Uganda—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Kampala, July 13, 2004

Mr. Rodrigo de Rato y Figaredo
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. de Rato:

1. On behalf of the Government of Uganda, I hereby transmit the attached memorandum of economic and financial policies (MEFP) that sets out the objectives and policies that the Government intends to pursue in fiscal year 2004/05 (July-June), as well as the underlying medium-term macroeconomic policy framework. These are in line with the priorities set out in the Poverty Eradication Action Plan (PEAP) and its forthcoming revision, and the 2004/05 budget proposal, which was submitted to Parliament on June 10, 2004. The attached technical memorandum of understanding (TMU) defines the terms and conditions of the program.

2. In light of the progress achieved in the implementation of the program for 2003/04, and given the supporting details provided in the MEFP, the Government of Uganda requests a waiver for the missed observance of the performance criterion for end-December 2003 on the increase in base money; the continuous performance criteria on the accumulation of domestic arrears under the Commitment Control System and new lending by the Uganda Development Bank Ltd. (UDBL); and the structural performance criterion for end-March 2004 on the divestiture of the UDBL. With respect to this last criterion, as announced in the budget speech, the Government has decided to merge UDBL with the Development Finance Department of the Bank of Uganda and management of the institution will be contracted to a private firm. In addition, the Government will divest of a minority share.

3. The Government of Uganda also requests a fourth disbursement under its PRGF arrangement with the IMF in the amount of SDR 2 million (1.1 percent of quota), following completion of the third review by the IMF's Executive Board.

4. Looking ahead, the policies set out in the attached memorandum, together with continuing implementation of the broader policy agenda in the PEAP, aim at furthering economic growth and stability and reducing poverty. The performance criteria and benchmarks for the fourth review will be based on June and September 2004 targets, and performance criteria and benchmarks for the fifth review will be based on December 2004 and March 2005 targets as set out in Tables 1 and 2 of the MEFP.

5. The Government of Uganda will continue to provide the IMF with such information as the IMF requires to assess Uganda's progress in implementing the policies described in the accompanying memorandum. Furthermore, the Government will continue to consult the IMF on its economic and financial policies, in accord with the IMF's policies and practices on such consultations.

6. The Government of Uganda authorizes the publication and distribution of this letter, the attached MEFP and TMU, and all reports prepared by IMF staff regarding the PRGF-supported program.

Memorandum of Economic and Financial Policies
of the Government of Uganda for 2004/05

1. The Government of Uganda is committed to achieving sustained economic growth and poverty reduction through the pursuit of prudent macroeconomic policies and reforms aimed at removing supply-side constraints on growth and spurring structural transformation of the economy. The strategy to achieve these goals is set out in the Poverty Eradication Action Plan (PEAP), which is undergoing its second revision. The Government's economic program is supported by the International Monetary Fund (IMF) with a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF), which was approved in September 2002. This memorandum of economic and financial policies (MEFP) reviews the recent performance under the program and describes the policies and targets for fiscal year 2004/05 (July-June), including actions that the Government has taken to address program slippages.

I. Recent Performance Under the PRGF-Supported Program

2. Overall, the Ugandan economy continues to perform well. Real GDP growth at market prices is estimated to have increased to about 6 percent in 2003/04 and inflation has been reduced to the low, single-digit rates that have prevailed for much of the past decade. Export earnings increased sharply in 2003/04, led by strong growth in noncoffee export volumes, contributing to a decrease in the external current account deficit excluding grants to 11½ percent of GDP. Net inflows of private capital and donor support were sufficient to cover this deficit, leading to a further buildup of gross international reserves to about 6½ months of imports as of end-June 2004. In real effective terms, the Uganda shilling was fairly stable in 2003/04. However, a brief period of volatility in the foreign exchange market in the quarter up to March 2004 required intervention by the Bank of Uganda (BOU).

3. Revenue collections were broadly on target, led by a strong performance in income tax collection that offset shortfalls in domestic VAT. Preliminary data indicates that total spending remained within the original budget limit for the year as a whole, but the composition of expenditure deviated from budget intentions. This was due mainly to supplementary appropriations in the final quarter, of which U Sh 88 billion were resource supplementaries, mainly to meet security needs, provide support to the Presidency, and cover salary shortfalls. Nonetheless, through March 2004, the fiscal deficit before grants was within program projections.

4. The monetary base expanded somewhat more rapidly than programmed during 2003/04. While the BOU tried to adhere to program targets, only marginally missing the December 2003 ceiling, stronger-than-expected growth in demand for currency resulted in excessive tightness in banks' reserve positions and exerted upward pressure on interest rates. In recent months these pressures have subsided, as the BOU reorientated its instrument mix into longer-term treasury bonds, introduced at the beginning of January 2004, and higher sales of foreign exchange through sterilization, thereby reducing pressure on short-term interest rates. Growth rates of broad money and commercial bank credit to the private sector have moderated in recent months, but still remain quite strong. Performance indicators suggest that banks' portfolios are generally sound.

5. In terms of the PRGF arrangement, all quantitative performance criteria for end-December 2003 were observed with the exception of the ceiling on base money and the accumulation of new domestic arrears on expenditures covered by the Commitment Control System (CCS). The end-December performance criterion for the accumulation of net international reserves was observed by a wide margin, as was the end-December performance criterion on net credit to the Government by the banking system. The continuous performance criterion that the Uganda Development Bank Limited (UDBL) not engage in any new lending until its divestiture is completed, however, was not observed, owing to a small loan (U Sh 91 million) contracted in March 2004. In addition, the indicative quarterly ceiling on cumulative public administration spending was breached for each of the quarterly test dates through March 2004, while cumulative expenditure under the Poverty Action Fund (PAF) fell short of each of its indicative quarterly floors.

6. On the structural program, progress has been made despite some delays:

• An initial offering of two-year treasury bonds was conducted in January, followed by offerings of longer-term bonds in subsequent months. (Benchmark for June 30, 2004.)

• On December 31, 2003, the Internal Auditor's Office of the Ministry of Finance, Planning and Economic Development (MFPED) issued its report on the stock of nonwage/nonpension arrears outstanding as of June 30, 2003. (Benchmark for December 31, 2003.)

• Nearly 75 percent of the domestic arrears accumulated on spending covered by the CCS during 2002/03, which totaled U Sh 11.8 billion, had been paid by June 2004. The remaining balance of these arrears will be paid by end-September 2004. (Full payment was a benchmark for March 31, 2004.)

• Government developed a time-bound plan for paying down nonwage, nonpension domestic arrears, according to age profile and other well-defined rules. In 2004/05, the budget is allocating U Sh 55 billion a year to paying down these arrears and other arrears, including pensions, wages, statutory court awards and utilities. In addition, the Government has designated a committee in the MFPED (Internal Audit, Treasury) to be responsible for executing the plans to clear all outstanding arrears and ensuring that no new arrears are accumulated. (Benchmark for June 30, 2004.)

• Cabinet approved the principles of a broad reform of the public pension scheme in April 2004. The Government is currently seeking financial support for this reform. It is expected that a time-bound plan to clear pension arrears, which is part of the broader pension reform, will be ready for adoption by Cabinet by end-September 2004. (Performance criterion for June 30, 2004.)

• In May 2004, the Uganda Revenue Authority (URA) rolled out the automated system for customs data (ASYCUDA++) at the new Customs Business Center; it merges two major customs points (the Railway General Station and the Kampala Longroom) that account for at least 60 percent of all customs transactions. This strategy replaced the previous plan of rolling out ASYCUDA++ to at least three stations other than the Kampala Longroom. (Benchmark for June 30, 2004.)

• The URA is preparing a register of the pay-as-you-earn tax by employee and tax bracket. Its target of identifying 75 percent for the late filers within 45 days, however, has not been consistently achieved. (Benchmarks for June 30, 2004.)

• A draft anti-money laundering bill has been circulated to all stakeholders for their comments in advance of submission to Cabinet. (Benchmark for June 30, 2004.) The BOU has received comments on the draft from commercial banks and other stakeholders and is currently reviewing the draft bill before submitting it to the Minister of Finance, Planning and Economic Development.

• The Government has decided on the divestiture option to follow for the UDBL. The UDBL will be merged with the Development Finance Department of the Bank of Uganda and management of the institution will be contracted to a private firm. In addition, the Government will divest of up to 30 percent of its shares. No new lending will be undertaken by the UDBL during the run-up to divestiture. (Performance criterion for March 31, 2004.)

7. Based on the circumstances and the corrective actions noted below, the authorities are requesting waivers for the nonobservance of the three missed quantitative performance criteria for December 2003 and, because of its late implementation, the nonobservance of the structural performance criterion for March 2004, regarding the divestiture of the UDBL.

• The nonobservance of the base money ceiling. The breach in December was relatively minor (U Sh 3.1 billion or less than ½ percent of the stock of base money at the beginning of the year), and warranted, given unexpected developments in the demand for money, observed mainly through higher currency issues. The BOU, together with the MFPED, will implement the recommendations of the IMF technical assistance mission of March 2004 to strengthen its liquidity management and forecasting capacity.

• The accumulation of new arrears under the CCS. The overcommitments (U Sh 2.1 billion) incurred during the first half of 2003/04 will be paid by end-December 2004, while any overcommitments incurred during the second half of the year will be cleared by end-June 2005. In line with the rules of the CCS, the payment of these obligations will use resources within each sector's expenditure ceiling. In the future, the Government will strive to have all overcommitments incurred in one quarter cleared during the following quarter in line with the rules of the CCS. The implementation of the integrated financial management system (IFMS) to all line ministries (and 10 local governments) in 2004/05 will facilitate the monitoring of performance under the CCS. Moreover, new pre-payment arrangements for utilities, as called for in the budget speech, should help eliminate an important source of arrears.

• New lending by the UDBL. The new loan contracted by the UDBL reflected poor communication between Government and UDBL management regarding the implementation of the PRGF-supported program. The Government has since informed UDBL management that all new lending should cease until the divestiture has been completed.

• Government decision on the divestiture of the UDBL. Having decided on the divestiture plan, Government will solicit bids from private investors for a minority share and management responsibilities of the UDBL by end-September 2004.

II. The Policy Agenda for 2004/05

8. In keeping with the revised PEAP, the policy agenda for 2004/05 aims at a further narrowing of the fiscal deficit before grants—which will require significant tax policy and tax administration measures to raise government revenues, and reductions in nonpriority spending—and public expenditure management measures to increase the effectiveness of government spending, especially on programs to reduce poverty. It includes financial sector measures to encourage the mobilization of resources for investment, and implementation of policies aimed at increasing Uganda's international competitiveness. These policies also aim to improve governance and raise the incomes of the poor.

9. It is envisaged that real GDP growth would be about 6 percent in 2004/05, while inflation would be held below 5 percent. To achieve the inflation objective, the BOU intends to limit the rate of growth of base money to 13.2 percent during the year. The overall fiscal deficit, excluding grants, will be reduced to 10.9 percent of GDP (from 11.2 percent of GDP in 2003/04), as government revenues grow from 12.6 percent of GDP in 2003/04 to 12.9 percent of GDP in 2004/05, while total spending remains roughly constant relative to GDP. Sterilization operations needed to mop up the injection of liquidity would thus be reduced, which is expected to further ease pressures on domestic interest rates and the exchange rate. The external current account deficit, excluding grants, is projected to widen to 13 percent of GDP in 2004/05, as the growth in export volume moderates from the strong performance in 2003/04, while the growth in imports is projected to remain strong. The current account deficit would be fully financed through net inflows of private capital and net donor inflows. Gross international reserves are expected to end the year at 6.2 months of imports.

10. Increasing government revenue is critical to the goal of reducing the fiscal deficit. In this regard, the Government will step up efforts to improve the operations of the URA. In the initial stage of the improvement process, the URA aims to build a database of tax payers and tax offenders; continue the cleanup of the taxpayer registries for VAT, corporate, withholding and personal income tax, and ensure their consistency with the tax identification number (TIN) and step up the number of comprehensive audits of large taxpayers.

11. To support the second phase of URA improvements, the Government is committed to restructuring the URA and implementing strong and definitive actions to underpin its integrity and professionalism. In this connection, the Government has appointed a new board of directors for the URA and will request assistance from the IMF to assess the structural and operational changes needed to strengthen the URA. The Government plans to follow up on these recommendations as part of the structural conditionality in subsequent program reviews. To fight corruption, the URA will pursue an investigation of the asset declarations of all URA officials at management level and develop a revised, integrated Code of Conduct for the institution. The Inspector General of Government (IGG) will be requested to follow up on the investigation of potential wrongdoing at the URA. Finally, steps will be taken to recruit additional staff and enhance the capacity of the workforce. When appropriate, disciplinary actions will be taken, including dismissal of staff.

12. While strengthening tax administration is essential for fairness and increased tax collections over the medium term, it will not suffice to meet the revenue needs in the year ahead, especially in light of the revenue loss that is expected from the launch of the East African Community (EAC) customs union, which could reach up to U Sh 75 billion (½ percent of GDP in the first 12 months). The 2004/05 budget proposal includes tax measures aimed at mobilizing additional revenue of about U Sh 30 billion (0.2 percent of GDP). The Government is committed to avoiding policies that might undermine revenue collection, including granting preferential tax treatment to specific investors or firms. To achieve greater transparency in the Government's policy of encouraging industrial development, beginning in 2004/05, the MFPED will submit to Parliament on an annual basis, a comprehensive list of companies that have benefited from tax expenditures, government subsidies, loan guarantees, and other incentives. The list would identify the nature of the benefits received.

13. Uganda's participatory budget process has helped align the 2004/05 budget with the priorities identified in the PEAP. In particular, the Government has given a priority to funding key poverty-reduction sectors, including education and health. In addition, it has provided funds for the scheduled implementation of the Plan for the Modernization of the Agriculture (PMA), the maintenance of basic infrastructure (such as roads), as well as to cover some major initiatives to strengthen governance and fight corruption. In the defense sector, an increase in spending will be dedicated to defense modernization, guided by the 2003 Defense Review; this will support efforts to restore peace in the North.

14. Looking ahead, in order to generate savings to fund the revised PEAP's priorities, including those related to security, the Government remains committed to streamlining public administration. To achieve this objective, a number of far-reaching measures will be adopted to generate annual savings from the public administration sector of at least U Sh 15 billion within the next three years.

15. In recent years, substantial progress has been made in implementing a transparent budget process, which is essential for achieving a high degree of effectiveness in government programs. Nevertheless, budget execution is still subject to some highly distortionary practices. In particular, the existence and accumulation of domestic arrears and the addition of unfunded supplementary spending over the course of the year typically result in budget outturns that deviate substantially from budget intentions, especially for expenditures not protected under the PAF. In light of these weaknesses, the Government is committed to strengthening both budget formulation and execution through the following steps:

• To improve the budgeting of public sector wages, a policy paper will be sent to Cabinet by end-September 2004 for harmonizing sector specific pay reforms within the overall pay reform strategy.

• The regulations of the Public Finance and Accountability Act (PFAA) will be amended by end-December 2004, including provisions to ensure proper ex-ante and ex-post integration of donor projects into the budget, and that proper reporting agreements are in place.

16. Clearing outstanding arrears and eliminating new arrears remains a challenge. Beginning in 2004/05, the following steps will be taken to strengthen the strategy for dealing with the existing stock of arrears and avoid the emergence of new arrears:

• A government team will be assigned full responsibility for the execution of the plan to clear the current stock of nonwage, nonpension arrears according to age profile (including the outstanding stock of nearly U Sh 40 billion post-CCS overcommitments accumulated between the implementation of the CCS and June 2002), as well as for the strict enforcement of the CCS. Moreover, the CCS will be expanded to cover all types of expenditure and will be computerized within all central government ministries by June 2005, in conjunction with the implementation of the integrated financial management system (IFMS).

• To further strengthen the control of arrears, the Treasury will work more closely with the Ministry of Public Service and the Privatization Monitoring Unit (PMU) to improve compilation and verification of the stock of all arrears at any given date, including those for wages, pensions, utilities, unpaid court awards, nonwage recurrent and development expenditures. The verified arrears will be classified by type and, to the extent possible, by age profile, in a manner that will allow the updating of the stock as information on the flow of new arrears and/or their clearing emerges from the IFMS.

• Prepayment arrangements for telephone services will be extended to all line ministries by end-December 2004; similar arrangements will be explored for other utilities.

17. With one-third of PAF spending executed by local governments, there is a need to upgrade the capacity for accounting and reporting by local governments and the monitoring of their activities. In 2003/04, the Government implemented the fiscal decentralization strategy (FDS) to achieve such an upgrade, with 15 pilot local governments. Fiscal decentralization will be expanded in 2004/05 to the remaining local governments and 13 municipalities. These local governments will be subject to the new budgeting and planning manuals under the FDS to ensure better reporting and greater accountability. In addition, 4 of the pilot local governments started implementing the IFMS in January 2004. Technical assistance from the IMF is being provided to facilitate some of these initiatives and strengthen the public expenditure management systems at the subnational level, including the implementation of the CCS for local governments and the development of adequate fiscal reporting and poverty-reducing expenditure tracking under the FDS. Other policies geared toward improving public expenditure management include the ongoing implementation of the new chart of accounts, which establishes uniform budget classifications across all local governments (for both pilot and non-pilot governments in the strategy). Finally, the FDS envisages the completion of sector policy reviews, with the aim of aligning sector policies with the decentralization strategy of the Government.

18. On monetary policy, to maintain low inflation and a stable environment for financial intermediation and the foreign exchange market, the BOU will continue to target base money. Broad money (M2), excluding foreign currency deposits, is projected to expand by 15.1 percent in 2004/05, while bank credit to the private sector is expected to increase by at least 16.0 percent. The BOU will implement a number of recommendations of the recent IMF technical assistance mission aimed at strengthening the liquidity management framework.

19. Mobilizing domestic financial resources for investment is an important element to enabling stronger economic growth. The Government has recently prepared a proposal for a reform of the pension system, which could generate substantial long-term savings for private sector capital formation. A proposal for reforming the public pension system will ensure that all government obligations under the reform are incorporated into the budget. As such, excessive guarantees of minimum benefits will be avoided by switching to a defined contributions system and debts arising from the transition to a capitalized pension system would be explicit. As part of the pension reform, a restructuring of the National Social Security Fund (NSSF) will be needed. For this purpose, it is necessary to establish a qualified and independent regulator for the NSSF as soon as possible. By December 2004, the Government will submit a bill to Parliament for the repeal of the NSSF Statute, which would establish the BOU as the interim supervisor.

20. Other measures to facilitate term lending to productive sectors and, more broadly, financial services to rural areas and small towns will be implemented in 2004/05. As stated above, the UDBL will be restructured in a manner that ensures its sustainability through sound financial management. In addition, the MFPED has embarked on an outreach plan for micro-finance institutions (MFIs), with the goal of increasing the capacity of staff and management of MFIs and encouraging their expansion into areas that presently lack access to financial services. In order to promote the development of the MFI sector, the Government will limit its involvement in the sector to capacity building and regulation. Under the new Microfinance Deposit Taking Institutions Act, about five MFIs are currently in dialogue with BOU in preparation for licenses to act as deposit-taking institutions. These MFIs would be subject to BOU regulatory supervision and would offer the potential for substantial savings by, and intermediation for, small-scale clients. In order to further foster financial sector development, the Government will undertake a diagnostic review of the Housing Finance Corporation of Uganda, with the intention of increasing private equity participation in the institution. The Government also intends to divest the National Insurance Corporation. The Financial Institutions Act will help to maintain the soundness of the financial system.

21. To increase productivity, enhance Uganda's international competitiveness, and achieve a more sustainable and less vulnerable external position, the Government will continue to base its policies on the Medium-Term Competitiveness Strategy (MTCS), the Plan for the Modernization of Agriculture (PMA), and the Strategic Exports Program (SEP), which emphasize creating an enabling environment for private business and commercial agriculture.

22. On March 2, 2004, the heads of state of Kenya, Tanzania, and Uganda signed the protocol for the customs union as a transitional stage to a more integrated EAC. The tariff rates agreed for the common external tariff (CET) are higher than Uganda's current tariff structure. However, all discriminatory excise taxes and other charges imposed on imports that currently exist will be removed when the CET comes into effect, thus mitigating the negative impact on competitiveness. Business opportunities are expected to grow under the customs union with its market of 90 million people, which would encourage new investment. Through the auspices of the EAC, Uganda hopes to tap the region's vast potential in mineral, water, energy, forestry and wildlife resources, and, as a first step in this direction, will seek major improvements to regional infrastructure, particularly in the areas of transportation and communications.

23. As discussed in the draft revised PEAP, the Government plans to introduce Export Processing Zones (EPZs) and Export Processing Villages (EPVs) in 2004/05. To ensure the integrity of these operations and to avoid unfair competition in the domestic market, it will be necessary to securely enclose these areas with strict implementation of customs duties and other taxes on sales to Ugandan residents. Moreover, any incentives will avoid elements that could seriously erode the tax base. The Government will also propose to the EAC Secretariat that the other member states adopt a common code of conduct for investment incentives and company income taxation to avoid harmful tax competition.

24. Notwithstanding the progress made in the past year in obtaining debt relief under the HIPC Initiative, Uganda still faces an unsustainable external debt situation. The Government is taking steps to improve this situation not only by encouraging exports, but also by exercising better debt management. The strategy of borrowing on IDA-equivalent terms or better has generally been adhered to; in addition, beginning in 2004/05, the Government will set caps on new borrowing consistent with its fiscal deficit reduction strategy and debt sustainability. Further, by end-December 2004, the Government will issue instructions that clarify the responsibilities of all departments and agencies involved in contracting external debt, as well as in the operations of broader debt management. Consistent with PFAA regulations and Treasury Office of Accounts (TOA) instructions, the Government will clarify monitoring and operational procedures for the contraction of external debt and debt management by end-June 2005.

III. Medium-Term Macroeconomic Policy Issues

25. The 2003 household survey revealed that the incidence of poverty has increased somewhat in recent years and income inequality has risen markedly further. While the rise in poverty was fairly widespread throughout the country and across income levels, except for the top quintile, it appears that migration away from regions of insecurity and reduced earnings in agriculture were important factors behind this setback. In addition, the slowdown in economic growth in recent years limited the opportunities for raising incomes.

26. These developments have informed the second revision to the PEAP, which will provide an updated framework for government policies to reduce poverty. In particular, greater emphasis will be accorded to raising rural incomes by increasing agricultural productivity, improving the allocation of public resources, accelerating the process of structural transformation, and establishing security for all regions of the country. As a priority, over the medium term, the Government will allocate additional resources for the modernization of the Ugandan People's Defense Forces (UPDF). This increased spending will need to be (partially) funded through efficiency savings, including in the defense sector, and cuts in nonpriority areas, in order to ensure both the maintenance of fiscal sustainability and the protection of critical social expenditure. To address the need to increase agricultural productivity and rural incomes, the Government is committed to stepping-up the implementation of the PMA.

27. Economic policies will focus on spurring export-led private sector growth, while enhancing fiscal and external sustainability. Central to this strategy is the gradual reduction in the fiscal deficit over the medium and long term. Sterilization of large fiscal injections of liquidity can lead to high interest rates and an excessively strong national currency that crowds out private investment and the export sector. It will be necessary to keep these pressures under control. The success of this strategy will depend on strong annual increases in government revenues coupled with spending restraint. At the same time, there is a need to increase the effectiveness of government spending to ensure that public service delivery continues to improve.

Table 2. Uganda: Structural Performance Criteria and Benchmarks for 2003/04 and 2004/05
Policy Measure	To Be Implemented by:
Structural Performance Criteria
Adoption by cabinet of a time-bound plan to clear the stock of pension arrears.	June 30, 2004
Start second phase of Improvement of the URA: Prepare a revised comprehensive Code of Conduct for all URA staff Complete verification of the asset declarations of all URA management staff.	September 30, 2004
Amend the regulations of the Public Finance and Accountability Act (PFAA) to (i) ensure proper ex-ante and ex-post integration of donor projects into the budget, and (ii) to clarify the responsibilities of all departments and agencies involved in contracting external debt as well as in the operations of broader debt management.	December 31, 2004
Structural Benchmarks
Include in the documents for the 2004/05 budget an update of plan for clearing the stock of nonpension arrears.	June 30, 2004
Cabinet to approve measures to streamline the public administration generating total annual savings of at least U Sh 15 billion within the next three years.	June 30, 2004
Complete initial stage of the Improvement of the Uganda Revenue Authority (URA): Roll out automated system for customs data (ASYCUDA++) to at least three stations other than the Kampala long room. Identify 75 percent of late filers within 45 days of the statutory filing period. Prepare registry of pay-as-you-earn (PAYE) per employee and tax bracket. Step up the number of comprehensive audits on large taxpayers by 30 percent.	June 30, 2004 June 30, 2004 June 30, 2004 September 30, 2004
Payoff arrears accumulated under the Commitment Control System (CCS) in 2002/03.	September 30, 2004
Solicit bids from private investors for a minority share and management responsibilities of the UDBL.	September 30, 2004
MFPED will submit to Parliament on an annual basis a list of companies receiving subsidies and other benefits from the Government, and the costs of such benefits.	September 30, 2004
Issue the implementing regulations for the new Financial Institutions Act.	September 30, 2004
Payoff arrears accumulated under the Commitment Control System (CCS) in the first half of 2003/04.	December 31, 2004
Verify the overall stock of arrears for all ministries for which IFMS was rolled out by end-June 2004, in a manner that will allow subsequent updating of the stock per ministry with information from the IFMS.	December 31, 2004
Submit to cabinet an anti-money laundering bill.	December 31, 2004
Submit a bill to parliament to repeal the National Social Security Fund (NSSF) statute to pave the way for the regulation of the NSSF by the BOU.	December 31, 2004

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Technical Memorandum of Understanding
(July 13, 2004)

A. Introduction

28. This memorandum defines the quantitative benchmarks and performance criteria described in the memorandum of economic and financial policies (MEFP) for the 2004/05 financial program that would be supported by the IMF Poverty Reduction and Growth Facility (PRGF), and sets forth the reporting requirements under the arrangement.

B. Base Money

29. Base money is defined as the sum of currency issued by Bank of Uganda (BOU) and the commercial banks' deposits in the BOU. The commercial bank deposits include the statutory required reserves and excess reserves held at the BOU and are net of the deposits of closed banks at the BOU and Development Finance Funds (DFF) contributed by commercial banks held at the BOU. Under this definition, the daily average of June 2004 base money was estimated at U Sh 809 billion. The base money limits for the 2004/05 program will be cumulative changes from the daily average of June 2004 to the daily average of September 2004, December 2004, March 2005, and June 2005, and will be monitored by the monetary authority and provided to the IMF by the BOU.

C. Net Claims on the Central Government by the Banking System

30. Net claims on the central government (NCG) by the banking system base defined as the difference between the outstanding amount of bank credits to the central government and the central government's deposits with the banking system, excluding deposits in project accounts. Credits comprise bank loans and advances to the government and holdings of government securities and promissory notes. NCG will be calculated based on data from balance sheets of the monetary authority and commercial banks as per the monetary survey. The limits on the change in net claims on the central government by the banking system will be cumulative beginning end-June 2004 for the 2004/05 program.

D. Net International Reserves of the Bank of Uganda

31. Net international reserves (NIR) of the BOU are defined for program monitoring purpose as reserve assets of the BOU net of short-term external liabilities of the BOU. Reserve assets are defined as external assets readily available to, and controlled by, the BOU and exclude pledged or otherwise encumbered external assets, including, but not limited to, assets used as collateral or guarantees for third-party liabilities. Short-term external liabilities are defined as liabilities to nonresidents, of maturities less than one year, contracted by the BOU and include outstanding IMF purchases and loans.

32. For program-monitoring purposes, reserve assets and short-term liabilities (excluding liabilities to the IMF) at the end of each test period will be calculated by converting reserve assets measured in Uganda shillings as reported by the BOU using the end-month Uganda shilling per U.S. dollar exchange rate. The U.S. dollar value of outstanding purchases and loans from the IMF will be calculated by converting the outstanding SDR amount reported by the Finance Department of the IMF using the U.S. dollar per SDR exchange rate at the end of each quarter.

E. Expenditures Under the Poverty Action Fund

33. The expenditures under the Poverty Action Fund (PAF) include both wage and nonwage current expenditures under the PAF, and domestic development expenditures under the PAF. The minimum cumulative expenditures under the PAF are defined in Schedule A below. PAF expenditures will be measured based on checks cashed by central government units and line ministries, and releases to local governments.

F. New Domestic Budgetary Arrears of the Central Government

34. The nonaccumulation of new domestic payment arrears under the Commitment Controls System (CCS) is an indicative target to September 2004 and March 2005 and a performance criterion to December 2004 and June 2005. New domestic payments arrears are defined as the sum of (i) any bill that has been received by a spending ministry from a supplier of goods and services delivered (and verified), and for which payment has not been made within 30 days under the recurrent expenditure budget or the development expenditure budget. For the purpose of program monitoring, the monthly reports for both recurrent and development expenditure under the CCS will serve as audits of arrears to September 2004, December 2004, and to March 2005, while the annual report by the Internal Auditor Office's of the Ministry of Finance, Planning and Economic Development (MFPED) at end-June 2005 shall be used to determine the new arrears created during the entire 2004/05 fiscal year. The result of these audits should be available no later than seven weeks following the close of the covered period.

G. Ceiling on Public Administration Expenditures

35. The quarterly expenditure limits for the public administration sector are defined in Schedule B. For the purpose of program monitoring, the public administration sector includes all expenditure (excluding that financed by donor projects) of the following votes: Office of the Prime Minister (003) (excluding development), Foreign Affairs (006), Missions Abroad (201-223), National Planning Authority (108), URA (008), State House (002), Public Service (005), Public Service Commission (027), Local Government (011) (excluding development), Mass Mobilization (135), Office of the President (001) (excluding ISO/ESO and E&I), Specified Officers' Salaries (100), Parliamentary Commission (104), Local Government Finance Commission (147), Uganda Human Rights Commission (106), and Electoral Commission (102). Any supplementary allocation of votes in the public administration sector that would exceed program ceilings will be accommodated by cuts in votes belonging to other categories within this same sector. Public administration expenditures will be measured by the cash releases to the line ministries and other government units listed above.

H. Promissory Notes

36. A promissory note is a written promise by the government to pay a debt, where government is defined as the central government,¹ local governments, and autonomous government agencies. It is an unconditional promise to pay on demand or at a fixed or determined future time a particular sum of money to, or to the order of, a specified person or to the bearer. The government will not use promissory notes or any form of a promise to pay for goods and services at a future date, and all domestic arrears payments will be settled in cash or by the transfer of immediately available funds.

I. Adjusters

37. The NIR target is based on assumptions regarding import support, assistance provided under the Heavily Indebted Poor Countries (HIPC) Initiative, and external debt-service payments. The NCG target, in addition to being based on the two aforementioned assumptions, is also based on assumptions regarding domestic nonbank financing of central government fiscal operations.

38. The Uganda shilling equivalent of import support (grants and loans) plus HIPC Initiative assistance in the form of grants on a cumulative basis from July 1, 2004 onward is presented under Schedule C. The ceiling on the cumulative increase in NCG will be adjusted downward (upward), and the floor on the cumulative increase in NIR of the BOU will be adjusted upward (downward) by the amount by which import support, grants and loans, plus HIPC Initiative assistance, exceeds (falls short of) the projected amounts.

39. The ceiling on the increases in NCG will be adjusted downward (upward) and the floor on the increase in NIR will be adjusted upward (downward) by the amount by which debt service due² plus payments of external debt arrears less deferred payments (exceptional financing) falls short of (exceeds) the projections presented in Schedule D. Deferred payments are defined to be (i) all debt-service rescheduled under the HIPC Initiative; and (ii) payments falling due to all non-HIPC Initiative creditors that are not currently being serviced by the authorities (that is, gross new arrears being incurred).

40. The ceiling on the increase in NCG will be adjusted downward (upward) by any excess (shortfall) in nonbank financing³ less payment of domestic arrears accumulated prior to introduction of the CCS (up to a maximum amount of U Sh 55 billion) relative to the programmed cumulative amounts presented in Schedule E.

41. The base money ceiling will be adjusted upward up to a maximum of U Sh 10 billion in September 2004, December 2004, March 2005, and June 2005 if the amount of currency issued by the BOU exceeds those projected in Schedule F.

42. The Development Finance Department of the BOU provides export credit guarantee schemes (ECGS) to commercial banks. As of May 2004, the outstanding ECGS amounted to U Sh 3.05 billion, which have a maximum guarantee period of six months. These contingent liabilities fall due on the BOU balance sheet, and therefore do not affect the program targets for the NIR and the NCG.

J. Nonconcessional External Borrowing Contracted or Guaranteed
by the Central Government, Statutory Bodies, or the Bank of Uganda, and Arrears

43. The program includes a ceiling on new nonconcessional borrowing with maturities greater than one year contracted or guaranteed by the government, statutory bodies, or the BOU.⁴ Nonconcessional borrowing is defined as loans with a grant element of less than 35 percent, calculated using average commercial interest rates references (CIRRs) published by the Organization for Economic Cooperation and Development (OECD). In assessing the level of concessionality, the 10-year average CIRRs should be used to discount loans with maturities of at least 15 years, while the 6-month average CIRRs should be used for loans with shorter maturities. To both the 10-year and 6-month averages, the following margins for differing payment periods should be added: 0.75 percent for repayment periods of less than 15 years; 1 percent for 15-19 years; 1.15 percent for 20-25 years; and 1.25 percent for 30 years or more. The ceiling on nonconcessional external borrowing is set at zero and is to be observed on a continuous basis. The coverage of borrowing includes financial leases and other instruments giving rise to external liabilities, contingent or otherwise, on nonconcessional terms. Excluded from the limits are changes in indebtedness resulting from refinancing credits and rescheduling operations, and credits extended by the IMF. For the purposes of the program, arrangements to pay over time obligations arising from judicial awards to external creditors that have not complied with the HIPC Initiative do not constitute nonconcessional external borrowing.

44. The definition of debt, for the purposes of the limit, is set out in point 9 of the Guidelines on Performance Criteria with Respect to External Debt (Executive Board's Decision No. 12274-(00/85), August 24, 2000). It not only applies to the debt as defined in Point 9 of the Executive Board decision, but also to commitments contracted or guaranteed for which value has not been received. The definition of debt set forth in No. 9 of the Guidelines on Performance Criteria with Respect to External Debt in IMF Arrangements reads as follows:

"(a) For the purpose of this guideline, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers' credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers' credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair, or maintenance of the property.

(b) Under the definition of debt set out in point 9(a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt."

45. The ceiling on the accumulation of new external payments arrears is zero. This limit, which is to be observed on a continuous basis, applies to the change in the stock of overdue payments on debt contracted or guaranteed by the government, the BOU, and statutory bodies⁵ from their level at end-June 2004. It comprises those external arrears reported by the Trade and External Debt Department of the BOU, the Macro Department of the Ministry of Finance that cannot be rescheduled because they were disbursed after the Paris Club cutoff date.

K. Monitoring and Reporting Requirements

46. The authorities will inform the IMF staff in writing at least ten business days (excluding legal holidays in Uganda or in the United States) prior to making any changes in economic and financial policies that could affect the outcome of the financial program. Such policies include but are not limited to customs and tax laws (including tax rates, exemptions, allowances, and thresholds), wage policy, and financial support to public and private enterprises. The authorities will similarly inform the IMF staff of any nonconcessional external debt contracted or guaranteed by the government, the BOU, or any statutory bodies, and any accumulation of new external payments arrears on the debt contracted or guaranteed by these entities.

47. The information, such as the issuance of treasury bills, the intervention in the foreign exchange market, daily average exchange rates, and the interest rate on government securities, will be transmitted to the IMF's resident representative weekly, within five working days of the end of each week.

48. The BOU will reconcile the monetary survey data with the financial statements on an annual basis and with the financial records on a quarterly basis. The Internal Audit Department (IAD) of the BOU will review the reconciliations of monetary survey data with the financial records and the audited financial statements.

49. The government will provide the IMF staff with a summary of the fiscal accounts, both on a monthly and quarterly basis, with a seven-week lag from the end of the reporting month and quarter. Revenues will be recorded on a cash basis as reported by the Uganda Revenue Authority and the MFPED. Expenditures shall be recorded when checks are issued, except for domestic and external debt-service payments, cash transfers to districts, and externally funded development expenditures. Expenditures on domestic interest will be recorded on an accrual basis and external debt service will be recorded on a commitment basis (i.e., when payment is due). Cash transfers to districts will be recorded as expenditures of the central government when the transfer is effected by the BOU. Expenditures on externally funded development programs will be recorded as the sum of estimated disbursements of project loans and grants by donors, less the change in the stock of government project accounts held at commercial banks in Uganda. Information on required and approved supplementary allocations in each month should be provided to the IMF within 15 days of the end of each month.

50. The government will provide the IMF staff with a summary of expenditure cash limits on a quarterly basis with a one-week lag from the date they are provided to ministries, and no later than two weeks after the beginning of the quarter.

51. The government will provide the IMF staff with a summary of the contingent liabilities of the central government on a quarterly basis with a seven-week lag from the end of the reporting quarter. For the purpose of the program, contingent liabilities include all borrowings by statutory bodies, loans borrowed by public enterprises or the private sector and guaranteed by the government, claims against the government in court cases that are pending, or court awards that the government has appealed.

52. Final accounts of the local government authorities for fiscal-year 2002/03 will be consolidated by end-September 2004 by the Ministry of Finance, Macro Department. The summary Status of Submission of District Monthly Accounts Returns will be provided to the IMF Resident Representative within 45 days of the end of each month. A report explaining any noncompliance with the monthly reporting requirement by districts will be provided at the same time as the summary status report to the IMF. Any noncompliance by 45 days following the end of a month will result in a reminder letter being sent from the Treasury Inspectorate Department to the District Chairperson. Any noncompliance for an additional month will result in a memorandum being sent from the Commissioner of the Treasury Inspectorate Department to the Budget Director indicating that the monitoring and accountability grants to the noncompliance districts should be discontinued until compliance is restored. A memorandum indicating this action will be sent to each noncompliant district.

53. The quarterly summaries prepared under the CCS and the overcommitments not backed by cash accumulated in the previous quarter that was cleared in the current quarter will be provided to the IMF staff within 40 days after the end of each quarter.

54. As supplementary information, the government will provide the IMF staff on a monthly basis, with a seven-week lag from the end of the reporting month, a statement of the following: (i) outstanding stock of checks issued by the Uganda Computer Services of the MFPED, disaggregated into checks issued for commitments arising during July 1, 2004 through June 30, 2005, and checks issued to settle intraministerial payment obligations; and (ii) the value of budget support (grants and loans) received by the government, and the value of projections of donor project support received so far. The government will provide the IMF forecasts of the value of budget support and project support (grants and loans) expected to be received for the rest of the current year and the medium term, by donor and sector, by the end of each reporting quarter.

55. As supplementary information, the BOU will provide the IMF staff on a monthly basis, with a seven-week lag from the end of the reporting month, a statement of the following: (i) cash balances held in project accounts at commercial banks; (ii) total value (measured at issue price) of outstanding government securities from the Central Depository System (CDS); and (iii) the stock of government securities (measured at issue price) held by commercial banks from the CDS.

56. The government will provide the IMF staff on a quarterly basis, with a seven-week lag from the end of the reporting quarter the following: (i) a statement on new loans contracted during the period as per the loan agreement, with additional information on disbursement provided within six months; and (ii) a statement on creditor participation in the HIPC Initiative, the status of creditor litigation cases, and cash payments relating to the settlement of awards.

57. The BOU will provide the IMF staff on a quarterly basis, with a seven-week lag from the end of the reporting quarter, (i) monthly commodity and direction of trade statistics; (ii) the stock of debt, disbursements, principal and interest, flows of debt rescheduling and debt cancellation, arrears, and committed undisbursed balances—by creditor category; and (iii) the monthly composition of nominal HIPC Initiative assistance, disaggregated into grants, flow rescheduling, and stock-of-debt reduction by creditor.

58. The consumer price index will be transmitted monthly to the IMF with no more than a two-week lag from the end of the reporting month. The balance sheet of the BOU, the consolidated accounts of the commercial banks, and the monetary survey will be transmitted to the IMF on a monthly basis with a lag of no more than seven weeks from the end of the reporting month.

59. Standard off-site bank supervision indicators for deposit money banks will be transmitted to the IMF quarterly and on-site reports transmitted as needed, based on the findings of the off-site reports.