to the country. Its initial economic policy initiatives represented experimentation with various policy instruments through a series of ad hoc measures. These included appreciation of the exchange rate, increased producer prices, higher government salaries, the doubling of other budgetary outlays, the reimposition of price controls and the establishment of monopolies for key items in external and domestic trade. These measures further aggravated the macro-economic imbalances. However, the new government used the experience gained to appraise and formulate its development strategy. The improved security situation, the Government's obvious strong commitment to economic and social development, its emphasis on the integrity of public life and on the integration of different power groups and economic philosophies into the national mainstream contributed to a qualitativc change in the economic environment. This change facilitated the recognition of the severity of the economic crisis facing the country and the need for a major reversal of economic policies to deal with it. After extensive debate, a consensus was reached on the direction of reform and a comprehensive program of economic recovery was launched. First Year of the Economic Program 9. The Economic Recovery Program, covering a three year period beginning July 1987, was launched on May 15, 1987. Its key objectives were to: - restore price stability and bring about a sustainable balance of payments position; stimulate economic growth, through improved producer incentives and marketing in agriculture and increased capacity utilization in agro-processing and industry; - improve resource use in the public sector through additional revenue mobilization, improved resource allocation, and greater discipline, accountability and efficiency. 10. The program for the first year, 1987/88, aimed at restoring GDP growth to 5 percent and reducing inflation to around 90 percent. The exchange rate, a key price in the economy, was depreciated by 329 percent to U Sh 60 per U.S. dollar (77 percent in foreign currency terms), with a view to restoring the competitiveness of Uganda's exports. This was done in conjunction with a major currency reform whereby 100 old U shillings were converted to 1 new U shilling and a 30 percent conversion tax was imposed on all outstanding currency and bank deposits as a way of reducing the excess liquidity in the system. An Open General Licensing (OGL) system was introduced for selected industrial units as a way of prioritizing and reducing delays in the allocation of foreign exchange for key sub-sectors. Producer prices were raised substantially, including a 182 percent increase in the price of coffee. Petroleum prices were adjusted in line with the exchange rate and designed to yield revenue to the budget.  - iv - 11. The centerpiece of the reform program was the fiscal adjustment aimed at producing positive public savings, and reducing substantially the Government's recourse to oumestic bank borrowing. This task was complicated by the need to accommodate a substantial increase in civil service salaries and wages which had been greatly eroded in real terms, and to quadruple development expenditures from their very low past levels in order to provide some momentum to the rehabilitation of the country's infrastructure. Thus to repay the banking system while substantially raising expenditures required a major increase in budgetary revenues. This was to b- achieved partly through increases in revenues from coffee induced by the 329 percent devaluation of the shilling, and partly through higher taxes and improved tax administration. A major increase in aid financed grants was envisaged together with higher external borrowings and debt rescheduling. A number of structural policies were also to be pursued in the area of tax administration, budget formulation, expenditure control and parastatal reforms. 12. A sharp reduction in public sector borrowing was the principal means by which monetary expansion was to be contained at &bout 40 percent, while at the same time, permitting credit to the private sector to expand strongly, and allowing for a much needed increase in net foreign assets. 13. These measures were supported by an IMF structural adjustment facility (SAF), a Paris Club rescheduling of bilateral debt and arrears, as well as an IDA and Africa Facility Economic Recovery Credit for $US89 million, approved by the Executive Directors in September 1987. 14. While shortcomings in data do not permit an adequate analysis of the economy's response to the policies introduced in May 1987, an initial and partly impressionistic assessment is possible. After three successive years of declining output, GDP, at factor cost, is estimated to have risen by just under 3 percent in 1987.1 This increase was propelled by the growth in agriculture, which responded strongly to improved producer prices and the return of peace and security to most regions of the country, which allowed farmers to return to their land and dedicate their time more fully to generating uutput. Industrial production grew by an impress4.ve 15 percent as industry responded strongly to the improvements in physical security and to the modest amounts of foreign exchange made available for rehabilitation, raw materials and spares. Investment surged to 12 percent of GDP, up from 8 percent in the previous year, due mainly to the stimulus from increased public investment. Progress on road rehabilitation, for instance, encouraged private and public sector investments in the rehabilitation of the vehicle fleet, and restored the flow of goods between regions. The sprucing up of Kampala for the Preferential Trade Area (PTA) conference in November 1987 may at first appear to have been a low priority, but it has contributed much to a feeling that normalcy is returning, which is helping to rebuild the shattered confidence of Ugandans. 15. These are indeed important achievements attained under the most difficult of circumstances. They would have seemed even more impressive 1/ Mission estimates. Government has recently revised 1987 GDP estimates which suggest a growth rate of 4.5 percent.  had progress been greater in the area of stabilization. The Government has been the first to recognize the high costs of the disappointing performance in this area. After an initial improvement between June and August 1987, inflation exploded in September. It has been high ever since, with prices rising by 188 percent in 1987/88. Although this represents a substantial deceleration in the rate of inflation over the May 1986/May 1987 performance (256 percent), it substantially exceeded the program target. A variety of exogenous shocks contributed to this, including: - the decline in world coffee prices below program forecasts and the reimposition of coffee quotab ir late 1987; - delays in the arrival of external assistance, which compressed import capacity and impeded the domestic supply response; - higher than anticipated non-reschedulable debt service obligations, due partly to the dollar devaluation; - tension on the Uganda-Kenya border which disruptid foreign trade; and - continuing problems in transporting food to urban areas. 16. These factors contributed to, but were not solely responsible for, the overshooting of monetary targets under the program. Broad money expanded by 230 percent, due mainly to a domestic credit expansion of close to 200 percent. One key element in this deterioration was the collapse of all the key assumptions relating to coffee. Lower world prices and export volumes, when combined with ag,-tessive Coffee Marketing Board (CMB) purchases at substantially higher producer prices, improved transportation, more efficient operations of the CMB and local cooperatives, and the reopening to cultivation of areas previously affected by the war, resulted in an unplanned buildup in CMB's stocks. Hence the profits CMB expected to generate on its stocks following the devaluation failed to materialize. This contributed to the over three-fold expansion in crop financing as well as a halving of coffee revenues over budget estimates. The inf.:ationary impact of this larger credit expansion on account of coffee was compounded by the fact that the higher volume of coffee sales to the CMB at the substantially higher producer price was immediately translated into higher incomes for coffee producers with a rather high propensity to consume. At the same time there were substantial delays in earning the foreign exchange from the coffee so purchased, because of the quotas and border closures. Moreover, whatever foreign exchange was earned went largely into debt service and petroleum imports. What was left was used for intermediate goods with inevitable lags in converting these into consumer goods, rather than for direct consumer goods imports. Thus the unsatisfied demand for consumer goods on the official market resulted in pressure on the parallel market exchange rate, which then fed back into inflation. 17. A second key element in the credit expansion was the slippage in fiscal performance. This was due largely to unplanned outlays on defense, particularly on account of continued insurgency in the north and east, the PTA conference, and relief efforts for displaced persons. Disbursements from external loans and external debt relief also fell below expectations.  - vi - On the revenue side, the primary setback was on coffee account. Nevertheless, non-coffee revenues substantially exceeded targets largely as a result of higher inflation rates. Resource mobilization efforts and improved tax administration also yielded impressive results. External grants also exceeded budget estimates. However, this did not offset the deterioration in other areas and resulted in a substantial recourse to additional bank borrowing as well as an accumulation of external arrears. 18. Large wage increases in the parastatal and private sectors following the May 1987 devaluation and the increase in civil service wages and salaries also contributed to inflationary pressures. Credit to the private sector other than for crop financing also quadrupled during the year, reflecting a rather passive credit policy, including a reduction in nominal interest rates (which were already substantially negative in real terms) despite raging inflation. As a result, by end-June 1988, the banking system was facing a liquidity crisis due both to the rapid expansion in lending and the reluctance of its customers to hold deposits, for a variety of reasons, including negative real interest rates. 19. Results on the external front were also disappointing, reflecting a deterioration in the terms of trade, due primarily to lower coffee prices. Instead of rising by 13 percent, export earnings fell by 21 percent. With imports rising by 22 percent (due partly to imports associated with the PTA conference and defense outlays), the overall balance for 1987/88 was negative by US$93 million, as against a planned surplus of US$23 million. The gap was financed partly through the accumulation of arrears of over US$40 million and through debt rescheduling. The official exchange rate was held at U Sh 60 to the dollar, and thus appreciated in real terms by close to 230 per cent during 1987/88. The parallel market rate premium rose from just under two to over six times during the course of the year. Lessons from an Unsuccessful Stabilization Effort 20. What are the lessons to be drawn from the unsuccessful stabilization effort of 1987/88? The key lessons relate to the exogenous shocks and to the nature and speed of government response to these shocks. Uganda's difficulties this past year were clearly compounded by adverse developments in the international coffee market and by Uganda's landlocked status. The lower than anticipated earnings from coffee and delayed exports depressed government revenues. Combined with an aggressive coffee purchase policy, this caused an increase rather than a reduction in CMB stocks, and thus fuelled domestic credit expansion and boosted the demand for consumer goods, while delaying the earning of foreign exchange to finance imports of such goods. One set of lessons from this experience thus relates to coffee. The coffee crop has been neglected for decades. The decline In real producer prices in recent years has greatly eroded incentives for replanting and maintenance. Without a substantial improvement in incentives, the sustainability of exports is threatened even at the constrained quota level. However, the Governmer.t's flexibility in this area in the short term is greatly reduced by the large volume of stocks accumulated by CMB; hence, the need to establish a producer price for coffee that is consistent with fiscal and monetary stability. As inflation is lowered and coffee stocks are reduced, the conflict between  - vii - the objectives of restoring producer incentives and restoring macro- economic stability will greatly diminish. Further improvements in CMB's financial management would of course provide some leeway to policymakers, as would policies designed to reward higher quality and more easily marketable coffee. However, an enhanced role in coffee storage for farmers, and in the internal and external marketing of coffee for the private sector also needs consideration. 21. The slow response of donors to Uganda's recovery program also played an important role in the deterioration of the budgetary and balance of payments situation. The importance of substantial quick disbursing assistance with the minimum of procedural delays cannot be overstated. Donors should also be willing to finance consumer goods imports so as to alleviate the present extreme scarcities of such goods. Donor assistance will need to be monitored closely and action taken to fill gaps that arise or reduce possible delays. The Government will also need to strengthen its own aid-coordination machinery and streamline procedures currently delaying aid utilization. 22. Ultimately however, the failure of Uganda's economy to adjust arose because the authorities delayed their response to the domestic consequences of external shock. While, with the benefit of hindsight, the fiscal and monetary targets may have been too ambitious, the extent of the monetary expansion that took place was too large by any standards. The measures taken in January's mini-budget helped boost revenues and contain expenditures. But, in the absence of an exchange rate adjustment aimed at reversing the real appreciation, they proved too little too late. Moreover, government actions, if not stated policies, contributed to an expansionist fiscal and monetary stance. These actions were not directed against the adjustment program. They resulted partly from unexpected and politically unpostponable new domestic demands, such as the security threat on the Kenya border. They also partly reflected preventable design flaws, such as the failure to take into account in the original budget the substantial outlays on the PTA conference, and the bias in import allocations against consumer goods. 23. Of more relevance to the 1988/89 program, government inaction resulted from a weaker than anticipated institutional capacity to coordinate, monitor, analyze and implement corrective measures to maintain the course of adjustment. The mini-budget announced in January 1988, for example, represented the Ministry of Finance's rather respectable effort to increase revenues and institutionalize expenditure cuts intended in the shadow budget used for the first half of 1987/88. But since it was based on constrained resources and incomplete information, it failed to address the large problems created by uncontrolled expenditures and unbudgeted spending financed directly by the Bank of Uganda. This overestimation of institutional capacity last year underscores the importance of corrective action in this area in 1988/89. The 1988/89 Program 24. The program unveiled on July 1, 1988 for 1988/89, while constituting a substantial adjustment effort, draws on the 1987/88 experience and attempts greater consistency with implementation capacity.  - viii - While the program is characterized by the Government's strong commitment to the reform program and its willingness to take politically difficult measures, its targets reflect the recognition that the attainment of stabilization will take more than one year because of the severity of the shortages in the economy, the infrastructure constraints, the implementation difficulties and the liquidity overhang. Apart from a more cautious and less ambitious stance, the program differs from the 1987/88 program in several ways. First, more flexible exchange rate policies will be pursued. The large further adjustment in the exchange rate announced on July 1, 1988 (see para 25 below) is accompanied by a firmer commitment from government to a more frequent and timely adjustment aimed at preventing a repetition of the real effective appreciation of the exchange rate that occurred last year. Second, the program attempts to avoid the over- stimulation of coffee sales to the CMB in the present very difficult international market for coffee. Third, the government has committed itself to a more active monetary policy. Fourth, recognizing the failure of program monitoring in the last fiscal year, a program monitoring committee has been established to follow developments on a monthly basis and to initiate corrective action where necessary. Finally, there has been a more concerted effort to explain the program to the public. 25. ThIe program for 1988189 is once again set within a policy framework that extends over the next three years. While the primary short run goal is that of stabilization, the stabilization policies are integrated into medium-term policies designed to bring about structural adjustment in the Ugandan economy. The key stabilization and adjustment measures announced on July 1, 1988 are as follows: - depreciation of the exchange rate by 150 percent (60 per cent in foreign currency terms) to U Sh 150 per U.S. dollar, reversing the real appreciation that had taken place since the May 1987 devaluation; - a 107 percent increase in the producer price for robusta coffee, with similar or larger increases in other crops; - a significant reduction in the budget deficit (commitment basis) together with net repayments of Treasury obligations to the banking system. This is to be achieved through a number of measures including the impact of exchange rate adjustment on export and custom revenues, increased petroleum duties, road taxes, import commissions, and expenditure reduction including a 30 percent cut in group employees; - an increase in interest rates by 10 percentage points, with further adjustments to be considered in light of inflationary developments; - the containment of monetary expansion, mainly through a reduction in net bank credit to Government of U Sh 5 billion, while permitting an adequate expansion in credit to the private sector; - the establishment of an inter-ministerial monitoring committee to review economic developments and report monthly to the Minister of Finance.  - ix - 26. Looking beyond the immediate stabilization program, the key areas of policy which will determine the success of the adjustment program are: (i) public sector resource management policies; (ii) exchange and trade policies; (iii) supply side measures designed to improve incentives and the infrastructure; and (iv) measures to strengthen core economic institutions. These are reviewed briefly below: 27. Public Sector Resource Management Policies. The budget for 1988/89 initiates measures that will attempt to achieve a substantial fiscal adjustment over the medium term. The large increase in coffee revenues anticipated will be supplemented by measures to broaden the tax base and move towards a greater reliance on income, excise and sales taxes. A major review of taxes and tariffs is being initiated for this purpose. On the expenditure side, expenditure levels represent significant real reductions. As excess staff is eliminated progressively, the Government plans to improve average wages and salaries for highly skilled and technical staff. Outlays on operations and maintenance, particularly for key sectors like health, education and transport will be substantially raised. At the same time, there are substantial infrastructure rehabilitation needs that must be addressed through the public investment program. Given these claims on resources, reconciling the conflicting objectives of stabilization (whi-h requires a substantial net transfer of resources to the banking system) and development will call for substantial external financial support. 28. Effective demand management calls for a substantial reduction in the ratio of domestic credit to GDP. This implies, as indicated above, shifting resources from government to the private sector. This will need to be supplemented by higher interest rates to reduce the excess demand for loans and increase, if only marginally, the efficiency with which credit is used. Despite the adjustment in interest rates announced in the program, barring a unexpected success in the fight against inflation, the real cost of short term borrowing will remain negative through 1988/89. To prevent a damaging repetition of the events of 1987/88 it will be necessary for the Bank of Uganda to intensify bank supervision and ensure that private sector credit expands at a pace compatible with the targeted reduction in net credit to government. In the medium term, monetary policy has two critical tasks: to stimulate domestic savings and develop better instruments for short-term macro-economic management. 29. Exchange and Trade Policies. Despite the substantial recent devaluation, the Uganda shilling remains overvalued, with the parallel market rate enjoying a substantial premium, reflecting the continuing severe scarcity of foreign exchange at present levels of demand and supply. This in part reflects the large unsatisfied domestic demand for imports, the low level of exports, the slow recovery in aid levels, the overhang of past debt, expansionary financial policies, and a continuing sense of uncertainty which accounts for a stroaLg preference for assets denominated in foreign currencies. The Government, however, is anxious to see some progress in the area of demand management and the removal of supply bottlenecks before it attempts to establish a market clearing exchange rate. While such progress is essential to reducing the demand for imports and establishing the credibility of the program, and a transition period to an equilibrium exchange rate is inevitable, tight fiscal and monetary  p,olicies, without a corresponding major shift in relative prices and incentives will result in austerity and stabil'zation without ensuring an adequate supply response. The Government, therefore, needs to pursue simultaneously effective demand management and an aggressive exchange rate policy coupled with a phased trade liberalization, aimed at quickly restoring price incentives for efficient production in agriculture and industry, shifting relative incenti-res away from rent seeking activities, and reducing the current anti-export bias facing export diversification activities. A substantial real adjustment in the exchange rate should permit a phased expansion of the OGL sys.em, providing importers foreign exchange on demand (unlike at present) while eroding the huge rents currently conferred on its few beneficiaries and ensuring a more efficient use of the foreign exchange so released. At the same time, the government should continue its sensible policy of freely permitting imports financed against the importers' own foreign exchange. 30. Supply Side Policies. Within the complex range of supply side policies being pursued by government, the ones relating to coffee wiJl continue to play a central role in a return to macro-economic stability and growth. In the short term, the Government faces a difficult trade off between the pressing need to provide an adequate stimulus to rehabilitation and replanting of the ageing coffee bushes and the need not to overstimulate sales to the CMB in a difficult international coffee market. This is reflected in its decision not to pass on the full benefit of devaluation to coffee farmers in the 1988/89 program. These short-term trade-offs should also be alleviated by differential pricing to reward quality and measures to reduce the operating costs of CMB such as shifting part of the burden of storage to farmers. For the rest of the program, producer prices will be adjusted periodically to improve producer incentives subject to monetary and fiscal constraints. In the medium term further measures to improve quality control, reduce processing costs and increase the efficiency of marketing through a greater role for the private sector also need to be explored. The Government has, more recently, met with some success in tapping non quota markets for coffee, and these efforts should be continued. 31. Reducing the dependence on coffee is a high priority. This implies improved incentives, strengthened extension services and easier access to inputs and credit for tea, tobacco, cotton and sugar. Output of the latter is ready to expand with the resumed operations at the sugar factories following rehabilitation. The present policy of pursuing increased production in all food crops without adequate consideration for their comparative advantage may be short-sighted. The experiment with state monopolies in the internal and external marketing of these crops has proved a failure and has wisely been abandoned. 32. The rehabilitation of the industrial sector is a high priority for government. While the initial recovery in output is encouraging, the sector remains constrained by severe shortages of foreign exchange, infrastructure constraints, lack of management and technical skills and the availability of credit. An industrial sector strategy is being developed that includes measures to rationalize and improve the management of the public industrial enterprises, restore expropriated enterprises to their previous or other private owners, and to facilitate through credit and management contracts a larger role for the private sector.  - xi - 33. While the efforts to rehabilitate the productive sectors are important, a key to the success of the recovery program will be the speed and efficiency with which transport and power bottlenecks are removed. In the short term, road, rail and ferry services must continue to meet a growing demand while infrastructure constraints persist. This requires, inter alia, continued and enlarged foreign exchange availability for bicycles, vehicles and equipment, and in particular, fuel and spares. Reconstruction of the rundown trunk and feeder roads has begun, but implementation constraints will need to be carefully monitored to ensure a substantial recovery of the system in the next two or three years. Greater attention to maintenance is also needed to extend the useful life of scarce capital investments and reduce medium-term investment requirements. 34. Institutional Strengthening. Strengthening the capacity of government to undertake policy analysis and implement and monitor a complex development program is a major task. The medium-term program rightly focuses on actions to strengthen core Central Government bodies responsible for macroeconomic management -- the Ministry of Finance (MOF), Ministry of Planning and Economic Development (MPED), and Bank of Uganda (BOU). 35. Two units in MOF that are critical to the budget process -- the Economic Analysis Unit and the Budget Division -- will be strengthened and a computerized management information system established to improve the budget process. The budget process needs to be streamlined and communications improved between MOF, line ministries, and other core economic ministries. In addition, the distribution of budget resources need to be reexamined and the heavy bias toward salaries and wages corrected. Institutional strengthening of MOF will be initiated under the Third Technical Assistance project. Under the same project, minicomputers will be installed and software provided to support foreign exchange monitoring and transactions at BOU. Over the years, MPED has gained strength in economic analysis, projections and planning, and staff morale has improved. The Second and Third Technical Assistance Projects continue to provide assistance to MPED, particularly in strengthening its statistics capability. 36. In planning the Public Sector Investment Program (PSIP), the Government has adopted a four-year rollover approach. MPED has initiated actions to improve planning capabilities within line ministries, and to establish monitoring capability at all levels. However, the plan's link with the budget still remains weak, and plan coverage needs to be expanded to include domestically-financed projects and all externally-funded projects so that all public investment decisions are based on the same priorities and subjected to the same rigor of selection. 37. The Government has also taken an important step toward civil service reform by conducting a census of the civil service and increasing civil service salaries. It must follow through on its decision to do away with some 30,000 "ghost' employees, and meet numerical targets for reducing the number of temporary staff and group employees. Reform of civil service pay and employment policy is critical for improved efficiency and control of government expenditures. Some of the policy instruments employed in other countries to deal with similar problems include a freeze on recruitment, voluntary retirement and retrenchment of redundant workers.  - xii - The feasibility and desirability of these policies in the Ugandan context need to be examined. However, a trimmer civil service, restraint in recruiting, well-targeted staff training based on the findings of the functional study currently underway, and improved pay and logistical support to civil servants should provide the basis for further reform and a better functioning civil service. Economic and Social Impact of the Program 38. The principal outcomes of the proposed program are expected to be an increase in output and economic growth and reduced inflation. Improved output in 1987, especially in the second half of the year, provides tangible evidence that, with progressive stabilization and continued improvement in sectoral policies, a real annual growth rate of 5.0 - 5.5 percent is achievable in the medium term, permitting a sustained increase in per capita income, averaging 2.5 percent annually between 1988 and 1991. Much of this growth, particularly in the agricu:'tural sector, which will be the main engine, represents recovery from the present very low levels of output to levels that are still significantly below what Uganda had attained in the 1960s. 39. The program will benefit .he poor by increasing economic opportunities and reducing inflation. The predominantly smallholder rural population will benefit from incentive pricing for agriculture permitted by a more realistic exchange rate policy. Higher public expenditures and aid financed programs on health and education and basic social services will also have a positive impact. There are nevertheless sections of the population that have suffered most from the 15 years of economic decline and the more recent civil wars who will need special attention. The Government is developing, with World Bank assistance, a set of cost- effective interventions in the areas of health, education, and employment- generating infrastructure rehabilitation targeted to these vulnerable groups. External Financing Requirements 40. As indicated above, the success of Uganda's program depends heavily on timely and adequate external assistance. The current account deficit, excluding official transfers, is expected to widen to $356 million in 1988. Over the next three years, the current account deficit is projected to range between US$360 and US$370 million. Taking into account amortization, the need to eliminate external payments arrears, IMF repurchases and the planned buildup in foreign exchange reserves over the period, the total financing requirements of the program over the 1989-91 period amount to about US$1.6 billion. Anticipated disbursements from past commitments will total US$447 million. To finance the balance required, after allowing for non-ODA flows, implies annual new ODA commitments of US$440 million in 1989, US$450 million in 1990, and US$475 million in 1991. 41. Of this, US$240 million in 1989, US$270 million in 1990, and US$200 million in 1991 will need to tak- the form of commitments of quick- disbursing assistance with the balance in the form of project aid. The substantial switch to quick-disbursing assistance is critical to the success of the recovery program. As for project aid, donors are encouraged  - xiii - to focus on rehabilitation of the economic and social infrastructure, and agricultural projects. Cofinancing with ongoing IDA programs would greatly ease the government's burden of aid coordination. Projects for the proposed program to mitigate the social costs of adjustment will be presented to donors in 1989. The recommended levels of assistance represent the bare minimum amounts needed and should, if possible, be exceeded. The levels recommended, as indicated above, assume additional resource flows from the IMF ESAF and the rescheduling of Paris Club debt on normal Paris Club terms for Uganda. The Government should, of course, pursue a more generous debt rescheduling both from Paris Club and reschedulable non-Paris Club creditors. 42. The corrective measures announced by the Government in July 1988 have made a significant contribution towards bringing Uganda's economic recovery program back on track. While the Government's policy agenda over the coming months and years remains most arduous, requiring politically difficult decisions and considerable attention to design and implementation of policies, chances of success will be greatly improved by adequate flows of external assistance. Unlike many Sub-Saharan African countries, Uganda is a resource rich country, with a potentially strong and vibrant agricultural sector. Given sound policies, political stability, and adequate external support, there is every reason to be optimistic about the longer term prospects for the economy. The Government has demonstrated its commitment to its program of economic recovery and rehabilitation. This represents an opportunity for progress that should be strongly supported.  I. DEVELOPMENTS LEADING TO THE ECONOMIC RECOVERY PROGRAM A. Backgrolnd 1.01 Uganda is well endowed with human and natural resources, but its economy has been devastated by political instability, economic mismanagement, and internal discord. At independence, Uganda was the envy of its neighbors, with one of the strongest, most promising economies in Sub-Sanaran Africa. Favored with a good climate and fertile soil, the agricultural sector could feed the population and generate adequate foreign exchange. The industrial sector, thoughi small, supplied the economy with basic inputs and consumer goods, and contributed foreign exchange through exports of textiles and copper. Uganda's transport system was regarded as one of the best in Sub-Saharan Africa and Uganda had access to an effective network of railway, port and airline facilities. Uganda's significant potential for developing hydroelectric energy was already being harnessed. With an established network and infrastructure, Uganda's health service had developed into one of Africa's best. School enrollment was still low, but the country had developed a reputation for quality education at all levels. 1.02 The years after independence demonstrated the country's economic potential. Real gross domestic product (GDP) grew 5.8 percent from 1962 to 1970, with per capita GDP increasing at least 3 percent a year. The country's savings rate averaged 15 percent of GDP, which allowed a respectable level of investment without undue pressure on domestic prices or the balance of payments. The Government's fiscal and monetary management was sound. Although Uganda's export volumes grew slowly (about 3.5 percent a year), export earnings not only covered import requirements but created a current account surplus in most years. 1.03 The decade and a half of devastation that started in 1970, however, radically altered the situation. The military coup in 1971 introduced a regime of singular repression and mismanagement that decimated rival tribes, terrorized entrepreneurs and intellectuals, and squandered the country's natural resources. Skilled personnel fled the country, the parastatal sector grew bloated with abandoned or confiscated industries, and professional standa.rds within the administration eroded. Recession in the OECD induced shrinking exports and declining terms of trade, and the breakup of the East African Community, which had provided a thriving market for Uganda's industrial exports and a reliable access route to foreign trade, accelerated Uganda's economic decline. Further damage was caused by the looting and destruction that occurred during the 1978-79 Liberation War. 1.04 Today, Uganda is one of the poorest countries in Sub-Saharan Africa, with a per capita GNP of about US$230 in 1987. It faces the formidable challenges of reversing the severe economic decline that has destroyed critical infrastructure, generated a persistent, unstable macroeconomic environment characterized by high inflation and balance of payments crises, and consequently, impaired the performance of key productive sectors.  -2- Agriculture 1.05 Agriculture is the dominant sector in Uganda, accounting for 76 percent of GDP at current market prices and earning 97 percent of export revenues. Well over 9C percent of the population lives in rural areas, and 03 percent of the working population pursues agriculture. Smallholders produce about 94 percent of agricultural output. Export crops (coffee, cotton, tea and tobacco) dominate; food crops (grains, vegetable oils, pulses and root crops) are grown for subsistence. The economy relies on coffee for 90 percent of its export earnings and 40 percent of government revenue. 1.06 The agricultural sector has experienced severe decline on account of the civil wars and turmoil of the past 15 years. Crop production today is much lower than it was in the early 1970s, when Uganda's agriculture was at its peak. Amidst general decline, production of most crops has fluctuated dramatically from year to year since about 1980 because of insecurity in various regions and wide swings in real producer prices. Only the subsistence food crops -- plantain, cassava and sweet potato -- have maintained relatively stable production. Nonetheless, Uganda is today self-sufficient in coarse grains, matoke bananas and root crops. The only significant food imports are 50,000 tons of wheat and rice, about 1,800 tons of milk powder and butter oil, and 40,000 tons of sugar annually. Per capita daily calorie consumption, at 2,483, is above the average for low income economies. 1.07 The amount of coffee marketed through official channels has varied widely in recent years, but present supplies are adequate to meet and even exceed slightly Uganda's export quota. Tea and cotton exports, however, are at less than 10 percent of their former volumes and have been in a long-term decline. This withering of traditional export crops, without compensatory diversification into new crops, is perhaps one of the greatest problems facing Ugandan agriculture. It is difficult to identify potential new exports in which Uganda could have a comparative advantage, because low-technology, low-yield production methods are used for most crops and few entrepreneurs have begun to test the markets. Industry 1.08 The industrial sector, wh'ch accounts for only 5 percent of GDP, is dominated by 60 large and medium-scale public enterprises that command most industrial investment and production and account for about 50 percent of the turnover in manufacturing. In most cases, these enterprises have a major share of, if not a monopoly on, the market. In contrast, the private sector has focused more on small and medium-scale manufacturing, which has increased in importance over time. The small-scale private sector units appear to be in much better health than the large-scale public sector units, but the Government will continue to play an active role in the latter's rehabilitation and ownership. Uganda is only now emerging from a prolonged period of political and economic turmoil, and although there are encouraging signs of a greater private sector involvement, it may take a few years for it to undertake enough large capital investments to overtake the public sector.  - 3 - 1.09 Within the industrial sector, agro-industries (cotton ginning, coffee curing, and sugar) account for 17 percent of industrial value added today; manufacturing of food products (tea, dairy, grain and processed foods) provides 6 percent; and miscellaneous manufacturing industries (including beverages, tobacco, textiles, soap, steel and paper) account for 77 percent. 1.10 Between 1962 and 1970, industry was the fastest growing sector of the economy. By 1970 it accounted for over 12 percent of GDP, 17 percent of formal sector employment, and almost 20 percent of export earnings, and a wide range of manufactured goods were produced. In the next 15 years, however, the general decline in the economy, foreign exchange scarcity, the deportation of non-national entrepreneurs who dominated the industrial and commercial sectors, and large-scale government confiscation of enterprises reduced capacity utilization and output to negligible levels. By 1985, industry accounted for only 4 percent of GDP, less than a third of its contribution in 1970. Transport 1.11 Uganda's primary challenge as a landlocked country is to secure adequate transport services for its external and internal trade. Fifteen years ago, Uganda had one of the best designed and maintained road networks in Sub-Saharan Africa. Access to external markets was assured through common ownership with Kenya and Tanzania of the East Africa railways, harbors and lake service systems. Air connections to Kenya, Tanzania, Europe and the main internal administrative centers were quite good, considering the level of aviation development at the time. Since the early 1970s, however, much of the country's transport infrastructure has been devastated. Large stretches of the toad network became impassable and the vehicle fleet was decimated after the Liberation War. 1.12 The country's transport infrastructure consists of about 27,000 km of roads, 1,200 km of railways, a wagon ferry terminal on Lake Victoria providing the important alternative routes to the sea from Jinja in Uganda via Kisumu to Mombasa in Kenya and via Mwanza to Dar es Salaam in Tanzania, some navigable river sections, an international airport at Entebbe and several small airfields around the country. The traffic density is largest on the trunk road corridor running from the Kenyan border to the Rwanda border and linking major agricultural production areas within Uganda to the capital, Kampala. Large sections of this corridor are in very bad shape. The feeder road network is extensive, but has also suffereL from long neglect and needs major repairs. Reconstruction of feeder roads has not yet progressed as far as that of trunk roads. The vehicle fleet is gradually being reconstituted by private and public sector imports. Given the state of the roads, the useful life of vehicles is relatively short, the investment carries a high risk and road transport is presently very expensive. Thus, in the short term, transport demand is exceeding supply for both freight and passengers. 1.13. The Ugandan transport system fulfills three roles: First, as the country is landlocked, it has to ensure reliable outlets to the sea, which it can only achieve through close cooperation with its neighbors, Kenya and Tanzania. Since the dissolution of the East African Community in 1977,  - 4 - this is governed by special bilateral agreements. While continuing to use the Kenyan routes for transit, Uganda is now also developing routes through Tanzania, in a justifiable effort to safeguard against overdependence on any one route. The traffic volume of exports (mainly coffee) and imports (especially essentials such as petroleum produjcts) is estimated to be well below 1 million metric tons per annum and, therefore, does not form the largest portion of Uganda's overall freight volume, but is nevertheless vital for Uganda's economy. Second, domestic transport ensures the movement of cash crops from farms to trading centers to processing plants, and of foodcrops from rural to urban areas and of agricultural inputs, fuel and consumer goods from urban to rural areas. Domestic transport may comprise the movement of several million tons of traffic each year. Third, Uganda lies on the Northern Corridor from Mombasa inland and can in turn be used as a transit country for traffic from Rwanda, Burundi, Eastern Zaire and Southern Sudan. This involves large volumes which fluctuate depending on the competitiveness of these countries' alternative routes to the sea. In addition to freight transport, the system also needs to cater to substantial passenger traffic as Ugandans try to maintain their links with their areas of origin. Domestic air transport plays a minor role. Health and Education 1.14 From the early 1960s until the early 1970s, Uganda's health service had developed into one of Africa's best. There was an established network and infrastructure of health facilities. The country pioneered many low-cost health and nutrition programs, and social indicators were comparable to, if not better than, those of most countries in East Africa. Public health services, however, collapsed during the political turmoil and civil strife. Facilities were destroyed and looted, and equipment stolen. Personnel are still unpaid for long periods and drug supplies are sporadic. Mcreover, the organization and management of the health sector has weakened, and the respective roles and responsibilities of the Ministry of Health (MOH) and the Ministry of Local Government are not sufficiently clear. Most Maternal and Child Health (MCH) programs have been abandoned. The health of Ugandans has deteriorated draziatically. Im.unization programs now reach only 15-25 percent of the population (down from 70 percent in 1971), there has been a resurgence of such diseases as measles and malaria, and there is a growing AIDS epidemic. The crude death rate is estimated at 18 per thousand, above the average for low income economies. Some reports suggest a current infant mortality rate between 120 and 200 per 1,000 live births and a maternal mortality rate of more than 5 per 1,000 pregnancies. 1.15 Uganda's health facilities consist of two national referral hospitals, six regional hospitals, 70 rural and district hospitals, about 100 health centers, and other facilities such as dispensaries, maternities, and first aid posts. About 30 percent of the larger health facilities, particularly in rural areas, are operated by missions. Both MOH and mission facilities were damaged and looted during the years of turmoil but the MOH facilities have borne the brunt of the damage. Because of better salaries and benefits and support from external sources, mission facilities have managed to rehabilitate themselves and once again provide services of reasonable quality. MOH facilities have had few resources for rehabilitation, pay low salaries, and remain in a poor state.  - 5 - 1.16 Although school enrollment was low in the 1960s, the country had developed a reputation f3r the quality of its education. In spite of political turmoil and economic decline, the education system continued to expand, though at great expense to quality at all levels. Some of the most acute symptoms of decline in educational quality include: the almost total absence of textbooks and educat!lnal materials; a deteriorating teacher morale and productivity; an exodus towards better employment opportunities inside or outside the country; and a general lack of school maintenance. B. Recent Economic Developments 1.17 Between 1970 and 1980, Uganda's GDP fell 25 percent (about 42 percent on a per capita basis). Exports declined 60 percent in volume, and import volumes fell by half. The Government's budget became increasingly untenable, as the revenue base was undermined and controls on spending collapsed. The consequent deficits were financed increasingly by bank borrowing, which led to monetary expansion and price inflation (averaging 74 percent a year between 1971 and 1979). More than three-quarters of the broad money (M2) supply was in currency or demand deposits, one-third of it in currency held outside the banking system. Savings and investment rates, which averaged 13 percent of GDP in the 1960s, fell to about 6 percent by 1975 and remained low for the rest of the decade. Economic decline was particularly severe in the official econcmy. To survive, most Ugandans reverted to subsistence activities or participated in the pervasive parallel market system. 1.18 Thus, when the military regime was overthrown in April 1979, the Ugandan economy lay in ruins. Initial efforts to promote recovery were constrained by the political situation, administrative weaknesses and a severe shortage of foreign exchange. As a result, many of the adverse trends evident during the 1970s continued through 1980 and 1981. Only in mid-1981, did the Government make a break with the past in launching the Recovery Program (RP). The June 1981 policy package, supported by an IDA credit and a standby arrangement with the IMF, sought to stabilize the economy and foster growth through a combination of price adjustments, fiscal and monetary restraint and increased external flows. The official exchange rate was first devalued from U Sh 8 to U Sh 78 per U.S. dollar. Beginning in mid-1982, a dual exchange regime was introduced. The dual exchange system consisted of a managed exchange rate (Window I), and a higher, more depreciated, floating rate (Window II). Window I covered foreign exchange proceeds from traditional exports, official loans and grants, government debt service and arrears payments, contributions to international organizations, and inputs and petroleum imports deemed essential to rehabilitate the economy. Window II covered all other transactions, and the rate of exchange was determined by a marginal auction bid rate. 1.19 Many price controls were removed. Incentives to agricultural producers were restored through periodic adjustment of producer prices to reflect domestic and foreign price changes. Taxes on foreign trade, particularly gains from the dual exchange system, boosted government 'evenues from less than 1 percent of GDP in FY81 to over 6 percent of GDP .1 FY83. This, combined with extraordinary inflows of external assistance  - 6 - and some progress in controlling expenditures, reduced the budget deficit from 8.5 percent of GDP in FY82 to 2.8 percent in FY84. Inflation fell to about 30 percent annually at the close of FY84. 1.20 As Table 1-1 shows, economic stability and increased flows of external resources evoked a quick supply response. GDP at factor cost grew more than 8 percent in 1982 and more than 4 percent in 1983. Domestic demand exceeded GDP by about 3.5 percent and investment grew steadily (see Table 1-2). By the end of 1983 agriculture had clearly emerged as the engine of the economy's recovery. The growth in output marketed through official channels was most remarkable for coffee, for which purchases by the marketing board increased from 1.6 million bags (for the 1980/81 crop) to 2.8 million bags (for the 1981/82 crop). The subsequent sharp increase in exports was sustained in the following years only through gains in world coffee prices. C. The Crisis of the Mid-1980s 1.21 The recovery of 1983 proved to be tenuous and short-lived. Table 1-3 presents an overview of economic developments in the subsequent years. Real GDP declined in 1984 due to a sharp deterioration in security and erosion of producer incentives, and continued to decline in 1985 and 1986. Stabilization was not achieved and price incentives deteriorated. The real effective exchange rate showed continued appreciation indicating that the devqluations in this period did not sufficiently restore incentives for tradeables. Developments underlying these outcomes as well as movements in key fiscal, monetary and balance of payments variables are discussed below. 1.22 Recovery in the early 1980s proved fragile and remained partial, and infrastructure improvements lagged behind. Most of the few remaining industrial plants were operating at about 20 percent of installed capacity. The supply response was precarious, weakened by the lingering political insecurity and heavily dependent on continued economic stability and ample flows of imported inputs. With further cuts in imports and a rapid resurgence of inflation, the recovery collapsed in 1984. By 1983/84 industrial output was well below the levels of the early 1970s. GDP fell more than 5 percer.t, initiating a period of steady decline that by 1986 would have erased the gains in output achieved since 1981. 1.23 The reversal in performance observed during the second half of 1984 was essentially a fiscal problem. Large increases in military spending and poor control of public expenditures increased the fiscal deficit from 3 percent of GDP at the end of 1983 to 6 percent of GDP at the end of 19841 -- 70 percent of it financed by bank borrowing. From June to December, credit from the Bank of Uganda to the Government increased 62 percent, the money supply 52 percent, and prices more than 80 percent. 1/ Annual as opposed to fiscal year figures are only partly derived from government records. For the most part they are estimated as weighted averages of the corresponding fiscal years and may, therefore, differ markedly from the original sources.  - 7 - Table 1-1: REAL GRoHrH IN GROSS DUESTIC PRODUCT (In percentages) SECTORS 1982 1983 1984 1985 1988 1987 GOP - Monetary Sector 9.08 2.61 -1.15 2.57 -0.55 3.34 Agriculture 13.84 1.13 -5.85 3.99 -7.20 3.90 Industry 8.82 0.74 5.85 -9.91 -3.38 14.99 Services 6.18 3.94 0.55 4.01 3.94 1.31 GOP - Nononetary Sector 6.92 8.99 -11.58 -7.00 -2.08 2.16 Agriculture 7.85 7.62 -13.f5 -8.69 -3.02 2.03 Industry 15.38 0.00 6.67 1.85 2.80 2.80 Services 0.59 2.94 2.57 2.89 2.80 2.80 TOTAL GOP AT FACTOR COST 8.22 4.34 -5.35 -1.03 -1.09 2.93 Source: Central Bureau of Statistics, Ministry of Plaming and Economic Development, and Staff estimates. Table 1-2: NoMINAL GROSS WAESTIC PROOUCT BY EXPENDITURE (as percent of GDP) 1982 1983 1984 1985 1986 1987 GOP at factor cost 90.4 88.2 87.3 91.0 94.3 93.4 Net Indirect taxes 9.6 11.8 12.7 9.0 5.7 6.6 GDP at market prices 100.0 100.0 100.0 100.0 100.0 100.0 Export of goods and nonfactor services 8.3 9.5 15.8 9.5 9.4 9.7 ImPorts of goods and nonf actor services 11.8 12.9 16.1 12.7 12.1 16.9 Resource balance (RB) -3.5 -3.4 -0.2 -3.3 -2.6 -7.2 Domestic absorption 103.5 103.4 100.2 103.3 102.6 107.2 Gross domestic Investment 7.3 8.8 16.3 8.6 8.1 12.0 Total consunptlon 96.2 94.6 83.9 94.7 94.5 95.2 Net factor Income -0.6 -1.0 -2.2 -1.3 -0.9 -1.4 GNP at market prices 99.4 99.0 97.8 98.7 99.1 98.6 Gross forelo savings (-RB) 3.5 3.4 0.2 3.3 2.6 7.2 Gross domestic savings 3.8 5.4 16.1 5.3 5.5 4.8 Gross national savings (excl.transfers) 3.1 4.5 13.9 4.0 4.6 3.4 Net transfers 2.6 3.4 2.4 3.5 5.8 Gross national savigas (incl.transfers) 7.0 17.3 6.5 8.1 9.2 Source: Ministry of Plaming and Economic Development and Staff estimates.  Table 1-3: SELECTED ECONGMIC AND FINANCIAL INDICATORS (In domestic currenzy unless Indicated otherwise) Actual Estimated Proj. 1983 1984 1985 1988 1987 (Annual percentage changes) GOP real growth rate a/ -3.2% -6.9% -1.9% 3.9% Prices Consurer prices (average) 38.3% 133.1% 178.0% 238.5% GOP deflator 71.3% 172.4% 148.5% 152.9% External sector (In US$) Exports, f.o.b. 17.2% -20.0% 17.0% -14.5% ImPorts, c.l.f. -6.8% 2.