UGANDA PUBLIC EXPENDITURE REVIEW 2022–23 MODULE I IDENTIFYING BROAD MACRO-FISCAL OPTIONS FOR AN EFFECTIVE AND SUSTAINABLE FISCAL ADJUSTMENT Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 1 © 2023 International Bank for Reconstruction and Development/International Development Association or The World Bank Group 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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(Rachel Mabala, 2022) Design/Layout: Artfield Graphics Printed in Uganda by Artfield Graphics Additional material relating to this report can be found on the World Bank Uganda website (www.worldbank.org/uganda). 2 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Contents ACKNOWLEDGEMENTS......................................................................................................................................................VII EXECUTIVE SUMMARY.................................................................................................................................................... VIII 1. INTRODUCTION AND COUNTRY CONTEXT............................................................................................................ 1 2. MACRO-FISCAL EVOLUTION................................................................................................................................... 3 2.1. MACRO-ECONOMIC DEVELOPMENTS........................................................................................................................ 3 2.2 FISCAL POLICY DEVELOPMENTS AND CHALLENGES............................................................................................... 8 2.3 PUBLIC DEBT TRENDS AND SUSTAINABILITY........................................................................................................... 11 2.4 REVENUE EFFORT AND OUTCOMES............................................................................................................................ 12 2.5 OVERALL MACRO-FISCAL SUMMARY........................................................................................................................ 16 3. PUBLIC EXPENDITURES AND IMPLICATIONS FOR GROWTH.......................................................................... 17 3.1 TRENDS AND COMPOSITION OF SPENDING.............................................................................................................. 17 3.2 BUDGET EXECUTION AND OTHER CHALLENGES IN PUBLIC EXPENDITURE MANAGEMENT............................... 20 3.3 SPENDING AND GROWTH OUTCOMES.......................................................................................................................... 28 3.4 OVERALL EXPENDITURE IMPLICATIONS TO GROWTH AND DEVELOPMENT........................................................... 32 4. OPTIONS FOR FISCAL ADJUSTMENT . . ................................................................................... 3 3 4.1 BASELINE SCENARIO...................................................................................................................................................... 33 4.2 SIMULATIONS OF ALTERNATIVE SCENARIOS.............................................................................................................. 34 4.2.1 Current Fiscal Policy Stance Scenario................................................................................................................................ 34 4.2.2 Balanced Fiscal Policy Stance Scenario............................................................................................................................. 34 4.2.3 Improved Revenue Mobilization with Balanced Spending Scenario.................................................................................... 38 4.2.4 Improved Efficiency in Social Sectors Scenario.................................................................................................................. 40 4.2.5 Improved Efficiency in Implementation of Public Investment Projects Scenario.................................................................. 40 4.3. OVERALL IMPLICATIONS TO OPTIONS FOR ADJUSTMENT...................................................................................... 44 REFERENCES........................................................................................................................... 5 0 ANNEXES .............................................................................................................................................................................. 53 ANNEX 1: STATUS OF MACRO-FISCAL RECOMMENDATIONS OF PREVIOUS PERS..................................................... 53 ANNEX 2: STATUS OF IMPLEMENTATION OF SELECTED RECOMMENDATION OF WORLD BANK 2018........... .......... 57 ANNEX 3: STATUS OF IMPLEMENTATION OF RECOMMENDATION OF THE DOMESTIC REVENUE STRATEGY (FY20-FY25)........................................................................................................................................................................... 59 ANNEX 4: FISCAL RIGIDITY................................................................................................................................................... 61 ANNEX 5: CALIBRATION OF SDGSIM WITH COUNTRY DATA............................................................................................ 63 UGANDA PUBLIC EXPENDITURE REVIEW 2022–23 I List of Figures Figure 1. GDP growth was erratic during the decade prior to COVID-19 – percent change (y-on-y)....................................................................................................................... 3 Figure 2. GDP Growth in Uganda and comparator countries (2016-2021) – percent change (y-on-y)...................................... 3 Figure 3. Private consumption remains the main driver of GDP growth...................................................................................... 5 Figure 4. Growth mainly driven by services, with no major change in structure......................................................................... 5 Figure 5. Contribution of total factor productivity to GDP growth tapered off.............................................................................. 5 Figure 6. The incremental capital output ratio- additional capital produced less output............................................................ 6 Figure 5. Trade balance remains the biggest driver of current account deficits.......................................................................... 6 Figure 6. Government borrowing was a major financier of the current account deficit, before declining FY22............................ 6 Figure 7. Domestic credit to private sector by sector (UGX million – RHS and Percent % - LHS)................................................ 7 Figure 8. Domestic credit to the private sector (% GDP) (2016-2021)....................................................................................... 7 Figure 9. Fiscal operations FY11 to FY22 (% share of GDP)....................................................................................................... 7 Figure 10. Composition of public and publicly guaranteed debt................................................................................................. 7 Figure 11. Composition of Uganda’s creditors (2022)................................................................................................................ 9 Figure 12. General domestic revenue trend (share of GDP) (2016-2021)................................................................................ 11 Figure 14. General domestic revenue trend (share of GDP) (FY15/16-FY20/21)...................................................................... 12 Figure 15. Uganda domestic revenue effort versus comparators (share of GDP) (2016-2021)................................................. 12 Figure 16. Buoyancy of Uganda’s tax system (FY19–FY22)...................................................................................................... 13 Figure 17. Elasticity of the Uganda’s tax (FY19–FY22)............................................................................................................. 13 Figure 18. Tax structure of general Government revenue trend (share of GDP) (2016-2021)................................................... 14 Figure 19. Tax collection efficiency for VAT and CIT (2017-2022)............................................................................................ 14 Figure 20. Corporate Income tax collection for selected countries in SSA region (Share of GDP, 2018)..................................... 14 Figure 21. Tax collection efficiency of selected countries in SSA region (2018)........................................................................ 14 Figure 22. Progressivity of Uganda’s tax system...................................................................................................................... 15 Figure 23. Distribution of taxes by income deciles................................................................................................................... 15 Figure 22: Uganda’s planned and actual expenditure (% GDP)................................................................................................. 17 Figure 23: Government revenue and expenditure FY15-FY21 (% GDP)................................................................................... 17 Figure 24: Share of public expenditure by broad spending category (Percentage).................................................................... 17 Figure 25: Cross-country comparison of public expenditure categories, FY15-FY21* (Average, % GDP)................................. 17 Figure 26: Share of capital expenditure by vote function (Percentage)..................................................................................... 18 Figure 27: Capital expenditure versus maintenance, (Average, % GDP)................................................................................... 18 Figure 28: Actual government expenditure between NDPI and NDP II periods (% GDP)............................................................ 18 Figure 29: Changes in government expenditure between NDPI and NDPII (% GDP).................................................................. 18 Figure 30: Domestic general government health expenditure per capita (Current US$, 2016-2021)........................................ 19 Figure 31: External health expenditure per capita (Current US$, 2016-2021).......................................................................... 19 Figure 32: Released funds as share of approved budget (Percent)........................................................................................... 20 II UGANDA PUBLIC EXPENDITURE REVIEW 2022–23 Figure 33: Budget execution as share of released funds (Percent)........................................................................................... 20 Figure 34: Capital budget execution as share of released funds (Percent)................................................................................ 21 Figure 35: Total value and share of supplementary budgets.................................................................................................... 21 Figure 36: Supplementary budget beneficiaries....................................................................................................................... 21 Figure 37: Sources of supplementary funding......................................................................................................................... 23 Figure 38: Stock of domestic arrears (quantity and share of budget)...................................................................................... 24 Figure 39: Trends in classified expenditure.............................................................................................................................. 24 Figure 40: Beneficiaries of Classified Budgets......................................................................................................................... 26 Figure 41: Annual real growth in GDP and public expenditure trends (FY11-FY21).................................................................. 27 Figure 42: Correlation coefficient between public expenditure components and GDP (FY11-FY21).......................................... 28 Figure 43: Share of public expenditure by component............................................................................................................. 29 Figure 44: Share of wage bill and capital expenditure FY15-FY21* (% of GDP)....................................................................... 29 Figure 45. Contribution and Acceleration to Growth, by Economic Classification (FY18-FY21)................................................. 29 Figure 46. Fiscal rigidity: Uganda’s share of non-discretionary spending in comparison with other regions (%)..................... 29 Figure 47. Rigidity Estimations. Expenditures by Policy Cluster/Sector..................................................................................... 30 Figure 48. Financing sources for adjusting the budget (Percent of GDP)................................................................................. 31 Figure 49. Fiscal Outcomes Under Various Policy Scenarios..................................................................................................... 31 Figure 50. Total expenditure with higher efficiency in social sectors....................................................................................... 38 Figure 51. Development Outcomes of Various Fiscal Options................................................................................................... 39 Figure 52. Poverty Indicators Under Various Fiscal Options..................................................................................................... 40 Figure 53. Equivalent Variation per Capita............................................................................................................................... 42 Figure 54. Other Social Indicators Under Various Fiscal Options............................................................................................... 43 List of Tables Table 1: Selected macroeconomic indicators............................................................................................................................. 8 Table 2: Fiscal developments, FY11–FY22 (Percent of GDP)..................................................................................................... 10 Table 3: Uganda: Funding Requirement Versus Provisions for Road Maintenance..................................................................... 23 Table 4: Uganda: Domestic arrears payment and accumulation............................................................................................... 26 Table 5: Simulations for options for fiscal adjustment.............................................................................................................. 33 Table 6: Macroeconomic Results Under the Baseline............................................................................................................... 34 Table 7: Expenditure allocations by Programs......................................................................................................................... 35 Table 7: Government roles in many productive sectors not fulfilled.......................................................................................... 48 Table 8: Core Projects Implementation Progress by Program as of May 2022.......................................................................... 41 Table 9: Impact of improvement in marginal productivity of public capital on GDP growth....................................................... 41 Table 10: Table Matrix of Recommendations........................................................................................................................... 46 UGANDA PUBLIC EXPENDITURE REVIEW 2022–23 III Abbreviations CEP Collection and Enforcement Plan CI Composite Indicator CIT Corporate Income Tax CPIA Country Policy and Institutional Assessment DC Development Committee DRM Domestic Revenue Mobilization DTS Digital Tax Stamps EFRIS Electronic Fiscal Receipting System EPRC Economic Policy Research Centre ESSP Education and Sports Sector Strategic Plan FDI Foreign Direct Investment FY Fiscal/ Financial Year GDP Gross Domestic Product GoU Government of Uganda HIPC Highly Indebted Poor Countries ICOR Incremental Capital Output Ratio IFMS Integrated Financial Management System IGFT Intergovernmental Fiscal Transfer IMF International Monetary Fund KCCA Kampala Capital City Authority LGs Local Governments MDAs Ministries, Departments and Agencies MoFPED Ministry of Finance, Planning and Economic Development MTEF Medium Term Expenditure Framework MTP Medium-Term Plan MYCS Multiyear Commitment Statement NDP National Development Plan NIRA National Immigration Registration Authority IV Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment OAG Office of the Auditor General PAYE Pay As You Earn PDMF Public Debt Management Framework PER Public Expenditure Review PFMA Public Finance Management Act PID Public Investment Department PIMA Public Investment Management Assessment PIMS Public Investment Management System PIP Public Investment Plan PPP Public‐Private Partnership SDGs Sustainable Development Goals SDGs Sustainable Development Goals SDGSIM Sustainable Development Goals Simulation SSA Sub-Saharan Africa UBOS Uganda Bureau of Statistics UgIFT Uganda Inter Government Fiscal Transfer UGX Uganda Shillings UN United Nations UNRA Uganda National Roads Authority UPE Universal Primary Education UPOLET Universal Post O-Level Education & Training URA Uganda Revenue Authority URSB Uganda Registration Service Bureau USE Universal Secondary Education VAT Value Added Tax WBG World Bank Group WDI World Development Indicators Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment V A metal welder fabricating a wndow in Kiseka market, Kampala (Badru 2021) Public Expenditure Review 2022-23 VI Identifying Board Options for an Effective and Sustainable Fiscal Adjustment ACKNOWLEDGEMENTS T he Uganda Public Expenditure Review 2022–23 was undertaken as a programmatic, analytical, and advisory task executed jointly between the Government of Uganda and World Bank staff and consultants. On the World Bank side, the overall task was led by Rachel K. Sebudde (Senior Economist, EAEM1), while the government side was led by Charles Byaruhanga (Advisor on Budget) Ministry of Finance, Planning and Economic Development. The team for Module I comprised Rachel K. Sebudde (Senior Economist, EAEM1); John Matovu (Consultant, EAEM1); Paul Lakuma (Consultant, EAEM1); Daniel Lukwago (Consultant, EAEM1); Moses Kajubi (Senior Governance Specialist, EMFTX); Alex Giron Gordillo (Consultant, EMFTX); and Massimo Mastruzzi (Senior Economist, EMFTX). Data analysis for the module was supported by Hirut Wolde (Consultant, EAEM1); and Macklean Kwesiga (Ministry of Finance, Planning and Economic Development), The analytical work was strengthened by comments and suggestions from peer reviewers, including Christian Eigen-Zucchi (Lead Economist, EMFTX); and Emilija Timmis (Senior Economist, EECM2). On the government side, great collaboration and leadership was provided by the Permanent Secretary and Secretary to Treasury, Ramathan Ggoobi, and Ishmael Magona (Ag Director Budget), with the core team working closely with the World Bank led by Charles Byaruhanga (Advisor Budget), and comprising Albert Musisi, Moses Bekabye, Mohammed Kabanda, Mustapha Achidri, Ivan Kasozi, and staff of the Budget Department. The team appreciates the overall guidance from Vivek Suri (Practice Manager, EA1M1), Philip Schuler (Lead Economist/Ag. Practice Manager), Abha Prasad (Practice Manager AE1M1); Marek Hanusch (Program Leader, AFCE2), Rosemary Mukami (Country Manager, AFMUG), and Keith Hansen (Country Director, AFCE2). The team would like to thank Esther Ampumuza and Pearl Namanya for providing logistical and administrative support throughout the process. We are also grateful to Virginia Larby for excellent editorial support. We are thankful for the great partnership we enjoyed with the Ministry of Finance, Planning and Economic Development and the access given to most of the data used in this report. The preliminary findings were shared with the National Treasury and the discussions with government at various points of production of this work enriched the outcome. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment VII Executive Summary Uganda has an ambition to become a modern and prosperous economy by 2040. Realization of this vision hinges on implementation of six five-year National Development Plans (NDPs) now in their third series. The NDPs should have provided the framework for allocation of resources through the corresponding five-year medium-term expenditure framework (MTEF)s and annual budgeting process. While richly endowed with natural resources (land, minerals, and a fast-growing youthful population), productivity and human capital are low. Based on the World Bank’s Human Capital Project (2022), a child born in Uganda is expected to be 38 percent as productive as they would have been with a complete education and full health. A typical Ugandan child who starts school at age 4 completed 7 years of education by age 18 years, or just 4.5 years if adjusted for learning, well below the Sub-Saharan average of 8.3. The “wasted” years are due to the poor quality of education. Overall growth decelerated during the decade prior to COVID-19, as the effects of the first generation of pro- market and public sector reforms dissipated. Real Gross Domestic Product (GDP) growth that averaged close to 8 percent per annum during the decade prior to FY11/12, was around 5 percent – discounting the effects of COVID-19. Slower growth weakened the link between economic growth and poverty reduction, and increased inequality. The bulk of the workforce remains employed in low productivity jobs, and total factor productivity has been negative on average over the last decade. Because of the fast-growing population, per capita real GDP growth decelerated to 1.1 percent in the five years prior to the COVID-19 crisis, from 2.1 percent between FY09/10 and FY13/14. While Uganda’s fiscal policy has not generated sufficient growth, it raised its fiscal and debt vulnerabilities, contributed to crowding out of private sector credit, and threatens the country’s hard-earned macroeconomic stability. On the back of low revenue collections, the fiscal deficit expanded substantially from 4 percent of GDP in FY15/16 to 9.2 percent in FY20/21, with the latter being partly due to the response to the COVID-19 pandemic. Public debt rose from about 30 percent of GDP to 50.6 percent in FY21/22, despite the rebasing of GDP in 2019 that raised the economic base by almost 18 percent. Debt vulnerabilities have increased and for the first time since the country received debt relief in 2006, the country’s risk of debt distress rose from ‘low’ to ‘medium’ under the joint World Bank- IMF Debt Sustainability Analysis completed in June 2021. While the fiscal deficit has since reduced to about 5 percent by FY22/23, as the government embarked on a fiscal consolidation, debt reached 50.6 percent and the vulnerabilities have increased. With the surge in public investments, public gross capital formation – in real terms – more than tripled to an average growth of 19 percent per annum in FY14/15–FY18/19, compared to the increase of 4 percent observed in FY09/10–FY13/14. On the other hand, private investments were growing more slowly at about 6 percent during FY14/15–FY18/19 from an average of 4 percent over the five pre-COVID-19 years. This sluggish growth in private investments raises concerns about the ability of public investments to crowd in private investment, as well as the negative impact of public sector borrowing on private sector credit, and the overall cost of doing business in the country. Domestic arrears also remain a challenge for fiscal management and private sector growth. This implies that Uganda’s fundamental development challenge is how to replace a growth model based on debt-financed government spending that has emphasized infrastructure, with one in which private sector activity leads economic growth. The latter would be supported by the state through investments in human capital and targeted regulations to promote a green inclusive growth to reduce inequality and poverty and ensure sustainability. This requires a structural transformation to move land, labor, and capital into higher productivity activities before oil production commences and potentially destabilizes such transitions. The government entered a period of fiscal consolidation to keep debt on a sustainable path and limit private sector crowding out, whilst the economic recovery reels with shocks, and remains in critical need of revitalization of key sectors (education and health). Going forward, a fiscal strategy that can create space for critical spending priorities, whilst also supporting Uganda’s process of fiscal consolidation, is crucial. Looking forward, Uganda faces an enormous challenge with spending due to the fast-growing population – expected to more than double to around 104 million by 2060. On average, this implies addition of over 1.5 million students to the education system annually, while over 60 percent of this population will be below 24 years of age calling for huge investments in education and health, if they are to become fully productive and contribute strongly to the country’s development. This sharp increase in the size of the population will aggravate the country’s many ongoing challenges in the delivery of basic education and health services. Substantial resources will be required to serve a larger population, achieve significant improvements in quality, and address the current low access rates. If investments in health and education are not shifted to a higher trajectory in the short term, the access and quality gap will keep increasing over time and catching up at a later stage will prove extremely difficult. VIII Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Estimates from the World Bank (2020) indicate that the cost of providing social services in Uganda should almost double just to maintain education and health outcomes at the FY18/19 sub-optimal quality and access levels. This sub-optimal situation implies that only one-third of Ugandan students complete the seven-year primary cycle, while gross enrollment rates in secondary schools would stagnate at around 30 percent. Even then, the total cost of providing education services (primary and secondary) rises from US$480 million in FY18/19 to an average of US$833 million during the period FY19/20–FY24/25. Similarly, the expenditure needed to provide basic health services to the growing population in line with the 44 percent coverage rate, was to rise from US$703 million to US$914 million by FY20/30. To enhance quality and access levels and achieve the Sustainable Development Goals (SDG) – which also represents government’s ambition – government will need to double these amounts. The education sector budget will need to almost double to US$979 million per year, while achieving the universal health coverage goals by FY20/30 requires US$1.8 billion by FY29/30. Mobilizing such resources must be combined with efficiency improvements within the education and health sectors, as well as effective management of their budgets through better systems and controls, a greater role for the private sector and increased support from development partners. Uganda must improve its fiscal operations to improve both allocation of resources and efficiency in the utilization of the resources. Sustaining fiscal policies that have been pursued over the last decade will yield growth, but not at the country’s full potential while social indicators continue to stagnate or decline. In recognition of the need to adjust, the government has started on a fiscal adjustment path aimed at improving fiscal outcomes. The government’s current fiscal stance can be expected to modestly accelerate growth and slowly achieve some social indicators. There is room to readjust the budget that would result in a higher growth path. By reallocating resources to further rebalance the governance and security programs, the integrated infrastructure program, and other productivity enhancing programs – especially agro-industrialization, minerals and manufacturing and the human capital development programs especially of health and education – Uganda’s fiscal policy instrument can generate higher growth and better social indicators. The outcomes would be more sustainable if the country mobilized domestic revenues more strongly and used the additional revenue in a balanced way, and if they raised efficiencies in spending in social sectors and increased the marginal productivity of capital. A balanced fiscal adjustment is crucial not only for reducing the fiscal deficit, but also to generate faster growth and better social outcomes in Uganda. Typical balanced adjustment that entails a 1 percentage point increase in budget share for each of these growth enhancing programs (agro-industrialization, mineral development, and manufacturing), combined with an increase of 2 percentage points in the share of spending on education and health, while reducing the share of administration, governance, and security by 2 percentage points, would accelerate average GDP growth to 6.6 percent over the period FY23/24 to FY29/30, compared to about 5.2 percent under the recent re- prioritization under the mid-term of the NDPIII. The improvement would arise, notwithstanding the additional savings, from efficiency improvements. The funding needs for social sectors are enormous, partly because they have been underfunded in the past, but also because of huge population pressure. Within the health sector, there is scope for raising efficiency through improved distribution and management of health workers, and through strengthened procurement and management of essential drugs and medical supplies. Notwithstanding the potential efficiency gains herein, government spending on health is too low. Increasing it would enable households to reduce their out-of-pocket spending on health, enable the government to ensure adequate staffing, replace obsolete medical equipment and expand access to drugs and medical supplies. Similarly for education, inadequate funding, inefficiencies, inconsistent policies in early childhood education, and gaps in effectiveness of teaching lead to late entry, grade repetition, and low development of basic skills.  More efficiency gains will come from deeper reforms of intergovernmental transfer systems (IGFT) and the public investment management system (PIMS). Recent reforms to the IGFT system have brought enormous efficiency gains by improving the processes for transfer of funds to service delivery units at Local Governments (LGs) but will need to be enhanced through better budgeting and planning, as well as more discretion to LGs. Similarly, recent reforms to the PIMS notwithstanding, stronger mechanisms and capacities in project preparation and execution, better management of assets, stronger legal framework containing incentives for enforcing established guidelines, and stronger technical capacity in PIMS across government will generate efficiency gains which are crucial to sustain high levels of growth and poverty reduction. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment IX Recommendations From a macro-fiscal perspective, the government ought to brace for deeper reforms that will support a more meaningful fiscal adjustment, generate higher growth, and support better socio-economic outcomes. (i) Whilst Government has recently embarked on a fiscal consolidation, this agenda can be made more effective and growth accelerating by pursing a balanced adjustment in spending, while improving the domestic revenue mobilization effort. More balanced spending would mean allocating many more resources to human capital development and growth enhancing activities. (ii) Pursue expenditure policies that will genuinely reduce wasteful expenditures, including through cuts to the large public administration budget, efficiency improvements across government, strengthened anti-corruption systems, and re-allocation of the budget system. (iii) Expedite implementation of outstanding reforms under the Domestic Revenue Mobilization (DRM) strategy and earlier recommendations to expand the tax base, close leakages in the tax policy frameworks (e.g., tax expenditures) and enhance efficiencies in tax administration. Higher revenues will raise government capacity to spend and reduce borrowing, especially from domestic sources, which has dire implications to the private sector. (iv) Undertake policies to reduce inefficiencies in the social sectors, especially education and health. These inefficiencies include absenteeism of teachers, repetition and drop out of students as well as diversion of funds. Detailed reforms on education and health are elaborated under module 3. (v) Improve efficiency in the execution of public investments by deepening reforms in public investment, especially with respect to project implementation and maintenance of physical assets and incorporating climate change perspectives in managing these investments. An additional real growth rate ranging from 0.2–0.5 percent annually could be realized just through efficiency gains in capital utilization. Detailed reforms under the PIM are well elaborated in module 2. X Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Uganda Public Expenditure Review 2022-23 Modules 01 Module I: Identifying broad macro-fiscal 03 Module 3: Identifying options for enhancing options for an effectiveness, effective and efficiency and sustainable fiscal equity in spending adjustment to build human capital (education and health) 02 Module 2: Identifying options for enhancing 04 Module 4: A summary report to synthesize the key effectiveness, messages across efficiency and equity the different in public spending in modules for policy two critical areas of makers, and service delivery conclude the review UGANDA PUBLIC Public Expenditure EXPENDITURE Review REVIEW Identifying Board Options for an Effective and Sustainable Fiscal 2022-23 2022–23 Adjustment XI XI UGANDA PUBLIC Public Expenditure EXPENDITURE Review 2022-23 REVIEW 2022–23 XI XI 14 UGANDA PUBLIC EXPENDITURE REVIEW 2022–23 Enhancing Effectiveness, Efficiency, & Equity In Spending On Education 1. INTRODUCTION AND COUNTRY CONTEXT 1 Uganda has an ambition to become a modern and prosperous economy by 2040. Realization of this vision hinges on implementation of a five-year national development plan initiated in 2010 when government shifted from the poverty reduction action plans to longer-term planning. These plans constitute the government’s operational framework for transforming Uganda into a modern and prosperous country. The first National Development Plan (NDPI) covered the period FY09/10–FY14/15 and the second (NDPII) was for the period FY15/16–FY19/20. NDPIII was launched in 2021 and is expected to end by FY24/25. The NDPs should have provided the framework for allocation of resources through the corresponding five-year Medium-Term Expenditure Frameworks (MTEFs) and annual budgeting process. 2 While richly endowed with many natural resources, Uganda is still a low-income country with huge untapped potential. According to the United Nations’ Food and Agriculture Organization, Uganda’s soils are some of the most fertile in the region and with about 6.9 million hectares of arable land, represent 70 percent of the total arable land in the East Africa region. But agricultural productivity is very low. In addition to the huge oil reserves expected to start production within two years, Uganda has numerous minerals that have not been exploited. The country has almost doubled its population over the last two decades – from 24 million in 2000 to an estimated 47 million by FY21/22, according to the UN estimates. Almost 50 percent of this population is below 15 years of age, hence a dependency ratio of 86.7 – one of the highest in the world. Almost 70 percent of the population still relies on peasantry agriculture, and the bulk of those who have shifted out of the natural resource-based low productivity production are into low productivity services. Uganda per capita income reached US$ 930 per person (using the World Bank Atlas method) in FY21/22, which was still below the low-middle income threshold of US $ 1085. 3 Despite the fast-increasing population, Uganda has a very low human capital stock, with a child born in 2022 expected to achieve just 38 percent of productivity compared to what would have been the case if it completed education and enjoyed full health. The World Bank’s Human Capital Project estimated that in FY21/22, the probability that a child would survive to age 5 years stood at 95/100, while 29 percent of those surviving were stunted, and so at risk of cognitive and physical limitations that can last a lifetime. A typical Ugandan child who starts school at age 4 years completed 7 years of education by age 18, with this indicator reducing to 4.5 years if adjusted for learning, with 2.5 years considered “wasted” due to the poor quality of education. This is well below the sub-Saharan average of 8.3 years. Given the range of fatal and non-fatal health outcomes that a child would experience as an adult, the survival rate is also low, with only 70 percent of children who pass age 15, living beyond 60 years. 4 These development challenges have been compounded by the stalled structural transformation, declining productivity, and slowed economic growth over the most recent decade, contrasted to the earlier success in economic policy formulation. On the back of liberalization and pro-market policies pursued over 1990s and early 2000s, Uganda maintained a stable macroeconomic environment and implemented strong private-sector oriented reforms that raised average economic growth to over 8 percent per year, and almost halved the poverty rate from 57 percent in FY91/92 to 31 percent in FY05/06. Since then, both the pace of growth and poverty reduction have been slower, structural transformation stalled as many economically active people remain trapped in low productivity, and low-income activities due to both a poorly educated and rapidly growing (3 percent per annum) population. Agriculture and non-wage smaller enterprises employ the bulk of new entrants into the labor market. 5 Economic policy to address these challenges over the last decade has increasingly raised fiscal risks and vulnerabilities, calling for a fiscal adjustment. Uganda’s recent debt-financed infrastructure drive, aimed at addressing binding constraints to growth, and raising productivity has reduced spending on human development priorities, contributed to crowding out of private sector credit, and raised its fiscal and debt vulnerabilities. This situation was exacerbated by COVID-19 and faces high risks on account of relentless shocks. To address these challenges, the government embarked on a fiscal consolidation and expenditure rationalization agenda during the National Development Plan III mid-term. To support this process, the World Bank and Government of Uganda (through its Ministry of Finance, Planning and Economic Development) have undertaken a Public Expenditure Review (PER) focused on selected aspects of fiscal policy management and outcomes with a view to determine how Uganda can achieve a more inclusive growth agenda amidst a fiscal consolidation. 1 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 6 This module of the PER sought to identify options for an effective and sustainable fiscal adjustment by considering key macroeconomic variables, fiscal policy priorities, spending trends, and Uganda’s overall development needs. It has, therefore, detailed Uganda’s macro-fiscal challenges and government’s current fiscal policy stance in relation to both the short-term shocks and longer-term structural issues such as demographics and structural transformation; outlined spending problems in key sectors (e.g., infrastructure and human development) and their impact on efficiency and effectiveness of fiscal policies; and provided an assessment of the broad options for expenditure rationalization and restructuring. The report summarizes the outcome of the analysis together with options for macro-fiscal adjustment and a proposed action plan that includes broad expenditure rationalization measures and the quantification of potential fiscal savings. 7 This module is the first of a four-module PER and is focused on selected aspects of fiscal policy management and outcomes with a view of supporting an effective and sustainable fiscal adjustment to a more inclusive growth agenda. The other three modules are i) Module II, which identifies options for enhancing effectiveness, efficiency, and equity of spending in two areas critical for service delivery: (a) public investment management, and (b) the intergovernmental fiscal transfers (IGFT) system, including the plans and assumptions underpinning the Medium- Term Plan (MTP) for financing of local service delivery; ii) Module III, which identifies options for enhancing spending on human development, by delving into the efficiency, effectiveness, and equity of spending within the education and health sectors; and iii) Module IV, which synthesizes the key messages from the various modules for policy and decision makers, and provides a conclusion of the PER in the form of a summary report. 8 Previous PERs have informed this agenda, with some leading to reforms that have made some improvements. The most recent public expenditure review at the macro level was undertaken over a decade and half ago, in 2007, and carried the theme of finding space for growth.1 In response, to address critical growth constraints, the Government of Uganda (GoU) fiscal strategy doubled the allocation towards infrastructure development and has sustained high spending in these sectors since then. However, corresponding recommendations to address inefficiencies have either been implemented very slowly or not at all. Follow-up PERs that are sector specific2,3 or issue specific4,5 have also been implemented only selectively (Annex 1). This PER drew lessons from implementation of previous recommendations, which informed the formulation of the new ones. In addition to raising resources for many underfunded priorities in the country, the PERs underscored the need to improve efficiency and effectiveness of spending. 9 The rest of this report is presented in four parts. Chapter 2 discusses the macro-fiscal developments and changes to overall fiscal management; Chapter 3 assesses the expenditure trends and their implication on growth and social outcomes; and Chapter 4 relays the results and implications of simulations of the options for fiscal adjustment, before concluding with the final remarks and recommendations. 1 World Bank 2007. 2 World Bank 2009. 3 World Bank 2010a. 4 World Bank 2010b. 5 World Bank 2013. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 2 2. MACRO-FISCAL EVOLUTION 2.1 Macro-Economic Developments 10 Real Gross Domestic Product (GDP) growth averaged close to 8 percent per annum during the first decade of the 2000s but has since decelerated into an erratic path during the first two of the six National Development Plan (NDP)s. This slowdown happened as the effects of the first generation of pro-market and public sector reforms dissipated. Over the first two NDPs implemented prior to the COVID-19 outbreak, average GDP growth slowed from 5.5 percent to 5.0 percent, driven by the services sector. The reduction in the contribution of the service sector to GDP growth was only partially offset by some increase in the contribution of agriculture and construction. Amidst weakened institutions – less able to enforce policies and implement investments to generate growth – weather and external commodity price shocks reduced economic activity; GDP growth slowed to less than half the target of 7 percent under government’s NDP. A combination of floods, locust invasion, and the COVID-19 mobility restrictions, cut short a recovery between FY17/18 and FY18/19, and thrust a broad-based squeeze on the economy that almost halved GDP growth to 3.0 percent in FY19/20. Overall, the decline in GDP growth since 2016, placed Uganda well behind regional neighbors like Rwanda and Kenya, even though it stayed above the SSA average and structural6 peers. Figure 1. GDP growth was erratic during the decade prior to COVID-19 – percent change (y-on-y) Source: UBOS Figure 2. GDP Growth in Uganda and comparator countries (2016-2021) – percent change (y-on-y) Source: WDI 6 The criteria for selection of structural peers included: (i) per capita income – below $1500 GNI per capita; revenue collections – within the bottom 30 percent of revenue share in the world; (iii) human capital development – within bottom 30 percent ranking in Human Development Index and Human Capital Index; and (iv) Oil exporters meeting all the other criteria. Hence countries included in this average are Benin, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Comoros, DRC, Ethiopia, Gambia, Guinea, Madagascar, Malawi, Mali, Niger, Senegal, Sierra Leone, Sudan, Tanzania, Togo, Zambia, and Zimbabwe. 3 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 11 Recently, the Uganda economy has been resilient, recording a post-COVID-19 recovery amidst successive global shocks – including the war in Ukraine – commodity price shocks, and a volatile global economy. Between FY20/21 and FY21/22, growth has been mainly driven by improvement in services and, to a small extent, manufacturing. Meanwhile, agriculture continues to be battered by weather shocks, amidst inadequate adoption of technologies for climate adaptation, and weak regulations and systems for input markets, including seed certification and appropriate use of fertilizers and pesticides. The contribution of agriculture to overall GDP growth fell back to 22 percent in FY21/22, compared to 37 percent reached during the height of COVID-19 in in FY19/20. Nevertheless, agriculture remains the largest source of primary employment for over 61 percent of the working population,7 which has adverse implications on its productivity. 12 COVID-19 and commodity shocks further weakened the link between economic growth and poverty reduction, increased inequality, and threatened to stem the structural transformation that emerged during NDPII (FY15/16–FY19/20). Alongside a reduction in the share of agriculture to GDP from 26 percent during NDPI (2010/11–2014/15) to 23 percent under NDPII, there was a reduction in the workforce employed in on-farm agriculture and a take-off in industrial production. Due to the COVID-19 crisis, poverty is estimated to have increased by about 2 percentage points between 2017 and 2020 on account of job losses and reduction in family business incomes due to restrictions during the pandemic. According to the periodic phone surveys conducted by the Uganda Bureau of Statistics (UBOS) since June 2020, employment rates remained below 80 percent of the pre-COVID-19 levels, even after all restrictions had been removed. Moreover, food insecurity increased – also exacerbated by the commodity price shocks and relentless weather-related shocks. This demonstrates that poor people or households remain highly vulnerable to shocks. Furthermore, the reduction in the total workforce employed in agriculture and take-off in non- farm activities were stalled by COVID-19, while the bulk of the workforce remained employed in low productivity jobs and the total factor productivity has been, on average, negative over the last decade. In addition, Uganda sustained high levels of inequality for most dimensions (e.g., incomes, assets, access to services and opportunities), which COVID-19 exacerbated. 13 Private consumption remains a key driver of aggregate demand, although its contribution declined between NDPI and NDPII as that of private investments and exports increased. Private consumption contributed 60 percent of GDP growth in the five years prior to COVID-19 (also corresponding to the NDPII period), compared to 75 percent in the earlier five years of NDPI. This lower consumption growth accounted for the pre-COVID-19 slower pace of poverty reduction in the face of increased shocks to income and holdings of assets, and persistent subsistence agriculture. With the surge in public investments, the growth in public gross capital formation more than tripled to an average growth of 19 percent per annum in FY15/16-FY18/19, compared to the increase of 4 percent observed in FY10/11-FY14/15, while that of private sector gross capital formation increased meagerly from 4 percent to 6 percent over these periods. Meanwhile, the contribution of net export turned into a strong positive contribution (25 percent) over these two NDPs periods, driven especially by improved service exports, although at a slower pace due to the decline in various sources of financing. Due to the COVID-19 shock in FY19/20, there was a slump across all drivers of growth, except public gross capital formation. Private capital formation only strongly recovered in FY20/22, partly on account of strong investments in the oil sector. This sluggishness raises concerns about the impact of public investments on private investment, through the financing channels, such as private sector credit, and the overall cost of doing business in Uganda. 7 UBOS, 2022 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 4 Figure 3. Private consumption remains the main Figure 4. Growth was through services, with driver of GDP growth (Percent) (Percent) no major change in structure of the economy Source: UBOS Source: UBOS 14 Uganda has also used capital less efficiently than the average developing countries. The slow capital formation has been matched with a slowing total factor productivity (Figure 5) and reduced efficiency in use of capital. The incremental capital output ratio (ICOR)8 increased from the average of 5.6 during the NDPI period to 6.1 during the NDPII, before raising well above 6 in the subsequent three years of NDPIII. The ICOR compared unfavorably with Kenya, which also increased from 3.3 during FY02/03–FY06/07, to 5.3 during FY07/08–FY11/12, and the average of 3 for sub- Saharan Africa and generally expected level for developing countries. This raises questions about Uganda’s efficiency in the use of capital inputs, suggesting that, even projects that have overcome execution challenges, have not catalyzed private investments to generate faster growth. Figure 5. Contribution of total factor productivity to GDP growth tapered off Source: World Bank staff calculations 8 The incremental capital output ratio (ICOR) is defined as the ratio between investment in a period and the subsequent growth in output. The higher the ICOR, the lower the efficiency. Since, growth in output can arise from other factors beyond investment in new capital (e.g., productivity enhancements or increased capacity utilization rate), and the lag between investment and increased output varies, reliable measures of ICOR should be over a long period of time, say three decades. Therefore, estimations over shorter periods are only approximate. 5 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Figure 6. The incremental capital output ratio- additional capital produced less output Units of capital/output Source: World Bank Staff Calculations 15 The current account narrowed on the back of smaller deficits on trade and services and steady remittances, before COVID-19 reversed the trends. Driven by the sharp reduction in imports, the trade deficit declined to 6.9 percent of GDP during the period FY15/16 to FY18/19 (the pre-COVID-19 NDPII period), from 9.6 percent in the five years earlier. Exports stagnated at about 10.9 percent of GDP, for a sector that remains highly concentrated in a few markets and a few primary commodities, and hence vulnerable to global shocks. By 2019, primary commodities (coffee, tea, cotton, fish, and maize) accounted for 76 percent of Uganda’s merchandise exports. The narrowing of the deficit on services was mainly supported by the reduction in transport costs in line with the lower import bills, and some marginal increase in travel receipts. Yet the 0.3 percentage point of GDP increase in private remittances to 3.8 percent of GDP under NDPII, was more than fully offset by the reduction in government grants, and increased outflows of investment income. The COVID-19 crisis reduced the trade deficit as imports collapsed, but the services deficit widened, reflecting the collapse of the travel industry. Recovery has been underpinned by stronger import growth of goods and to support investments in the oil sector, with remittances and travel credits improving marginally, leaving the current account at 7.9 percent of GDP by FY21/22. 16 To finance the current account deficit, government external borrowing doubled to 3.3 percent of GDP during FY16-FY19, as foreign direct investment inflows slackened through the NDP II period and later because of the pandemic. Foreign Direct Investments (FDI) averaged close to 4 percent of GDP during FY10/11-FY14/15 period, but slowed to 2.8 percent during FY15/16-FY18/19, and had not recovered beyond this level in FY21/22, even though private sector borrowing had emerged. Government borrowing that had doubled to 3.3 percent of GDP during FY15/16- FY18/19, stayed elevated through FY19/20 and FY20/21 as International Financial Institutions bumped up support to manage the COVID-19 shock, contributing to the build-up in reserves during this period. This helped keep the foreign exchange reserves at 3.8 months of future import cover, albeit lower than the average of 4.5 months throughout the decade prior to COVID-19. The post-COVID-19 improvement in the current account allowed foreign exchange reserves to recover back to above 4.5 months in FYFY20/21 and FY21/22. Some of the adjustment to the persistent current account deficit was through the real effective exchange rate that depreciated by an average of 8 percent per annum during FY10/11-FY14/15 but has since been gradually appreciating despite the successive shocks. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 6 Figure 7. Trade balance remains the biggest driver of Figure 8. Government borrowing was a major financier current account deficits (percent) of the current account deficit, before declining FY21/22 (percent) Source: Bank of Uganda Source: Bank of Uganda 17 The financial system remained sound and well capitalized through the decade, but private sector credit growth decelerated and hence failed to support private sector investments and growth. Uganda’s banking system has capital and liquidity levels that are consistently well above the regulatory requirements. At about 22 percent and 20 percent of risk weighted assets, through the NDPI and NDPII period respectively, both the regulatory capital and regulatory core capital were more than twice the required levels of 8 percent and 10 percent, respectively. The banking system, which offers over 90 percent of the credit in the financial system, remained liquid, with the average ratio of liquid assets to deposits increasing from 42 percent to 46 percent, over NDPI and NDPII periods, before reaching 52 percent in FY20/21. Non-performing assets jumped from 3.9 percent to 5.7 percent between NDPI and NDPII, and further to 6 percent in FY19/20 on account of the COVID-19 shock, but not above the levels of concern (10 percent according to the Basel International Standards). However, credit to the private sector decelerated from an average growth rate of 20 percent over the NDPI period to 9.2 percent during NDPII. On average, Uganda’s stock of private sector credit averaged only about 11 percent of GDP, far below comparator countries – both of structural peers and within the region. Figure 9. Domestic credit to private sector Figure 10. Domestic credit to the private sector by sector (percent) (percent GDP) (FY15/16-FY20/21) Source: Bank of Uganda Source: World Development Indicators 18 Private sector credit temporarily accelerated on the back of the relatively low inflation and policy response measures but has since decelerated. Credit growth benefited from the government’s COVID-19 emergency measures and liquidity support programs remaining strong through February 2021. Since then, inflation and corresponding monetary tightening and increased fiscal borrowing from the domestic market, reduced the rate of growth of private sector credit and it was less than 8 percent for FY21/22. 7 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Table1: Table 1:Selected macroeconomic Selected macroeconomic indicators indicators FY10/11 FY11/12 FY12/13 FY13/14 FY14/15 FY15/16 FY16/17 FY17/18 FY18/19 FY19/20 FY24 FY20/21 FY21/22 FY22/23 Output, prices, and exchange rate (Annual Percentage Change, unless otherwise indicated.) Est. Real GDP Growth 6.6 3.4 2.7 5.2 5.1 4.8 3.9 6.3 6.4 2.9 3.5 4.7 5.3 Non-Oil real GDP 6.3 6.4 2.9 3.5 4.7 5.3 GDP deflator 5.0 24.2 6.1 3.4 3.8 4.0 6.3 4.4 3.0 3.1 2.5 4.8 4.6 Headline inflation - average (%) Exchange Rate (Ugandan Shilling/US$) 14.5 10.1 1.3 -2.0 11.4 21.8 2.5 3.7 1.9 -0.3 -1.5 -2.4 0.0 Real effective exchange rate ("–" = depreciation) -0.9 4.5 3.3 7.8 -3.7 -7.2 -1.4 -5.4 1.7 2.3 0.6 3.7 Money and credit Broad money (M3) - (% change) 25.7 7.2 6.6 17.4 15.9 7.1 12.8 7.3 23.2 8.5 10.0 14.5 Credit to non-government sector 43.6 11.5 6.4 13.9 20.4 4.0 5.7 10.8 13.6 8.8 8.3 12.0 13.5 Credit to Private Sector (% change) 43.6 11.5 20.4 13.9 20.4 4.0 10.8 13.6 8.8 8.3 11.0 8.3 Credit to the private sector (% of GDP) 17.3 15.0 12.4 12.9 14.3 13.7 11.7 12.1 12.5 12.7 13.4 13.8 3 Bank of Uganda Policy Rate 20.0 11.0 11.0 13.0 15.0 10.0 9.0 10.0 7.0 6.5 7.5 10.0 M3/GDP (percent) 27.0 22.5 18.6 20.1 21.3 21.1 21.7 18.9 18.5 21.5 22.0 22.0 22.3 NPLs (% of total loans) 1.6 3.9 4.0 5.8 4.0 8.3 6.2 4.4 3.8 6.0 4.8 5.3 Public debt (Percentage of GDP, unless otherwise indicated.) Public Gross Debt 31.0 26.5 30.1 26.1 28.3 32.2 38.0 34.8 35.6 41.9 49.0 50.6 50.9 External 17.3 16.2 17.5 15.3 15.8 18.7 24.3 24.4 24.1 28.6 31.6 31.3 31.9 Domestic 13.7 10.3 12.6 10.9 12.5 13.4 13.7 10.3 11.1 13.3 17.4 19.3 19.0 Debt Service 6.1 6.9 Debt service-to-exports ratio 5.6 5.4 5.6 13.5 14.4 8.5 16.6 23.7 9.5 14.5 13.4 Debt service-to-revenue ratio 29.0 35.7 40.8 18.9 19.3 20.5 23.9 27.9 11.6 17.5 15.7 Interest payments3 1.4 1.4 1.6 2.0 2.6 1.9 1.9 2.1 2.7 3.1 3.3 Interest payments (% of Revenue) 12.2 11.9 12.0 15.6 15.2 17.0 20.1 22.8 23.8 Investment and savings Investment 25.0 24.6 27.8 26.7 24.6 24.9 24.4 24.6 25.7 27.0 28.4 26.2 25.5 Savings 12.3 12.3 14.9 18.8 16.9 8.7 20.5 19.4 19.0 20.3 19.0 18.3 16.2 External sector Current account balance -11.4 -11.2 -6.3 -7.6 -7.3 -6.3 -3.7 -5.3 -7.0 -6.7 -9.5 -7.9 -9.2 Trade balance -6.3 -8.1 -6.4 -7.5 -6.7 -8.0 Exports (goods and services) 22.8 23.2 20.2 18.2 18.2 18.7 19.0 15.1 15.0 12.0 16.5 12.2 15.9 Imports (goods and services) 40.6 38.8 30.3 27.9 28.7 28.8 25.9 21.6 22.3 20.2 28.7 22.4 25.7 Gross international reserves In billions of US$ 2.0 2.6 2.9 3.4 2.9 3.0 3.4 3.1 3.2 3.9 4.2 4.1 3.7 In months of next year's imports of goods and services 3.2 4.2 4.5 5.2 5.0 5.3 5.2 3.8 4.3 4.4 4.9 3.7 3.0 Memorandum items: GDP at current market prices Ush. billion 39,086 50,193 64,758 70,458 76,883 83,120 91,718 120,431 132,096 139,697 148,310 162,721 184,254 US$ billion 16.8 19.6 25.0 27.8 27.2 24.1 26.0 32.9 35.4 37.6 40.5 45.6 47.8 GDP per capita (Nominal US$) 487.0 551.0 757.0 817.0 778.0 673.0 704.0 867.0 934.0 926.0 969.0 1057.0 1077.0 5 Population (million) 31.8 32.9 34.1 34.6 35.5 36.5 36.6 39.0 40.3 41.6 42.9 44.2 Source: Bank of Uganda, MoFPED, IMF, World Bank staff estimates Source: Ugandan Authorities, IMF, and World Bank estimates 2.2 Fiscal Policy Developments and Challenges 19 Fiscal policy expanded rapidly over the decade before COVID-19, mainly for infrastructure development amidst sluggish revenue growth. The government increased spending in FY09/10 and FY10/11 to mitigate the impact of the FY07/08–FY09/10 financial crisis. This was through fiscal stimulus policies, that aimed to address Uganda’s significant infrastructure constraints and supported election and security spending pressures. This non-cyclical response to the global economic crisis, was further caught up in the management of other exogenous shocks, particularly a prolonged drought and global commodity inflation, that followed later and contributed to macroeconomic instability. With external grants steadily declining and an underwhelming performance of tax revenues – averaging no more than 11.3 percent of GDP over the two NDP periods – the spikes in spending increased the average fiscal deficit for the period FY10/11-FY14/15 to 4.2 percent of GDP, almost tripling the value recorded during the earlier half decade. Major adjustments had to be made to restore fiscal stability before the country could revert to its investment plan. As the commodity super-cycle ended, the government seized the new opportunity to plan and escalate infrastructure spending to address binding constraints to growth through the new development strategy, the NDPII. During this period, the fiscal deficit averaged 5.0 percent of GDP, financed mainly through concessional loans, but also increased non-concessional borrowing, hence doubling the external financing to 2.6 percent of GDP in this period. This illustrates how a non-rule based fiscal framework could easily be captured by unforeseen exogenous factors, and even more so by internal political pressures. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 8 Figure 11. Fiscal operations FY10/11 to FY21/22 (percent of GDP) a. Domestic revenues and grants b. Expenditure c. Fiscal deficit d. Financing of the deficit Source: MoFPED 20 COVID-19 introduced new shocks to revenues and spending pressures, which the government accommodated without major adjustment to the fiscal framework. Despite the increased spending pressures and negative shocks to revenues, the government re-prioritized expenditure peripherally to manage the COVID-19 crisis. The main fiscal response measures included: deferring payment of corporation tax or presumptive tax for corporations and small, medium-size enterprises (SMEs) in the most affected sectors, like the hospitality industry; deferring payment of PAYE of employees; waiving interest on tax arrears; exempting taxes on items and equipment used for medical treatment; providing financial support to water and electricity utilities; and speeding up payment of outstanding VAT refunds. These measures came on top of a fiscal program that had envisaged the total expenditures to surge almost 3 percentage points of GDP during FY19/20 to finance oil related and tourism infrastructure development, the national airline and power transmission lines. With the revenues declining as businesses shrunk, the deficit rose to 7.1 percent of GDP during FY19/20, and further to 9.4 percent of GDP in FY21/22, before it started to decline. 21 The government’s fiscal response helped contain the spread of the pandemic and minimized the economic and social impacts, but it widened the fiscal deficit. External grants steadily declined, but domestic revenue did not improve in tandem to cover the gap. The average domestic revenue collection increased by only two percentage points of GDP between NDPI and NDPII, yet the year-on-year changes were sporadic, making it hard to justify any consistent strategy to raise the country’s revenues. Except FY16/15 when domestic revenue surged on account of improvements in collection of domestic taxes, while also benefiting from the high international commodity prices, annual growth in revenues for all other years were far less than 0.5 percentage points of GDP. COVID-19 disrupted the first year of implementation of the Domestic Revenue Mobilization (DRM) strategy FY19/20–FY23/24, launched October 2019, stalling revenue collections at 12.4 percent of GDP – a full percentage point below the original target. Suppressed domestic demand, the disruption of international trade, and the temporary tax relief granted to firms and households, reduced tax receipts across the board, led by taxes on profits, income, and international trade. Whilst revenues began to improve in FY20/21, reaching 13.4 percent of GDP, their level remained unchanged the following year, due to the new shocks to the economy. Uganda’s revenue effort remains below its regional peers and the Government of Uganda’s own target of 16 percent of GDP. With this low revenue effort, the increased spending to address infrastructure gaps and the cost of the stimulus package, were to be funded through borrowing leading to higher public debt. 9 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 22 The planned spending over the last decade did not fully materialize, thereby helping to contain the pace of growth of the fiscal deficit but curtailing the effectiveness of the fiscal policy. Persistent under-execution of the budget resulted in an unpredictable fiscal policy, whose impact is difficult to quantify and anticipate. The fiscal framework had budgeted total government expenditures averaging over 20 percent of GDP from FY15/16 to FY19/20, resulting in an average fiscal deficit of 6.5 percent every year during the implementation of the five-year NDPII. The actual fiscal deficit averaged 4.8 percent of GDP – almost 2 percentage points below the forecast. In terms of budgeting, development expenditures accelerated faster in this frontloading scenario, and overtook the contribution in share of total spending, compared to the recurrent expenditures. However, actual spending was lower by about 2 percentage points. The deviation from the budget was most severe on the development side. In contrast, the recurrent side has perpetually exceeded its budget, consuming even any additional revenues (as was the case in FY09/10–FY10/11 when the fiscal revenue surged on account of capital gains from the oil sector). Up to today, recurrent spending still takes a larger share of the budget than development spending. Such persistent inconsistencies lower the credibility of the budget, as well as the capacity of authority to use fiscal policy to influence real development outcomes. 23 The financing of the deficits through domestic borrowing exacerbated the debt service burden. Financing through domestic borrowing sources averaged 1.5 percent of GDP during FY10/11–FY14/15 but declined slightly by a tenth of a percentage point during NDPII. As the deficit increased over the last three financial years, so did the domestic financing, which averaged 4 percent of GDP between FY20/21 and FY21/22, way above the recommended limit of 1 percent of GDP. 2: Table2: Table Fiscal Fiscal developments, developments, FY10/11–FY22 FY10/11–FY21/22 (Percent (Percent of of GDP) GDP) NDPI NDPII NDPIII FY10/11-FY14/15 FY15 / 16-FY 19 / 20 FY20/21 FY21/22 FY22/23 FY23/24 Proj. FY24/25 Proj. Total revenue and grants 11.3 12.9 14.7 14.1 14.7 15.9 16.1 Revenue 10.1 12.1 13.4 13.4 13.6 14.4 14.9 Tax revenue 9.4 11.5 12.4 12.5 12.5 13.3 13.8 Non-tax revenue (including AIA) 0.2 0.5 0.9 0.9 1.0 1.1 1.0 Oil revenues (including capital gains tax) 0.5 0.0 0.1 - - - 0.0 Grants 1.2 0.9 1.3 0.7 1.2 1.5 1.3 Budget support 0.5 0.3 0.4 0.1 0.0 0.0 0.0 Project grants 0.7 0.6 0.9 0.6 1.1 1.5 1.3 Expenditures and net lending 14.3 17.6 23.7 21.5 19.9 19.4 19.5 Current expenditures 8.3 9.5 12.6 13.1 12.7 12.2 11.4 Wages and salaries 2.8 3.1 3.5 3.5 3.8 3.5 3.4 Interest payments and commitment fees 1.0 1.9 2.7 3.0 3.3 3.0 2.8 Other current spending 4.4 4.4 6.4 6.6 5.6 5.7 5.2 Development expenditures 5.4 6.9 10.2 7.8 6.7 6.7 7.4 External 3.1 4.2 6.5 5.0 3.5 3.0 3.2 Domes�c 2.3 2.7 3.7 2.9 3.1 3.8 4.3 Net lending and investment 0.4 1.0 0.4 0.2 0.1 0.3 - Other spending (clearance of arrears, etc.) 0.2 0.2 0.5 0.4 0.4 0.1 0.7 Overall balance (3.0) (4.7) (9.0) (7.4) (5.1) (3.5) (3.4) Primary balance (1.9) (2.7) (6.3) (4.3) (1.9) (0.5) (0.6) Financing 3.0 4.7 9.0 7.4 5.1 3.5 3.4 External financing (net) 1.4 2.9 4.0 3.0 3.8 2.6 1.5 Disbursement 1.6 3.5 5.0 4.0 5.1 3.9 3.0 Budget support 0.2 0.5 2.2 1.5 3.0 1.3 - Concessional project loans 1.4 3.0 2.8 2.5 1.8 1.7 1.5 Non-concessional borrowing - 0.2 0.6 0.9 1.0 1.7 2.4 Amor�sa�on (-) (0.3) (0.6) (1.0) (1.1) (1.3) (1.7) (2.0) Domes�c financing (net) 1.5 1.7 4.6 3.4 (4.5) (4.1) (2.4) Fiscal Deficit Including grants (3.0) (4.7) (9.0) (7.4) (5.1) (3.5) (3.4) Excluding grants (4.2) (5.6) (10.4) (8.1) (6.3) (5.0) (4.6) Expenditure 14.3 17.6 23.7 21.5 19.9 19.4 19.5 Source: MoFPED Source: and MoFPED World and Bank World staff estimates Bank Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 10 2.3 Public Debt Trends and Sustainability 24 The persistent fiscal deficits also led to a rapid increase in debt during the NDPII period, raising fiscal vulnerabilities and eroding fiscal buffers to be used in the face of shocks. Uganda benefitted from the Highly Indebted Poor Countries (HIPC) Initiative and by 2006 – at the completion point – had reduced public debt to less than 20 percent of GDP. Uganda’s public debt increased gradually and remained below 30 percent of GDP through the NDPI period. However, this debt almost doubled between FY14/15 and FY19/20, and its composition shifted towards non- concessional terms which raises vulnerabilities. Uganda’s total public debt as of June 2023 stood at US$ 22 billion, equivalent to 50.6 percent of GDP. Within this number, external debt amounted to US$ 13.6 billion or 62 percent, while domestic was at US$ 8.4 billion. The debt increased particularly fast between FY18/19 and FY20/21, partly under the weight of COVID-19, but also mainly to finance infrastructure projects. Figure 12. Composition of public and publicly Figure 13. Composition of Uganda’s guaranteed debt creditors (FY21/22) Source: MoFPED Source: MoFPED 25 Due to the surge in debt during FY15/16 to FY20/21 against reduced debt carrying capacity, Uganda’s risk of falling into debt distress increased to ‘moderate’ since FY20/21. As the public debt surged during FY20/21, Uganda’s debt carrying capacity9 was also considered to have weakened from strong to medium. According to the World Bank-IMF assessments, whilst Uganda’s debt remains sustainable, the country’s risk of debt distress shifted to ‘moderate’ in June 2021, up from the ‘low’ risk that Uganda has maintained in the past two decades. The most recent debt sustainability assessment10 maintains that the risk is still moderate, but the space to absorb shocks is limited. Under the baseline scenario, both external public and publicly guaranteed debt and total public debt burden trajectories remain below their respective indicative thresholds and benchmarks over the medium term. However, shocks – especially to exports – could result in breaches of external debt burden thresholds and the public debt benchmark. Specifically, given that a median shock could lead to a breach for the external debt service indicators, Uganda has limited space to absorb shocks. 26 The changing structure of debt, towards more non-concessional borrowing, has increased liquidity pressures and heightened the risk of crowding out public investments in critical areas. Debt service (interest and principal due) as a percentage of revenue reached 42.9 percent in FY20/21. The increase in debt service has mainly been a result of increased domestic borrowing (which is typically more costly) and non-concessional/commercial external debt. In FY21/22, domestic debt accounted for over 84 percent of interest payments, creating budgetary vulnerabilities, and limiting the available fiscal space for other critical priorities. Costly government debt crowds out public investment in human capital, and in FY21/22 the central government’s interest bill (3.1 percent of GDP) significantly exceeded total education spending (2.1 percent of GDP). 9 The classification of debt carrying capacity is guided by the composite indicator (CI) score, which is determined by the World Bank’s CPIA and other variables, such as real GDP growth, import coverage of foreign exchange reserves, remittances as percent of GDP, and growth of the world economy. The CI also incorporates forward-looking elements with the calculation based on 10-year average (5 recent years of historical data and 5 years of projection). Uganda’s CI is 3.11, which is well above the threshold value of 3.05; it categorizes the country as having a “strong” debt-carrying capacity. 10 Joint IMF-World Bank Joint Debt Sustainability Assessment, May 2023. 11 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 27 The inherent risks in the debt portfolio are reflected in the weighted interest rates that have continued to increase because of a greater reliance on non-concessionary borrowing. Furthermore, the average time to maturity of the portfolio increased from about 7 years during the NDPI and NDPII period, to about 10 years into the first two years of NDPIII, depicting increased exposure to refinancing risks. With the changing structure of debt, the debt service burden has also substantially increased with the ratio of interest payments to domestic revenue increasing from 10.4 percent during FY10/11-FY14/15 to 16.9 percent during FY15/16-FY18/19, a trend that steepened over the first two years of NDPII to an estimated 24.2 percent in FY22/23. The deviation from government’s benchmark of 15 percent stated in the Public Debt Management Framework (PDMF) has widened. To manage these risks, the Bank of Uganda has rolled over maturities and introduced bond switches to the market. However, during FY22/23, a large stock of maturities remained unpaid by government, reflecting the large liquidity problem they have been grappling with. In addition, the aggressive borrowing by government from domestic sources has also continued to crowd out resources for the private sector—which undoubtedly should be the engine of growth. 28 Debt management has been further complicated by the recent rise in interest rates both on the domestic and international markets. Realizing the need to limit additional borrowing from the domestic market to avoid crowding out the private sector, during FY22/23, government made efforts to substitute domestic borrowing with external debt. It therefore arranged short-term syndicated loans to replace domestic borrowing. However, due to the tightness and disruptions in the international financial markets, these did not work as smoothly and had to be renegotiated. Rolling over of maturing debt has neither been very successful as bidders expect much higher rates than the government was ready to pay for. Failure to pay off securities as they mature has inevitably increased government borrowing from the central bank. 29 The measured debt burden also excludes contingent liabilities. By FY17/18, contingent liabilities were estimated at 12 percent of GDP, with these comprising state-owned enterprise debt of 9.1 percent of GDP and a public‐private partnership (PPP) stock of 2.8 percent of GDP.11 Government contingent liabilities increased to 108 percent of GDP in FY20/21.12 Most of the contingent liabilities arise out of court claims, guarantees, and commitments under public-private partnerships (PPPs). This, and other shocks – like a slowdown in growth – and the choices that the government makes on the financing of its large infrastructure projects, remain key sources of vulnerability. 2.4 Revenue Effort and Outcomes 30 Uganda mobilized an average of 12 percent of GDP in domestic revenues during FY15/16–FY20/21 (NDPII), an increase of 2 percentage points compared to the earlier half decade (NDPI), but this is well below peer countries. The tax effort increased from an average of 9.4 percent of GDP to 11.5 percent over this period. While the upward trend had continued to an average of 13.4 percent of GDP in FY21 and FY21/22, the first two years of NDPIII, it remains below the average for sub-Saharan Africa that jumped to 20 percent of GDP in the five years ending FY20/21. At 13.2 percent by FY22/23, it had still not reached the lower band about the SSA average (see Figure 15). Figure 14. General domestic revenue trend Figure 15. Uganda domestic revenue effort versus comparators (share of GDP) (FY15/16-FY20/21) (share of GDP) (FY15/16-FY20/21) Source: MoFPED Source: World Bank Development Indicators 11 IMF-2019. 12 OAG 2021. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 12 31 Structural factors are important, given that elasticity of Uganda’s tax system remains less than unitary. Alarge section of the economy is untaxed, especially the informal and commercial agricultural sectors, which complicate efforts to widen the tax base and increase domestic revenue. This also explains why Uganda still relies on indirect taxes and international trade for its revenue effort. Moreover, whilst Uganda’s tax system has been buoyant13 over the past three years, except for Corporate Income Tax (CIT), tax elasticity to GDP over the same period was less than unitary, with GDP growth not yielding an equivalent growth in tax revenues. It implies that if no discretional changes were introduced during this period, for every 1 percent increase in GDP, per year, tax revenue would have increased only by 0.97 percent. Excise duty has the smallest elasticity, at 0.65, while value added tax (VAT) is at 0.77 and international trade taxes at 0.75, implying a need to rethink their design and choice of bases, in light of the structure of the economy. Figure 16. Buoyancy of Uganda’s tax system Figure 17. Elasticity of the Uganda’s tax (FY18/19–FY21/22) (FY18/19–FY21/22) Source: URA and UBOS Source: URA and UBOS 32 Beyond structural factors, the low tax effort is also partly an outcome of low efficiency in collection. Productivity of the tax instruments is still low. While Uganda’s tax structure is like that of its regional peers, the country relies more on VAT, other international taxes and Pay-As-You-Earn (PAYE). By FY21/22, 79 percent of the total taxes collected were from VAT collections. This same ratio is 63 percent for Kenya, 71 percent in Tanzania, and 57 percent in Rwanda. As a share of GDP, Uganda collects 4 percent in VAT and 2.2 percent for PAYE, all lower than neighbors. Uganda’s efficiency in collection remains the lowest in the region across all tax instruments. While Uganda’s VAT C-efficiency14 has increased to 14 percent by FY21/22, it is the lowest among its peers (Figure 18), as the several practices have perforated what would have otherwise been an effective tax collection system. These include VAT exemptions, zero- rating, and deeming15 practices. Similarly, a generous incentive system has partially eroded CIT tax efforts, which too has a very low C-coefficient, which results in a CIT collection of 1.6 percent of GDP, the lowest amongst peers. PAYE also remains meagre due to exemptions of some income groups, including security personnel, members of parliament, judges, and judicial officers. 13 Tax buoyancy and elasticity estimate the responsiveness of tax revenue to changes in Gross Domestic Product (GDP). Tax buoyancy is the ratio of the percent- age change in tax revenue, including the changes in the tax collection due to changes in tax base or tax rates or both, to the percentage change in GDP (Jenkins & Shukla 1994). Tax elasticity is the ratio of the percentage change in tax revenue, if no discretionary changes are made in tax rate or base, to the percentage change in GDP. If the elasticity of certain taxes is low, that tax revenue will not increase as income or GDP increases. This indicates that the structure of the tax system needs to be redesigned and the tax bases carefully chosen and defined to improve revenue mobilization 14 The c-efficiency ratio is an indicator of performance and efficiency of a tax system. It is estimated as the ratio of the revenue collected as a share of what would be collected with a standard rate (i.e., product of standard rate and consumption). 15 Deeming refers to the practice of central government assuming VAT liabilities – i.e., VAT payable on taxable supplies is charged but not paid by the recipient of the taxable supply. In Uganda, the recipient of the supply is recognized as a licensee undertaking mining or petroleum operations or is recognized as a beneficiary on an on-going aid-funded project. 13 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Figure 18. Tax structure of general Government revenue Figure 19. Tax collection efficiency for VAT trend (share of GDP) (FY15/16-FY20/21) and CIT (FY15/16-FY21/22) Source: URA and UBOS Source: URA and World Bank Staff Calculations Figure 20. Corporate Income tax collection for selected Figure 21. Tax collection efficiency of selected countries in SSA region (Share of GDP, FY17/18) countries in SSA region (FY17/18) Source: Kenya Revenue Authority; Rwanda Revenue Authority; Tanzania Source: Tax Administration Forum (2019) and URA Revenue Authority; and Uganda Revenue Authority 33 The Domestic Revenue Mobilization Strategy (DRMS) FY19/20–FY23/24 – adopted three years ago – has barely been implemented and only limited results seen so far (see Annex 3). The DRMS aimed to address challenges in revenue mobilization and to unlock revenue potential. Uganda’s recent tax reform goals have been fourfold – to broaden the tax base, increase efficiency of collection, create incentives for the private sector, and ensure equity of taxation. The DRMS contains comprehensive revenue management reforms intended to encompass most of the important revenue sources and involve the adoption of new tax codes. The reforms were directed at rationalizing the tax structure and tax rates, widening the tax base, reducing exemptions, and simplifying procedures. Nonetheless, the implementation of the DRMS was interrupted by the COVID-19 shock and other factors. 34 On the administration side, there are some improvements brought about by adoption of technology, but only a small portion of the tax register is within the tax bracket, while filing and compliance rates have declined. New processes, including the introduction of Electronic Fiscal Receipting System (EFRIS) and Digital Tax Stamps, have been associated with increased compliance and revenue gain since the year FY20/21.16 Nonetheless, there is an unexploited potential to leverage technology to increase tax compliance. For example, there has been limited integration of data from third-party sources to the e-Tax system. Data sources such as the Integrated Financial Management System (IFMS), which pays government suppliers; the National Identification Registration Authority (NIRA), which registers citizens; and the Uganda Registration Services Bureau (URSB), which registers business, have not been fully utilized to establish taxpayer compliance gaps.17 In addition, e-TAX functionalities such as simplified returns, prefiling and online registration are yet to be fully established. Consequently, whilst the size of the Taxpayer Register more than doubled to 2.6 million taxpayers over the five years ending FY21/22, URA monitors filing and compliance for less than 30 percent of total register. On-time filing ratios declined – PIT’s dropped from 14 percent in FY17/18 to 3 percent in FY19/20, while VAT’s dropped from 84 percent to 75 percent and CIT’s remained stagnant at 32 percent in this period. 16 Namunane 2022. 17 URA 2022. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 14 35 Similarly, reforms recommended by the World Bank18 and within the DRM strategy have only partially been implemented (Annex 4). Broadly, there were inconsistencies in the implementation of recommendations to address inefficiencies related to closing gaps in the tax policy. For instance, in some cases, the scope of exempt and zero-rated items was reduced, while it was expanded elsewhere, resulting in a not so clear strategy on addressing this problem. As a result, revenue loss from deemed VAT increased four-fold from UGX 147 billion (0.1 percent of GDP) in FY15/16 to UGX 582 billion (0.36 percent of GDP) in FY21/22. Excise duty reforms generated growth in excise revenues, but the system still carries the burden and economic losses that result from non-neutral multiple rates that discriminate based on product source. This influences supplier behavior and creates opportunities for tax planning. Reforms in tax administration have made more progress and hence yielded more revenues than policy changes. On average, administrative measures accounted for 73 percent of the total revenue collections over the past three years. Closing leakages, such as tax expenditures while continuing to improve administration effectiveness, would yield a much better outcome. Nevertheless, tax administration is still faced with many constraints, including the staff capacity to manage arrears and conduct of audits, as well as manage the technological interventions to maximize their efficiency by curbing forgery of Digital Tax Stamps (DTS) for instance, and “invoice trading” of EFRIS. 36 With respect to equity, the tax system imposes a higher burden on the poor, hence it remains regressive. Based on the Kakwani Index19 estimated at -0.58, Uganda’s tax system remains regressive, with this regressivity mainly attributed to indirect taxes – VAT and excise duty (Figure 22). VAT is the most regressive because consumption goods (food, beverage, alcohol and tobacco and utilities related housing, water, electricity, and gas) that attract VAT, represent 10 percent of household incomes. Direct taxes slightly mitigate, introducing some progressivity by shifting the burden to the rich. Concentration shares show that the richest decile, that receive 46 percent of market income pays 51 percent of total direct taxes (with the share for non-wage income tax and user fees above 80 percent) (Figure 23). However, whilst they bear the biggest burden of direct tax, what they pay is only 5 percent of their income. PAYE is relatively regressive (the burden for both the poorest 7 deciles and the richest 3 deciles is equal at 4 percent) compared to other direct taxes. This is on account of the design of the threshold that starts at low-income levels but rises quickly, making the population with limited purchasing power to be taxed heavily.20 Therefore, while the total PAYE tax burden is shared equally between the 3 richest deciles and the other 7 deciles, it takes only 19 percent of the richest decile income, while it takes about 34 percent of the income for the lowest 7 deciles. Furthermore, 50 percent of all collections is paid by the top 35 highest taxpayers in the country, which further confirms the narrowness of the tax base, aggravated by the high levels of tax evasion and weaknesses in the tax administration system. Figure 23. Distribution of taxes by income deciles Figure 22. Progressivity of Uganda’s tax system a. Indirect taxes b. Direct taxes Source: World Bank staff calculations Source: World Bank staff calculations 18 World Bank 2018c. 19 The Kakwani (1977) 20 World Bank 2018a 15 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 37 To raise the tax effort, Uganda would need to accelerate implementation of reforms, including those in the DRMS. For tax policy, it would have to close the leakages within the VAT instrument by reviewing the list of exemptions, zero-rating and deemed VAT applied to goods and services supplies to energy contractors and subcontractors, construction, agricultural tools and machinery, health, education, and passenger transportation services. The excise duty regime could also be further improved by raising the rates for cigarettes and harmonizing the alcoholic and non-alcoholic multi-tiered regime. Additionally, policy changes such as creating a single tier structure, and taxing all cigarettes at the same specific tax rate would yield more revenue. As for alcohol, there is a need to rationalize taxes on beer to remove special dispensation for local producers. Also, classifying beverages according to alcohol content/ strength would boost revenues. On the tax administration side, the quest to expand the tax register should be matched with enforced filing and actual payment of taxes. This requires ensuring the accuracy of the registration database and the number of active taxpayers. Further, the administrative and policy efforts to manage offsets, arrears and debt that have yielded significant improvements in the past few years need to be enhanced. This calls for a well-resourced Collection and Enforcement Plan (CEP) to validate arrears, institute collection measures, and enforce difficult debt. 2.5 Overall Macro-Fiscal Summary 38 Overall growth decelerated during the decade prior to COVID-19, as the effects of the first generation of pro-market and public sector reforms dissipated. Real GDP growth that averaged close to 8 percent per annum during the decade prior to FY11/12, was around 5 percent between FY12/13 and FY17/18. COVID-19 cut short the strong recovery that had been achieved between FY17/18 and FY18/19, further weakened the link between economic growth and poverty reduction, and increased inequality. It could have also reversed the benign structural transformation that had reduced the workforce employed in on-farm agriculture and a take-off in non-farm activities. The bulk of the workforce remains employed in low productivity jobs and the total factor productivity has been, on average negative over the last decade. On account of the fast-growing population, per capita real GDP growth decelerated to 1.1 percent in the five years prior to the COVID-19 crisis, from 2.1 percent between FY09/10 and FY13/14. This was driven by a combination of the slowdown in economic growth and high population growth, which accelerated annually to about 3.6 percent in FY18/19. 39 Uganda’s fiscal policy over the decade to FY20/21 raised its fiscal and debt vulnerabilities, contributed to crowding out of private sector credit, did not generate sufficient growth, and threatens the country’s hard- earned macroeconomic stability. On the back of low revenue collections, the fiscal deficit expanded substantially over the latter part of the decade, from 4 percent of GDP in FY15/16 to 9.2 percent in FY29/21, partly in response to the COVID-19 pandemic. Over this period, public debt rose from about 30 percent of GDP to almost 50 percent in FY20/21, despite the rebasing of GDP in 2019 that raised the economic base by almost 18 percent. Debt vulnerabilities increased and for the first time since the country had received debt relief in 2006, the country’s risk of debt distress rose from ‘low’ to ‘medium’ under the joint World Bank-IMF Debt Sustainability Assessment completed in June 2021. 40 With the surge in public investments, public gross capital formation more than tripled to an average growth of 19 percent per annum in FY14/15-FY18/19, compared to the increase of 4 percent observed in FY09/10-FY13/14. On the other hand, private investments accelerated more slowly to about 6 percent during FY14/15- FY18/19 from an average of 4 percent over the five pre-COVID-19 years. This sluggish growth in private investments raises concerns about the ability of public investments to crowd in private investment, the negative impact of public sector borrowing on private sector credit, and the overall cost of doing business in the country. Domestic arrears also remain a challenge for fiscal management and private sector growth. 41 As a result, Uganda’s fundamental development challenge is how to adjust this growth model based on debt-financed government spending that has emphasized infrastructure development, albeit yielding low return, with one where public investments are well managed and with high return to benefit the private sector activity and eventually allow it to lead economic growth, supported by the state through investments in human capital and targeted regulations to promote a green inclusive growth to reduce inequality and poverty, and ensure sustainability. Furthermore, the government urgently needs to facilitate structural transformation so that land, labor, and capital move into higher productivity activities before oil production commences and potentially destabilizes the economy. At the same time, government is entering a period of fiscal consolidation to keep debt on a sustainable path and limit private sector crowding out, whilst still facing the impacts of the COVID-19 crisis (including reduced revenues and additional spending pressures) and the need to support the recovery and revitalization of key sectors (education and health) as the pandemic wanes. Going forward, a fiscal strategy that can create space for critical spending priorities, whilst also supporting Uganda’s process of fiscal consolidation, is crucial. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 16 3. PUBLIC EXPENDITURES AND IMPLICATIONS FOR GROWTH 3.1 Trends and Composition of Spending 42 Government expenditure increased over the last decade, but the trend21 was more pronounced in the 5 years to FY20/21. Increasing at an average rate of 0.6 percent of GDP per annum, public expenditure (including net lending) rose from 14.3 percent of GDP during NDPI to 17.6 percent of GDP during NDPII. In the first year of NDPIII which also witnessed the peak of COVID-19, this share soared over 6 percentage points to 23.7 percent of GDP in FY20/21 (Figure 24). Compared with peers over the most recent 7-year period (FY15/16-FY21/22) where data was available, Uganda’s average expenditure of 18 percent of GDP is lower than the regional average of 25 percent (excluding peer countries). Uganda’s low level of expenditure is in tandem with its very low revenue effort. The ratio of revenues as percentage of GDP over this period was well below the sub-Saharan Africa (SSA) region average, which stood at 21 percent and compares very poorly to peer countries, except Ethiopia. Uganda’s neighbor Rwanda collected revenues of up to 23.4 percent of GDP, a major factor contributing to the high expenditure (28 percent), without causing major fiscal and debt accumulation issues. Therefore, the first point of effort in ensuring Uganda increases spending to address its development constraints is raising more revenues. 43 There has been a strong bias towards capital expenditure to close the infrastructure gap and hence address binding constraints to growth. Concerned that Uganda’s low capital investment would undermine growth, the PER (2007) had recommended that the budget shifts spending towards infrastructure and reduces wasteful expenditures to free up budgetary resources. Indeed, Government changed its fiscal strategy in the years that followed and embarked on an infrastructure drive, doubling the allocation for infrastructure development from 8.2 percent of the national budget in FY07/08 to 16.2 percent in FY08/09, a stance that has been maintained since then. However, capacities to prepare and implement these projects were not developed in tandem as is evidenced by the continued delays, cost over-runs, and generally low return on these investments (in terms of growth dividend) over the past decade. 44 The infrastructure drive to address binding constraints to growth notwithstanding, the distribution between recurrent and capital expenditure remained relatively constant during the pre-COVID-19 decade. This was mainly as underperformance on the budgeted capital expenditure, especially on the externally funded activities, was offset by overspending the recurrent budget. Government’s budgets indicates that the share of recurrent spending in the overall budget declined from 61 percent to 58 percent between NDPI and NDPII but had increased again to 65 percent through the first half of NDPIII. However, after re-classification22 of some of the items from the development budget, the share of capital expenditure in total expenditures (excluding interest payments and net lending) 23 declined marginally between NDPI and NDPII (i.e., from 18.1 percent to 17.7 percent) but surged by 11 percentage points into FY19/20 and FY20/21 (the first two years of NDPIII). Figure 24: Uganda’s planned and actual expenditure (% Figure 25: Government revenue and expenditure GDP) FY14/15-FY20/21 (% GDP) Source: MoFPED BOOST and World Bank Staff calculations Source: MoFPED BOOST and World Bank Staff calculations Note: Expenditure excludes interest payments and net lending 21 The periods used in trend analysis correspond to the Uganda National Development Plan. NDP I (FY10/11–FY014/15), NDP II (FY15/16–FY19/20) and NDP III (FY20/21–FY24/25) of which we have one year of data FY20/21. 22 Reclassification is based on expenditure data in the ‘Uganda BOOST v1.0 FY10/11-FY20/21’. 23 The analysis covers all domestically financed central government expenditures but is not comprehensive on externally funded projects. 17 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 45 The largest share of the capital budget was spent on construction of roads and bridges, buildings, and other structures, having more than doubled from 29 percent to 65 percent between NDPI and NDPII. Machinery, aircraft, transport, and medical equipment also increased, but remained less than 20 percent of capital spending over these periods. A considerable share of the capital budget is classified assets24, which appeared during NDPII and took 14 percent, but rose to a staggering 52 percent during FY20/21. However, the rate of capital formation growth over the past two decades (1.5 percent per annum) is far less than the rate of growth of spending in these sectors. Given the large budget for roads and bridges at the national level, Uganda National Roads Authority (UNRA) has over the past decade executed, on average, 21 percent of the capital budget, with its share increasing strongly between NDPI and NDPII as the budget for roads and bridges doubled. The Ministry of Energy and Mineral Development and Ministry of Defense, followed with 12 percent and 10 percent, respectively. Figure 26: Share of public expenditure by Figure 27: Cross-country comparison of public expenditure broad spending category (Percentage) categories, FY14/15-FY20/21* (Average, % GDP) Source: MoFPED BOOST and World Bank Staff calculations *RWA: FY/1617-FY20/21; ETHIO: 2015-17 Source: World Bank 46 The fourfold increase in capital spending went mainly on building new assets with little effort on maintenance of existing ones. Previous public expenditure reviews had highlighted that maintenance of assets is crucial to elongate their lifespan and maximize the return on the investments. The PER 2007 highlighted the need to immediately address the backlog of maintenance in the road and water sub-sectors. In 2010, the government created the Uganda Road Fund, through the Road Fund Act (2008), which became fully operational on July 1, 2010, with the objective of financing routine and periodic maintenance of public roads under UNRA, Kampala Capital City Authority (KCCA), Districts and Municipalities. However, the road fund is not operating as a self-sustained (Second Generation) fund, leaving the burden of financing maintenance squarely on the Consolidated Fund, which allocated 0.1 percent of GDP throughout the last decade against a fourfold increase in investments into new assets (Figure 28 and Figure 29). Hence, between NDPII and NDPIII, while on average 64 percent of the works and transport sector budget went into construction and rehabilitation of national roads, only 10 percent is used for maintenance of both national and district roads. Figure 28: Capital Expenditure by Economic Figure 29: Capital Expenditure versus maintenance Activities (average percentage share) (average percentage of GDP) Source: MoFPED BOOST and World Bank Staff calculations Source: MoFPED BOOST and World Bank Staff calculations 24 Classified Assets in this case maybe military weapons and other security details for confidential operations. According to the GFSM2014 “only some sin- gle-use items, such as certain types of ballistic missile with a highly destructive capability, may be classified as fixed assets, the rest are classified under military inventories and their use as withdrawals from military inventories.” Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 18 47 The sectoral composition of spending reveals the government’s clear prioritization of the infrastructure sectors, within the domestically financed budget. The government directed about 20 percent of domestically funded spending to programs involving works and transport, energy and water. The share of these infrastructure sectors accounted for over 53 percent of the public investment program (capital spending), through both development plans, even as the share of spending on energy declined drastically. Following the effort to address infrastructure constraints started in FY08/09, the works and transport has maintained the highest spender position through the three NDPs. Over 60 percent of this budget was spent on the construction and rehabilitation of national roads and some on acquisitions of land. Although maintenance of both national and district roads increased its share in the budget on the back of the Urban Road Network Development program, it accounted for 4 percent of the capital spending during FY15/16–FY20/21, after halving to 2 percent; too small to preserve the value of roads and maximize return from this investment. Infrastructure was identified as a major strategic goal in the National Vision 2040, which regarded the growth of the infrastructure sectors as pivotal to support industrialization, boost exports, and strengthen budgetary revenues. 48 The third-largest share of public spending went to security, with recent increases making it the largest spender during NDPIII, as regional security risks increased. The share of security spending in overall spending stood reduced from 12.8 percent in NDPI top 11.6 percent during NDPII. During FY20/21, this share shot to 16.6 percent, as new regional security risks emerged. The strong position of security is amplified within the domestically funded budget, where security spending share of total expenditure was 17.9 percent and 16.4 percent during NDPI and NDPII, respectively. Figure 30: Actual government expenditure through NDPI, NDP II Figure 31: Changes in government expenditure and NDPIII (% of total expenditure) between NDPI and NDPII (% of total expenditure) Source: MoFPED BOOST and World Bank Staff calculations Source: MoFPED BOOST and World Bank Staff calculations 49 Despite the rapidly growing population and increasing ambition for social economic transformation, the spending on social sectors remained minimal. Investing in human capital has been identified as another pillar of the country’s development model, which seeks to promote economic competitiveness and industrialization through the expansion of science and technology. However, spending for social sectors has been declining, from 23 percent during the NDPI period, to 21 percent in the NDPII era, and then further below 20 percent in the first two years of NDPIII. 50 Specifically for education, spending is not growing in tandem with the rapidly increasing demand due to fast rising population. While the sector has been one of the largest spenders, the share in total spending on education decreased from 15.5 percent to 13.7 percent over the NDPI and NDPII periods, before falling to about 10 percent during the first two years of NDPIII. Overall spending as a share of GDP has been kept at a meagre 2 percent of GDP. This is against a backdrop of various challenges in the education sector, including high dropout rates, inefficiencies and ineffectiveness in the sector leading to Uganda’s children receiving only 4.3 years of learning by age 18, compared to the expected 6.8 years. Funding for Universal Primary Education (UPE), Universal Secondary Education (USE), Universal Post O-Level Education & Training (UPOLET), Teacher Education and Vocation Education is low thus affecting quality of education delivery. These issues are elaborated in Module III(A) of this PER, which undertakes a deeper assessment of spending within the education. 19 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 51 Spending in education in Uganda has increasingly gone into the tertiary sector. The share of education sector spending to the tertiary sector increased from 47 percent during NDPI, to 53 percent during NDPII. Secondary and pre-primary / primary education both reduced share by 14 percent and 5 percent each respectively. Some key priorities like the establishment of primary schools in parishes and rehabilitation of traditional schools have not received any funding. Inspection of schools and higher institutions of learning have been particularly hampered by budget cuts. On the other hand, development spending share on education has remained stagnant at 2.3 percent with some years such as FY20/21 declining to 1.1 percent, owing to budget cuts and reallocating more resources to the health sector. 52 On the recurrent side, the biggest driver of education spending increases was the intergovernmental grants and wage bills, mainly comprised of general staff salaries. These two categories of spending accounted for approximately 40 percent of total allocations during the pre-COVID-19 decade, before falling back to 36 percent in FY21/22.While funding for LG programs declined to only 11 percent of the total government discretionally budget in FY20/21, the annual trend over the last five years has been improving. Given the mandate of implementation of the planned activities, LGs have mainly been underfunded, especially as government budget increased with large capital budgets that are implemented at the center. This is blamed on the weak capacity of LGs, corruption, and the rigidity of donor conditions. This has greatly hampered LGs in providing mandated services as per the LGs Act. Government should increase funding for other LGs services such as water, agriculture, and rural roads, and stay on track with commitments under the Uganda Intergovernmental Fiscal Transfers (UgIFT) program, which has shown promising results. 53 Public spending on health declined between NDPI and NDPII, despite being low, barely half a percentage point of GDP. The share of this spending averaged 7.9 percent of the total during the NDPI period but was down to 6.8 percent during the NDPII. With this level of funding, government funded barely 17 percent of the total health spending in the country during the NDPII period. The bulk of health funding comes from the domestic private sector or external sources. And even as the latter form of funding reduced between NDPI and NDPII, the level of external funding to Uganda’s health sector is far higher than many of its peers except for Rwanda (Figure 33). However, total spending remains low and most of Uganda’s indicators remain below the average status for low-income countries and not likely to achieve the Sustainable Development Goal (SDG) targets on health. The underlying problem is that there are still huge gaps in the provision of quality healthcare. Service availability and readiness at health facilities are very low. These issues are elaborated upon in Module III (B) of this PER, which deeply analyzed spending in the health sector. Figure 32: Domestic general government health Figure 33: External health expenditure per capita expenditure per capita (Current US$, FY15/16-FY20/21) (Current US$, FY15/16-FY20/21) Source: World Development Indicators Source: World Development Indicators 3.2 Budget Execution and Other Challenges in Public Expenditure Management 54 There has been an improvement with respect to releasing the budget to spending units, but actual execution worsened between NDPII and NDPIII. The increase in the deviation between the release performance and actual execution indicates the enormous challenges in implementation, as the increase in the budget outpaced the execution capacity of the government. The deterioration in execution of recurrent expenditure during the last three years was led by significant increases of deviations of interest payments (-10.8 percent points) and social benefits (-4.9 percent points) while expenditures in wage bills and purchases of goods and services have remained mostly stable during this period. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 20 55 Overall budget execution declined between NDPI and NDPII, but the trend reversed in recent years. The overall improvement was driven by the capital budget mainly on account of domestically funded projects and driven by a few large projects. On the other hand, execution of recurrent spending declined, partly on account of the COVID-19 induced lockdown of activities in the education sector. Figure 34: Released funds as share of approved Figure 35: Budget execution as share of budget (Percent) released funds (Percent) Source: MoFPED, World Bank Source: MoFPED, World Bank 56 Overall execution rates expose challenges in project execution, particularly for externally financed projects. On average, approximately two thirds of the capital budget was executed from FY15−/16 to FY20/−21, and externally financed projects were the main contributor to this low absorption.25 Aggregate budget performance of GoU- funded projects was higher (averaged 99 percent) compared to external funding (averaged 84 percent) over the past twelve years (Figure 36). Delays are common in the execution of externally funded projects – mainly due to weak project planning and implementation practices, inadequate counterpart funding, poor coordination among ministries, departments and agencies (MDAs) and local governments, as well as challenges in land acquisition for the right of way to construct these infrastructure projects. Figure 36 Capital budget execution as share of released funds (Percent) Source: MoFPED 25 IMF 2022 21 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 3.2.1 Project Execution 57 A significant under-execution of the infrastructure budget reflects capacity gaps, significantly weakening the impact of the fiscal policy and effectiveness of the overall development program. During the implementation of the first NDP from FY09/10 to FY14/15, the level of actual development expenditure remained well below the levels envisaged under the plan. According to the Public Investment Plan (PIP), only 78 percent of planned investments were realized in this period. As a result, the value of the backlog of planned infrastructure investments had increased by more than US$ 1 billion by the end of the first NDP. Under-execution continues to undermine the effectiveness of fiscal policy by lowering the multiplier effect, especially from the expenditures that have on average fallen below plans by about 2 percentage points each financial year. 58 Recent reforms in public investment management are yet to fully raise effectiveness in project management and therefore budget effectiveness. Since 2016, Uganda has implemented several reforms in public investment management. These include strengthening the Development Committee (DC) and giving it a strong role as a gatekeeper for new investment proposals, establishing the Projects Analysis and Public Investment Department (PAP), as well as the Integrated Bank of Projects (IBP) to facilitate the effective tracking of public project and development of policy, guidelines, and manuals to improve the quality of project preparation and appraisal.26 Additional measures relate to including a pipeline of projects in the budget, reducing overcommitment for multi-year projects by barring the admission of new projects under any overcommitted program, and fostering an open and competitive bidding process. In this respect, Uganda is well ahead of its comparators in many aspects of public investment management in institutional design (especially budget comprehensiveness and project selection). However, as noted by a recent Public Investment Management Assessment (PIMA) by the IMF, effectiveness is lagging significantly behind design, with the weakest effectiveness institutions being multi-year budgeting, maintenance, availability of funding, portfolio oversight, and asset monitoring.27 59 There is a challenge of timely and accurate recording of multiyear commitments and projects not being fully protected from budget cuts. The lack of a verification process for multiyear commitments has undermined the effectiveness of the multiyear commitment statement (MYCS) and the large infrastructure agencies have reported the repeated accumulation of arrears due to unpaid contracts. For instance, UNRA’s unpaid interim payment certificates have averaged around UGX400 billion per year, and this rose to UGX 700 billion in FY20/21.28 The IMF PIMA indicates that more than half of the projects in the PIP receive insufficient funds. This is supported by examples of delays, cost overruns and stalled projects cited in the FY20/21 Auditor General’s report, which indicated that delays amounted to 5 percent of total capital spending. The delays in implementation of roadwork contracts, is estimated to cost over UGX 2.5 billion per month.29 There is need to integrate the MYCS process into the mainstream budget review process to ensure there are more stringent mechanisms to protect ongoing projects that they receive the required funding they need to be completed on time. 60 Inadequate funding for routine and capital maintenance is leading to quicker depletion of capital assets. Lack of routine maintenance, or postponing maintenance to later stages, increases rehabilitation and asset replacement costs. For instance, Uganda is losing about 10 percent per annum of road assets due to poor road maintenance.30 Whilst it is estimated that the routine and periodic maintenance cost for the entire life of a road should lie between 2 and 3 percent of the initial capital investment, delayed maintenance is most likely to cause this amount to increase.31 Moreover, the effort made to budget for road maintenance has been discounted by the fractional allocation that has seen less than 50 percent (on average) of the annual road maintenance needs funded from FY14/15 to FY20/21. Therefore, beyond the political economy factors of desiring to cut ribbons for new projects, rather than maintaining old ones, budgeting, actual execution of the budget and lack of data on status of assets, have constrained availability of resources for maintenance. 26 IMF 2022. 27 IMF 2022. 28 Ibid. 29 Byaruhanga A, Benon C. and Basheka 2017. 30 BMAU 2019. 31 Ibid. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 22 Table 3: Uganda: Funding Requirement Versus Provisions for Road Maintenance (UGX Billion) Financial Year Budget Required Amount provided Percentage of amount required FY15/16 582 261 45 FY16/17 400 217 54 FY17/18 596 268 45 FY18/19 596 313 52 FY19/20 596 282 47 FY21/22 596 310 52 Source: MoFPED 61 Lack of standardized prices within infrastructure projects is leading to high unit costs of public projects. Uganda has high unit costs relative to other comparable countries. It is estimated that the average construction cost for upgrading roads to paved standard with bituminous surface treatment in Uganda was UGX 2.36 billion per km during the NDP II period.32 Evidence from other developing countries indicates that corruption is a major factor explaining unusually high unit costs.33 This is exacerbated by lack of standardized unit costs of infrastructure projects. The excessive over pricing and ever-increasing unit costs due to limited budgets, have led to a diminishing scope of infrastructure service delivery in Uganda at various levels.34 Therefore, improving the governance and standardized unit costs could greatly improve value for money and deliver a significantly higher amount of infrastructure. 3.2.2 Supplementary budgeting 62 Supplementary expenditures remain a key phenomenon of Uganda’s fiscal operations, which distorts its annual planning and budgeting processes. Although supplementary expenditures are provided for within the Ugandan legal framework under the Constitution of the Republic of Uganda (Article 156) and the Public Finance Management Act, 2015 (Section 25) there are concerns that the use of supplementary expenditures by government is undermining the credibility of annual planning and budgeting. During the last seven (7) FYs, in nominal amounts, the total supplementary expenditure approved by Parliament has been increasing from UGX 889 billion (3.7 percent of the approved budget) in FY15/16 to UGX 3,769 billion (9.9 percent of the approved budget) in FY21/22 (Figure 37). Figure 37: Total value and share of supplementary budgets Source: MoFPED & Parliament data 32 UNRA 2018. 33 Collier, P., and Cust, J. 2015. 34 Matovu J. 2012. 23 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Figure 38: Supplementary budget beneficiaries Source: MoFPED & Parliament data 63 The bulk of recent supplementary spending is not emergency in nature. With most supplementary budgets being accessed to fund recurrent activities (i.e., wages, purchase of vehicles) they do not meet the conditions under the Public Finance Management Regulations (2016) Regulation 18(5) of being unforeseeable, unabsorbable, and unavoidable. This, in turn, undermines the credibility of annual planning and budgeting. For instance, during FY19/20, UGX 201 billion – representing 12 percent of the total supplementary expenditure was to cater for wage shortfalls. 64 The main beneficiaries of the supplementary expenditure are the Ministry of Defense, State House, and the Presidency (Figure 38). It should be noted that supplementary requests for the Ministry of Defense and State House are in most cases classified expenditures, and therefore not subject to scrutiny by Parliament. They are also usually included as part of the 3 percent legally acceptable threshold of the Public Finance Management Act (PFMA), 2015 – under section 25 (1). In addition to distorting the budget, some of the classified spending does not align with national development priorities and reduce the resources that could otherwise be used for the provision of critical public goods and services. It should be noted that, the Ministry of Health, and MoFPED have received substantial amounts of supplementary budgets during the last three FYs, mainly to deal with the impacts of Covid-19. 65 Most supplementary funding is approved without matching revenue or funding sources, hence distorting budget system. According to the Office of the Auditor General (OAG) report, during FY20/21, supplementary funding totaling UGX 6.13 trillion (13.7 percent of approved budget) was granted by the MoFPED and approved by Parliament with no clear source of the funding. Whereby such supplementary expenditures end up being financed by internal budget cuts (suppression of budgets) (Figure 39), which distorts implementation of plans/activities by the affected votes. On the other hand, where the additional expenditures were funded through additional borrowing, it put unanticipated pressure on the country’s debt situation as such resources are normally accessed through increased domestic borrowing, and hence impacting on private sector credit . For instance, during FY19/20 part of the supplementary expenditure was funded by borrowing from Stanbic Bank (U) Ltd and the Trade Development Bank. A similar situation was observed in FY22/23. The continued approval of supplementary funding without matching revenue, could be attributed to fiscal indiscipline which leads to increased funding gaps intra year, which affects the earlier budget objectives and plans. Figure 39: Sources of supplementary funding Source: MoFPED & Parliament data Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 24 66 The all-encompassing annual overall resource envelope provides more fiscal space for supplementary expenditure. MoFPED takes advantage of the fact that Article 13 (section 10) of the PFM Act requires that the annual budget indicates all government fiscal operations including borrowing by government and drawing down of govern- ment deposits. This means that the overall annual resource envelope includes domestic revenue, domestic and external borrowing, budget support, appropriation in aid, and domestic debt refinancing. Consequently, the 3 percent window for supplementary spending without Parliamentary approval provided by the legislation, is much higher – as nearly one quarter of the total resource envelope is domestic debt operations (securities redemption, interest payments on treasury bonds and bills) which are not allocatable to government MDAs and LGs. This provides more fiscal space for supple- mentary expenditure under the 3 percent window without prior Parliamentary approval. 67. The provisions to fund supplementary expenditures through the Contingencies Fund are not adhered to. The Constitution makes provision for a Contingencies Fund, and the PFMA stipulates that the Fund should retain three and half percent of the approved budget by government of the previous financial year to fund supplementary expenditures (85 percent) and natural disasters (15 percent). In FY22/23, UGX 223.9 billion (0.5 percent of the approved budget) was provided for by the Contingencies Fund in the budget presented to Parliament, but it was later scrapped. Lack of funding of the Contingencies Fund distorts implementation of the approved budget due to budget cuts and reallocations to fund supplementary budgets. Going forward, the MoFPED needs to comply with the statutory obligation as per section 26 of the Public Finance Management Act 2015 (as amended) to allocate money for the contingency fund. 68. Beyond distorting budget prioritization and undermining the credibility of the budget, supplementary budgets have created undue borrowing pressures, and if sustained could be detrimental to debt outcomes and sustainability. Between FY16/17 and FY21/22, for every UGX 1.0 trillion increase in spending on account of supplementary budgeting, domestic borrowing increased by 0.35 percentage points of GDP. Maintaining supplementary budgets at the average over the past five years of UGX 2.4 trillion, equivalent to about 7 percent of the budget can raise the domestic debt level to over 25 percent of GDP in the next few years. 69. A key solution to addressing the supplementary budgeting problem lies in improved budgeting, clear identification of sources of financing, more effective usage of the Contingency Fund, and adherence to the legal provisions for use of this instrument. Improved budgeting requires that MDAs and LGs effectively strengthen capacities to budget for known expenditures to minimize supplementary requests during budget execution. In addition, MoFPED need to clearly indicate sources of financing and impact on deficits and debt for any supplementary requests before submission to Parliament. Furthermore, Development Partners need to align their funding (especially projects) with the government planning and budget cycle to minimize in-year additional funding. Proper budgeting would also mean improved funding of the contingency fund to be used more effectively, in case of emergencies to insulate vital programs from budget cuts due to supplementary expenditures. The PFM Act needs to be amended to limit the 3 percent threshold the Minister of Finance can approve without prior approval of Parliament to only the total budget allocated to MDAs and LGs not the overall annual resource envelope. 3.2.3 Domestic Arrears Accumulation 70 The stock of domestic arrears has been growing over the last decade despite putting the commitment control system in place. Domestic arrears increased from UGX 1.075 trillion (1.1 percent of GDP) in FY15/16 35 to UGX 4.65 trillion (3.1 percent of GDP) in FY20/21, constituting 10.2 percent of the approved budget.36 In FY20/21, arrears were almost four and a half times higher than they were in FY15/16, and ten times what they were in FY10/11. 71 Arrears accumulate for various reasons, many of which are within the control of the executive arm of government. The bulk of these arrears arise from delinquent obligations for payment of services for utilities due to under budgeting and a prepayment system that is functional for only a few types of utilities. Another source is the failure to pay for contributions to international/regional organizations. Then there are court awards, over which the ministries have no control; and last, the supply of other goods and services. Due to the lack of a clear monitoring system, the reliability, coverage, and accuracy of the arrears data is also questionable. 72 Apart from distorting the budget, arrears accumulation has implications for the private sector activities and overall economic growth. Arrears accumulation is an indirect and informal form of financing the budget, as government buys services, which it does not pay within the contracted time. The completion of related follow-up services is usually delayed and has the potential to distort budget implementation, thereby delaying delivery of services to the public. On the other hand, since this is not formal public debt, it disguises the true level of the liabilities that government must resolve. The arrears accumulation is an indication of the failed commitment control system, lack of fiscal discipline, poor financial management and leadership, and approving supplementary budgets with no matching 35 MoFPED 2021. 36 OAG 2021. 25 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment funding (as discussed above.) The continued accumulation of arrears undermines public confidence in fiscal policy, and government’s ability to meet future payment obligations. This is in addition to other economy-wide impacts like the cashflows of private suppliers and contractors and the quality of credit in the banking system. Figure 40: Stock of domestic arrears (quantity and share of budget) (UGX) (Percent) Source: MoFPED & OAG Table 4: Uganda: Domestic arrears payment and accumulation Budget Payment New Accumulation  Share of Previous Share of Previous Year  Amount Amount stock (%)  stock (%)  (UGX billion)  (UGX billion) (UGX billion) FY14/15  80.0 224.7 16% -62.6 -5% FY15/16  80.0 118.9 9% 929.2 70% FY16/17  110.0 184.0 8% 30.6 1% FY17/18  300.0 304.9 13% 282.5 12% FY18/19  381.0 418.8 16% 767.2 30% FY19/20  449.5 404.7 12% 503.9 15% FY20/21  454 794.3 21% 811.4 21% FY21/22  555.4 605.8 13% 2,900.0 62% Source: MoFPED & OAG 73 Previous efforts at addressing the arrears problem have not been effective. A domestic arrears strategy adopted in FY17/18 was followed with a gradual increase in the amounts provided annually to clear the arrears. However, the amounts allocated were too small – on average standing at 38 percent of the existing stock – while the accumulation continued. (Table 4). Government is currently implementing a new Domestic Arrears Strategy, which became effective in FY22/23. This strategy requires accounting officers to submit to MoFPED a detailed list of beneficiaries and amounts owed to them for scrutiny at the central level and for accumulated arrears to be automatically paid within the MTEF allocation of the entities accumulating them. This implies that rather than the MoFPED financing arrears accumulated by a vote, they are to be automatically deducted by MoFPED from the MTEF allocations in the following FY, hence taking the first call on the available resources.37 74 The MoFPED would have to strengthen containment measures to curtail further accumulation of arrears. This includes strengthening commitment controls, the sanction regime for officers responsible for unauthorized spending commitments, with penalties at personal/individual level, and through automatic confirmation of fund availability before incurring expenditure commitments. This can be done using technology and upgrading such controls within the IFMIS system. There is also a need to monitor unpaid government financial obligations on a quarterly basis, and ring-fencing the budget provisions allocated to clearing domestic arrears to prevent them from being redirected to other budgetary spending. 37 MoFPED 2022c. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 26 3.2.4 Classified Expenditure 75 Whilst Uganda had kept a good record on budget of transparency over the years, this is increasingly being dented by classified expenditures. Budget transparency continues to improve as the Uganda budget website continues to provide interactive budget information up to the last spending unit. Moreover, the site also allows for feedback from citizens regarding funds received and how they were utilized. Nevertheless, not all expenditures are subjected to this kind of scrutiny, as they are legally protected because of their sensitivity. According to the PFM Act 2015, “the expenses and commitments incurred by an authorized agency for the collection and dissemination of information related to national security interests and includes the cost of procurement and maintenance of the related assets” are classified (Box 1). With this broad definition, many items can easily be categorized as classified, and incorporated into spending any time of the year. These classified expenditures have been increasing over the past four years, with severe implications to budget transparency and accountability. Box 1: Guiding principles for-classified expenditures (1) The rnoney appropriated for classified expenditure shalI only be used for defence and national security purposes. (2) A committee of parliament comprising of the chairperson of the comrnittee responsible for defence and internal affairs, and another member appointed by the Speaker shall scrutinise the classified expenditure budget in a closed session (3) To ensure the Confidentiality of defence and national security matters, a budget for classified expenditure shalI be presented as a single line item. (4) An Accounting officer of a vote to which subsections (3) applies shall, in accordance with standards and guidelines issued by the Accountant General, establish appropriate systems of internal control in respect of the trancactions and resources of the vote. (5 ) Where money appropriated by Parliament for classified purposes is not sufficient, the supplementary funding shal I be in a accordance with the requirements of section 25. Surce: Article 24, PFM ACt 2015 Figure 41: Trends in classified expenditure Source: MoFPED 76 Classified expenditures have increased by over 500 percent in nominal terms over the past six years, hence more than tripling their share of the national budget. Some of these expenditures are included in the budget and hence duly appropriated by Parliament as part of the normal budgeting process, but a large part is spent through supplementary budgeting. Classified budgets increased from UGX 441 billion in FY16/17 to UGX 2,766 billion in FY22/23, representing an increment of 527 percent over a period of six years. The proportion of the classified budgets to the total approved national budget increased from 1.7 percent in FY16/17 to 5.7 percent in FY22/23.38 The spike in FY20/21 is in tandem with increased defense spending due to heightened insecurity within the region (Figure 41). It is also worthwhile noting that globally, nations are witnessing unprecedented increases in classified expenditure.39 38 MoFPED 2023 39 Mubangizi P. 2020. 27 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 77 Over the last three years, more institutions outside security organs and the presidency have been added to those with classified budgets. As is the case in many countries, most of the classified budgets are under defense and security – Ministry of Defense, Internal and External Security Organizations, and Uganda Police – State House, and the Office of the President. These account for over 90 percent of the classified expenditures (Figure 42). However, over the last three FYs more institutions (such as Ministry of Internal Affairs, Inspector General of Government, National Citizenship and Immigration Control, Financial Intelligence Authority, Directorate of Public Prosecutions, Uganda Prisons Service, and Directorate of Government Analytical Laboratory) joined the aforementioned institutions in having classified budgets. It should be noted that, although the classified expenditures are audited by the Office of the Auditor General, the reports are not scrutinized by Parliament, and neither made public, which puts accountability for such funds at risk. Classified expenditures can be an opening for corruption and siphoning of public funds that would have been channeled to provide critical social services. Figure 42: Beneficiaries of Classified Budgets Source: MoFPED 78 Some of the classified expenditures – especially those approved under the supplementary budgets – are funded through borrowing. For example, of the UGX 2.4 trillion (5.9 percent of approved budget) government borrowing from Stanbic Bank and the Trade Development Bank during FY19/20, 60 percent was for classified expenditures, amounting to UGX 1.47 trillion (3.6 percent of approved budget).40 Regulations on accounting for classified expenditure as stipulated under Section 81 (2)(g) of the Public Finance Management Act 2015 (as amended) to ensure proper use and accounting for these expenditures. 3.3 Spending and Growth Outcomes 79 The importance of public spending in the country’s policymaking depends on what extent it affects final expected outcomes – not just in the short term. This section explores to what extent levels and changes in public spending affected growth, one of the main goals of public policymaking, in both the short and long run. 80 During the last decade, changes in public expenditure have been correlated with variations in GDP, but with this general pro-cyclical behavior being derived from the recurrent expenditures. The average annual rate of GDP growth of 4.3 percent over the period FY10/11-FY19/20 corresponded to 10.1 percent annual growth in public expenditure, albeit higher volatility in the latter – at 9.4 percentage points, the standard deviation of public expenditures tripled that of GDP growth. The main drivers of this pro-cyclical behavior of Uganda’s public expenditure are the components of the recurrent expenditure which apart from subsidies, are strongly correlated with GDP growth. Interest payments move positively with the business cycle, which may be explained by expenditure soaring more than revenues and thus fiscal deficit/borrowing requirements increasing – when GDP rises. The high level of correlation of wages may suggest that stronger economic performance has led to public service hirings and modifications in the salary schedule (Figure 44 ).41 40 Mubangizi, P. 2020. 41 Uganda’s Employment Act of 2006 sets the minimum standards of employment and provides that in terms of appointment of officers, there shall be appointed a Commissioner responsible for the implementation of the provisions of the Act, under the directions of the corresponding minister, making the hiring of public officials a rigid procedure to follow. Also, after a presidential commitment to enhance salaries of public servants by 50 percent starting in FY15/16, in March 2019, the Ministry of Public Service presented a revised salary schedule to Parliament seeking a salary enhancement for various civil servants. In March 2022, another proposal for salary increases was presented, but the National Budget Framework Paper for FY22/23-FY26/27 postponed it until the economy recovered from the impact of COVID-19 and resources become available. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 28 Figure 43 Annual real growth in GDP and public Figure 44: Correlation coefficient between public expenditure trends (FY10/11-FY20/21) expenditure components and GDP (FY10/11-FY20/21) Source: World Bank staff estimates Source: World Bank staff estimates Figure 45: Share of public expenditure by component Figure 46: Wage bill and capital expenditure (Percentage) FY14/15-FY20/21* (% of GDP) Source: World Bank Staff * RWA: 2017-21; ETH: 2015-17. Source: World Bank Staff 80 Spending related to running the state takes the largest share of total expenditure in Uganda and has been growing at the fastest speed. Based on the Medium-Term Expenditure Framework (MTEF) sector classification in the national budget and documents,42 three policy clusters can be identified for sectorial analysis: i) Economic sectors (covering infrastructure and other sectors such as agriculture, energy, and economic growth facilitators); ii) Social sectors which includes areas of human development – health, education, and social protection; and iii) Public service sector (which primarily deals with functioning of the state apparatus, security, and regulatory framework). During the period FY11/12-FY20/21, expenditure on public services accounted for almost 60 percent of total spending. This type of expenditure has been growing since FY17/18 and accelerated sharply during the two fiscal years FY19/20 and FY20/21), led by major allocations to defense and interest repayment which individually grew over 35 percent in both years. This has been at the expense of the social sectors, and the economic sectors. Hence, as a share of GDP, spending in public services currently accounts for twice the allocations to social sectors as well as those related to economic activities. 42 The functional classification of the budget, by which expenses are classified by the national need that it addresses, reflecting its major governmental purpose, is not available for the period of analysis. 29 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 81 Beyond the broad macro variables – including the level and composition of public spending, inflation targets, and overall macroeconomic stability – there are micro drivers of public spending pressure that can be fundamental to growth goals. The identification of expanding spending lines turns into a priority to reduce possible impending fiscal pressures which would lead to macro fiscal problems. It also helps differentiate between budgetary pressures that are temporary and those that may require further attention by measuring expenditure size and changes in growth rates for spending categories (or individual items) to compare their contribution to overall expenditure in each period.43 Thus, line items registering relatively significant or unusual changes in their patterns are worth observing more closely for their impact on total spending and because they may require reforms to allow fiscal savings. Figure 47. Contribution and Acceleration to Growth, by Economic Classification (FY17/18-FY20/21) Source: World Bank Source: World Bank 82 The degree to which fiscal allocation decisions can be adjusted has an impact on fiscal space in the short term. Allocations and the corresponding composition of expenditures can generate budgetary constraints that limit the ability to reprioritize the structure of public budget in a specified period (“fiscal rigidities”). Non-discretionary budget items constrain the predictability of fiscal allocations and deepen expense inertia in the budget. Flexibility varies for the different components of public budgets since not all of them can be easily modified by the authorities in the short term. The components of the budget catalogued as rigid or inflexible are not subject to the immediate discretion of the authorities during the fiscal year. Whilst this distinction between discretionary and non-discretionary expenditures is not exhaustive to determine rigidity, it provides an initial indicator of the space available to adjust the budget in the short run.   83 The existence of fiscal rigidities cannot be explained by a single factor but as a reflection of the administrative decisions about the role of the state, the prioritization of public policies, and their means of financing. Fiscal rigidities are essentially institutional caps which reduce the ability to modify the current structure of public budget in the short to medium term. In that sense, it is central to understand the type of existing fiscal rigidities, degree (or lack) of flexibility and the reasons behind its presence. As stated by Centragolo et al (2010), the institutional arrangements limiting the discretion in budget planning result from the immediate response to ensure compliance with specific policy objectives (especially under weak institutional frameworks). Increasing rigidities can be seen as a reflection of the roles and functions that the public sector has assumed over time and despite the boundaries generated to the maneuverability of fiscal policy, they respond to the need for an institutional framework contributing to the achievement of public policy objectives that reflect the roles assumed by the state in different development models.44 Expenditures which can be tagged as obligations of the government mainly include social security benefits, ear-marked transfers, civil service payroll, and repayment commitments (see Annex 2 for detailed description of budget rigidity). 43 Merotto, D. et al 2015.  44 Budgetary inflexibilities may have diverse regulatory roots and involve different legal instruments, contracts and institutional obligations of the public sector that have an impact over budgetary decisions such as: i) policies or programs designed to benefit those who finance them (such as social security or health poli- cies); ii) Rights and guarantees established in various regulations, which give rise to specific allocations of resources to protect certain expenses; iii) Intergovern- mental transfers, linked to the degree of decentralization of the fiscal policy; iv) Rigidities linked to macroeconomic dynamics, such as interest payments on public debt, indexation of salaries and pensions, fiscal rules, stabilization funds; v) Rigidities linked to tensions within the public sector, which encompasses both the conflicts between sectors due to the determination of public spending priorities, as well as the expenses inherent to the operation of the public sector and which turn out to be politically inflexible.  Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 30 Figure 48 Fiscal rigidity: Uganda’s share of non-discretionary spending in comparison with other regions (%) 84 Based on the high level and broad estimate of budget rigidity described above, Uganda has limited space for fiscal flexibility. The share of non-discretionary spending in the budget has been increasing, and it accounted for over 56 percent during the most recent period of analysis FY17/18-FY20/21. This share could have reduced over the past two years as increased capital expenditure also increased the value of non-rigid lines in the budget. With the caution that comparison of rigidity levels across countries could be hampered by differences in their country specific characteristics and budget structure, it is notable that regional peers show a lower rigidity composition. This does not necessarily reflect similar challenges in implementing fiscal policy as some rigidities may be easier to change in a specific country context, depending on the legal and other institutional framework. Over the period FY17/18-FY20/21, the average share in SSA countries was 48 percent, within the same ranges for low-income countries and the world. This makes Uganda’s budget structure less manageable for adjustments in the short-to-medium term (Figure 48) Figure 49. Rigidity Estimations. Expenditures by Policy Cluster/Sector. . 31 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 85 Across sectors, the economic sectors are the most flexible and hence can be modified for fiscal policy purposes in the short to medium term. Compared to a share of 53 percent, non-discretionary spending items account for 32 percent of the budget for economic sectors, which was the lowest, albeit having steadily declined (approximately 17 percentage points) over the period FY10/11 to FY20/21. Social sectors have the highest levels of rigidity in the economy with approximately 75 percent of the budget under this condition during FY10/11-FY20/21 (Figure 49c), mainly because a large portion of their budget is for wages and salaries. The rigidity of social sectors has increased, driven mostly by the buildup of inertia of sectorial wages and grants which represent approximately 18 and 60 percent of all the non-discretional item lines, respectively, during the last five years. 3.4 Overall Expenditure Implications to Growth and Development 86 Increased spending on infrastructure has been at the expense of investing in social sectors such as education and health, which experienced a recent decade-long decline in real per capita allocations, thereby impacting service delivery. The government has completed several large infrastructure projects, such as two dams (Karuma and Isimba), as well as the motorway connecting Entebbe Airport with Kampala to mention a few. At the same time, the non-wage recurrent transfers to local governments (LGs) per capita declined by 51 percent in primary education and 65 percent in health from their peaks in the 2000s. Three years ago, the government embarked on reforms to start reversing this trend – increasing fiscal transfers to LGs for non-wage recurrent and capital spending in education and health. This effort continues to compete for fiscal space with a range of other large infrastructure investments already underway or planned in the sectors of energy and transport such as the Standard Gauge Railway connection to Kenya, oil well access roads, and the oil pipeline to Tanzania worth an estimated $3.5 billion. This competition for resources will intensify with additional demands on government to meet its commitments in developing the oil sector ahead of production in FY24/25. 87 Despite this competition on account of infrastructure, Uganda faces an enormous challenge with spending due to the fast-growing population which is expected to more than double to around 104 million by 2060. On average, over 60 percent of this population will be below 24 years of age, calling for huge investments in education and health, if to become fully productive and contribute strongly to the country’s development. This sharp increase in the size of the population will aggravate the country’s many ongoing challenges in the delivery of basic education and health services. Substantial resources will be required to serve a larger population, achieve significant improvements in quality, and address the current low access rates. If investments in health and education are not shifted to a higher trajectory in the short term, the access and quality gap will keep increasing over time, and catching up at a later stage will prove extremely difficult. 88 According to the World Bank (2020), the cost of providing social services in Uganda is estimated to almost double just to maintain education and health outcomes at the 2019 sub-optimal quality and access levels. This would mean that only one-third of Ugandan students complete the seven-year primary cycle and gross enrollment rates in secondary schools remain stagnated at around 30 percent. Maintaining this status while absorbing a growing population of students was estimated to raise the total cost of providing education services (primary and secondary) from US$480 million in 2019 to an average of US$833 million during the period FY18/19–FY24/25. Similarly, the expenditure needed to provide basic health services to the growing population in line with the 44 percent coverage rate was to rise from US$703 million to US$914 million by FY29/30. 89 These resources would have to be significantly increased to enhance quality and access levels and achieve the Sustainable Development Goals (SDG), also representing government’s ambition. For example, to meet the Education and Sports Sector Strategic Plan (ESSP) targets for the FY19/20–FY24/25 period, the education sector budget will need to almost double to US$979 million per year. At the same time, to get on track to meet the universal health coverage goals by FY29/30, the required resources need to be increased from US$1.4 billion in FY19/20 to US$1.8 billion by FY29/30. Mobilizing such resources must be combined with efficiency improvements within the education and health sectors, as well as effective management of their budgets through better systems and controls. It will also call for a greater role for the private sector and increased support from development partners. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 32 4. OPTIONS FOR FISCAL ADJUSTMENT 90 As government pursues a fiscal consolidation path, it is crucial to ensure an adjustment that will maximize economic and social outcomes, including addressing the budget challenges identified above to raise efficiency of spending. The results of an assessment of the fiscal options available to government provide insights on how this fiscal adjustment could be undertaken.45 Using the simulations generated by the Sustainable Development Goals Simulation (SDGSIM) model (see annex 3), various policy considerations were compared to a BASE scenario which attempted to replicate the macroeconomic indicators during the past five years (FY16/17–FY21/22) and projects them up to FY29/30. With a key assumption that the government will not undertake any specific extra measures, the BASE scenario is assessed against alternative simulations to determine the required fiscal policy options that would achieve the desired development objectives, not achievable under this business-as-usual scenario. In each of these alternative simulations, different financing options are explored. Lastly, a holistic simulation that assumes that all fiscal consolidation, balanced fiscal strategy with increased resources for the social sectors, and improved efficiency in implementation of public projects is also assessed. Table 5 summarizes the simulations. Table 5: Simulations for options for fiscal adjustment Scenario Description BASE Baseline (business as usual) assumes no specific policy action beyond what has been done over the past five years FY16/17-FY21/22 GovtFiscPol Current Government Fiscal Policy depicted in the NDPIII mid-term review and by the medium-term budget framework FY23/24-FY25/26 BalFiscPol Balanced Spending Fiscal Policy, adjusted to increase spending for human capital and non-in- frastructure productive growth enhancing sectors BalFiscDRMPol Balanced Spending with increased domestic resource mobilization ImpEff Improved efficiency in spending 4.1 Baseline Scenario 91 The scenario assumed that Uganda pursues the same fiscal policy as the average observed over the past five years and does not add any specific policy interventions. The business-as-usual scenario results into outcomes that are not targeted by policymakers. The closure rules under this scenario are summarized in Box 2. Box 2. Baseline scenario-Clouser Rules This business-as-usual scenario results in outcomes that are not targeted by policymakers, but rather, assume outcomes achieved over the period FY16/17-FY21/22. The closure rules are as follows: 1. The fiscal balance adjusts as government spending on education, health, and water and sanitation increases by 4-5 percent annually in line with inflation, and on other government activities like roads and agriculture by 5 percent, amidst stagnant domestic revenue assumed at 13 percent of GDP and no changes in tax rates. The deficit derived under this scenario oscillates within 3-5 percent, in line with the charter of fiscal responsibility. The deficit is financed by borrowing domestically and externally. 2. The balance between savings and investment is maintained as household savings adjust endogenously to investments set which are set exogenously. 3. The real exchange rate adjusts for changes in net foreign exchange flows and inflation differentials. At only 0.1 percent per annum, the real exchange rate appreciation does not significantly impact export competitiveness. 4. Factor markets are cleared by the rents accruing therein. For the labor market, the model calibration replicates the current unemployment/underemployment rate, set at a minimum of 5 percent. Above 5 percent, wage changes generate both labor demand and supply responses. Unemployment in Uganda is more prevalent among the unskilled. 45 World Bank 2023 33 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 92 Under the BASE scenario, the growth and socioeconomic outcomes are meager. Annual GDP growth accelerates to and stays at about 5 percent, resulting in an average of 4.8 percent over the period FY16/17–FY29/30 (Table 6). Without policy interventions and excluding the oil production which government expects to start around 2025, total factor productivity growth is halved to an average of 1.2 percent, compared to pre-COVID-19. Factor productivity for agriculture declines to a range of 0.1–0.3 percent over the projection period, while that for other sectors goes to between 0.5 and 1 percent. Social indicators improve, but at a very slow pace. Poverty marginally declines to 16.5 percent, unemployment remains high, at 14 percent and other social indicators marginally improve. For example – under-five, mortality declines from 50/1000 to 39.5, while maternal mortality would reduce to 265/1000 by FY29/30. Table6: Table 6:Macroeconomic MacroeconomicResults Under Results the Baseline Under the Baseline FY17/18 FY18/19 FY19/20 FY20/21 FY21/22 FY22/23 FY23/24 FY24/25 FY25/26 FY26/27 FY27/28 FY28/29 FY29/30 Absorption 6.1 6.2 2.8 3.4 4.4 4.8 4.8 4.9 4.9 4.9 4.9 4.9 4.9 Consumption - private 6.9 6.0 2.6 3.2 4.3 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 Consumption - government 6.5 7.0 3.4 3.9 4.9 5.3 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Fixed investment - private 6.0 6.5 2.9 3.6 4.6 5.0 5.1 5.1 5.1 5.2 5.2 5.2 5.2 Fixed investment - government 6.0 6.4 2.9 3.5 4.5 5.0 5.0 5.0 5.0 5.1 5.1 5.1 5.2 Exports 7.6 7.2 3.5 4.1 5.2 5.6 5.6 5.6 5.6 5.5 5.5 5.5 5.6 Imports 6.3 6.0 2.6 3.2 4.3 4.8 4.9 4.9 5.0 5.0 5.1 5.1 5.2 GDP at market prices 6.3 6.4 2.9 3.5 4.5 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 GDP at factor cost 6.3 6.4 3.0 3.5 4.6 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Total factor employment (index) 3.9 3.9 3.3 3.3 3.4 3.5 3.6 3.6 3.7 3.7 3.7 3.7 3.8 Total factor productivity (index) 2.4 2.5 -0.4 0.2 1.1 1.5 1.4 1.4 1.3 1.3 1.3 1.3 1.2 GNI 6.1 6.2 2.8 3.4 4.4 4.9 4.9 4.9 4.9 4.9 4.9 4.9 4.9 GNDI 6.1 6.2 2.8 3.4 4.4 4.9 4.9 4.9 4.9 4.9 4.9 4.9 4.9 GNI per capita 2.2 2.5 -0.5 0.3 1.6 2.2 2.2 2.2 2.2 2.2 2.2 2.3 2.3 GNDI per capita 2.2 2.5 -0.5 0.3 1.6 2.2 2.2 2.2 2.2 2.2 2.2 2.3 2.4 Real exchange rate (index) 0.8 0.4 0.3 0.3 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 -0.4 Unemployment rate (%) 14.1 14.0 14.5 14.7 14.7 14.7 14.6 14.6 14.5 14.4 14.3 14.2 14.1 Headcount poverty rate (%) 21.5 20.7 21.1 21.2 21.0 20.4 19.8 19.2 18.6 18.2 17.7 17.1 16.5 Under-Five mortality 49.9 48.5 47.3 47.6 47.5 46.8 45.9 45.0 44.1 43.2 42.4 41.6 39.5 Marternal mortality 447.1 420.7 427.6 424.9 408.9 387.6 366.9 347.5 329.4 312.3 296.1 280.6 265.6 Source: World Bank staff estimates 4.2 Simulations of Alternative Scenarios 4.2.1 Current Fiscal Policy Stance Scenario 93 In line with the fiscal consolidation effort, the government has undertaken actions to reprioritize and rationalize expenditures. The government’s current fiscal stance, as reflected in the budget framework and priorities for fiscal years FY23/24 and FY24/25, espouses an effort at fiscal consolidation and re-prioritization of the NDPII hinged strongly on the NDPIII mid-term review that reprioritized interventions, projects, and actions across all the NDPIII programs,46 amidst the financial resource constraint underpinned by the fiscal consolidation agenda. The re-prioritized activities based on set criteria47 resulted in a budget that allocated 31 percent of the total budget to interest payments, debt payments, and domestic refinancing of debt; 18.9 percent to human capital development program (education, health, and social welfare); 15 percent to governance and security; 10-13 percent to infrastructure (energy and integrated transport); and 3 percent to the productive sectors such as agro-industrialization for the next two years (see Table 7). This allocation formed the basis for the current medium term expenditure framework. 46 The NDPIII reprioritization process involved the following: (i) a program-by-program situation analysis that documented the achievements, challenges, emerg- ing issues as well as lessons learnt; (ii) selection of key priority interventions for the remaining 2½ years of NDPIII implementation through a review of the Program Implementation Action Plans (PIAPs) by the Program lead agencies with the respective program stakeholders; (iii) a review of the current budget structure (wage, non-wage, multi-year commitments [MYCs]) to determine their alignment to the priorities; and (iv) a review of the MYCs to determine the proportion of the budget resources requirement, besides the statutory obligations. 47 The criteria for prioritization projects/interventions/activities for the remaining period of the NDPIII included: (i) presidential directives; (ii) ability to quicken economic recovery, (i.e., directly impacts production and consumption); (iii) higher multiplier effect and dependencies; (iv) direct/proximate impact on household income and food security; (v) low hanging fruit (including cost neutral activities); (vi) achievable within the remaining two years of the plan; (vii) implementable within the budgeted resources; (viii) capable of hedging the economy from shocks; and (ix) contributing to the operationalization of the Parish Development Model. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 34 94 The government’s current policy stance modestly accelerates growth but does not significantly improve social economic indicators. According to the simulation results, the government’s current policy scenario will increase average real GDP growth to 5.4 percent annually over the period FY23/24–FY29/30, driven by public investments and productivity growth with factor productivity increasing from 1.29 to 1.34 percent. However, if public investments48 are financed by foreign borrowing, the real exchange rate will appreciate more strongly than in the baseline, and hence lower export growth, while unemployment will decline marginally to 12.37, compared to 14 percent in baseline. Poverty barely changes compared to the 16 percent in the baseline while marginal improvements are recorded for other social indicators including infant and maternal mortality rates. Table 7: Expenditure allocations by Programs Agro-industrialisa�on 1,450 1,591 1,748 3.01 3.28 3.38 Mineral Development 33 37 151 0.07 0.08 0.29 Sustainable Development of Petroleum Resources 872 1,074 1,194 1.81 2.21 2.31 Manufacturing 419 451 497 0.87 0.93 0.96 Tourism Development 195 216 366 0.40 0.45 0.71 702 628Water Management Climate Change, Natural Resources, Environment, Land and 972 1.31 1.45 1.88 Private Sector Development 1,654 1,633 1,833 3.44 3.37 3.55 Sustainable Energy Development 1,574 1,261 1,915 3.27 2.60 3.70 Integrated Transport Infrastructure and Services 4,301 3,910 5,274 8.94 8.06 10.20 Sustainable Urbanisa�on and Housing 375 365 522 0.78 0.75 1.01 Digital Transforma�on 124 180 400 0.26 0.37 0.77 Human Capital Development 9,100 9,200 9,371 18.91 18.97 18.12 Innova�on, Technology Development and Transfer 274 283 318 0.57 0.58 0.61 Public Sector Transforma�on 208 218 221 0.43 0.45 0.43 Community Mobilisa�on and Mindset Change 75 85 144 0.16 0.18 0.28 Governance and Security 7,171 7,598 7,628 14.90 15.67 14.75 Regional Balanced Development 1,157 1,167 1,358 2.40 2.41 2.63 Development Plan Implementa�on 1,193 1,196 1,296 2.48 2.47 2.51 Administra�on of Jus�ce 400 405 421 0.83 0.84 0.81 Legisla�on, oversight & representa�on 915 915 965 1.90 1.89 1.87 Sub-Total 32,118 32,487 36,593 66.73 66.98 70.77 Interest, Debt Payments & Domes�c Refinancing 15,112 15,112 15,112 31.40 31.16 29.23 Domes�c Arrears 662 662 1.38 1.37 - Appropria�on in Aid/Local Revenue 239 239 0.50 0.49 - Grand Total 48,131 48,500 51,705 100.00 100.00 100.00 Source: National Planning Authority. 4.2.2 Balanced Fiscal Policy Stance Scenario 95 A further rebalancing of the budget allocations would generate higher growth and better social economic outcomes. As discussed in section 3.2 above, whereas investments in infrastructure are correlated with high growth in the short term, this growth is not necessarily sustained in the long run, nor is it inclusive. Allocating higher resources to both the social programs – especially health and education – as well as other productive and growth enhancing sector49s, beyond infrastructure would not only improve socioeconomic outcomes, but also generate more sustainable longer-term growth. Earlier analysis has revealed that while increased investments in infrastructure could increase the long-term growth rate by 0.4 percentage points, investments into education and health must not be neglected, as they have a particularly stronger impact on Uganda’s long-term growth potential, estimated at 0.7 percentage points, almost double the infrastructure impact (Box 3).50 Within a resource-constrained fiscal consolidation environment aiming to reduce the deficit, and an assumption of insignificant increases in domestic revenues, such resources should be derived from more frugal behavior and rationalization in other non-social sectors. 48 The marginal productivity of public investments is as sumed at 0.3. 49 The productive sectors in this simulation include agriculture, mining and the manufacturing sectors. 50 Agenor, P and Nganou J. 2016. 35 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Box 3: Expenditure Allocation and Long-term Economic Growth in Uganda: Insights from an OLG Framework Analysis of the long-term impact of various policy interventions on Uganda’s economic growth has been done using an Overlapping Generations Model (OLG). The analysis explored budget-neutral increases in government spending on health, education, and infrastructure; improvements in spending efficiency, increases in govern- ment resources through higher tax revenues or foreign inflows; and composite reform programs. This OLG model emphasizes key variables such as the individual saving rate, the fertility rate, the survival rate at middle age, the public-private capital ratio, the private capital-effective labor ratio, and the growth rate of output. The following are the key findings from this analysis: 1. Health: An increase of 3 percentage points in government spending on health, financed by cutting unproductive spending, improves the health status, productivity, and effective labor supply. The higher savings from improved health raises the private capital stock but reduces the public-private capital ratio. Nonetheless, the overall impact is positive, with the GDP growth rate gaining about 0.7 percentage points. 2. Education: An increase of 3 percentage points in government spending on education, financed by cutting unproductive spending, enhances individual human capital stock, effective labor supply, and growth. Higher human capital raises wage income, government revenue, and spending on health, resulting in improved health status. The growth rate increases by approximately 0.7 percentage points. 3. Infrastructure: An increase of 3 percentage points in government spending on infrastructure, financed by a cut in unproductive spending, has a positive impact on growth. The higher public-private capital ratio stimulates productivity, while indirect effects promote human capital accumulation, health services production, and private savings. The growth rate increases by around 0.4 percentage points. 4. Spending Efficiency: Improvements in the efficiency of various components of government spending lead to substantial growth benefits. Increasing efficiency parameters from 0.36 to 0.6 results in higher growth rates, with increases of 1.5 percentage points for health, 2.4 percentage points for education, and 1.3 percentage points for infrastructure. Reforms in governance and public finance management can exert growth effects as strong as increases in public expenditure. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 36 5. Government Resources: a. Tax Revenues: Raising the tax revenue-to-GDP ratio from 12.7 percent to 15.1 percent, and further to 18 percent, leads to significant growth impacts. The growth rate increases by 1.5 percentage points and 3.3–3.7 percentage points, respectively. These reforms contribute to higher government spending, improved health and education outcomes, and increased output. b. Foreign Resources: An increase in autonomous government resources, such as foreign inflows, allocated entirely to infra- structure investment, results in higher growth rates. The growth effect is magnified without negative impacts on savings and private capital accumulation. The increase ranges between 0.8 and 0.9 per- centage points, depending on parameter values. 6. Composite Reform Programs: Three composite reform programs combining multiple policy interventions yield substantial long-term growth benefits. The programs involve increases in spending, improved investment efficiency, tax re- forms, and increased foreign resources. The growth rate increases between 1.2 and 4.6 percentage points, depending on the strength of the reform program. This emphasizes the significance of strategic fiscal policy management including spending and tax in helping Uganda achieve sustained economic growth and development. Source: Agenor and Nganou 2016, updated 2019. 96 The simulation of a rebalanced spending scenario under this PER also demonstrates that there is room to raise growth while improving the welfare of the population by reallocating resources within the current resource envelope. This simulation assumes the allocation to the human capital development program to have increased from 18.6 percent to 21 percent of the budget and that to other productive sectors identified as agro- industrialization, mineral development and manufacturing, to rise from 4.6 percent to 5.6 percent of the total budget, to be matched with a slower growth of the governance and security program leading to a 2 percentage point reduction in allocation, and 1 percentage point loss for the integrated infrastructure program. The results of the simulation indicate that real growth would average 6.6 percent compared to 5.4 percent in the current policy scenario, while unemployment falls from 14 to 12 percent and poverty declines more rapidly to 12.8 percent by FY29/30. This scenario also raises total factor productivity growth to an average of 2.5 percent, compared to 1.4 percent, and under-five mortality and maternal mortality would also improve at a faster rate. This assumes efficient use of the reallocated resources within the social sectors to add to labor productivity as well as direct interventions for the productive sectors. Increased allocation to agro-industrialization program would target interventions such as irrigation schemes and extension services. 97 While the bulk of the activities in agriculture, manufacturing and mining are ideally private sector, government still has role to play to streamline the policy and regulatory framework generally to create a conducive environment for the private sector to thrive. Within the NDPIII, several interventions aimed at raising productivity fall in this category of activities, yet according to the NDPIII mid-term review, these activities are underfunded and portray a huge divergence between planned allocations into these sectors and actual expenditures which is due to implementation challenges. Within the agriculture sector, for example, government needs to improve access to digital technologies, mechanization, and water for production, while also strengthening agricultural research and technology development, systems for management of pests, vectors, and disease, and agricultural input markets and distribution. In mining, government needs to invest in exploration of the geothermal resources in the country, regulation of the artisanal and small miners, and strengthening of the legal and regulatory framework, including a review of the Mining Act 2003; Strengthen the capacity to undertake mineral certification, trading, testing, inspection, regulation and enforcement. There is also need to strengthen capacity to monitor, inspect and enforce health, safety and environmental provisions, as well as systems for earthquake, landslides and other geohazard monitoring. 37 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 4.2.3 Improved Revenue Mobilization with Balanced Spending Scenario 99 Whilst Uganda’s revenue performance has not been stellar, historically, more effort to finance emerging needs and support the fiscal consolidation would yield better outcomes compared to maintaining the current status quo. As discussed in section 2.5, Uganda’s narrow tax base (which leaves a large part of the economy untaxed), combines with high levels of tax evasion, tax avoidance, and inefficiencies in tax administration, to a low tax effort, even by low-income countries standards. The revenue-supported fiscal adjustment scenario assumed a concerted effort by the government to raise more domestic revenue collection from direct taxes (tax-dir) and indirect taxes (tax-com), without changing import taxes (tax-imp). The scenario presupposes that if oil revenues yield an additional 1 percent of GDP per year starting in 2026, overall domestic revenues could rise by 0.5 percent of GDP annually. Therefore, the total revenues would rise from 13 percent to 16 percent of GDP by FY29/30. This would reduce domestic borrowing to less than one percent of GDP and net foreign borrowing from 3.5 percent to 2 percent of GDP, over the same period. Overall fiscal resources could therefore increase from 23 percent to 32 percent, providing additional fiscal space (Figure 50). 100 A simulation that assumes such a concerted revenue effort, with additional resources spent on education, health, and enhancing agriculture productivity, yields high real GDP growth and better social indicators. This scenario combines extra revenue effort with the balanced approach above. The results indicate that the real GDP growth average of 6 percent falls slightly below that realized under the balanced growth scenario (6.6 percent) due to the reduction in household disposable incomes as taxes increase, which lowers savings and investments. Nevertheless, this would still yield a higher and more sustainable growth path as it lowers the fiscal deficits, also making it superior to government’s current fiscal stance, which yields a similar growth path. Figure 50. Financing sources for adjusting the budget (Percent of GDP) Source: World Bank staff estimates 101 Improvements in domestic revenue mobilization would support the most efficient fiscal consolidation. The current fiscal stance pushes the fiscal deficit at an average of 10 percent during the period FY23/24–FY29/30, way above the level recommended under the charter of fiscal responsibilities of 3 percent of GDP. In contrast, the growth effects of the balanced fiscal policy stance improved the fiscal deficit by an average of 1.0 percent of GDP (Figure 51). It is important to note that these results are only realized when the revenue effort is followed with an improved balanced expenditure allocation. Increased revenue efforts under the current BASE scenario had a negative effect on growth and other socio-economic outcomes. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 38 Figure 51. Fiscal Outcomes Under Various Policy Scenarios a. Revenue to GDP b. Expenditure to GDP c. Overall balance to GDP Source: World Bank Staff estimates 39 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 4.2.4 Improved Efficiency in Social Sectors Scenario 102 Efficiency is a key element of the four pillars of fiscal space. As discussed in section 2.4 above, inefficiencies in spending have derailed many programs across sectors as well as through dysfunctional systems and processes. Within the education sector, for instance, inefficient public spending on students who repeat and drop out amounted to UGX 298 billion (US$ 82 million) or 24 percent of the overall public spending in primary education between FY16/17 and FY21/22. Teacher absenteeism was estimated to have contributed UGX 57 billion in FY19/20, equivalent to 2 percent of the total education spending, while up to UGX 244.6 billion was diverted from public education. The health sector, too, has struggled with various challenges resulting in waste and inefficient use of resources, including absenteeism of personnel, misallocation of funds at health facilities, and mismanagement of drugs. 103 The simulation of increased efficiency in the sectors of education, health, water, and sanitation suggests that efficiency savings would generate additional resources equivalent to 0.3 percent of GDP. This result assumes that on account of improved efficiency in these sectors, productivity would improve by 2 percent annually and hence require fewer fiscal resources for the same planned outputs (as demonstrated in Figure 52) to achieve the same social indicators targets. Alternatively, the saved resources could be used to enhance funding in the same sectors and hence raise growth and realize better social outcomes, as in the balanced scenario above. Figure 52. Total expenditure with higher efficiency in social sectors Source: World Bank staff estimates 4.2.5 Improved Efficiency in Implementation of Public Investment Projects Scenario 104 Finally, despite a significant amount of resources allocation to the capita budget, inefficiencies in public investment management are a major drain on Uganda’s growth and development outcomes. As the government continues to invest heavily in infrastructure, slow implementation of projects has had negative effects on growth that was anticipated under previous development plans (see section 2.4). There is also anecdotal evidence showing declining levels of efficiency in the utilization of public capital. This decline in efficiency has a direct impact on the rate of growth and productivity on the various sectors. Reforms in the public investment management systems, including those to stop leakages through corruption and mismanagement, will need to be strengthened to derive the maximum benefits from these capital investments. 105 The NDPIII mid-term review demonstrated the public investment management challenges that government still need to overcome if the country is to raise its capital stock and grow effectively. A total of 69 core projects were identified and expected to be the key drivers of the transformation within the NDPIII. At the time of the midterm review (i.e., 2.5 years after they were planned), only 20 projects were under implementation. The rest were either under preparation or still ideas. These included 14 projects that are under preparation (Proposal, Profile, Pre- Feasibility, Feasibility), 14 at the project concept stage and 21 at project idea awaiting approval from the Development Committee. The integrated transport sector with the largest share (19 percent) made the most progress, as nine out of the 13 projects are under implementation. However, projects for other key programs, such as the agro-industrialization (12 projects) and the human capital development (7 projects) remain ideas, removing any chance of having these projects completed within the NDPII timeline (Table 8). Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 40 Table 8: Core Projects Implementation Progress by Program as of May 2022 Sno Programme Idea/Wish Concept Preparation On Going Rejected Total List 1 Agro-industrialisation 8   2 2 12 2 Mineral Development   1     1 3 Sustainable Development of Petroleum   1   2 3 Resources 4 Manufacturing 1     2 3 5 Tourism Development   3 2   5 6 Natural Resources, Environment, Climate 2   1 1 4 Change, Land and Water Management 7 Private Sector Development 2     1 3 8 Energy Development 2 1 2 3 8 9 Integrated Transport Infrastructure and   2 1 9 1 13 Services 10 Sustainable Urbanisation and Housing   1 1   2 11 Digital Transformation     2   2 12 Human Capital Development 4 1 2   7 13 Innovation, Technology Development and 1   1   2 Transfer 14 Community Mobilisation and Mindset   3     3 Change 15 Regional Development 1       1   TOTAL 21 13 14 20 1 69 Source: MoFPED 106 A simulation of improvements in efficiency that would have allowed these projects to be implemented faster and within the NDPIII demonstrates the additional benefits to growth across all scenarios. Assuming that if projects would be implemented better, then the marginal productivity of public investments would improve from 0.3 to 0.5, then growth outcomes would be superior to all other scenarios, as the productivity improves across all sectors. It indicates that even for the current fiscal policy scenario, growth could be 2-percentage points higher than what is likely to be achieved without these efficiency improvements. Similarly, poverty declines faster while the improvement in the other social indictors is deeper. Table 9: Impact of improvement in marginal productivity of public capital on GDP growth   FY22/23 FY23/24 FY24/25 FY25/26 FY26/27 FY27/28 FY28/29 FY29/30 BalFiscPol-mpk(0.3) 5.2 5.1 5.0 5.0 5.0 5.1 5.2 5.3 GovFiscPol-mpk(0.3) 5.1 5.0 5.0 4.9 4.9 5.0 5.1 5.3 BalFiscPolDRM-mpk(0.3) 5.3 5.2 5.1 5.1 5.1 5.2 5.3 5.4 GovFiscPol-mpk(0.5) 6.0 5.9 5.9 5.8 5.8 5.8 5.8 5.7 BalFiscPol-mpk(0.5) 6.6 6.5 6.5 7.2 7.4 7.4 7.4 7.3 BalFiscPolDRM-mpk(0.5) 6.5 6.4 6.3 7.1 7.2 7.3 7.2 7.1 Source: World Bank staff estimates 41 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Figure 53. Development Outcomes of Various Fiscal Options Source: World Bank staff Computation Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 42 Figure 54. Poverty Indicators Under Various Fiscal Options Source: World Bank Staff Computation Figure 55. Equivalent Variation per Capita Source: World Bank Staff Computation Figure 56. Other Social Indicators Under Various Fiscal Options 43 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment PO. The percentage of individuals below poverty line 4.3. Overall Implications to Options for Adjustment 107 The results above re-emphasize the need for Uganda’s fiscal operations to improve both allocation of resources and efficiency in the utilization of resources. Sustaining fiscal policies that have been pursued over the last decade will yield growth but not at the country’s full potential, while social indicators continue to stagnate or decline. In recognition of the need to adjust, the government has started on a fiscal adjustment path, aimed at improving fiscal outcomes. The current fiscal stance can be expected to modestly accelerate growth and slowly achieve some social indicators. There is room to readjust the budget that would result in a higher growth path. By reallocating resources to further rebalance the governance and security programs, the integrated infrastructure program, and other productive programs especially agro-industrialization, minerals and manufacturing and human capital development programs especially health and education, Uganda’s fiscal policy instrument can generate higher growth and better social indicators. The outcomes would even be more sustainable if the country mobilized domestic revenues more strongly, while spending such additional revenue in a balanced way, would raise efficiencies in spending in social sectors, and increase the marginal productivity of capital. 108 This analysis has demonstrated that a balanced fiscal adjustment is crucial not only for reducing the fiscal deficit, but also to generate faster growth and better social outcomes in Uganda.  A typical balanced adjustment would entail a 1 percentage point increase in budget share for agro-industrialization, mineral development, and manufacturing (categorized as growth enhancing sectors), combined with an increase of 2 percentage points in the share of spending on education and health; while reducing the share of administration, governance, and security by 2 percentage points would accelerate average GDP growth to 6.6 percent over the period FY23/24 to FY29/30, compared to about 5.2 percent under the recent re-prioritization under the mid-term of the NDPIII. The improvement would arise, notwithstanding the additional savings from efficiency improvements. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 44 109 The funding needs for social sectors are enormous, partly because they have been underfunded in the past, but also because of the huge population pressure. Within the health sector, there is scope for raising efficiency through improved distribution and management of health workers, and through strengthened procurement and management of essential drugs and medical supplies. Notwithstanding the potential efficiency gains herein, government spending on health is too low. Increasing it would enable households to reduce their out-of-pocket spending on health, enable the government to ensure adequate staffing, replace obsolete medical equipment and expand access to drugs and medical supplies. Similarly for education, inadequate funding, inefficiencies, inconsistent policies in early childhood education, and gaps in effectiveness of teaching lead to late entry, grade repetition, and low development of basic skills.  110 More efficiency gains will come from deeper reforms of intergovernmental fiscal transfer systems and the Public Investment Management System (PIMS).  Recent reforms to the IGFT system have brought enormous efficiency gains by improving the processes for transfer of funds to service delivery units at LGs but will need to be enhanced through better budgeting and planning, as well as more discretion to LGs. Similarly, recent reforms to the PIMs notwithstanding, stronger mechanisms and capacities in project preparation and execution, better management of assets, stronger legal framework containing incentives for enforcing established guidelines, and stronger technical capacity in PIMs across government, will generate efficiency gains, crucial to sustain high levels of growth and poverty reduction. 111 Most of these issues have been analyzed more deeply within other modules of this PER. At the macro- fiscal level, the government ought to brace for deeper reforms that will support a more meaningful fiscal adjustment, generate higher growth and support better socio-economic outcomes. The broad recommendations are summarized below and expound in Table 10. (i) Make the fiscal consolidation agenda more effective and growth accelerating by pursuing a balanced adjustment in spending, while improving the domestic revenue mobilization effort. More balanced spending would mean allocating many more resources to human capital development and growth enhancing activities. (ii) Pursue expenditure policies that will genuinely reduce wasteful expenditures, including through cuts to the large public administration budget, improve efficiency across government, strengthen anti-corruption systems, and re-allocate the budget system. (iii) Expedite implementation of outstanding reforms under the Domestic Revenue Mobilization (DRM) strategy and earlier recommendations of the World Bank (2019) study to expand the tax base, close leakages in the tax policy frameworks, such as tax expenditures, and raise efficiencies in tax administration. Higher revenues will raise government capacity to spend and reduce borrowing especially from domestic sources which has dire implications on the private sector. (iv) Undertake policies to reduce inefficiencies in the social sectors especially education and health. These inefficiencies include absenteeism of teachers, repetition and drop out of students as well as diversion of funds. Detailed reforms on education and health are elaborated under module 3. (v) Improve efficiency in the execution of public projects by deepening reforms in public investment management, especially with respect to project implementation and maintenance of physical assets and incorporating climate change perspectives in managing these investments. Efficiency gains in capital utilization could generate an additional 0.2–0.5 percentage points of GDP growth annually. Detailed reforms under the PIM are well elaborated under module 2. 45 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Table 10: Matrix of Recommendations. Key Theme Key Findings/ Issues of Concern Recommendations 1. Macro-fiscal Uganda’s recent fiscal policy has not generated suffi- Adjust the growth model based on debt-financed govern- policy inconsistency cient growth, raised its fiscal and debt vulnerabilities, ment spending that has emphasized infrastructure with or contributed to crowding out of private sector credit, a low return, with one where public investments are well and threatens the country’s hard-earned macroeco- managed and with high return to benefit the private sector nomic stability. activity and allow it to eventually lead economic growth, supported by the state through investments in human cap- Sustaining the same policy stance modestly acceler- ital and targeted regulations to promote a green inclusive ates growth but does not significantly improve social growth to reduce inequality and poverty, and to ensure economic indicators. sustainability. Whereas the infrastructure deficit remains, fiscal consoli- dation should be pursued with a further rebalancing of fiscal spending by reducing the share of public administration, governance, and security while increasing the budget share for growth enhancing sectors and human capital. Pursue expenditure policies that will genuinely reduce wasteful expenditures, including through cuts to the large public administration budget, improve efficiency across government, strengthen anti-corruption systems, and re-allocate the budget system. Reduce inefficiencies in the social sectors – especially education and health The changing structure of debt, towards more Maximize effort to access and use concessional financing. non-concessional borrowing, has increased liquidity Mobilizing such resources must be combined with efficiency pressures and heightened the risk of crowding out improvements within government MDAs public investments in critical areas. Reforms recommended in earlier work and within the Expedite implementation of outstanding reforms under the DRM strategy have only partially been implemented. DRM strategy. 2. Budget allocative Despite the rapidly growing population and increas- Significantly increase funding towards social sectors efficiency challenges ing ambition for social economic transformation, the (especially education and health) to enhance quality and spending on social sectors remained minimal. access levels and achieve the Sustainable Development Goals (SDGs). In addition, reduce inefficiencies in the social Despite a significant amount of resources allocation sectors –especially education and health (see recommen- to the capita budget, inefficiencies in PIM are a major dations on education and health). drain on Uganda’s growth and development outcomes Continue to strengthen reforms in the PIM systems, such as stronger mechanisms and capacities in project preparation Declining funding to LG (only 11 percent of the total and execution, better management of assets, stronger legal government discretionary budget in FY20/21) framework containing incentives for enforcing established guidelines, and stronger technical capacity in PIMs across government, stopping leakages through corruption and mismanagement. Increase funding for other LG services such as water, ag- riculture, and rural roads, and stay on track with commit- ments under the Uganda Intergovernmental Fiscal Transfer (UgIFT) program, which has brought enormous efficiency gains by improving the processes for transfer of funds to service delivery units at LGs but will need to be enhanced through better budgeting and planning, as well as more discretion to LGs. 3. Budget Execution Inadequate funding for routine and capital maintenance Increase funding for routine maintenance of capital assets and Other Chal- leading to quicker depletion of capital assets. to meet minimum internationally acceptable standards of lenges at least 25 percent of the capital budget. This implies that for every US$ 3 million invested in new roads, government should be investing US$1 million in maintenance. Lack of standardized prices within infrastructure pro- Improve governance and standardize unit costs. jects leading to high unit costs of public projects. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 46  Challenge of timely and accurate recording of multiyear Improve budgeting for projects by adopting a project cycle commitments and projects not being fully protected approach and integrate the multiyear commitment state- from budget cuts. ment process into the mainstream budget review process to ensure there are more stringent mechanisms to protect ongoing projects and that they receive the required funding they need to be completed on time (see PIM recommenda- tions). Supplementary expenditures distort annual planning Strengthen capacities of MDAs and LGs to budget for known and budgeting processes, and some are approved expenditures. without matching revenue or funding sources, hence distorting the cash budget system. Improve funding of the contingency fund to more effectively be used in case of emergencies. Amend the PFM Act to limit the 3 percent threshold that the Minister of Finance can approve without prior approval of Parliament, to only the total budget allocated to MDAs and LGs not the overall annual resource envelope. Align development partners funding (especially projects) with the government planning and budget cycle to minimize in-year additional funding. The stock of domestic arrears has been growing over Strengthen commitment controls and sanctions regime the last decade despite putting in place the commit- for officers responsible for unauthorized spending com- ment control system. mitments, with penalties at personal/individual level, and through automatic confirmation of fund availability before incurring expenditure commitments. Closely monitor unpaid government financial obligations on quarterly basis. Ring-fence the budget provisions allocated to clearing domestic arrears to prevent them from being redirected to other budgetary spending. Classified expenditures denting Uganda’s budget Develop and operationalize regulations for accounting for transparency efforts; increased by over 500 percent in classified expenditure as stipulated under Section 81 (2)(g) nominal terms over the past six years. of the Public Finance Management Act 2015 (as amended) to ensure proper use and accounting for these expenditures. 4. Revenue Effort Uganda’s revenue effort remains below that of regional Close gaps and leakages in tax policy and improve efficien- and Outcomes peers and the Government’s own target of 16 percent cy in tax administration. of GDP. 4a. Uganda relies More than half of taxes in Uganda were derived from Improve efficiency of taxes, especially the CIT by ration- mostly on VAT, VAT, other international taxes, and PAYE. CIT exemp- alizing tax expenditure (exemptions, depreciations, and other internation- tions have doubled from UGX 177.19 billion in FY16/17 deduction etc). al taxes, and PAYE to UGX 335.73 billion in FY21/22 4b. Low revenue Uganda’s VAT (14 %) and CIT (4 %) collection-efficien- Scale up the use of DTS and EFRIS and address the chal- growth is partially cy is below the sub-Saharan Africa average. However, lenges faced by the two innovations such as forgery of DTS an outcome of the adoption of technologies such as Digital Tax Stamp and invoice trading. low collection (DTS) and Electronic Fiscal Receipt Invoicing System efficiency in VAT (EFRIS) has improved the performance of VAT. The VAT and CIT. collection efficiency has more than doubled. 4c. Broadly, there In some instances, the scope of exempt and zero- Reduce the scope of exemptions and zero-rated supplies to were inconsist- rated items were limited. In others, the scope was exports, basic and life-saving medication, and educational encies in the expanded. For example, in FY19/20, the exempt list material for primary and secondary education. implementation of was expanded to include aircraft; insurance services; recommendations rice mills; agricultural sprayers; operators of technical/ proffered to deal vocational institutes; free zones and industrial parks; with inefficien- and wood, welding, and sewing machines. cies related to VAT exemption and zero rating 47 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 4d. The stock of In FY21/22, the stock of offsets stood at UGX 188 Match budget resources put aside to pay-off successful offsets has billion, up from UGX 94.9 billion in FY16/17. audits with increased audit capacity. increased despite efforts to refund taxpayers in a credit position 4e. VAT deeming Revenue loss from deemed VAT has increased fourfold Improve transparency and minimize the scope of companies practices contin- from UGX 147 billion (0.1 percent of GDP) in FY15/16 to benefiting from deemed VAT. ue to challenge UGX 582 billion (0.36 percent of GDP) in FY21/22 the integrity of the VAT system. 4f. There is a scope The current system increases the burden and econom- Excise tax rate for cigarettes could be increased significantly to increase ic losses that result from cigarette and alcohol con- and harmonized for all cigarette brands. excise tax rate sumption and lead to revenue losses. In addition, the for cigarettes multiple rates are non-neutral and influence supplier Create a single tier structure, taxing all alcohol and non- and harmonize behavior and create opportunities for tax planning alcoholic beverages at the same specific tax rate. the alcoholic and non-alcoholic multi-tiered regime. 4g. The tax register The taxpayers register more than doubled to 2.6 million Remove uncertainty about the accuracy of the registration has been grow- taxpayers in five years ending FY21/22. Out of these, database and the number of active taxpayers. ing; however, few URA’ filing and compliance covers less than 1 million Review registration process for accuracy and simplicity. registrant file or taxpayers. While filing ratios are seemingly high, they  pay taxes and the are calculated as a percentage of targeted active Clean databases, ensure data integrity and minimize on-time ratios taxpayers and not as a percentage of the tax register. duplication and multiple TINs. have fallen. Relatedly, on-time filing ratio for PIT dropped from  Match data to other registration systems 14 percent in FY17/18 to 3 percent in FY19/20. While  that of VAT was relatively high, it also dropped from 84 Allocate a TIN to all ID card holders. percent to 75 percent in the same period. Progressively lift on-time VAT filing rate and reduce non- filers. 4h. There is an Data sources such as that related to government Fast track the review and enhancement or procurement of unexploited suppliers (i.e. the Integrated Financial Management the e-tax system. potential to lev- System (IFMS)),; the National Immigration Registration Integrate e-tax with primary registries such as Uganda erage technology Authority (NIRA); and the Uganda Registration Service Registration Service Bureau, NSSF, KCCA, to enable URA to to increase tax Bureau (URSB), which registers business, have not use third-party information to prepopulate returns, validate compliance. been fully utilized to establish taxpayer compliance returns, and inform audit and investigations. gaps. Train URA staff in using the vast amount of data to support service delivery, audit, and investigations. 4i. Resources for Resources set aside to process refunds have sig- Set aside budget resources to facilitate refunds. processing refund nificantly deviated from the rate of processing over  Develop capacity to audit and process refunds. claims have been the DRMS period (FY18/19–FY21/22). For example, made available actual refunds were more than resources set aside but have not kept by MoFPED to refunds in the FY21/22 by UGX 0.95 up with the rate billion. This may undermine the prompt processing of of processing. approved refunds or slow down the rate of verification and audits. In addition, increased resources ought to be matched with administrative capacity to verify large high-risk taxpayers to reduce invalid credits. 4j. Debt and arrears While the amount of debt collected has increased four- Reduce the delays by government paying tax commitments recovery have fold – from UGX 348 billion to UGX 1,321 billion in the it has made to some companies. improved over period between FY16/17 and FY21/22 – the stock of Integrate the e-tax system with the debt and arrears time. However, debt has increased at the same pace from UGX 1,275 management register. there is a scope billion to UGX 4,683 billion in the same period. to curtail the Reduce the backlog of cases in the court system. stock of debt and Reactivate the URA Board debt committee to authorize debt arrears. write-offs. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 48 4k. While many The government has approved a framework for tax Review and reform legal loopholes that undermine reforms have been expenditures and commissioned a repository of tax transparency in tax expenditure. made, capacity expenditures. In addition, the government continues Develop capacity to estimate tax expenditure. challenges constrain to estimate the cost of tax expenditures and publish policy efforts to ad- a report every year. Also, tax expenditures continue Establish the operational definition and the full scope of tax dress tax expendi- to be introduced every year using the budget frame- expenditures. tures works. However, policy inconsistencies that provide for Develop capacity to identify and track the cost and benefit discretionary tax expenditures undermine the reform of tax expenditures efforts. In addition, operational definition and the full scope of tax expenditures have not been established. Capacity challenges in data analysis have also been identified. 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Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 52 ANNEXES ANNEX 1: STATUS OF MACRO-FISCAL RECOMMENDATIONS OF PREVIOUS PERs. 1.Uganda Public Expenditure Review: Uganda Fiscal Policy for Growth (Report No. 40161-UG) Year: 2007 Issues identified Recommendations Status of implementation Impact Pillar I: Increase infrastructure investments and maintenance spending if impressive growth is to continue Low capital Shift composition of budget To address critical growth constraints, Government of Uganda (GoU) fiscal investments to spending towards infrastructure, strategy changed to increase allocation towards infrastructure development undercut by reducing wasteful – from 8.2% of the national budget in FY 2007/08 to 16.2% in FY 2008/09. Uganda’s expenditures and freeing up The same stance has been maintained over the past decade. However, capital Impressive budgetary resources formation, as a share of the budget remained unchanged as a result of growth, though procurement delays for key infrastructure projects (e.g., Karuma Hydro Power fiscal space is Project). reducing. By 2017, Uganda’s fiscal space remained insufficient to meet its infrastructure needs, with an infrastructure financing gap estimated at US$0.4 million per annum. Whereas there is Immediately address the backlog The Uganda Road Fund, created through the Road Fund Act (2008, became fully scope for prudent of maintenance in the road operational on July 1, 2010, with the objective of financing routine and periodic new concessional and water sub-sectors, and maintenance of public roads under UNRA, KCCA, Districts and Municipalities. borrowing for adequately fund maintenance However, it is not operating as a self-sustained (Second Generation) Fund. infrastructure, disbursement Identify and aggressively As share of total national budget, allocation towards the transport sector rates in address the causes of slow significantly increased, however, allocations towards the energy sector remained infrastructure disbursements in the roads and stagnant. projects are too energy sector, and increase low. budget allocations in tandem The slow disbursements, especially for external funding in the roads and energy sector, remain a big challenge. Given the high Establish programs to fix losses inefficiencies in in electricity and water (e.g., Under the electricity distribution concession, distribution losses have been the infrastructure water network in need of repair), reduced from 35% in 2005 to 16.4% at the end of 2019 against a target of sectors, a shift in and encourage parastatal 15.0% and UEDCL energy losses net of evacuation losses increased from 15.6% the composition investments in tandem in 2014 to 23.8% in 2020. In the water sector, Non-Revenue Water (NRW) stood of spending at 20% and collection efficiency stood at 85% in 2009/10. NRW improved to towards these Increase access and quality 33.5% for NWSC and 37.8% for Small Towns, while collection efficiency was up sectors is bound to of existing road and energy at 90.1% in 2019/20. face major infrastructure challenges, In 2008, the paved roads length stood at 3,051 km (19% of network), which including waste increased to 5,398km (24% of network) in 2019, although below the NDP II and loss, target. The proportion of national road network in fair to good condition stood at e.g., in PAF 93% for paved and 75% unpaved in June 2019, compared to 65% for paved and priority sectors 60% for unpaved in June 2008. and agencies. According to the UNHS 2019/20, 56% households in Uganda used electricity for lighting (27% solar kit, 19% grid-electricity and 11% solar home system), compared to only 11% in 2005/06. Use donor funding more Information not availed by Government effectively to avoid being too skewed to rural access 57 MoEMD 2020. 58 The portion of the water produced that is not sold to the customers but either lost by leakages in the system (physical losses) or by illegal consumption (commercial losses). 59 MoWE 2010. 60 MoWE 2020. 61 MoWT 2009. 62 MoWT 2020. 63 MoWT 2020. 64 MoFPED 2008. 65 UBOS 2021. 66 UBOS 2007. 53 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Ensure private participants PPP Act enacted in 2015 to strengthen management of PPPs. are bearing their fair share of PPP Unit created at the Ministry of Finance in 2015 to implement, monitor, business risks (establish a PPP and report on PPPs. The PPP Regulations provide procedures for PPP projects unit) development, feasibility, and contracting Carefully assess costs/benefits The PPP Act (2015) set up a high-level PPP committee to validate PPP projects of PPPs before entering new and provide overall guidance on PPP policy. As of November 2020, there were ones (and limit fiscal costs to eight PPP on-going projects, however, since they were all in their preliminary government) stages, they have not been exposed to any ascertainable financial exposure. Give parastatals a relatively Information not availed by government greater responsibility for investment decisions and make them internalize more of the costs of their business decisions (limit subsidies provided to them) Comprehensively monitor and In accordance with Section 52 (1c) of the Public Finance Management Act measure the performance of (PFMA), 2015, the Accountant General, within three months after the end of each parastatals and off-budget financial year, submits to the Minister and the Auditor General the consolidated accounts summary statement of the financial performance of Public Corporations, State Enterprises and Companies where Government has controlling interest. The Office of the Auditor General reviews these statements and submits them to Parliament. Pillar II: A better fiscal strategy for growth Ministry of Finance should insist PFM reform implemented to improve preparation, implementation, and reporting, that sectors measure and report with a shift to output-based budgeting using the Output Budget Tool (OBT) in FY on main outputs and unit costs 2008/09, to Program Budget System (PBS) in FY 2017/18, and to a more result of their main outputs in annual and performance-based system in FY2022/23. Budget framework papers. Reduce the growth rate and Total spending on employee costs (wages and salaries) as share of total recurrent share of total spending on spending increased from 25% during NDP I to 29% during NDP II but driven by employee costs (especially in the service delivery sectors. Employee costs shifted away from standard towards MDAs that are not delivering contractual employment. front-line services, e.g., education, health) – includes reducing growth rate of civil and public service numbers Reduce wasteful expenditure The Integrated Personnel and Payroll System (IPPS) was introduced in 2010, (e.g., reduce absentee rates, under the leadership of the Ministry of Public Service (MoPS), to manage human improve procurement processes, resources better. improve maintenance) – start by evaluating the efficiency of Salaries, Pension and Gratuity are decentralized, and Accounting Officers are existing programs held accountable for staff performance, including elimination of ghosts and absenteeism. Procurement processes have improved – the PEFA score on competition, value for money and controls in procurement improved from D+ in 2012 to C+ in 2016, thanks to reforms including PPDA’s regulatory role, standard procedures set in the legal and regulatory framework, and online procurement portal (Electronic Government Procurement; e-GP). Nevertheless, competition is still limited (i.e., use of the army starting in 2021, and weak compliance with procedures leaving several procurements not subject to open competition. Maintenance (of assets) remained underfunded during NPD I & NDP II (0.11% of GDP against Capital expenditure of 0.61% and 2.81% of GDP during NDP I and NDP III respectively) leading to quicker depletion of capital assets. World Bank 2022. MoFPED 2018. World Bank 2022. NPA 2009. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 54 Roll out initiatives to achieve The Comprehensive National Development Planning Framework (CNDPF) better public spending efficiency approved in 2007 is the country’s strategic planning framework, rolled out – better choice of technology, six 5-year national development plans (NDPs). The third plan (NDPIII) shifted limit institutional overlap, better into a program approach to improve planning, budgeting, implementation, and program performance reporting. The Program Implementation Action Plans (PIAP) lays out each program’s action plan and financing framework, its monitoring, and evaluations arrangements as well as governance arrangements. However, the PIAP commitments are yet to be fully translated into the annual approved budgets and work plans to ensure attainment of program objectives. 73 In February 2021, government decided to merge, mainstream, and rationalize sixty-nine (69) government agencies, commissions, authorities, and boards, to facilitate efficient and effective service delivery, and fifty-three (53) were rationalized in phase one. Improve accountability for the Budget Monitoring and Accountability Unit (BMAU) in the MoFPED strengthened delivery of quality public services and scope of work enhanced to deepen monitoring of selected priority sectors. Half year and Annual Budget Performance Reports (ABPRs) published, and Government Annual Performance Review (GAPR) introduced in 2008/09 and linked to Budget through the ABPRs. Collaboration with CSOs on budget performance review enhanced, especially during the Budget week. Contestability function of Budget MoFPED Budget Directorate implemented the OBT Tool and the Program needs to be strengthened Budgeting System (PBS) that focus on outputs and outcomes. – better illustrate financing implications and fiscal/growth Effective FY 2023/24, budget ceilings are at program level and Program Working trade-offs of new programs and Groups (PWGs) discuss program priorities and resource allocation to votes in line initiatives. with the Budget Strategy and PIAPs Prioritize list of high- The “gate keeping role” of MoFPED enhanced with stronger appraisal and return, high-import content selection processes (e.g., development committee, project preparation guidelines; infrastructure projects for criteria for project appraisal, feasibility studies for all projects, etc). Nevertheless, inclusion in the Budget and set the institutional and legal framework remains weak, not all projects fully comply up efficient implementation to these administrative measures (e.g., ‘parachute projects’), while many gaps arrangements. remain in implementation. Some of the specific education In 2019, the Integrated Inspection System (IIS) and Teacher Effectiveness and sector (the sector used as an Learner Achievement (TELA) were piloted. TELA is a time on task performance example of wasteful spending management system. and where efficiency gains could be made) recommendations The government rolled out the new lower secondary education curriculum included: reduce absentee rates; in February 2020; teaching subjects were reduced from 43 to 21. The new expand double shifting in both curriculum is competence based emphasizing the “to do aspect” while enhancing primary and secondary schools; the confidence of learners. and reduce the number of core courses taught in secondary schools to 10 Pillar III: Improve revenue performance Rationalize exemptions and While registered taxpayers increased from 763,150 in FY 2014/15 to 1,783,493 ineffective fiscal incentives to in FY 2020/21, the tax effort remains low, and tax-to-GDP ratios has trended simplify the tax system and below the NDP targets. According to MoFPED, revenue foregone due to tax broaden the tax base expenditures increased from 0.87% of GDP in FY 2016/17 to 1.56% in FY 2021/22. Government committed to the implementation of Tax Exemption Rationalization Plan and to adopt a tax expenditure fiscal governance framework. Enhance the effectiveness of Government’s Domestic Revenue Mobilization Strategy aims to increase the revenue administration tax-to-GDP ratio to between 16-18% by 2023/24 by, among other measures, increasing the efficiency of the tax administration. 55 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment Initiate a program/framework to Government is committed to the implementation of the Tax Exemptions keep track on an ever-increasing Rationalization Plan developed and approved in November 2022. number of tax expenditures (i.e., more transparency, reported to Transparency has improved as the Minister of Finance, reports to Parliament the public through Parliament), on Tax Exemptions as per the Ugandan Constitution (Article 152(2)) and Public and to make sure they are Finance Management Act 2015 (section 77); and the MoFPED publishes a report treated and scrutinized as to Tax Expenditure for the previous FY. However, the processes for evaluation, government spending channelled allocation, and management of these expenditures are opaque. through the tax system, and judged regarding effectiveness, equity, and efficiency All tax expenditures should be All tax exemptions are provided for within the laws, after MoFPED sieved out governed by the tax law those that were not. However, the rules for granting tax exemptions are not transparent and incentives are granted arbitrarily. A list of tax benchmarks for each A tax benchmark was developed in 2020/21, but it will need to be developed type of tax should be established, further to match international good practice. with tax expenditures defined and listed as deviations from the provisions in the benchmarks (ideally tax expenditures should be either repealed or replaced with direct budget expenditures) Databases and models should This is one of the pillars of the tax expenditure governance fiscal framework, be developed to estimate which was adopted in 2022, but it is yet to be implemented. and document the cost of tax expenditures in the Budget Integrate tax expenditures into This is one of the pillars of the tax expenditure governance fiscal framework, revenue policy analysis, into the which was adopted in 2022, but is yet to be implemented Budget appropriation process, and into various Budget laws and regulations designed to increase transparency (e.g., assess functional classification of tax expenditures, and integrate tax expenditure projections into the MTEF) NPA 2022. MoFPED 2022b. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 56 ANNEX 2: STATUS OF IMPLEMENTATION OF SELECTED RECOMMENDATION OF WORLD BANK 2018 Key Issues Identified Recommendations Action taken Impact/COMMENTS TAX POLICY - VAT 1. VAT policy gap stands at (i) College and higher education (i) Supply of imported education (i) Refund situation created for 1% of GDP. 2. Zero-rating should be brought under VAT. and health materials was domestically supplied materials 3. Deeming practices (ii) Exempt basic health care and exempted while locally produced (ii) Loss of revenue from the challenge the integrity of medicines. But tax specialized education and health materials expanded scope of exempt and the VAT system. 4. Refunds care including yoga, massage, zero rated. No further action on zero-rated items and offsets nonprescription medicines brought education, health and financial (iii) Resources for refund of to VAT. services; and items in the 5th audited offset will reduce (iii) Bring agriculture in the tax net. Schedule of EACCMA services negative returns of those in a (iv) Bring financial services fees and (ii) Regional airtime rates credit position. commissions into the tax net. harmonized. However, the scope of (v) Review the list of exempt items on zero-rated items was expanded. the 5th Schedule of the EACCMA. (iii) Offset refunds set to 6 months (vi) Standardize regional airtime tax and a budget for refund provided rates. (vii) Limit the scope of Zero-rating. (viii) Limit deeming practices to core materials, limit the scope and provide guidance on qualification criteria. (ix) Limit off-set to 3 months; improve the governance of offset; and increase the refund budget TAX POLICY – EXCISE DUTY 1. Cigarettes are cheap 1. Increase rates on cigarettes 2. Tax No action taken for 1 and 2; 3. 1. Likely increased healthcare relative to other household cigarettes at the same rate 3. Ensure Various reforms for efficiency of burden and economic losses goods and comparator DTS is exploited to the fullest extent DTS; 4. Revised rates for alcoholic that result from tobacco-related countries 2. Multi-tiered 4. Increase the rates on alcohol and and non-alcoholic beverages; disease. 2. Increased revenue structure is problematic non-alcoholic drinks 5. Classify 5. No action on basing rates on due to use of DTS and revised 3. Digital Tax Stamps Alcoholic beverage according to alcoholic strength; 6. Regional alcoholic and non-alcoholic (DTS) not fully utilized 4. alcoholic strength 6. Harmonise and internal rates harmonized 7. beverages 3. Tax planning as Excise duty on alcohol both inland regional telecom rates 7. Scope of hydrocarbons expanded a result of multiple rates. 4. and non-alcoholic Expand the scope of hydrocarbons to include plastics 8. No action on Revenue gain and neutrality due beverages is in-elastic and impose rates that factor energy inflation indexing to harmonized telecom rates. 5 5. Discrimination of duty content 8. Introduce inflation Revenue gain and progressivity by source of raw material indexation. brought by expanding the scope 6. Multiple telecom rates of hydrocarbons. both in Uganda and the region influence supplier behavior and create opportunities for tax planning. 7. Regressivity of rates on petroleum product 8. Absence of inflation indexing TAX POLICY – INCOME TAX 1. Exemptions have 1. Re-examine investment incentives. 1. Tax expenditure frameworks 1. Systems still non-neutral cascaded in agriculture 2. CBA for exemptions. 3. Review PIT developed. 2. Efforts to conduct and exemptions have creeped and other sectors. 2. No exemption. 4. Global taxation of all CBA initiated but capacity deficits to other sector. 2. Exemption Cost Benefit Analysis (CBA) income. 4. Review PIT thresholds and undermine the process. 3. No undermine morale and lead to for exemptions. 3. Several introduce inflation indexation. 5. Cap action on PIT schedule. No action revenue losses. 3 The PIT system Categories of PIT are losses to seven (7) years. 6. Bring on 4, 5, & 6 7. Interest deduction could be potentially regressive. exempt. 4. PIT threshold the depreciation regime closer to capped to 30% of chargeable 4. Generous loss deductions and starts at low-income economic depreciation. 7. Cap interest income depreciation regime undermine levels and climbs quickly. deduction ratio to 30% of chargeable revenue 5. Losses carried forward income. undermine the CIT system. 6. Generous depreciation regime. 8. High debt- equity ratios 57 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment TAX ADMINSTRATION 1. Problem with accuracy 1. Simplify and ensure accuracy of Efforts are being made for 1, 2 & Increased filling. Result of 1, 2 of tax payer information. registration. 2. Minimise duplication 3; 4. Enhance capacity to enforce and 3. 4.Improved tax compliance 2. Poor knowledge of of Tax Identification Number (TIN) compliance by recruitment and 5. Increased compliance and potential taxpayer base. 3. and link other database. 3. Expand training of staff; building analytic reduced leakage. 6. Increased Limited scope of tax-payer the scope of TREP. 4. Capacity capability 5. Risk identification revenue. 7. Integration of the education. 4 Constraints constraints among core URA on-going; 6. Debt and arrear legal, policy, and debt system in audits and verification. functions: international tax unit, data collection enhanced; 7. New into eTax. 8. Knowledge of gaps. 5. Identification and analysis and forecasting, auditing e-tax system to be procured; 9. Coordination. 10. Improved management of risks to and investigative functions. 5. Identify 8. Ongoing data analysis amidst service delivery and revenue revenue administration specific risks across key compliance analytical capacity challenge; collection. 11. Reduce leakages. operations. 6. indicators (registration, filing, 9. Efforts to share information 12. VAT refund and debt Accumulation of arrears payment, and reporting) for each enhanced; 10. Staff and system collection among other functions and debt. 7. The e-tax risk sector. 6. Increase collections re-organization to implement CIPs enhanced system has challenges. through the implementation of a well- ongoing; 11. Integrity initiatives 8. Limited analysis of resourced Collection and Enforcement ongoing; 12.CIP interrupted by URA data to improve tax CIP. 7. Review, fix and update the COVID 19, but there are capacity compliance. 9. Scope e-tax. 8. Integrate and analyse the challenges therein to improve information existing data. 9. Increase information sharing. 10. Scope to sharing between MOFPED and URA. improve implementation 10. Re-organise URA. 11. Improve of laws, organizational the quality of public expenditure; structure, staff numbers periodically publish tax expenditure; and capacity. 11. Scope and measure and deal with corruption. to improve transparency 12. Lack of compliance Improvement and accountability in tax Plan (CIP) administration. 12 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 58 ANNEX 3: STATUS OF IMPLEMENTATION OF RECOMMENDATION OF THE DOMESTIC REVENUE STRATEGY (FY20-FY25) Institution (Role) Recommendation Current Efforts to Build Planned Efforts to Build Impact/COMMENTS/ Capacity and Strengthen Capacity and Strengthen Challenges Management Management A. MoFPED –TPD (i) Simplification of Tax governance VAT Act is being reviewed Revenue gain by 0.2% (Oversight/Policy) procedure and broadening framework adopted with a view to reforming of GDP of tax base. and Tax Expenditures the VAT Law. 2. Studies Rationalization Plan and analysis on tax prepared. expenditure adjustments (ii) Track tax expenditures Tax Expenditures Identify data analyst to Analytical capacity deficits monitoring framework to conduct the quantification. identified 2. Data gaps 3. guide the quantification, Currently being done by Conflicting definition of analysis, and reporting fellows from ODI what is tax expenditure 4. approved 2. Repository Tax expenditure report is of tax expenditures was not complete set up 3. repository of tax expenditures was set up (iii) Tax expenditures Tax expenditures are should be governed by the currently guided by the tax law law 2. Streamline the authorizing framework for Tax Expenditures through implementation of the Tax Expenditure Governance Framework. The framework requires all tax expenditures to be appraised and approved using a pre-identified criterion. Development of practice Need for development of notes practice notes/guidelines. 2. Policy inconsistency as section 40(a) of the Tax Procedure Act still provides instruments for discretionary exemptions. (iv) Benchmarks for each Addressed under the Tax Implementation of the tax Implementation type of tax should be Expenditure Governance expenditure rationalization challenges in developing established Framework plan. and tracking indicators that address the objective of the tax expenditure such as jobs, purchase of local supplies, welfare, technological transfer (v) Estimate the cost of tax Development of a Implementation expenditures database and tax challenges in development expenditures analytical of the database models is in progress. (vi) Integrate tax Tax expenditures are To be implemented Capacity challenges expenditures into introduced through budget law, policy, and parliament every year 2. frameworks Government has been interested with a proposal to develop a process map for tax expenditure 59 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment B. Budget Monitoring and Develop DRM monitoring DRMS Monitoring 1.Produce annual DRMS Many indicators do not Accountability Unit (BMAU) and evaluation system and Evaluation (M&E) reports measure actual output of Frameworks an activity. They measure outcomes which can be a result of many other unrelated activities C. Uganda Revenue Execute a compliance (i) Arrears management (i) Expanding the scope of Government is biggest Authority (URA): Implementation Plan (ii) Reviewing the TREP (ii) Trade facilitation contributor of the stock of Administration warehousing regime of (iii) Cargo control arrears (UGX 400 billion). imports (iii) Deployment of management (iv) Valuation 2, 3 & ¬4 face capacity scanners (iv) Recruitment goods (v) Enforcement (vi) challenges. 5. Forgery of and training of staff to Automation (vii) Custom DTS and Invoice trading enhance compliance External Tariffs (CET). in EFRIS. (v) Implementation of Fiscal Receipting and Invoicing System (EFRIS), Digital Tax Stamps (DTS) and Rental income tax collection solution (vi) Automation of tax Audit (vii) Building capacity to audit high-risk sectors – telecom, financial sector, and manufacturing (viii) Improving integrity through technology Source: World Bank Reports, MoFPED reports and URA’s Strategic Plan Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 60 ANNEX 4: FISCAL RIGIDITY For the estimation of rigidity by economic classification in Uganda, the following concepts and categories were taken into consideration: • High rigidity: includes personnel expenses linked to the permanent plant (due both to the impossibility of making layoffs, as well as to the difficulties in reallocating functions), temporary plant (although contracts may not be renewed once the expiration occurs, this would imply a high political cost), social contributions, intergovernmental capital transfers, social security benefits, public debt interest, and earmarked transfers to institutions are also included. • Medium rigidity: includes non-personnel services (NPS) such as basic services (such as energy, water, and gas), rentals and other rights, maintenance, repair and cleaning services, technical and professional services, transportation, and mobility, among other things. Although some of these items may include items linked to salaries, it is not possible to identify and incorporate them together with the more rigid items. This would imply that some of these expenses have a slightly higher degree of rigidity. In terms of current transfers, transfers to the private sector (scholarships, prizes, social assistance, transfers to private companies, transfers to non-profit institutions), transfers to municipalities other than co-participations, and transfers to entities of the national government are of medium rigidity. • Low rigidity: included as expenses easier to reallocate are items linked to the materials and supplies, direct real investment (non-financial assets), financial investment and capital transfers to the private sector and to other entities of the public sector.   61 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment ANNEX 5: CALIBRATION OF SDGSIM WITH COUNTRY DATA The analysis is based on the SDGSIM model which originated from the MAMS (Maquette for MDG – Millennium Development Goal – Simulations). This model is a dynamic-recursive computable general equilibrium (CGE) model (Lofgren et al 2006). The model is also linked to a micro-simulation module which is used to generate poverty estimates under the various scenarios. The SDGSIM model is integrated with an additional SDG module which links the SDG indicators to its determinants. The model provides a rich framework differentiating between government activities and private sector activities in education, health, and water and sanitation. A detailed description of SDGSIM/MAMS and how it works is provided in Lofgren and Bonilla (2006). This section will mainly focus on describing how the Uganda specific database required to calibrate SDGSIM was derived. The first disaggregated Ugandan Social Accounting Matrix was derived in 2002 which was later modified in 2007 by IFPRI and updated by UBOS in 2017. The SAM on which the accounting consistency of the SDGSIM model is based builds from the 2017 SAM but it takes into account a more elaborate public sector. Annex Table 5.1 shows the structure of the Ugandan SAM. To make it easier to understand its structure, it is aggregated to two activities and two commodities: one private and one public; as indicated below, the numerical SAM is more finely disaggregated. Instead of monetary values, this table describes the content of the cells (excluding row and column totals) that have values. For each account, the values for the row and column totals are equal. Its notation is found in Annex Table 5.2. Like any standard SAM, the one in Table 2 is a square matrix with identical accounts in rows and columns. The cells show payments from column accounts to row accounts. The sum of the entries in the column of an account represents its total expenditures while the sum of the entries in its row shows its total receipts. Because of consistency (a feature of the real world and, in the absence of errors in data or concepts, also of any SAM), the row and column totals of each account must be equal. This simply means that no account (or no economic entity) can spend more than it receives, and that any payment received must be used in some way that is captured in the SAM. The SAM has three institutions which include government, households, and the rest of the world. Households are aggregated with the enterprises. The households are also classified based on urban and rural classification. Each of the institutions above has its own capital accounts. The taxes considered are both direct (income and corporate tax), import, and other indirect taxes. The model includes public investment demands for the various services provided by the government and one private investment demand. Interest payments are also disaggregated into foreign and domestic payments based on the 2017 fiscal accounts. The 2017 SAM was built in several steps. The initial task in building a SAM involves compiling data from various sources into the SAM framework. This information is drawn from national accounts, household surveys, foreign trade statistics, government budgets, balance of payments, and various other publications. This information often uses (i) different disaggregation of sectors, production factors, and socio-economic household groups, (ii) different years and/ or base-year prices, and (iii) different data collection and compilation techniques. Consequently, the initial or prior SAM inevitably includes imbalances between row and column account totals. The prior macro-SAM is based on national and government accounts and balance of payments. This SAM was built in such a way that it balanced with no inconsistencies across sectors. The capital accounts and the balance of payments data were used to disaggregate the savings and investment accounts of the macro-SAM. The total value of government consumption spending is taken from government accounts (UBOS 2017) and disaggregated across commodities using information from the 2017 supply-use table (UBOS 2017). Government spending is primarily for the purchase of administrative services, education, roads, health, and agriculture services. In this way the government is treated as a sector producing government services as well as a demander of these services. The technical coefficients used in the SAM are derived from the 2017 supply-use table (UBOS 2017), which contains detailed information for a large number of sectors. Workers’ incomes from wage and self-employment are drawn from the 2017 Uganda National Household Survey (UNHS5) (UBOS 2017). Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 62 Annex 6 Table 5.1. Stylized SAM for SDGSIM* act-prv act-gov com-prv com-gov f-lab f-cap hhd gov row taxes cap-hhd cap-gov cap-row inv-prv inv-gov dstk total act-prv output act-gov interm interm output com-prv cons exp inv inv dstk com-gov cons f-lab va va yrow f-cap va yrow hhd va va trnfr trnfr gov trnfr trnfr taxes row imp yfac yfac trnfr trnfr taxes taxes taxes taxes cap-hhd sav nffng cap-gov sav ndfg nffg cap-row sav drf inv-prv inv inv inv-gov inv dstk dstk total Source: Source: etal Lofgrenet Lofgren 2006. al2006. Annex Annex Table5.2. Table Accounts and 5.2.Accounts andCell CellEntries Entriesin Stylized SAMSAM for SDGSIM in Stylized for SDGSIM Account Explanation Cell entry Explanation act-prv ac�vity - private produc�on ndfg net domes�c financing to government act-gov ac�vity - government produc�on nffg net foreign financing to government com-prv commodity - private produc�on nffng net foreign financing to non-government com-gov commodity - government produc�on cons consump�on f-lab factor - labor dstk stock change f-cap factor - private capital exports hhd household imp imports gov government interm intermediate inputs row rest of world inv investment (gross fixed capital forma�on) taxes taxes - domes�c and trade output produc�on cap-hhd capital account - household sav savings cap-gov capital account - government taxes taxes (direct and indirect) cap-row capital account - rest of world trnsfr transfers inv-prv investment - private capital va value added inv-gov investment - government capital yfac factor income to RoW dstk stock change yrow factor income from RoW drf change in foreign reserves Source: Lofgren et al 2006. Source: Lofgren et al 2006. SDGSIM is an economy-wide simulation model for country-level analysis of strategies pursuing selected parts of the 2030 agenda and, more broadly, for analysis of medium- and long-run development policies. The model integrates a recursive dynamic CGE model with a module that links specific SDG-related policy interventions to SDG achieve- ments, including interventions related to poverty and inequality indicators. Like most other CGE models, SDGSIM is a “real” model: while relative price changes play a central role, neutral inflation (i.e., inflation without relative price changes) does not matter.79 The base year of SDGSIM for Uganda is 2017. 79 For example, a doubling of all prices, wages, rents, and, all incomes has no impact on the real quantities that are produced, consumed, invested, and traded; only the nominal values change. 63 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment As indicated by Annex Figure 1, which serves as the reference point for our model overview, the major building blocks of SDGSIM are activities (the entities that carry out production), commodities (activity outputs or, exceptionally, imports without domestic production; linked to markets), factors (also linked to markets), and institutions (households, the government, and the rest of the world). The private capital account also has its own box given the multiple links that exist between private investment demands and their financing. In any SDGSIM application (and dataset), most blocks are disaggregated – the disaggregation in SDGSIM-Uganda is shown in Table 2. Annex Figure 1. Aggregate payment flows in SDGSIM Factor domestic wages and rents private investment financing Households Markets trnsfr+interest private consumption dir taxes lending factor demand trnsfr-interest indir taxes gov cons and inv Government Private interm input demand Capital trnsfr-interest Account lending Activities lending Domestic FDI Commodity Rest of Markets imports World domestic demand exports foreign wages and rents private investment Source: World Bank staff elaboration. Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment 64 65 Public Expenditure Review 2022-23 Identifying Board Options for an Effective and Sustainable Fiscal Adjustment