Uganda - Third Structural Adjustment Credit

Report No. PIC4843 Project Name Uganda-Third Structural (@) Adjustment Credit Region Africa Sector Structural Adjustment Lending Project ID UG-PA-2987 Implementing Agency Ministry of Finance Date Prepared September 13, 1996 Appraisal Date October 10, 1996 Project Board Date May 27, 1997 Country Background 1. With a per capita income of about US$250 in 1995, Uganda ranks among the poorest countries in the world. Poverty in Uganda is largely the consequence of civil war, political instability and economic mismanagement during 1972-85. The country has relatively good growth potential, however. It is blessed with fertile soils and a good climate. Agriculture is the mainstay of the economy: it accounts for more than 50 percent of GDP, about 75 percent of export earnings and around 80 percent of employment, and it provides inputs for a number of manufacturing and processing industries. Smallholders are the backbone of Ugandan agriculture; over 80 percent of the farmers cultivate less than two hectares. The country is predominantly rural, with only 11 percent of the population living in towns and cities. Industry has grown rapidly since 1987 but its contribution to GDP is only around 12 percent. Manufacturing accounts for about half of industrial output. Adjustment Program 2. The Government of Uganda embarked upon an Economic Recovery Program (ERP) in May 1987. The basic objective of the program was to bring about rapid and sustained improvements in the standard of living of the average Ugandan. This objective was to be achieved through stabilization and structural reforms aimed at: (i) restoring internal and external financial stability and lowering inflation through prudent fiscal and monetary management; (ii) creating the conditions for rapid and sustained growth through deregulation and improved incentives; and (iii) developing human capital through investments in education, health and other social services. 3. The Government has made substantial progress in reforming the economy. First, it lowered the rate of inflation from about 100 percent in the early-1990s to single digits last year. Price stability has actually been maintained since 1992. Relatively low inflation has been accompanied by a fairly stable exchange rate, although increased inflow of foreign exchange after the introduction of inter-bank market for in 1993 the Ugandan shilling  has experienced temporary appreciation. Secondly, the Government has deregulated the incentive and regulatory framework. Thirdly, it has pursued the reform of public sector institutions: the size of the civil service and the military has been reduced; there is better control over the civil service payroll; and privatization of public enterprises has been accelerated. The supply response in exports has not yet been as strong as one would have hoped for but there are many encouraging signs: nontraditional exports have been growing rapidly, although from a very low base. The 1994/95 coffee boom due to an increase in the world price of coffee raised rural incomes considerably. Between FY87 and FY95 real GDP grew at an average annual rate of 6.9 percent, or 3.7 percent in per capita terms. In 1994/95 real GDP growth was over 10 percent. 4. The Government has embarked on a wide-ranging decentralization program under which much of the public services delivery is being devolved to districts and local governments. Decentralization of personnel was undertaken at one go, while financial decentralization is being implemented in a phased manner. Part of the recurrent budget is being decentralized in three phases: thirteen districts in 1993/94, fourteen districts in 1994/95 and twelve districts in 1995/96. Successful implementation of the decentralization program is likely to remain extremely challenging because of scarce resources and manpower capacities in the local governments. 5. In spite of rapid growth in recent years and many achievements in reforming the economy and its institutions, Uganda faces formidable hurdles that must be overcome before there can be any assurance of sustained economic growth and poverty reduction. First, institutional capacity to guide social and economic development needs further strengthening. Secondly, agricultural technology and know-how currently in use requires substantial improvement. Thirdly, the human capital base is very deficient. Fourthly, a strong financial system capable of mobilizing and allocating savings is lacking. Fifthly, Uganda needs a much stronger private investment response. The challenge for the Government, the World Bank and other donors is to systematically remedy these deficiencies. The Proposed Structural Adjustment Credit 6. Following initial discussions at the Consultative Group meeting in July 1995, the Ugandan Government has requested the Bank to prepare a Third Structural Adjustment Credit (SAC III). The new SAC would provide balance-of-payments as well as budgetary support. 7. The 1996/97 Budget and National Development Strategy 1996/97- 1998/99 spells out the linkage between management of the budget, macro stability, economic growth and poverty reduction. Within this context, the proposed SAC III focuses on long term fiscal sustainability, including a more efficient tax system as well as better management of public expenditures. On the revenue side, the SAC program includes measures to expand the tax base, and to lower the level and dispersion of trade taxes in order to reduce anti- export bias throughout the economy. On the expenditure side, the - 2-  focus is on improving efficiency in the management of public expenditure, taking into account the ongoing decentralization process. Improving the budgetary process is a necessary condition for implementation of the Government's recently announced Strategy for Poverty Eradication. In addition, SAC III includes measures to reduce the fiscal burden of public enterprises and incorporates the fiscal impact of financial sector reforms within the overall macroeconomic framework. 8. Description. The credit, in the amount of about US$100 million, will be granted on IDA terms for a period of 40 years, including a grace period of 10 years, at 0.75 percent per annum. 9. Benefits and Risks. The proposed program will support the recent gains in achieving macroeconomic stability and will accelerate structural and institutional reforms in Uganda. The measures to improve tax collection and to reduce dependence of the public sector on aid should result in a more sustainable fiscal position over the next few years. Efficiency gains are expected both in the private and public sectors, with the increased participation of the private sector in key areas of the economy and the expected improvement in the management and operation of the public sector. The main risks associated with this operation are related to the institutional capacity to carry out the necessary reforms. To minimize these risks, the Bank is currently implementing the Institutional Capacity Building Project and preparing a technical assistance credit to support economic and financial management. 10. Environmental Impact. In accordance with the Bank's Operational Directives on Environment Assessment (OD 4.01), a Structural Adjustment Credit falls in category "U" and does not require an environmental assessment. Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington, D.C. 20433 Telephone No.: (202) 458-5454 Fax No.: (202) 522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by the Public Information Center week ending April 4, 1997 - 3 -