Public choices for private initiatives : prioritizing public expenditures for sustainable and equitable growth in Uganda (Vol. 1 of 3) : Volume one

Report No. 9203-UG Public Choices for Private Initiatives Prioritizing Public Expenditures for Sustainable and Equitable Growth in Uganda (In Three Volumes) Volume I February 12, 1991 Country Operations Division 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 World Bank authorization.  TABLE OF CONTENTS PUBLIC CHOICES FOR PRIVATE INITIATIVES Prioritizing Public Expenditures for Sustainable and Equitable Growth in Uganda CHAPTER 1: THE REFORM AGENDA Progress Made and Remaining Challenges ................... I Introduction ............................................ 1 The NRM Government and its Economic Inheritance .................. 2 The Experience under the Economic Recovery Program ................ 2 The Reform Agenda: Progress Made and Remaining Challenges .... ....... 4 CHAPTER 2: SECTORAL ISSUES AND STRATEGIES Implications for Public Expenditure Policy ................... 13 Overview ............................................. 13 Agriculture ............................................ 16 Industry .............................................. 17 Transport ............................................. 19 Power ............................................... 20 Health ............................................... 21 Education ............................................. 22 Water ............................................... 23 CHAPTER 3: PRIOR1TJZ!NG EXPENDITURE ALLOCATIONS .... ......... 27 Overview ............................................. 27 Expenditure Allocations for Key Sectors and Activities ................. 28 Intersectoral Expenditure Allocations ............................ 30 Civil Service Issues ..................................... 36 Expenditure Allocations Across Economic Categories ...... ............ 37 The Macroeconomic Framework: Implications for Expenditure Allocations .... 38 CHAPTER 4: CIVIL SERVICE PAY AND EMPLOYMENT ..... ............ 49 Civil Service Employment .................................... 49 Compensation of Employees . ................................. 54 Strategy for Pay and Employment Policy ......................... 58 CHAPTER 5: RECOMMENDATIONS FOR EXTERNAL ASSISTANCE .... ..... 63 Balance of Payments and External Financing Requirements .............. 63 Enhancing Project Assistance for Critical Recurrent Programs .... ........ 66 Aid Coordination and Utilization ............................... 69 Issues for Donors ............ ............................ 70 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.  2 - ANNEXES Annex I The Macroeconomic Framework ........ ................ 73 Annex 11 Issues Pertaining To Revenue Mobilization ...... ........... 85 Annex Im Progress Under Budget Reform Program ...... ............ 89 FIGURES Figure 3.1: Distribution of Recurrent Expenditures Figure 3.2: Inter-country Comparisons Figure 3.3: Comparison with Other SSA Countries TEXT BOXES Box 1.1 Stabilization and Fiscal Adjustment Under the ERP Box 2.1 Uganda's Infrastructure and Institutions: The Legacy of Destruction and Decay TEXT TABLES Table 1.1: Key Economic Indicators Table 3.1: Ministerial Total Expenditure by Ministry and Sector Group (As Percentage of Total Expenditure) Table 3.2: Ministerial Recurrent Expenditure by Ministry and Sector Group (As Percent of Total Recurrent Expenditure) Table 3.3: Total Development Expenditure (Percentage of Ministerial Shares) Table 3.4: Expenditure Across Economic Categories Table 3.5: Central Govermment Operations Table 3.6: Some Components of a Fiscal Reform Scenario Table 4.1: Number of Employees, Uganda Public Service Table 4.2: Estimates of Compensation Packages for Civil Servants, Uganda, 1989/90 Table 4.3: Estimate of Government Payroll for the Traditional Civil Service, 1989/90 Table 4.4: Wage Bill Calculation for Traditional Civil Service, 1989/90 Table 5.1: External Requirements and Resources Table 5.2: Recommendations for External Aid ANNEX TABLES Table 1.1: Key Macroeconomic Indicators, 1984/85-1992/93 - HFP Scenario Table 1.2: Key Macroeconomic Indicators, 1984/85-1992/93 - Modified Scenario Table 1.3: Monetary Projections Table 1.4: Balance of Payments Table 1.5: Central Government Revenue Table 1.6: Central Government Operations Table 1.7: Sununary of Central Government Finance  THE REFORM A GENDA Progress Made and Remaining Challenges Introduction 1.1 In the three years since the Economic Recovery Program was launched, the overall implementation record has been a positive one. The Government has been successful in restoring peace and security over much of the country, and has implemented a wide-ranging package of structura^ and financial policies aimed at achieving a high rate of growth and reducing financial imbalances. These measures included several large initial devaluations of the exchange rate followed by regular adjustments aimed at improving Uganda's competitiveness, a partial liberalization of the import system, the suspension of surrender obligations for non-coffee exports, the elimination of most price controls in the economy, the elimination of virtually all marketing monopolies, and more recently, the legalization of the parallel market for foreign exchange. In addition, a major review of the civil service was initiated and an important beginning was made to the rehabilitation of the country's infrastructure. As a result of these measures, there has been substantial progress in reviving economic activity and creating a climate conducive to development. In addition, inflation has been lowered sigaificantly over the past three years to within the program target in FY89/90. 1.2 However, major challenges remain. In particular, the Government has found it difficult to restore fiscal and monetary discipline at the pace anticipated in the program in part due to external shocks, but in part due to weak implementation capacity and delayed corrective measures. At present, the external environment is particularly unfavorable for Uganda, and the Government faces major challenges in meeting its targets in the short term. In addition, critical structural problems remain which need to be addressed if achievements made thus far are to be sustained. In view of Uganda's reliance on coffee for over 90 percent of its export earnings and its precarious balance of payments situation, export diversification remains a principal area of concern requiring further action. Significant reforms are required in the incentives and regulatory system (e.g., official exchange rate determination and foreign exchange allocation, regulations governing business operations) to foster strong and efficient private sector participation in the economy. Uganda's financial sector is beset with severe, deep-rooted structural problems that are impeding efficient mobilization and allocation of resources for growth, and contributing to macroeconomic instability. Tax effort remains extremely low, and together with high requirements for defense, constrains much-needed expenditure for economic and social sectors. At the same time, much of the country's economic and social infrastructure is in ruins, requiring rehabilitation and maintenance. The quality of and access to basic social services (especially primary health and education) for most of the population is severely lacking as is public expenditure on these services.  2 Chapter 1: The Reform Agenda: Progress Made and Remalning Challenges Unfortunately, the civil service required to implement these programs is overstaffed, unmotivated and ineffective. At the same time, the capacity of the organized private sector has been impaired on account of the flight of skilled managers, technicians and industrialists during the 1970s. Finally, progress is required in the divestiture and restructuring 3f a large and inefficient parastatal sector, and in disposing of unsettled expropriated properties. 1.3 Much of this is a product of an unfortunate inheritance -- a decade and a half of decline, devastation and destruction. The Government has already initiated import,nt steps in several of these areas. These will need to be reinforced by a comprehensive reform agenda in the next phase of adjustment in Uganda. The NRM Government and its Economic Inheritance 1.4 When the NRM Government assumed power in January 1986, it inherited a nation tom apart by ethnic and religious conflicts, and an economy shattered by years of civil war, political instability and physical insecurity. Severe macroeconomic imbalances fuelled inflation and contributed to acute foreign exchange scarcity. Revenues had dropped to 7.4 percent of rIDP. Industrial enterprises lay abandoned. Even the remarkably resilient agricultural sector had been disrupted as farmers fled their 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 who remained were deeply demoralized by physical insecurity and declining real incomes. 1.5 In responding to these difficult circumstances, the NRM moved quickly to build a broad- based government and to restore peace and security to most parts of the country. However, the NRM govermnent's early success in achieving political stability was not matched with success in the economic sphere. In FY86/87, expansionary fiscal policy, combined with transportation bottlenecks and lack of foreign exchange, resulted in a year-end inflation rate of 233 percent. The sharp acceleration of inflation jolted the Government into a reappraisal of its economic policies. This was done in collaboration with the Bank and the Fund. The Government formulated a new set of policies which formed the basis of the Economic Recovery Program (ERP). The Experience under the Economic Recovery Program 1.6 The ERP launched in May 1987 had three principal aims: to bring about internal financial stability and lower the rate of inflation; to reduce the imbalances in the external accounts; and to promote economic rehabilitation and growth. The program accorded high priority to stabilization through demand management; demand management in turn focused on fiscal adjustment, or reduction in government borrowing from the banking system. Growth was to be achieved primarily through improvement in producer incentives and rehabilitation of infrastructure. 1.7 The principal components of the FY87/88 program, supported by an IMF Structural Adjustment Facility (SAF), IDA's Economic Recovery Credit, and assistance from other multilateral and bilateral donors, were a 77 percent devaluation of the Ugandan shilling in foreign currency terms, a 30 percent conversion tax on currency and bank deposits held by the public, increases in crop producer prices and petroleum prices, and a program of gradual trade liberalization through the creation of an Open General Licensing (OGL) system which made foreign exchange regularly available to a limited number of manufacturing firms. While real GDP grew  Chapter 1: The Reform Agenda: Progress Made and Remaining Challenges 3 by 6.6 percent in FY87/88 on account of improved security, transportation and producer incentives, the program failed to achieve its stabilization objective as evidenced by a year-end inflation rate of 243 percent. Fiscal adjustment, the central objective of the program, was not achieved, partly on account of a low coffee tax outturn and partly on account of overruns in expenditures for defense and the PTA conference. An unchecked increase in private sector credit and a shortfall in external financing also fuelled inflation. 1.8 During FY88/89, the Government pursued its stabilization objective with renewed vigor. The FY88/89 budget announced a 60 percent devaluation of the Uganda shilling; deposit and lending rates were increased; revenue raising measures, including petroleum price increases, were adopted; an Economic Monitoring Committee was set up to monitor program performance and propose corrective actions. During the year, the Government further liberalized foreign exchange allocations through a Special Import Program (SIP) which made foreign exchange available on a first-come first-served basis for a wide range of imports. In addition, the Government introduced a 100 percent export retention scheme for all non-traditional exports. Although inflation decelerated sharply in the first half of FY88/89 to a cumulative 7 percent between August 1988 and January 1989 and the Government obtained an Enhanced SAF (ESAF) from the IMF, structural prcblems remained, and there was a resurgence of inflation during the second half of the fiscal year. Crop financing requirements grew rapidly under the new crop finance arrangements administered by the Bank of Uganda; in addition the Coffee Marketing Board (CMB) was not reimbursed by government ministries for a large increase in barter exports of coffee. There was also a large increase in lending by the government-owned Uganda Commercial Bank (UCB) and the Cooperative Bank. Worse still, the ey objective of fiscal adjustment, that is, repayments by Government to the banking system, was not achieved owing to shortfalls in external grants and coffee taxes, and expenditure overruns. Inflation accelerated between February and June 1989, averaging around 8 percent a month. The year ended with an inflation rate of 86 percent compared to the ESAF target of 55 percent. Economic growth, however, continued at over 6 percent in real terms in response to improved security and better infrastructure as well as improved incentives stemming from the dismantling of most price controls and marketing monopolies. 1.9 In the light of the failure to achieve stabilization problems encountered in FY88/89 and the collapse of the quota system under the International Ccifee Agreement (ICA) in July 1989, the Govermnent took a number of remedial measures. The Government revised the ma,roeconomic framework in consultation with the World Bank and the IMF, and adopted a revised budget that provided for a decline in net bank claims on the Government equivalent to 1.3 percent of GDP. In addition, on October 24, 1989, the Government devalued the Uganda shilling by 41 percent (from U Sh 200 to U Sh 340 to the U.S. dollar) which not only restored the real effective rate at the start of the FY88/89 progiam, but also achieved an additional 10 percent real depreciation. This was followed by monthly depreciations to maintain the real effective rate; the exchange rate stood at U Sh 440 per lJ.S. dollar as of end-June 1990. In addition, several important tax changes were introduced in FY89/90 to broaden the revenue base and reduce unwarranted exemptions. Measures were also undertaken to curb inflationary crop financing. During the year, while there was a shortfall in revenues, current expenditures were kept close to budgeted levels and import support was higher than budgeted. As a result the Government was able to make its targeted repayments to the banking system. 1.10 Following the adoption of the above measures, the domestic economic situation has improved appreciably. Output growth has continued in the 6-7 percent range, reflecting in particular a marked recovery in agricultural production and manufacturing output. The inflation target of 30 percent for FY89/90 was met, with the rate declining sharply to 29 percent by end- June 1990. Nevertheless, growth in money supply was higher than programmed.  4 Chapter 1: The heform Agenda: Progress Made and Remainlng Challenges 1.11 The success in FY89/90 notwithstanding, the first quarter (July-September) of FY90/91 has bwn marked by a number of unfavorable developments, the chief of which is the sharp rise in international oil prices following the crisis in the Gulf. The other unfavorable developments were the slump in deliveries of coffee to the CMB, late rains in some of the major food-producing areas, and reduced availability of import support. Commendably, the Government responded aggressively to these shocks. The pump prices of petroleum products increased by 68 percent between August 2 and September 20, 1990 or roughly by the increase in the landed cost of petroleum products. Moreover, the Uganda shilling was devalued further in order to maintain its real effective rate; thus, the currency was devalued by 8.3 percent in foreign currency terms during the first quarter. However, the first quarter of FY90/91 h3s already registered a cumulative inflation of 18 percent - already above the target for the year. In addition, the government budget is encountering problems on account of shortfalls in revenue and external financing as well as overruns on defense expenditures. The Reform Agenda: Progress Made and Remaining ChaOlenges 1.12 Over the past three years, the Government has made impressive progress in those aspects of its reform agenda that required immediate attention; however, much remains to be done to sustain progress made thus far. Overall, in order to facilitate sustainable and equitable growth, the Government needs to ensure a number of preconditions. First, there must be peace, security and political stability. Second, there must be financial stability. Third, the Government must remove the remaining constraints on the private sector and instead provide it with an environment in which private initiative can flourish based on Uganda's comparative advantage. Fourth, the Government must concentrate its resources on providing thost economic services and infrastructure which facilitate growth. Fifth, the Government must ensure that the quality of and access to education and public health is significantly improved not only to meet the basic needs of the people, including the poor and disadvantaged, but also to enhance human resource development and ensure long-term sustainability of growth. Finally, to accomplish the above, the Government will need to make a concerted attempt at institutional strengthening and capacity building - strengthening its own capacity to design and implement this reform agenda as well as ensuring that indigenous managerial and technical capacity of key institutions (public and private) that has been severely damaged and weakened is enhanced. Progress made and remaining challenges in each of these areas are discussed below. Table 1. 1 summarizes key performance and incentive indicators over the past three years. 1.12 Peace and Security. One of the most significant achievements under the NRM Government has been the restoration of peace and security over most of the country, and the re- establishment of political institutions that reflect the plural character of Ugandan society. This has been a major factor in the restoration of confidence in the private sector and in the revival of economic activity. Farmers, entrepreneurs, workers, traders and consumers have all been able to return to their normal activities as the state of siege and warfare has given way to peace. Peace, however, has come at a cost - specifically, the continuing high level of defense expenditures. 1.13 Economic Stabilzaon. A principal onDictive of ERP during the past three years has been achieving economic stabilization. As noted abov., while the Government was unsuccessful in this objective in the first two years, it took a number of remedial actions in FY89/90, including frequent exchange rate adjustments. In addition, a greater inflow of foreign exchange through import support helped ease supply constraints and provided needed counterpart funds to the budget. Consequently, the Government made a substantial 1.3 percent of GDP repayment of net bank claims. In addition, it took measures to curb both inflationary crop finance as well as excessive  Chap(er 1: The Reform Agenda: Progress Made and Remnaining Challenges 5 Table 1.1: KEY ECONOMIC INDICATORS ADSXtt"S~~~~~~~~n=m===c ms====a=3sz3Ds=DDnp Macro Economic Indlc:tors Uknit 1984/85 1985/86 1988/87 1987/88 1988/89 1989/90 GROWTH Real Gross Domestic Product Anmual Change (X) -3.3 1.2 3.3 6.6 6.9 6.3 PRICES Change In Consumer Prices Annual Average 105.6 120.3 258.2 189.7 141.1 57.5 Change In Consumer Prices End of Period 155.5 153.1 233.2 243.1 86.2 28.7 MONETARY Broad Miney Annual Change (X) 139.5 148.4 90.3 211.9 124.3 49.6 Net Domestic Credil Annual Change (X) 129.4 76.4 138.4 195.4 182.7 8.1 Net Credit to Goverrment Annual Change (" ) 131.0 58.8 166.2 190.9 ;21.4 -67.1 Net Credit to Private Sector Annual Change (X) 127.9 93.9 115.8 199.9 242.1 55.3 of which: Crop Financing Annual Change (X) 147.6 117.3 32.7 202.3 329.5 -1.5 Other Private Sector Annual Change (X) 109.1 67.4 237.7 198.5 191.1 104.2 FISCAL Budgetary Revenues Percent of GDPmp 9.9 7.4 5.0 7.1 5.6 5.9 of which: Coffee Percent of GDPmp 5.8 4.9 1.7 1.6 0.6 0.9 Budgetary Expenditures Percent of GDPmp 14.7 12.2 9.4 12.0 10.1 11.6 Budget Deficit (Comm., Incl Grants) Percent of GDPmp -4.2 -3.6 -3.9 -3.4 -2.9 -4.1 Budget Deficit (Comm., excl Grants) Percent of GDPmp -4.7 -4.9 -4.4 -4.9 -4.5 -5.7 Incentive Indicators Nominal Exchange Rate (average) U Sh/USS 5.1 10.9 19.8 60.0 170.4 319.5 Real Effective Exchange Rate 1980.100 (depreciation -) Aninal Change .. -2.4 78.0 -23.8 -15.1 -15.4 Ratio of Official to Parallel Market Exchange Rate Period Average X 55.4 39.2 19.4 25.2 36.2 48.8 Nominal Interest Rates: Deposit (min. one year) 1/ Percent 22.0 35.0 22.0 32.0 37.0 33.0 Lending (Commerce) 1/ Percent 25.0 40.0 30.0 40.0 50.0 45.0 External Trade Indicators I Volume of Coffee Exports mn of 60 kg bags 2.128 2.552 2.245 2.569 2.702 2.700 Index 1987/88.100 83 99 87 100 105 105 Aknmal Change Percent -31.8 19.9 -12.0 14.4 5.2 -0.1 Unit Value of Coffee Exports USSAg 2.57 2.59 2.44 1.85 1.74 1.03 Index 1987/88.100 139 140 182 100 94 56 Akuial Change Percent 42.8 0.8 -5.8 -24.2 -5.9 -40.8 Terms of Trade Index 1987/88.100 173.0 148.7 127.7 100.0 79.9 46.2 Annual Change Percent 1.5 -14.0 -14.1 -21.7 -20.1 -42.2 Source: Bank of Uganda, Ministry of Finance, IW, and staff estimates.  6 Chapter 1: The Reform Agenda: Progress Made and Remalning Challenges lending through the Government-owned commercial banks. As - result, the inflation target of 30 percent for FY89/90 was met. 1.14 The success in the preceding year notwithstanding, the record on fiscal and monetary performance is tenuous. Indeed, the preliminary budgetary outturn for the first quarter of FY90/91 indicated familiar problems: shortfall in coffee tax revenue and external financing, and overspending on the defense vote. Fiscal adjustment, therefore, continues to remain a principal challenge (see Box 1.1). A key imperative will be to raise the revenue effort, focusing in particular on strengthening tax administration as well as undertaking exchange rate adjustments to maintain coffee tax revenues. On the expenditure side, the Government will need to be firm in its commitment to adjust expenditures in line with the flow of revenue to the Treasury, and will need to closely monitor defense expenditures. Sustained success in economic stabilization will also require that the Government address underlying structural impediments leading to inflationary crop finance, In this light, the Government is taking important steps to reduce inefficiency in coffee marketing, transfer the responsibility for crop finance from the Bank of Uganda back to the commercial banks, turn the Coffee Marketing Board into a commercial organization with a substantial private shareholding, and reduce the marketing agencies' reliance on institutional credit. Financial sector reforms are also required to curb excessive and unproductive lending. This will entail improvement in bank supervision by the Bank of Uganda, restructuring of Government- owned, poorly-managed financial institutions, and the maintenance of positive real interest rates to improve financial intermediation. 1.15 Incentves and Regulatory Framework. The Government has made significant progress in improving the overall incentives and regulatory framework, principally the exchange and trade regime. Regarding the exchange rate, there have been several large initial devaluations followed by regular adjustments aimed at maintaining and improving Uganda's competitiveness. In line with this approach, the Government has devalued the currency from U Sh 14 to the U.S. dollar in May 1987 to U Sh 510 in November 1990, a nominal depreciation in foreign currency terms of 97 percent and a real effective depreciation of over 40 percent. On account of these, the ratio between the official and parallel market rates has steadily increased from 10 percent in May 1987 to 70 percent in November 1990. The Government's readiness to make regular exchange rate adjustments over the past 12 months to maintain Uganda's competitiveness is particularly significant as it underlines the distance the Government has traveled in its understanding, resolve and commitment to prompt corrective actions. This is in sharp contrast to the hesitant approach pursued up to the end of September 1989. The Government intends to reinforce progress in this area by achieving a unified market-clearing exchange rate by the end of 1991. In the meantime, the Government has undertaken far-reaching steps to improve incentives for exporters. In December 1988, all nontraditional exporters were granted 100 percent export retention thereby effectively sanctioning the conversion of all export receipts into local currency at the parallel market exchange rate; this scheme was extended to include all exports but coffee in March 1989. The legalization of the parallel foreign exchange market in July 1990 has further improved incentives for exporters. 1.16 Concomitant with movements in the exchange rate and increased inflows of foreign exchange, the trade regime has also been gradually liberalized. In terms of the official import regime, the OGL system, which assured foreign exchange to an initial small set of firms in the maniufacturing sector, has been expanded to include more firms and subsectors. This system of allocating foreign exchange is viewed as the principal channel for import liberalization. After meeting the requirements for OGL firms and the requirements of Government and the oil companies, the Government has been allocating foreign exchange to a wide range of sectors on a  Chapter 1: 7he Reform Agenda: Progress Made and Remaining Challenges 7 Box 1.1 Stabilization and Fiscal Adjustment Under the ERP During the first two years of the ERP, tho Government failed to meet its stabilization objective. There were slippages in fiscal and monetary policy and an inability to take corrective actions (e.g., exchange rate adjustments or cuts in expenditure) even when It became clear that the targets were being missed b! a large margin. 1'? impact of fiscat slippage. was particularly significant because demand managemant involving fial adjustment was a centerplece of the stabilization program; this in turn rearulted repayments of government debt to the banking system. During FY87t88, the program called for government repayments to the banking system equivalent to 17 percent of broad monoy. Far from making the programmed repayments, the Government increased its indebtednes to the banking system by an amount equivalent to 90 percent of broad moncy. Coffeetaxouturnuproved disappointing(witha shortfall equivalent to 2S percent of the total revenue target) partly because of a decline in world coffee prices, but also because, without adjusting the exchange rate, the coffee producer price was increased by 25 percent in February 1988. While gains owing to the currency conversion tax and higher sales and excise duties offset the shortfall in coffee taxes, total expenditures were 43 percent higher than budgeted. This was on account of unbudgeted expenditures, capital outlays for the PTA conference and defense expenditure. The FY88/89 program called for repayments of U Sh 5 billion of government debt to the banking system, equivalent to 20 percent of beginning period money supply. For the second year in a row the outcome was very different: the Government increa6ed its borrowing from the Bank of Uganda by U Sh 12 billion, equivalent to 46 percent of beginning period money supply. Part of the problem was caused by a large shortfall (U Sh 15 billion) in external grants (principally import-support grants whose disbursements were slowed down by the authorities' lack of fatniliarity with donor procedures). At the same time recurrent expenditures, including defense expenditures and the wage bill, were higher than programmed. There was also a large shortfall in coffee tax revenues owing partly to weak world prices but mainly to the failure of Government ministries and other agencies to pay for coffee shipped under barter arrangements for their account; in offect the Govemment was incurring extra-budgetary expenditures which was then paid for by the ChtB. As a result, only U Sh 5.4 billion of the U Sh 18.9 billion coffee tax revenue estimated for the year was collected. Although the Government was able to make up for the shortfall in coffee tPx revenue by collocting higher- than-programmed amounts from sales taxes and excise duties and raising petroleum duties, It could not offset the impact of the shortfall in externat grants and overruns in expenditure. PY89/90 saw the first successful effort at fiscal adjustment. The Government was able to make the targetd repayments to the baning system equivalent to 1.2 percent of CDP. This was in spitc of the fact that revenue performance waS much weaker than expected, largely on account of shortfalls in sales, excise, and export tax collections. aearly, the meaures that were introduced in the FY89t90 budget had failed to bear fruit. Revenuo from the coffee tax was lower depite the big depreciation of the official exchango rate, largely on account of lower-than-expected coffee shipments while tax revenue from petroleum products was much higher than programmed. In response to the revenue shortfalls currentexpenditureswere kept closeto thebudgeted level, but with defense expendituresmuch higherthan programmed, expenditures in key economic and social sectors suffered a severe squeeze (Chapter 111). In addition, disbursements of import suppon loans and grants were higher than the budgeted level. The net result was that the overall fuscal deficit (excluding gants) was well within the program target for the year. The succes in theprecedingyear notwithstanding,therefore, the record on fiscal performanceand adjustnent istenuous. There have consistentlybeen tevenue shortfallswhich are only partly explained by exogenousshocks such as the collapse of international coffee prices. In addition, there has been a pattern of expenditure overruns, fuelled principally by much higher than programmed defense expenditures. Indeed, the preliminary budgetay outturn for the firust quarter of FY90/91 indiwted that budget implementation was encountering familiar problems. There was a shortfall of coffee tax revenue and import support inflows, and overspending on the defense vote, The challenge of fiscal adjustment therefore continues to remain formidable, and will require continued government commitment to close monitoring and prompt corective actions.  a Chapter v: The Reform Agenda: Progress Made and Remainlng Challenges first-come first-served basis through the SIP. The SIP has provided wider access to official foreign exchange. The system, however, needs to be rationalized in conjunction with the Government's plans to achieve a market-clearing exchange rate by the end of 1991. The Government has also maintained a liberalized system for the importation of consumer goods and industrial Inputs by private entities/agents with foreign exchange from other-than-officil sources, under what is known as the "no forex" scheme. These impozts are priced on the basis of the open market exchange rate and therefore set the outer limit of effectiv. protection enjcyed by competing domestic producers. In addition, tax and tariff reforms have also been implemented to lower and rationalize effective protection. In the area of export trade, the Government has undertaken far-reaching actions by abolishing virtually all parastatal marketing mono[.3lies. In addition, controls on the internal movement of goods, especially crops, have also ;en scrapped. 1.17 These improvements in the overall incentives and regulatory framework need to be translated into an enabling environment for key sources of growth at the sectoral level; this is critical for the imperative of diversified growth and export diversification. In agriculture, the overall improvements on account of the 100 percent retention scheme (or movements in the exchange rate in the case of coffee) have yet to be translated into improved incentives for producers of traditional crops (cotton and tea) which constitute promising short-term sources of growth. The abolition of CMB's marketing monopoly and the licensing of three cooperative unions to export coffee constitute signific2nt and difficult actions undertaken by the Government; this, however, needs to be extended to embrace all qualified agents in the export trade. In addition, the monopoly of the Lint Marketing Board in cotton exports needs to be abolished to increase exports. For all other cr(,ps - toodcrops and nontraditional exports, which represent the principal promise for sustained and diversified growth - the incentives and regulatory framework are favorable, given the 100 percent export retention scheme and absence of any price or distribution controls. 1. 18 The industril sector has also benefitted from the improved incentives framework, specifically the dismantling of all price controls, the 100 percent export retention scheme and access to foreigh exchange under OGL; however, further reforms are required to create an ttractive business enviromnent and promote an efficient industrial sector. First, though a set of firms has grown rapidly from receiving assured foreign exchange for inputs under the OGL, they have received preferential access and tha: too at an implicit subsidy given an overvalued exchange rate. The viability of these firms will be put to test as the exchange and trade regime is fully liberalized and firms will need to compete for imported inputs priced at scarcity values. Second, the industrkl dimate including the regulatory framework needs further reforms, if not reorientation. Parliament passed in November 1990 a new Investment Code. The new Code provides a package of fiscal and non-fiscal incentives intended to attract efficient local and foreign investment while meeting legitimate regulatory concems. Still, various regulations goveming business operations, taxation and exit need to be rationalized. A joint UKODA-IDA Private Sector Assessment has identified a number of constraints in this area that need to be addressed in order to provide an enabling business environment. Third, the financal sector needs com,rehensive reforms to improve both the mobilization of savings and its allocation to productive activities, including term finance. Finally, an improved business climate, particularly for foreign investors, will require speedy and satisfactory resolution of claims on the Custodian Board properies. 1.19 Publc Enterprise Reform. Facilitating economic growth in Uganda is not merely a function of improving the incentives and regulatory framework; a significant part of economic activity in the large scale industrial sector, agricultural marketing and processing is under the public enterprise (PE) sector, consisting of 146 enterprises including some expropriated enterprises.  Chapter 7: The Reform Agenda: Progress Made and Remaining Challenges 9 However, progress in improving the efficiency of the PEs through divestiture or restructuring has been slow. A recently completed Public Administrative Reform and Planning Study (SARAPS) has recommended that the Government confine its direct ownership to a minimum number of strategic/essential enterprises, divesting itself of commercial activities. Of the PEs reviewed, it has recommended that 50 percent be privatized while another 30 percent be liquidated. The Government now needs to carry out divestiture and make progress in restructuring the remaining enterprises. Another difficult but Important area where progress has been slow has been in disposing off Custodian Board properties. This is critical not only for putting to use valuable, unutilized or underutilized assets, but also for providing a strong, clear and positive signal to investors with much-needed capital, technology and management. 1.20 Provision of Economic Infrastructure and Serices. While some progress has been made, further considerable improvements in this area form one of the most important priorities for the next phase of the reform agenda. The principal achievement in this area has been the rehabilitation of most of the major highways, carried out largely with donor funding. However, a maintenance crisis is looming on these rehabilitated roads. In addition, the vast network of gravel and feeder roads is almost uniformly in a state of acute disrepair; many segments are impassable either throughout the year or after periods of rain. These represent significant bottlenecks to the potential supply response. Power is another major constraint to economic activity. At present, daily peak demands, including export obligations to Kenya, are greater than the capacity of the Owen Falls hydroelectric station, and without major investments, the situation is likely to get worse in the near future. Among other economic services, a principal area of weakness is an ineffective agicultural research and extension network. This is a binding constraint to significantly raising yields through available or easily adaptable technology for the pressing imperative of agricultural and export diversification. In the area of environmentad protection, work is underway to improve forest protection and management through an ongoing Forestry Project, and the Government is preparing a National Enviromental Action Plan to promote a more balanced and sustainable use of its natural resources. 1.21 Baic Social Services. With the bulk of Government's scarce financial and administrative resources focused on achieving financial and political stability, relatively littlc has been accomplished thus far in the area of improving basic social services, with the principal achievements confined to a few donor-funded programs. The main achievements have beer- successful immunization against measles and major childhood diseases as well as provision of essential drugs for primary health care, provision of textbooks for primary schools, and an ongoing program of rehabilitation and expansion of water supply in seven major towns. Overall, however, the quality of and access to primary health care, primary education and sqfe water is severely lacking as is Government support or provision for these basic social services. These also constitute among the most pressing areas of need for the poor in Uganda. The joint Government-multidonor task force that prepared the Program to Alleviate Poverty and the Social Costs of Adjustment (PAPSCA) concluded that poverly in Uganda is better described in terms of grossly inadequate access to basic social services such as primary he-alth and education, than in terms of malnutrition on a large scale.' Improving social services therefore represents another critical area for Government action. Some of the northen diticts ae an exception, and the ongoing Social Dimenelons of Adjustment ProJect will provide a better underntanding of the nature of poverty, including the impact of economic reforms and adjustment.  10 Chapter 1: The Reform Agenda: Progress Made and Remaining Chalienges 1.22 Institutona Strengthening and Capacity Building. While some sreps at institutional strengthening have been undertaken, the Government's own capacity to design and implement policies and programs remains extremely w.ak and hence ap essential area of focus in the reform agenda. With the notable exception of the Economic Analysis Unit in the Ministry of Finance, set up with donor funds but run by Ugandans, significant weaknesses remain in key institutions responsible for economic management. In this contcxt, particular emphasis will need to be placed on strengthening the Bank of Uganda to effectively carry out bank supervision and formulation of monetary policy; strengthening tax administration as well as the design and implementation of budgetary policy in the Ministry of Finance; ensuring the effectiveness of the Project Monitoring Unit in the Ministry of Planning and Economic Development in facilitating the implementation of key projects; improving coordination between these key institutions, including the formulation, monitoring and implementation of a consistent macroeconomic policy package with reliable database; and significantly strengthening the capacity for monitoring and implementing the overall reform agenda. While actions are planned in each of these areas, lack of skilled and motivated personnel is a major constraint that will become even more formidable as the Government implements a necessarily broader and deeper reform agenda. One potential measure to alleviate this problem in the short run entails facilitating the return of qualified Ugandans living overseas. Donor support will be essential in making this happen. In addition, greater emphasis will need to be placed in strengthening policy analysis, planning and project monitoring functions of key line ministries. 1.23 Civd Service Reform. In a larger context, weaknesses in Government capacity stem from an overstaffed, unmotivated and ineffective civil service; indeed, one of the institutions most in need of reform and rehabilitation is the civil service. While significant progress has been made in establishing a permanent information system for the civil service and carrying out a major review, it is now critical that the Government act to streamline and rationalize the civil service to make it smaller, more effective and better nmotivated. This will require that major steps be taken to rationalize and reduce the size of the civil servict, including merger of ministries and positions with overlapping and duplicating functions; concomitantly, wages need to be increased, fringe benefits monetized and .llowances consolidated into basic pay. Significant progress in making the civil service effective is essential for the successful implementation of critical public sector programs and policies identified above. 1.24 Strengthening local governments. Some of the key areas of emphasis in the reform agenda - feeder roads, primary health care, primary education, rural water -- require that the central Government build on and support community initiatives and local governments. Communities have been undertaking these tasks themselves. This is as it should be; however, communities have been severely lacking in resources and technical skills. Improving their effectiveness will imply stronger powers to raise revenue locally and a clearer delegation of responsibility and authority. In addition, however, it will entail developing and strengthening mechanisms to channel financial and technical support. This will also be consistent with the larger process of political decentralization and consequent devolution of power to locally elected Resistance Councils for several aspects of political, economic and social development. 1.25 Strengthening managerial, technical and inteUectual capacity. In view of the flight of managers, entrepreneurs and technicians during the 1970s and the primary emphasis on the private sector as the spearhead for growth in the future capacity building should not be confined to the putlic sector. In this context, some important tasks, which will require that the Government mobilize external (particularly bilateral) assistance, include strengthening the management, business, accounting and marketing skills; and strengthening local institutions that provide training,  Chapter 1: The Reform Agenda: Progress Made and Remaining Challenges 11 consulting and research services to the private sector. The Government will also need to strengthen groups and institutions, such as Makerere University, Inrtitute of Public Administration, and the Management Training and Advisory Center, which will provide intellectual leadership and act as repositories of Uganda's management and analytical self-reliance in the future. 1.26 In summary, the Government has made significant progress in restoring peace and security, reducing inflation from 233 percent in FY86/87 to 29 percent in FY89/90, and improving the overall incentives and regulatory framework. This, combined with some important improvements in road infrastructure, has facilitated real GDP growth of over 6 percent per annum over the past three years. However, emphasis must now shift to addressing underlying structural impediments in key economic and social sectors as well as institutional strengthening and capacity building; consequently, emphasis must shift from general economic recovery to structural reform and adjustment.  SEC TORA L ISSUES A ND S TRA TEGIES Implications for Public Expenditure Policy Overview 2.1 Public expenditure policy needs to be geared to meeting the most pressing imperatives of the reform agenda. This requires, in particular, that expenditure programs, taking into account the strengths and initiatives of the private sector, facilitate key sources of growth, principally through effective economic infrastructure and services; improve basic social services; and strengthen the capacity of the civil service. 2.2 In this context, public expenditure programs in key economic and social sectors - agriculture, industry, transport, power, health, education, water - need to be reviewed. This teouires an examination of the state of affairs in these sectors, delineation of the role of the public and the private sectors, and within this, the role of public expenditure policy and expenditure allocations. As discussed in the next chapter. these issues provide guidance and input for expenditure allocations within and across sectors as well as across economic categories. 2.3 The present state of affairs is difficult and challenging. The devastation and neglect of critical economic and social infrastructure during the 1970s (see Box 2.1) has meant that there are vital bottlenecks (e.g. impassable roads, power shortages) to the supply response; equally important, the quality of and access to basic social services has deteriorated dramatically for most Ugandans. Specifically, despite Uganda's considerable potential, the agricultural sector is characterized by low yields on account of traditional technology; indeed, agricultural yields have declined as has industrial production relative to the 1960s. In addition, a large inefficient parastatal sector makes claims on scarce resources, and represents unproductive use of assets. The road network is impassable in many stretches and power outages disrupt economic activity. There is a resurgence of preventable diseases, more than 80 percent of the population does not have access to sa.'e drinking water, and now AIDS looms large as a daunting problem of economy-wide implications. Finally, the education system, despite commendable efforts and contributions by parents, has ceased to provide primary education of any reasonable quality to its children. 2.4 This is an unenviable and difficult inheritance for the present Government. In devising appropriate solutions, including the role of public expenditure policy, there is first the need to examine the role of the public and the private sectors, in particular to build on the conparative advantage and initiatives of the private sector which nas in any event been the dominant player in Uganda. For instance, while agriculture is the primary engine of growth for the economy, the predominant role rests with the private sector; the public sector therefore needs to phase out of its  14 Chapter 2: Sectoral Issues and Strategles Box 2.1 Uganda's Iufratructure and Institutlons: The Legacy of Destruction and Decay At indepedence in 1962, Uganda inherited a brad-based and reasnably well-developed network of public infatucture ad facilities. This wal further improved and expanded during the 1960a to become one of the best in Sub-Saharun Africa. The intemal road network was extensive and through membership of the Eadt African Community, Uganda shared acoes6 to an effective network of railways, pois and airline facilitiea. On the energy font, the country was bessed with an abundant potential for hydro-elctric development, a potential which was already being harnessed in part by the Owen Falls hydro-lectui station. Substantial progres was made in extending health services to rural areas and preventive health programs were strengthened. Uganda developed a reputation for the high quality of its education and Makerere University became an internationally renown