Report No: 97146-UG Economic Diversi cation and Growth June 2015 Joint Report of the World Bank and the Government of Uganda Uganda Country Economic Memorandum Economic Diversification and Growth in the Era of Oil and Volatility JUNE 2015 Joint Repor t of the World Bank and the Government of Uganda THE REPUBLIC OF UGANDA Contents Contents List of Acronyms................................................................................................... viii I. The Development of the Oil Sector������������������������������������������������������������������� 27 Preface.....................................................................................................................x II. The Macroeconomic and Fiscal Impact of Oil Production - Acknowledgments.................................................................................................xii A Baseline Scenario������������������������������������������������������������������������������������������ 32 Executive Summary..............................................................................................xv III. The Development of Uganda’s Mineral Sector�������������������������������������������������� 37 IV. The Macroeconomic and Fiscal Impact of the Mineral Sector�������������������������� 39 Pa r t I - V. Oil and Competitiveness����������������������������������������������������������������������������������� 40 A n E co n o m i c D e v e lo p m en t and D i v e r s i f i c at i o n S t r at e g y - Ma i n G o a l s �������������� 1 A. Dutch Disease: a textbook explanation������������������������������������������������� 40 B. Macroeconomic foundations of the resource curse/Dutch Disease������ 40 C. Other issues������������������������������������������������������������������������������������������� 43 C hapt er 1 Uganda’s Economy: Recent Developments, Current Economic Structure, Government Strategy, Opportunities for Economic Diversification�����������������������������������������������������������3 Pa r t II - POLICY PRIORITI E S A RO U N D FO U R B U IL D I N G B LOC K S ��������������������������������������������� 4 7 I. Recent Economic Developments������������������������������������������������������������������������������3 II. Salient Features of the Ugandan Economy���������������������������������������������������������������6 A. The supply-side of the economy�������������������������������������������������������������������7 B. The demand-side of the economy���������������������������������������������������������������10 Ch a p te r 3 C. Trade orientation������������������������������������������������������������������������������������������11 Strategic Implications of Oil and Mineral Sector Development: Short and Medium- D. Linkages analysis����������������������������������������������������������������������������������������12 Term Objectives����������������������������������������������������������������������������������������������������������� 49 III. The Government Strategy���������������������������������������������������������������������������������������14 IV. Economic diversification - A Sound Objective��������������������������������������������������������15 I. Supporting the Growth, Extending the Life of the Oil and Mining Sectors�������� 50 V. Lessons for Uganda - How Far Can Uganda Diversify?�����������������������������������������19 Ii. Maximizing the Economic and Fiscal Benefits to be Derived From Oil And A. Nurturing existing productive capabilities���������������������������������������������������19 Mining Exploitation�������������������������������������������������������������������������������������������� 50 B. Expanding export possibilities���������������������������������������������������������������������20 A. Transparent exploration and production licensing systems����������������� 50 B. Competent contract negotiations���������������������������������������������������������� 51 C. Mobilizing the largest possible tax take for the government ���������������� 51 C hapt er 2 D. Encouraging linkages through realistic Local Content Policies������������� 52 III. Minimizing the Negative Impact Of Oil and Mineral Resources����������������������� 59 Development of Oil and Other Extractives: Prospects of Oil and Mining Sector, A. Impact of oil and mineral resources on the environment ��������������������� 59 Macroeconomic and Fiscal Impact������������������������������������������������������������������������������������27 B. Impact of oil and mineral resources on other economic sectors����������� 59 IV. Using Oil Revenue to Reduce Poverty and Inequality�������������������������������������� 60 ii Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Chapt er 4 IV. Priorities for Public Sector Interventions �������������������������������������������������� 107 Strategic Implications of Oil and Mineral Sector Development: Long-Term Objective and Sustainability���������������������������������������������������������������������������������������������������������������65 Ch a p te r 7 I. Measuring the Growth of Long-term Capital - A Wealth Analysis���������������������������65 II. Size and Pace of Investment - Domestic and External Assets�������������������������������68 Implementation of the Strategy: The Impact of Regional Integration�������������� 111 III. Sector selection - Infrastructure or Human Capital�������������������������������������������������71 I. Uganda Derives Substantial Benefits from Its Participation in the EAC��� 111 IV. Public Finance Implications of Alternative Strategies��������������������������������������������73 II. Regional Integration also Depends on Improved Regional A. Two alternative scenarios�����������������������������������������������������������������������������74 Infrastructure and Services���������������������������������������������������������������������� 116 B. Clear fiscal rules - Savings and the NONG fiscal deficit�����������������������������76 III. New/Increased Production of Oil, Gas and Minerals in Uganda, C. Other issues: mobilization of domestic taxes����������������������������������������������79 Tanzania and Kenya Will Influence the Structure and the Benefits of D. Other issues: spending pressures���������������������������������������������������������������81 Regional Trade ........................................................................................... 119 IV. The Positive and Negative Impact of a Future Monetary Union ............. 121 Par t I I I - G ove rn m e n t Ac t i on s N e c e s s a r y to A dd r e s s S p e c i f i c I m p l e m en tat i o n I s s ue s  ��������������������������������������� 83 References:...................................................................................................... 125 Annexes: Chapt er 5 Annex 1: Non-hydrocarbon Government Revenue for Resource-rich Countries, 1992–2012....................................................................................... 129 Implementation of the Strategy : The Role of Improved Public Sector Management�����83 Annex 2: Key Features of the Uganda Dynamic Stochastic General Equilibrium I. Strengthening Uganda’s Public Sector Institutions�������������������������������������������������87 (DSGE) model................................................................................. 130 II. Improved Governance, Public Finance Management, Public Investment Annex 3: Key Features of the Uganda Macroeconometric Model (MacMod-UG) Performance, and Management of Expectations����������������������������������������������������89 135 A. Governance, corruption and accountability������������������������������������������������89 Annex 4: Key Features of the Uganda Maquette for MDG Simulations (MAMS) B. Public finance management������������������������������������������������������������������������93 model ............................................................................................. 143 C. Public investment management �����������������������������������������������������������������96 Annex 5: Key Features of the Uganda Overlapping Generations (OLG) model 146 Chapt er 6 Annex 6: Econometric Results of Firm Productivity and Export Analysis....... 155 Implementation of the Strategy: The Role of the Private Sector�������������������������������������99 Annex 7: Key Drivers of Mineral Development............................................... 158 I. The Private Sector as a Development Agent����������������������������������������������������������99 II. Current Situation and Prospects of Uganda’s Private Sector��������������������������������101 III. Specific Sectoral Issues����������������������������������������������������������������������������������������103 iii Contents Figures Figure 1: Export Diversification and Per Capita Income Growth in Oil- Figure 1.12: Sectoral Share of Imports (In Percent)................................. 12 producing Countries.................................................................................xvi Figure 1.13: Linkage Analysis of Uganda, 2009/10................................. 13 Figure 2: Uganda’s Export Trade..............................................................xvi Figure 1.14: Manufacturing Exports and GNI.......................................... 17 Figure 3: Economic Viability of Oil Areas Depending on Future Figure 1.15: Export Diversification and GNI............................................. 17 Barrel Price.............................................................................................. xviii Figure 1.16: Natural Resources and Manufacturing Exports................... 17 Figure 4: Impact of Oil Price on Projected Government Petroleum Figure 1.17: Natural Resources and Export Diversification..................... 17 Revenue.................................................................................................. xviii Figure 1.18: Uganda’s Traditional Exports Have the Lowest PCI, Its Figure 5: Higher Corruption (Less Transparency) in Natural Resource-rich Manufactured Ones the Highest.............................................................. 20 Countries..................................................................................................xxi Figure 1.19: Economic Complexity and GDP Per Capita......................... 21 Figure 6: Transparency and Economic Performance in Oil-producing Figure 1.20: Coffee’s Dominance Had Given Way to Other Products (Raw and Countries..................................................................................................xxi Processed). Traces of Manufactures are Emerging................................. 24 Figure 1.1: GDP Per Capita Growth Figure 2.1: Major Oil Producers in the World........................................... 28 (Annual Percent)........................................................................................ 4 Figure 2.2: Projected Oil Production........................................................ 30 Figure 1.2: Real GDP Growth Across Selected Sectors (Index 2003/04=100).................................................... 4 Figure 2.3: Economic Viability of Oil Areas Based on Varying Oil Prices.30 Figure 1.3: Uganda’s Recent Growth Lower than Long-term Average..... 5 Figure 2.4: Sector Contribution to GDP (Percent of Overall GDP)........... 31 Figure 1.4: Uganda’s Recent Growth lower than Comparators................. 5 Figure 2.5: Impact of Oil Price on Projected Government Petroleum Figure 1.5: Structure of Aggregate Supply................................................ 7 Revenue (US$ million).............................................................................. 32 Figure 1.6: Sectoral Contribution to GDP.................................................. 7 Figure 2.6: Source of Government Petroleum Revenue Figure 1.7: Labor Productivity in Oil-producing ....................................... 8 (at US$ 90 Per Barrel).............................................................................. 32 Nations...................................................................................................... 8 Figure 2.7: Uganda’s Real GDP Growth Path (With and Without Oil)....... 33 Figure 1.8: Sector Employment in Uganda............................................... 8 Figure 2.8: Uganda’s Per Capita GDP (With and Without Oil)................. 33 Figure 1.9: Taxes Structure (In Percent).................................................... 8 Figure 2.9: Uganda’s Trade Balance (With Oil)........................................ 34 Figure 1.10: Structure of Aggregate Demand.......................................... 10 Figure 2.10: Uganda’s Nominal vs. Real Exchange Rate........................ 34 Figure 1.11: Output Share of Exports (In Percent).................................. 12 Figure 2.11: An Illustration of the Dutch Disease..................................... 39 iv Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 2.12 : Hydrocarbon and Non-hydrocarbon Revenues Figure 4.14: Tax Revenue Inefficiency and Non-Oil Domestic (In Percent of GDP), 1992-2012............................................................... 43 Revenue (Percent Non-oil GDP)............................................................... 78 Figure 3.1: Status of Licensing................................................................. 51 Figure 4.15 : Real GDP Growth and Low Tax Revenue............................ 78 Figure 3.2: Horizontal Distribution of Poverty by Gini coefficient............. 60 Figure 5.1: Natural Capital and Corruption.............................................. 89 Figure 3.3: Access to Services Index by Sub-region............................... 61 Figure 5.2: Corruption and Income.......................................................... 89 Figure 3.4: Consumption and Access to Figure 5. 3: Implementation Gaps in Corruption...................................... 92 Services Index – Sub-regions.................................................................. 61 Figure 5.4: Accountability Chain.............................................................. 92 Figure 3.5: Headcount Poverty and Access to Services Index................ 61 Figure 6.1: Top Ten Business Environment Constraints for Firms in Figure 4.1: Average Adjusted Savings for Botswana, Nigeria and Angola Uganda.................................................................................................... 102 (1995-2012, Percent of GNI).................................................................... 67 Figure 6.2: Export Transformation Dynamics within EAC........................ 105 Figure 4.2: Uganda’s Total Wealth per capita after the oil discoveries.... 68 Figure 7.1: Export Destinations within Four Major Regional Economic Figure 4.3: Uganda’s Infrastructure Investment Needs up to 2025......... 73 Communities (RECs)............................................................................... 112 Figure 4.4: Education Attainment of Labor Force................................... 74 Figure 7.2: Share of Intra-EAC Exports and Imports (Percent of Total Exports Figure 4.5: Total Expenditure and Net Lending (Percent of GDP)........... 74 and Imports by EAC Countries), 2012.................................................... 113 Figure 4.6: Overall Fiscal Deficit, including Oil Revenues and Grants Figure 7.3: Formal and Informal Exports of Uganda by Destination, (Percent of GDP)...................................................................................... 74 2012....................................................................................................... 113 Figure 4.8: Debt-to-GDP Ratio (In Percent).............................................. 75 Figure 7.4: Share of Ugandan Exports by Destination and by Figure 4.7: Cumulative Spending on Infrastructure Investments............. 75 Product.................................................................................................... 114 Figure 4.9: Oil Savings............................................................................. 76 Figure 7.5: Divisions by Suppliers to Domestic Market of a Figure 4.10: NONG fiscal deficit (Percent of GDP)................................. 76 Resource-rich Country............................................................................ 115 Figure 4.11: Overall Fiscal Deficit (Percent of GDP)................................ 77 Figure A6.1: Productivity Distribution of Exporters vs Non-exporters..... 155 Figure 4.12: Total expenditure and net lending (In Percent).................... 77 Figure 4.13: Sustainable Budget Index in Uganda.................................. 78 v Contents Tables Table 1: Summary of CEM Recommendations................................................... xxxiv GDP)�����������������������������������������������������������������������������������������������������������������������72 Table 1.1: Poverty Trends, 1992–2013.................................................................. 6 Table 4.2: Effectiveness of Various Programs Reaching the Poor....................... 81 Table 1.2: Structure of Production and Factor Intensity (In percent)..................... 7 Table 5.1: Summary Institutional Assessment��������������������������������������������������������90 Table 1.3: Structure of Indirect Taxes-by-activity (In Percent)............................... 9 Table 5.2: Governance Indicators (Percentile Rank), 2012������������������������������������92 Table 1.4: Resources-Uses Equilibrium of GDP................................................... 10 Table 7.1: Decomposition of Uganda’s Export Growth 2000-2010: Intensive Table 1.5: Sectoral Structure of Aggregate Demand (In percent)........................ 11 Margin vs. Extensive Margin............................................................................... 115 Table 1.6: Savings-Investment Nexus.................................................................. 12 Table 7.2: Cargo Transit Time along the Northern Corridor (2005 Data)............ 116 Table 1.7: Uganda’s Trade Partners..................................................................... 13 Table 7. 3: Uganda’s Logistics Performance Index 2010................................... 118 Table 1.8: Diversification among the Oil-rich Countries....................................... 18 Table 7.5: Correlation Coefficients of Business Cycles among EAC Table 1.9: Uganda’s Top 5 Historical Export Products......................................... 19 Countries............................................................................................................. 122 Table 2.1: Oil Reserves in Sub-Saharan Africa.................................................... 29 Table 7.6: Correlation Coefficients of Terms of Trade Shocks with Medium Table 2.2: Selected Economic and Financial Indicators–Baseline Scenario....... 36 Future Energy Exports......................................................................................... 122 Table 2.3: Mineralization, Reserves and Project Status....................................... 38 Table 7. 7: Labor Migration Policies in East Africa.............................................. 123 Table 2.4: Pre–Tax and Post–Tax Subsidies for Petroleum Products in 2011 Table A6.1: Two-sample Kolmogorov-Smirnov Test for Equality of Distribution (Percent of GDP).................................................................................................. 44 Functions............................................................................................................. 155 Table 3.1: Mapping of Constraints and Ongoing Initiatives in the Oil and Gas Table A6.2: Determinants of Firm Productivity.................................................... 156 Sector................................................................................................................... 58 Table A6.3: Probit Estimates of Export Probability.............................................. 157 Table 3.2: Addressing Horizontal Inequality and Poverty through Cash Transfers Table A6.4: Tobit Estimates of Export Intensity................................................... 157 Policies, 2012/13.................................................................................................. 62 Table 4.1: Historical Government Expenditure At Function Level (In Percent of vi Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Boxes Box 1.1: Implementation Challenges�������������������������������������������������������������������������������������������������������� 4 Box 1.2: Country Experiences on Diversification������������������������������������������������������������������������������������ 16 Box 1.3: Product Complexity Index PCI�������������������������������������������������������������������������������������������������� 20 Box 1.4: A Short-erm Export Diversification Strategy������������������������������������������������������������������������������ 22 Box 1.5: A Long-Term Diversification Strategy���������������������������������������������������������������������������������������� 23 Box 1.6: Rationale for the Use of Macroeconomic Models in the Uganda CEM������������������������������������ 25 Box 2.1: Three exploration Areas in the Albertine Region���������������������������������������������������������������������� 29 Box 2.2: Basic Assumptions for the Projection of Future Oil Production������������������������������������������������� 31 Box 3.1: Development of Local Industrial Capacity: Malaysia Oil Field Services and Equipment: A Regional Hub Creation Strategy��������������������������������������������������� 53 Box 3.2: Financing of Oil Projects in Brazil��������������������������������������������������������������������������������������������� 54 Box 3. 3: Localization in Brazil���������������������������������������������������������������������������������������������������������������� 55 Box 4.1: Wealth Estimates: A Brief Note on Methodology���������������������������������������������������������������������� 67 Box 4.2: Angola Case Study������������������������������������������������������������������������������������������������������������������� 69 Box 6.1: Economic Transformation Requires a Combination of Improved Industrial and Employment Policies���������������������������������������������������������������������������������� 103 Box 6.2: Uganda Can move to higher value exports - the Product Space View ��������������������������������� 104 Box 7. 1: Macroeconomic Convergence Criteria under the EAC Monetary Union Protocol����������������� 121 vii List of Acronyms ACD Anti-Corruption Division of the High Court EA Exploration Areas AFCE Africa Region East Africa Country Unit EAC East African Community AFMUG Africa Region Uganda Mission EALA East African Legislative Assembly AFREC Africa Region External Communications ECOWAS Economic Community of West African States AMV Africa Mining Vision EDU Education Expenditure ANS Adjusted Net Savings EITI Extractives Industry Transparency Initiative ASGM Artisanal and Small-Scale Gold Mining EPCs Engineering, Procurement and Construction ASM Artisanal and Small-Scale Mining EPPs Entry Point Projects ASYCUDA Automated System for Customs Data FDI Foreign Direct Investment ATIA Access to Information Act FY Financial Year BNDES Brazil National Bank for Social and Economic Development GCC Gulf Cooperation Council BoU Bank of Uganda GDP Gross Domestic Product BP British Petroleum GFS Government Financial System BPD Barrel per day GIIP Gas Initially in Place CEDP Competitiveness and Enterprise Development Project GMFDR Macroeconomic and Fiscal Management Global Practice CEM Country Economic Memorandum GNI Gross National Income CEMAC Central African Economic and Monetary Community GS Gross Savings CGE Computable General Equilibrium HDI Human Development Index CHD Chad HIPC Heavily Indebted Poor Countries CIID Central Intelligence and Investigation Department ICT Information Communication Technology CNOOC Chinese National Offshore Oil Company IDA International Development Association COMESA Common Market for East and Southern Africa IFC International Finance Corporation COW Coalition of the Willing IFMS Integrated Financial Management System CPA Comprehensive Peace Agreement IG Inspectorate of Government CPI Consumer Price Index ILPI International Law and Policy Institute CSOs Civil Society Organizations IMF International Monetary Fund CSR Corporate Social Responsibility IOCs International Oil Companies DFID Department for International Development JBSF Joint Budget Support Framework DNR Depletion of Natural Resources JVPs Joint Venture Partners DPP Department of Public Prosecution LCPs Local Content Policies DRC Democratic Republic of Congo LICs Low-Income Countries DSGE Dynamic Stochastic General Equilibrium LPG Liquefied Petroleum Gas DTAs Double Tax Agreements MACMOD Macro-econometric Model E&P Exploration and Production MAMS Maquette for MDG Simulations E.I.A Environmental Impact Assessment MDAs Ministries, Departments and Agencies viii MDGs Millennium Development Goals PNP Progressive Nationalization Plan MEMD Ministry of Energy and Mineral Development PPDA Public Procurement and Disposal of Assets MENA Middle East and North Africa PPPs Public Private Partnerships MFM Macroeconomic and Fiscal Management PS Product Space MFNP Murchison Falls National Park PSA Production Sharing Agreements MFPED Ministry of Finance, Planning and Economic Development R&D Research and Development MICs Middle Income Countries RCA Revealed Comparative Advantage MNCs Multinational Corporations RECs Regional Economic Communities MoES Ministry of Education and Sports ROR Rate of Return MOU Memorandum of Understanding SADC Southern Africa Development Community MTEF Medium Term Expenditure Framework SAM Social Accounting Matrix NDP National Development Plan SBI Sustainable Budget Index NEMA National Environment Management Authority SDSP Skills Development Strategy and Action Plan NGOs Non-Governmental Organizations SMEs Small and Medium Enterprises NOC National Oil Company SSA Sub-Saharan Africa NOGP National Oil and Gas Policy STOIIP Stock Tank Oil Initially In Place NONG Non-Oil Non-Grant TASU Technical and Administrative Support Unit NPA National Planning Authority TFP Total Factor Productivity NRC Natural Resource Charter TSA Treasury Single Account NTB Non-tariff barriers UAE United Arab Emirates O&G Oil and Gas UBOS Uganda Bureau of Statistics OAG Office of the Auditor General UGX Uganda Shillings OECD Organization for Economic Corporation and Development UN United Nations OFSE Oil Field Services and Equipment UNCTAD United Nations Conference on Trade and Development OLG Overlapping Generations UNDP United Nations Development Program OPM Office of the Prime Minister UNEP United Nations Environmental Programme PAC Public Accounts Committee UNHS Uganda National Household Surveys PCI Product Complexity Index UPIK Uganda Petroleum Institute Kigumba PD Pollution Damages URA Uganda Revenue Authority PEFA Public Expenditure and Financial Accountability US$ United States Dollar PEPD Petroleum Exploration and Production Department WEF World Economic Forum PFM Public Financial Management WFADC Documentation and Communication Products PIM Public Investment Management PIMI Public Investment Management Index ix Contents Preface For about ten years, from the early 2000s to 2010, the Ugandan economy grew at an average of 7 percent per annum. This achievement was accompanied by a dramatic decline in poverty rates (from 68.1 percent in 1992/93 to 33.2 percent in 2012/13, using the international poverty line of $1.90 [2011 PPP]). Since then, a number of external and domestic factors slowed down the GDP growth rate (3.3 percent in 2013/14) which rebounded to 5 percent in FY2014/15 and an estimated 4.6 percent in FY2015/16. Uganda is about to become an oil-producing country, and the Ugandan population hopes that the new resource will accelerate economic growth, reduce poverty and enable the country to reach its long-term goal of becoming an upper middle income country in less than thirty years. The timing of the project and its impact will depend on the level of international oil prices, which are extremely low today. However, we have reasons to believe that the price of oil will rise again and that Uganda’s future oil production will have a major influence on the country’s economic and fiscal performance. The experience of other countries, in Africa and other parts of the world, shows that large scale production of oil, gas and other mineral resources offers great opportunities, but also presents major challenges. In Angola, during most of the 2000s, high oil production and high international prices boosted GDP growth, but a massively expanded and poorly managed public investment program created congestion, inefficiencies and inflationary pressures, instead of developing - slowly and soundly - the necessary long-term physical and human capital. A new Uganda Country Economic Memorandum entitled “Economic Diversification and Growth in the Era of Oil and Volatility” has been prepared by a team of World Bank economists working in close cooperation with a Ugandan Government team. The memorandum discusses the prospects of oil and mineral production in Uganda and uses the lessons of international experience to propose an agenda of policy and institutional reforms aimed at maximizing the positive impact of oil production and avoiding the “resource curse” that affected negatively Nigeria, Angola and too many other new producers of oil, gas and minerals in the world. We shall not try to summarize the main conclusions of the report but would like to emphasize the following six messages, which - we believe - can guide future government and donor policies. First Message. The government views economic diversification as a key component of its strategy. The report fully supports that view. Past experi- ence shows a strong correlation between diversification and long-term economic success. The report argues that Uganda does not need to remain a low-productivity economy dominated by agriculture and a mainly informal services sector. A product space analysis shows that Uganda has potential for the emergence of a modern manufacturing sector focused on agro-processing and light manufacturing, which would serve both the domestic and the regional markets and would provide substantial export opportunities for a variety of small and medium-sized enterprises. Second Message. Improved governance and a conducive business environment are essential to promote the type of private sector development that will make economic diversification possible. However, a sound and well managed public investment program, largely financed by oil-related government revenue, is equally essential to remove constraints to private sector growth. x Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Large investments in public infrastructure are urgently needed in the whole country and, in particular, in the underdeveloped and very poor Northern region. For the long-term, increased public spending in education and health is even more critical. This will offer opportunities to all and also create the well-trained labor force which a modern manufacturing and services sector will need. Third Message. The report includes a wealth analysis which shows that oil-producing countries should invest to develop the long-term capital (phys- ical and human) that will replace non-renewable oil resources when depleted. Quality, however, is more important than speed. A massive increase in public spending and a poorly designed and implemented public investment program will do more harm than good, stimulating a number of negative forces (resource curse, Dutch Disease) that will block the development of non-oil economic activities. The report advocates a “sustainable investing approach” that combines substantial savings with investment and links the size and speed of the public investment program to progress in absorptive capacity. Fourth Message. Regional integration already helped Uganda diversify its production and its exports. More important than regional free trade are measures that will reduce regional transaction costs, notably investments in regional transport and energy infrastructure, and also improvements in logistics services. More complex is the issue of the creation of a monetary union. The example of the Euro-zone shows how difficult it is for individual countries in a monetary union to make the necessary macroeconomic and fiscal adjustments to external and domestic shocks. More thinking is essential before final implementation of the reform. Fifth Message. More than one third of the Ugandan population remains poor and vulnerable to shocks and recent economic growth did not reduce income inequality. This is a major problem for many developed and developing countries today. Three types of measures could help reduce poverty and income inequality in Uganda. First, a significant infrastructure development program in the underdeveloped Northern region. Second, improved education and health services overall and in particular in the North. Third, the report discusses the feasibility of direct transfers to the poor linked with behavioral improvements (sending boys and girls to primary school, reducing dropout rates, vaccination and other basic health services). That type of scheme may be tested on a small scale in the poorest communities. Sixth Message. The CEM describes in general terms how Uganda can experience long-term growth, fight poverty and meet the challenges that come with the development of new resources. Much more needs to be done to translate the proposed strategy into specific action plans. This should be the priority of future economic and sector work for the Ugandan government and for its development partners. Diarietou Gaye Matia Kasaija Country Director for Eritrea, Kenya, Rwanda, and Minister of Finance, Planning, and Economic Development Uganda World Bank Government of Uganda xi Contents Acknowledgments The World Bank greatly appreciates the close collaboration Resource-Rich Developing Countries, Chapter 4. 15. Youssouf Kiendrebeogo and Jean-Pascal Nganou with the Government of Uganda (the National CEM 7. Vincent Belinga, Maximillien Kaffo Melou, and (2014): Firm’s Export, Productivity and Investment Task Force led by the Ministry of Finance, Planning and Jean-Pascal Nganou (2014): Analysis of the Oil Climate in Uganda: Evidence from the Enterprise Economic Development, in particular) in the preparation and non-Oil Government Revenues Nexus: Policy Survey, Chapter 6. of this report, requested by senior government officials. Lessons for Uganda, Chapters 2 and 4. 16. Rachel Sebudde and Faizal Buyinza (2014): Export, The report was prepared by a team led by Jean-Pascal N. Innovation and Firm level Productivity: Evidence 8. Paulina Aguinaga, Charles Ncho-Oguie, and Nganou (Senior Country Economist and Lead Author, from Manufacturing Firms in Uganda, Chapter 6. Jean-Pascal Nganou (2014): Review of Oil-Price Macroeconomic and Fiscal Management, MFM). It draws Subsidies: Lessons for Uganda, Chapter 2. 17. Andreas Eberhard, Lawrence Kiiza, and Jean-Pascal upon a series of background papers commissioned for the 9. Alexandre Kopoin, Jean-Pascal Nganou, Fulbert Nganou (2014): Prospects of Oil Resources in study, including: T. Tchana, and Albert G. Zeufack (2014): Public Uganda: A Macroeconometric Approach, Chapters 2 Investment, Natural Resource inflows and Fiscal and 4. 1. Thorvaldur Gylfason and Jean-Pascal Nganou Responses: A DSGE Analysis with Evidence from Sincere appreciation goes to our peer reviewers Sebastien (2014): Diversification, Dutch Disease, and Economic Uganda, Chapters 4 and 5. Dessus (Lead Economist and Program Leader, AFCW1), Growth: Options for Uganda, Chapters 1 and 5. 10. Sam Wills and Rick van der Ploeg (2014): Monetary Dr. Jean-Louis Kasekende (Deputy Governor, Bank of 2. John Matovu and Jean-Pascal Nganou (2014): Fiscal Union and East Africa’s Resource Wealth, Chapter 7. Uganda), Anand Rajaram (Practice Leader, Governance Policy Stance and Oil Revenues, Growth and Social Global Practice), Professors Van der Ploeg (Oxford Outcomes for Uganda, Chapter 4. 11. Rick van der Ploeg and Sam Wills (2014): Genuine University), and Thorvaldur Gylfason (University of Saving in East Africa: Guidelines for exploiting 3. Pierre-Richard Agenor and Jean-Pascal Nganou Iceland and University of Stockholm). Natural Resource Wealth, Chapter 7. (2013): Expenditure Allocation and Economic Growth in Uganda: An OLG Framework, Chapter 4. 12. Chandra Vandana, Ying Li, and Rachel Sebudde The team would like to thank Mr. Lawrence Kiiza (Director (2015): Uganda’s Diversification: from farm-to-firm 4. Jean-Pascal N. Nganou, Juste Some, and Guy of Economic Affairs, Ministry of Finance, Planning and produced exports or farm-to-farm produced exports?, Tchuente (2014): Growth, Institutions and Foreign Economic Development) Chairperson of the National Chapters 1 and 7. Direct Investments in Developing Countries, Chapter CEM Task Force for the helpful advice and Mr. Ernest 4. 13. Luc Désiré Omgba and Vanessa Mugabe (2015): Rubondo (Director, Petroleum Production and Exploration Natural Resource Charter for an efficient use of oil Department, Ministry of Energy and Mineral Development). 5. Andreas Eberhard, Willy Rwamparagi Kagarura, resources in Uganda: Building a bridge between the More thanks go to the participants who responded to the and Jean-Pascal Nganou (2014): Uganda: government and the population, Chapter 2 and 5. event organized for the Ugandan Delegation during the Transforming Natural Resources Wealth into Long- term Development-A Wealth Accounting Approach, 14. Kenneth Amaeshi and Jean-Pascal Nganou (2014): 2014 Spring Meetings where experts from within and Chapter 4. Sustainable Development of the Oil and Gas Sector in outside the Bank provided guidance on the overall storyline Uganda: The role of Corporate Social Responsibility and the areas for deeper analysis. 6. Jean-Pascal Nganou, Juste Some, and Guy Tchuente (CSR), Chapter 6. (2014): Government Spending Multipliers in Natural xii Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility The core team included Jean-Pascal N. Nganou (Senior Management Global Practice), Philippe Dongier (Country Macroeconomic Policy, MFPED), Mr. Patrick Ocailap Country Economist, Macroeconomic and Fiscal Director, AFCE1), Diarietou Gaye (Country Director, (Deputy Secretary to the Treasury, MFPED), Dr. Francis Management Global Practice), Andreas Eberhard AFCE2), Christina Malmberg-Calvo (Country Manager, Runumi (Commissioner Health Services Planning, Ministry (Consultant, Macroeconomic and Fiscal Management AFMUG), Ahmadou Moustapha Ndiaye (Country Manager, of Health), Mr. James Mayoka (Principal Economist, MoES), Global Practice), Yutaka Yoshino (Senior Economist, AFMUG), and Sajjad Shah (Country Program Coordinator, Mr. Samuel Semanda (Commissioner Agriculture Planning, Macroeconomic and Fiscal Management Global Practice), AFCE3). The team is also grateful to Andrea Dall’Ollio Ministry of Agriculture), Mr. Fred Mayanja (Assistant Rachel Sebudde (Senior Economist, Macroeconomic and (Lead Economist, Trade and Competitiveness Global Commissioner, Planning/Ministry of Agriculture), Dr. Fiscal Management Global Practice), Clarence Tsimpo Practice), Chiara Bronchi (Lead Governance Specialist, Thomas Bwire (Economist, Bank of Uganda), Mr. Benon (Senior Economist, Poverty Global Practice), Willy Kagarura Governance Global Practice), Valeriya Goffe (Financial Mwebaze Kajuna (Commissioner Policy and Planning, (Consultant, Macroeconomic and Fiscal Management Global Specialist, Finance and Markets Global Practice) and Dan Ministry of Transport and Communication), Mrs. Lucy Practice), Hazel Granger (Consultant, Macroeconomic and Kasirye (Resident Representative, IFC) for useful insights. Iyango (Assistant Commissioner Wetlands, Ministry of Fiscal Management Global Practice), Raphael N’Guessan Contributions by Marlon Lezama (Senior Coordinator, Water and Environment), Mr. Mike Nsereko (Director (Consultant, Macroeconomic and Fiscal Management Technical and Administrative Support Unit (TASU) of Policy, Planning and Information, National Environment Global Practice), Youssouf Kiendrebeogo (Economist, the Joint Budget Support Framework (JBSF)), Franklin Management Authority), Dr. Lawrence Bategeka (Private MENA Chief Economist Office), Adama Traore (Consultant, Mutahakana (Senior Operations Officer, AFMUG), and the Consultant), Mr. Hon. Steven Mukitale (former Chair Macroeconomic and Fiscal Management Global Practice), AFMUG team are greatly acknowledged. - National Economy, Parliament of Uganda), Mr. John Paulina Aguinaga (Consultant, Macroeconomic and Fiscal Bagonza (Director Research, Parliament of Uganda), and Management Global Practice), Travis Wiggans (Consultant, The team is indebted to the useful insights received from the Mr. Vincent Tumusiime (Director of Monitoring, Office of Macroeconomic and Fiscal Management Global Practice), National Task Force composed of Dr. Chris Ndatira Mukiza the President). and Vanessa Mugabe (Consultant, Macroeconomic and (Director Macroeconomic Statistics, UBOS), Mr. Samuel Fiscal Management Global Practice). Echoku (Head of National Accounts, UBOS), Mr. Timothy Sincere appreciation goes to Xavier De la Renaudiere Lubanga (Assistant Commissioner for Monitoring and (Consultant, GMFDR), Priya Susan Thomas (Knowledge This report benefitted from the outstanding support and very Evaluation, OPM), Mr. Maxwell Paul Ogentho (Director Management Officer, WFADC), and Susi Victor (Knowledge helpful advice of Jacques Morisset (Lead Economist and Corporate Services, OAG), Mrs. Peninah Aheebwa (Senior Management Analyst, WFADC) for an excellent editing Program Leader, AFCE1). Helpful comments were provided Petroleum Economist, MEMD), Mr. Edward Isabirye of the report. The dissemination strategy of the report was by: Kevin Carey (Lead Economist, Macroeconomic and (Senior Geologist, MEMD), Mr. George Bamugemereire prepared by Sheila Gashishiri (Communication Associate, Fiscal Management Global Practice), Apurva Sanghi (Lead (Deputy Inspector General of Government, IG), Mr. David AFREC) and Sheila Kulubya (Communication Specialist, Economist and Program Leader, AFCE2), Kofi Nouve Makumbi (Director for Ombudsman Affairs, IG), Dr. John AFREC) with helpful comments from Sandya Salgado (Senior Rural Development Specialist, Agriculture Global Matovu (Consultant Macro-economics, NPA), Dr. Patrick (Senior External Affairs Officer, External Communications Practice) and Anton Dobronogov (Senior Economist, Birungi (Director Development Planning, NPA), Mr. Moses Global Practice). Gladys Alupo (Program Assistant, Macroeconomic and Fiscal Management Global Practice). Ssonko (Senior Economist, Budget and Policy/MFPED), AFMUG), Damalie Nyanja (Team Assistant, AFMUG), and The report was prepared under the overall guidance of Albert Mr. Moses Kabanda (Senior Economist, Macro Economic Lydie Ahodehou (Program Assistant, GMFDR) provided Zeufack (Practice Manager, Macroeconomic and Fiscal Policy/MFPED), Dr. Albert Musisi (Commissioner outstanding operational support and formatting of the report. xiii Acknowledgements Credits Regional Vice President: Makhtar Diop Country Director: Diarietou Gaye Country Manager: Christina Malmberg Global Practice Director: John Panzer Global Practice Manager: Albert Zeufack Task Team Leader: Jean-Pascal N. Nganou Rights and Permissions The material in this work is subject to copyright. 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These include: video documentary, abridged version of this report, factsheet and blogposts relating to issues discussed in the report. © 2015 International Bank for Reconstruction and Development The World Bank Group 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000 www.worldbank.org xiv Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Executive Summary 1. The objective of the Ugandan government is to make Part 1: An Economic Development and Diversification expansion of modern manufacturing and services and job Uganda an upper - middle income country within thirty Strategy - Main Goals creation for the majority of the population. years. Economic diversification is a key component of that 3. The first part of the report focuses on the impor- 5. Although many resource-rich countries have devel- strategy. Over the next few years, however, oil and miner- tance of economic diversification for Uganda and on the oped their economies and enjoy higher standards of liv- al production will expand and will have a major influence prospects/challenges of oil and mineral development. It ing over time, the most successful ones are the few that on Uganda’s economic structure and performance. GDP addresses the following three issues: (a) why diversification have been able to diversify their production and export growth rate is expected to exceed 9 percent on average over is important for economic development; (b) where Uganda base (see Figure 1). Malaysia, Indonesia, and Mexico have the next two decades. Substantial benefits will be derived stands in that area and why it should give a new impetus to all moved away from oil dependence by diversifying their from the development of the extractive industry, but the full its diversification strategy; and (c) what are the prospects, exports, and witnessed accelerated and sustainable econom- exploitation of natural resources also involves risks which possible impact, and challenges associated to oil and min- ic growth over time. By contrast, Angola, Nigeria, Libya, any future oil-producing country should try to minimize. ing development for Uganda’s economy. and Venezuela have not succeeded in diversifying their 2. The CEM report discusses how the emergence of oil economies, and reported lower per capita growth over the and mineral production can contribute to Uganda’s A. Why is economic diversification past three decades. effort to promote economic diversification as a means to important for economic development? achieve sustainable and shared growth. Based on the les- Lessons from international experience B. Why should Uganda expand and sons from international experience, the report first outlines 4. Economic development is viewed as a process of struc- accelerate its diversification strategy? the elements of a development and diversification strategy, tural transformation through which a country moves 6. The structure of the Ugandan economy changed which the Ugandan government may wish to consider in the from producing ‘poor - country goods’ to ‘rich - country significantly over the past three decades, with a gradual design of its macroeconomic, fiscal and sectoral develop- goods’. A modern economy needs a combination of man- shift from agriculture to manufacturing and services. ment policies. It then focuses on the set of policies required ufacturing, trade, and services to optimize the standard of The growth in the last decade was largely driven by the to maximize the benefits of a diversification strategy in living of the population. Economic success is generally expansion of services, which now account for almost half an oil-producing country. Finally, it describes a series of reflected by the country’s ability to produce a variety of of the country’s GDP. The share of the primary sector actions which the government should plan, and carry out to goods and services that can be sold to other countries. For (including agriculture) declined to 30 percent, while deal with a number of specific implementation issues. a country like Uganda, the challenge is therefore to move industry represents approximately 23 percent. Among away from dominant (subsistence) agricultural activities services, telecommunication, transport, and financial that keep the rural population in poverty, and from over- services grew by over 7 percent annually over the past three dependence on a few natural resources that may delay the years, reflecting higher local demand and technological xv Exuecutive Executive Summary Summary Figure 1: Export Diversific tion and Per Capita Income Growth in Oil-producing Figure 2: Uganda’s Export Trade Countries Source: Cherif and Hasanov (2014): “Soaring of the Gulf Falcons: Diversification in the GCC Oil Source: Chandra et al. (2015). Exporters in Seven Propositions”, IMF Working Paper WP/14/177. changes (the mobile phone revolution). The industrial sector imports come from Kenya and 41 percent of its exports go sign for the future of the country’s industrialization process, grew by 6 percent between 2011 and 2013, reflecting the to South Sudan, the Democratic Republic of Congo (DRC), although the construction sector still relies on imported iron expansion of construction, fueled by growing investment Kenya, Rwanda and Burundi. Second, in terms of products, and steel. and the gradual urbanization process. Some growth was trade concentration (as measured by the contribution of five generated by manufacturing, particularly the emergence of top products in total export earnings) declined from over 95 8. The gradual transformation in the output and export agro-processing (including fish fillets, meat processing), percent in the early 1980s to about 86 percent in the 1990s structures of Uganda was not accompanied by a similar metal, and chemical industries (including gold). Although and 55 percent in 2010-12. Although coffee and cotton still shift in the employment structure. Today, approximately the primary sector remains the least-performing sector, its dominate Uganda’s exports (39 percent; see figure 2), the three-quarters of Ugandan households continue to report growth rate improved from 1.3 percent during the second country’s export basket now includes about 60 new products, agriculture as their primary economic activity. While the half of the 2000s to 1.9 percent in 2011-13. including cooking oils, processed fruits and vegetables, and labor force is moving away from farming, most of the new fish. In addition, several new sub-sectors (flowers, wood, jobs are created in informal and low-productive activities, 7. The transformation of Uganda’s economy is visible minerals, and chemicals) have emerged. Uganda also such as trading. The fastest growing sectors of the economy through an increased diversification of its trade base. exports light manufactures (skins and hides processed into (finance, communication) are not as labor intensive. This diversification is both geographical and in terms of high-value leather), and heavy manufactures, including Consequently, the current pattern of growth has only weakly products. First, Uganda’s trade has become gradually less construction materials made from iron and steel. The share benefited the bottom 40 percent of the population. dependent on Europe and increased its partnership with of manufactures in total merchandise exports increased Asian and regional countries. Fifteen percent of Uganda’s from 2 percent in 1994 to 34 percent in 2012. This is a good xvi Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 9. In this context, it is clear that Uganda should scale C. What are the prospects, potential tic and the regional markets (Burundi, DRC, South Sudan up its diversification efforts. The product space analysis impact, and challenges of oil and other and Rwanda), and (ii) exporting additional output through (PS) conducted in the main report, shows that a sound extractive industries in Uganda? a pipeline linking Uganda’s oil fields to the coast line of diversification strategy should be focused on light man- Kenya or Tanzania. Total production is expected to peak at ufactured exports, such as garments, leather, and wood 230,000 barrels/day by 2025, but will decline thereafter and a. Prospects of oil and mineral development products. These products do not require sophisticated skills, end around 2044. which are not readily available in Uganda, and would use 11. Today, the country’s total oil reserves are estimated the large pool of unskilled and semi-skilled workers avail- at 6.5 billion barrels (of which 1.3 billion barrels are 13. At this stage, the investment plans are influenced able in the country. Uganda’s strategy could get inspired by recoverable), but only 40 percent of the country’s by two important factors that are not entirely under the recent success of Ethiopia and Lesotho in developing potential has been explored so far. Drilling activity the control of the Government of Uganda. The first one a vibrant local manufacturing industry. Other opportunities intensified along the Albertine Graben in the early 2000s is the construction of the pipeline that will enable Ugan- include agriculture-related processing industries (cereals, with a special focus on three exploration areas (EA1 with da to export its oil through Kenya or Tanzania. The second dairy products, more types of cooking oils, and new sugar 923 million barrels of recoverable reserves, EA2 with factor is the medium to long-term price of oil on interna- products), that can leverage the country’s agriculture pro- 231 million barrels, and EA3A with 134 million barrels). tional markets. The economic viability of the three main duction. The existing chemicals and metal product indus- Beyond oil, Uganda has a rich mineral industry. Geological oil areas will largely depend on the future price of oil. tries can also serve as stepping stones towards more sophis- and airborne surveys conducted since 2003 identified 17 As illustrated in Figure 3, the rate of returns of the three ticated diversification in the longer term. minerals (copper, cobalt, gold, iron ore, columbite tantalite, existing areas will exceed 10 percent only if the oil price tin, titanium, tungsten, limestone/marble, phosphate, is over US$85. At a price of US$50, only one of the three 10. The oil and gas potential of the country can offer vermiculite, rare earth elements, kaolin, gypsum, salt, glass areas will generate a rate of return higher than 10 percent. an opportunity for Uganda to diversify its economy, sand, and dimension stones) with potential for commercial although this needs proper management to avoid a exploitation. Today, Artisanal and Small-scale Mining b. Impact of oil and mineral development negative impact on other forms of diversification. Oil (ASM) provides direct employment to more than 200,000 can help a country diversify through different channels. people and more than 1.5 million people benefit from 14. Oil production will have a significant impact on First, oil could help Uganda promote the emergence of an backward and forward linkages to the mineral sector. Uganda’s economy. This report used alternative macroeco- energy-intensive industry, such as chemicals, fertilizers, or nomic models to evaluate the (present and future) impact of cement. Second, oil will bring substantial revenues to the 12. In the oil sector, negotiations between the govern- oil production on Uganda’s economy. Based on an interna- state, which could invest them in infrastructure and human ment and international investors began in 2012, but tional oil price of US$90, our projections show that GDP capital development. Third, the exploitation of oil could are not yet finalized. Three major international oil com- growth rates could exceed 9.0 percent per year over the next create synergies with local industries through forward and panies, including Total (France) for EA1, Tullow (Ireland) two decades through a combination of demand and supply backward linkages. Successful countries are those which for EA2, and CNOOC (China) for EA3A, are expected to effects directly generated by oil activities. This impact will have been able to harness those channels over time. start production in 2017/18 (CNOOC) and 2019/20 (Total however vary over time, depending on production patterns. and Tullow). Current plans include (i) the processing of Those effects are also sensitive to the policies that will be 30,000-60,000 barrels/day in a local refinery for the domes- implemented by the Ugandan authorities. xvii Uganda’s Economy Executive Summary Figure 3: Economic Viability of Oil Areas Depending on Future Barrel Price Figure 4: Impact of Oil Price on Projected Government Petroleum Revenue Source: Oil & Gas Mega Model (Uganda). Source: Eberhard et al. (2014). 15. The first impact of oil on the local economy will be 2030/31, as the need for significant imported inputs declines to the government. The amount of additional public revenue created through the creation of 13,000 jobs during the and the construction phase winds out. At the same time, oil would average US$2.5 billion/year (more than 50 percent of initial phase of construction. The number of permanent exports will increase gradually from a very insignificant current government revenue). Based on past experience in jobs in and around the oil industry will decline to about level in 2017-20 to 6.6 percent of GDP in 2024-30. In line successful oil-producing countries, and taking into account 3,000 when production begins, but the development of local with these developments, the country’s trade balance (as Uganda’s situation, those revenues should be used to finance capacity through training and linkages, notably in sectors share of GDP) will first deteriorate slightly from a deficit of the existing needs in infrastructure and human capital. While like transportation and logistics, has the potential to boost 9.7 percent in 2014/15 to 17.9 percent on average over the smart management will require finding the right balance further economic growth and employment. period 2017/18 to 2020/21 but will improve significantly between consumption and savings, the current needs are thereafter due to the stronger performance of oil and non-oil so high in Uganda that a substantial share of the additional 16. The second impact is related to the sequential trade exports. revenues should be used to address current deficiencies. balance effects of oil. In fact, as foreign direct investment Access to electricity and connectivity are serious challenges (FDI) increases when firms are focusing on the construction 17. Third, oil production will also have a positive for private businesses but infrastructure investments phase in the petroleum sector as well as other oil-related (indirect) impact on Uganda’s economy through the use would help reduce Uganda’s lag with other low-income imports, growth in total imports is expected to accelerate of additional public revenue. On the basis of the production countries. Concurrently, improvements in education will be from 4.5 percent in 2014/15 to an average of 12.5 percent sharing agreements already concluded, and assuming a particularly critical to boost the stock of human capital in over the period 2017/18 to 2020/21. Subsequently, annual long-term international price of US$90 per barrel, about 70 the long-term, notably when oil and mineral resources are import growth will gradually decline, reaching 7 percent in percent of the net present value of oil production would go depleted. In brief, an assets diversification strategy which xviii Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility transforms natural capital (including oil) into tangible and sector developments could be financed through the on Congo, Venezuela, and Nigeria and many other oil- intangible capital is essential for the sustainability of the additional revenue that the government is set to receive producing countries. Volatility produces fluctuations in country’s wealth. The magnitude of the stream of additional with the onset of oil production. Simulations suggest that exchange rates, export earnings, output, and employment, oil-related government revenue, and therefore its growth the government will receive an additional US$56 billion and discourages investment and growth. impact, will largely depend on the future price for crude oil. in revenue over the next two decades, which, if soundly Revenue projections are very sensitive to the assumed oil invested, could also support the minerals sector. This in 21. The second level of challenges concerns public price (Figure 4). Before oil prices started declining heavily turn may attract additional FDI which could further boost finance. It starts with the temptation to borrow against in mid-2014, the price for one barrel of oil had hovered mining activity in the years to come.  (future) oil revenues. Few countries have been able to resist around the US$100 mark for several years. At this level, oil this temptation as illustrated by the recent example of Gha- revenue for the government would average close to US$2.5 19. There is little doubt that oil (and other minerals) can na. The government should realize that oil revenues are vol- billion a year between 2017/18 and 2044/45. Assuming an be a game changer for Uganda. As evidenced above, the atile and will depend on international oil prices on oil mar- international price of oil of US$50 per barrel, average oil exploitation of those resources can increase employment, kets. The establishment of contingent financial reserves is revenue will only amount to about US$800 million a year. government revenues, and exports. These direct positive important in that context. Often, the availability of oil reve- Similarly, the direct contribution of the oil sector to GDP effects can be magnified through smart policies that will nues reduces the country’s tax effort. A one percentage point would fall to 4.5 percent from 9 percent under our baseline favor the optimal allocation of public revenues towards increase in resource revenue (in percent of GDP) may lead scenario. infrastructure, and human capital. However, international to a decline in non-resource government revenue by 0.2-0.3 experience also demonstrates that the management of oil percentage points. Tax collection is weak in oil-producing 18. So far, the contribution of the mining sector has brings a full variety of challenges to policymakers. countries. Uganda will also have to establish a reliable and remained modest, but prospects are positive. The transparent public investment management system, which c. Challenges associated with oil and mineral development growth of the sector averaged 9.8 percent in recent years, will help the government select and implement an optimal but its contribution to GDP did not exceed 0.3 percent. 20. These challenges are at different levels. The first portfolio of investment projects. Finally, there is evidence Mineral exports (mostly gold, iron ore, silver, tin, tungsten, level is associated to the project cycle from construction to that resource-rich countries tend to allocate a smaller share vermiculite, cobalt, and copper) accounted for only 1 exploitation, and its impact on the country’s main economic of their national income to education. They send fewer chil- percent of total exports in 2012/13. However, Uganda’s rich and financial variables. The Dutch Disease effect is well dren to school than countries with the same income level mineral wealth is virtually untapped. Political, and economic known by economists. The massive inflows of FDI in the but fewer natural resources. A possible explanation is a false stability in the country, availability of geo-data, and growing phase of construction (even if it is partly compensated by sense of economic security that influences the mindset of global demand, notably from emerging countries like higher imports) can lead to a real appreciation of the local the authorities and segments of the population. China, and India, led to significant increases in FDI for the currency that will reduce Uganda’s export competitiveness. sector. To harness the exploitation of its mineral resources, This negative effect can even become more important after 22. The third level of challenges lies in the mix of policies the government must adopt a comprehensive development- the start of oil exports. Rising exchange rates together that the government will use to promote private sector driven policy, focused on the value of the derived demand with price hikes for services (triggered by oil revenue and activities. The government may wish to influence the allo- through the mineral value chain. This includes the creation expatriate workers’ earnings) would affect the profitability cation of resources by introducing a complex set of subsi- of a sound legal, and regulatory framework, and addressing of farm exports and tourism sector. The volatility of oil dies and incentives. For example, the government can be infrastructure inadequacies, and human capital deficiencies, prices can also have severe negative consequences for oil tempted to subsidize local oil prices with the good intent notably in knowledge-intensive areas. Many of the mineral producers. The volatility of oil prices had a major impact to favor local businesses but this can be detrimental in the xix Executive Summary longer term as it discourages energy saving behavior and that the country expects to receive from its untapped oil and contract negotiations and promoting more transparency in negatively affects the environment. The government may mineral potential by enhancing exploration and negotiating the licensing system. At the same time, during those initial also wish to indirectly subsidize resource-based industries good contracts with investors, while minimizing the negotiations, the government should attempt to minimize by not charging them enough for their extraction rights. negative social and environmental impacts of oil and the negative impacts oil and mineral developments may Taxing the revenue of these industries too lightly can lead mining production. Such actions should be taken at an have on the environment and ensure the emergence of to overvaluation of the currency and associated balance early stage of the cycle. The second building block is about a consensus on how oil revenues will be shared among of payment and external debt problems. Abundant natural macroeconomic and financial policy considerations, that stakeholders in the country. resources may also crowd out financial capital by holding is, savings and consumption trade-offs, borrowing, and a. Supporting oil and mineral exploration back the emergence of a well-developed financial system, volatility concerns. The third building block is about public and producing an inefficient allocation of savings across sector management, including allocative and financial 26. Uganda’s government must encourage exploration of industries and firms. efficiency of public expenditure, and efforts to minimize the oil and mineral deposits first in the parts of the oil-rich possible crowding out of non-resources expenditures and Albertine Graben region that have not been explored 23. These challenges, by nature, are not easy to address. aid. Finally, the fourth building block concerns policies to (about 60 percent of the region), and, second, where In addition, multiple and evolving factors have to be promote private sector development. All these four building potentially viable mineral deposits have been identified. taken into account in the decision making process. blocks are important but it is their combination that will The adoption of downstream and upstream laws in 2012 The oil-producing countries that have been able to opti- ultimately determine to what extent oil will help Uganda clarified the legal framework and paved the way for a new mize the use of their oil resources are those that have diversify its economy and improve the living conditions of round of exploration licenses. As a result, private FDI flows been able to increase the governance framework over the majority of its citizens. are among the highest in East Africa and keep growing. time. Countries rich in natural resources are generally get- However, more efforts are needed to attract additional FDI ting lower scores in terms of governance indicators (see A. Leveraging the benefits of oil and resources, facilitate the exploration and exploitation of the the Ibrahim index of Africa governance) and corruption extractives for economic diversification country’s resources, and create a business climate favorable (Transparency International; see also Figure 4). How- to the development of domestic economic activities linked ever, the most successful countries have been those that 25. Very often, policymakers focus their attention on with, or independent from, the oil and mineral sector. This were able to improve their scores over time (Figure 5). how to use the resources derived from oil. While this means: (i) additional geological and other surveys, which question is obviously important, the first stage should be can be (partially) financed by the public sector with the help to ensure that the maximum amount of revenues will be of Uganda’s development partners, and (ii) the creation Part II: Policy Priorities Around Four Building Blocks collected by the country. This supposes that exploration of a stable legal and institutional environment attractive activities continue and that contracts with investors 24. The second part of the report discusses how Uganda’s for private investors. The exploration of oil and minerals are well negotiated by the government. Therefore, the oil should be used as a tool to promote further economic requires large investments and state-of-the-art technology. government’s agenda should include measures aimed at diversification. Our proposal is to adopt an action plan It is economically risky and most of the developing supporting new exploration in areas with untapped oil and organized around four building blocks. The first building countries need the help of foreign investors to access the mineral potential and maximizing the economic and fiscal block includes measures aimed at strengthening the benefits most appropriate exploration technology. benefits expected from oil/mining production through good xx Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 5: Higher Corruption (Less Transparency) in Figure 6: Transparency and Economic Performance why the Petroleum Exploration Production Department Natural Resource-rich Countries in Oil-producing Countries of the Ministry in charge of Mineral Development, which is currently leading negotiations, may be overstretched resulting in long delays on processing production license applications. 29. An important step forward would be to improve accountability by publishing all contracts. The Access to Information Act of 2005 (ATIA) provides that detailed information on PSAs and production licenses should be available to the public, and an online cadaster similar to the one available in the mining sector (which provides detailed information on mineral licenses) should be introduced for the oil sector. A growing body of international evidence Source: Authors’ computations based on World Bank, World Source: Authors’ computations based on World Bank, World shows that full transparency regarding the conditions of Development Indicators, updates of World Bank data (2006) and Development Indicators, and data from Transparency Interna- contracts is an important pre-condition for accountabil- data from Transparency International. tional. ity. Without transparency, natural resource rents may be Note: ‘Natural Capital’ goes beyond ‘Natural Resources’. This confiscated and may not benefit the rightful owners of the explains Uganda’s very high share of natural capital as per the 2005 figures which do not include oil (that is, natural capital resource. represents 84 percent of tangible capital). 30. Adherence to the Extractives Industry Transparen- b. Strengthening capacity in contract negotiations and pro- with respect to three main exploration areas (EA1, EA2, and cy Initiative (EITI) would also send a positive signal to moting transparency in the licensing process EA3A). the local and international community about the gov- ernment’s commitment to good governance in the oil 27. First, the government should negotiate good con- 28. Second, the government should establish a multi- and mining sector. The recently enacted PFM Law indi- tracts with foreign investors. The bargaining power of oil sector team because oil contract involves many cates that annual and semi-annual reports of the Petroleum companies is reinforced by their vast experience in the field. different issues, ranging from land to labor, taxes and Fund should be submitted to the parliament. Ugandan laws The government should not hesitate to hire independent environment. The second recommendation would be to and regulations, however, do not require oil companies to expertise that will strengthen its negotiating position and invest in educating local staff on various aspects of the publish information about payments made to the govern- will help obtain the best possible outcome. So far, oil-re- oil and gas industry so that the country does not need to ment. The preparation of new regulations for implementing lated negotiations have been led by the Petroleum Explo- always rely on outside experts. Incidentally, some of the the PFM Act provides an opportunity to introduce manda- ration Production Department of the Ministry in charge of national institutions dealing with the oil sector, including tory disclosure requirements regarding payments by the oil Mineral Development. A first phase of production sharing the National Oil Company (NOC) and the Petroleum companies (in line with EITI standards). agreements (PSA) has already been negotiated with IOCs Authority, are not yet in place. This could also explain xxi Executive Summary revenues between the national and local governments. There have also been repeated calls on governments to distribute oil earnings directly to households in the form of lump-sum transfers based on the Alaska distribution model. These Contractors proposals are motivated by the lack of trust in political handling lifting leaders with respect to the management of oil earnings. equipment at an exploration Again, it would be essential to agree on the rules of the site in western games that will determine the allocation of oil revenues to Uganda finance structural investment and to help finance vulnerable groups. 34. Effective consultation mechanisms should lead to a sound infrastructure development program that will assess the above-mentioned trade-offs between the national and local governments as well as between structural investment projects and cash transfers. The government may launch specific studies on how oil revenues can be used to address poverty by targeted programs. It may want to explore the feasibility of conditional cash transfers to low-income households linked with special initiatives for the welfare of children and other vulnerable members of the c. Minimizing the impact of oil and mineral development on d. Agreement on basic principles of redistribution mecha- community. As Uganda spends around 0.4 percent of GDP the environment nisms on social protection schemes (excluding contributions to pension funds) compared to 2-3 percent in other developing 31.  The risk of environmental damage linked to oil pro- 32. Oil benefits can vary both in level and utilization. At countries, increasing spending on social protection duction is not immediate but should be addressed as ear- an early stage, it is important that all stakeholders agree on would enable the poor to better participate in the growth ly as possible. Environmental impact assessments should basic principles. There is no single blue print applicable process as Uganda transforms itself into a middle-income always be carried out before delivery of exploitation licens- to all oil-producing countries. Consequently, a dialogue country. It would also reduce vulnerability. Experience es. In addition, oil and mining companies should be respon- on the issue should be initiated and extensive consultation in other countries over the past decade shows that well- sible for restoring degraded land and polluted resources to mechanisms should be created to avoid future conflicts. designed large-scale social protection programs can have their original condition. The capacity of local communities a tremendous impact on the conditions of the poorest, at should be developed to ensure that environmental damages 33. The use of oil resources may worsen existing affordable fiscal cost. As an illustration of the effectiveness are minimized and to help these communities derive sub- inequality and may create conflicts between local of such programs, we have estimated that the impact of stantial benefits from local content policies. interests and national development objectives. It is providing monthly cash transfers of about UGX25000 to therefore important to set up clear rules of distribution of households in the North East, the West Nile, and the Mid- xxii Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility North regions would contribute to a significant reduction in a. Savings-Consumption trade-offs General Equilibrium (DSGE) model indicates that 15-30 poverty rates from 74.5 percent to 67.8 percent in the North, percent of oil revenue should be saved to minimize the from 42 percent to 33.7 percent in the West Nile, and from 37. Resource-rich countries pursue different invest- volatility of three key macroeconomic aggregates (public 35.6 percent to 31.1 percent in the Mid-North. ment strategies for their oil proceeds. Brazil used natural consumption, private investment, and total employment). resource rents to expand its savings abroad, while Botswa- B. Macroeconomic and financial policy na’s priorities were more focused on building its existing 39. In resource-rich countries, the ultimate policy goal considerations stock of infrastructure and human capital. Judgments about must be to transform a temporary increase in revenue the absorptive capacity of the domestic economy and about into a long-lasting source of income. To measure to which 35. To leverage its new resources for further economic the appropriate pace of investment are the main factors that extent countries save and invest in a sustainable manner, the diversification and ensure the sustainability of the should determine savings and consumption trade-offs. The ‘wealth accounting framework’ uses the concept of adjusted country’s wealth, Uganda must transform its natural strength of the institutional framework should also be tak- net savings (ANS), which takes into account investments capital into physical, human, financial, and social en into account. In weak institutional set ups, investment in different forms of capital, including depreciation. While capital. Maintaining macroeconomic and financial stability spending leads to low returns due to poor project selection, Sub-Saharan Africa grew robustly at an average annual rate is an important part of this objective. The government’s appraisal, and implementation. In such circumstances it of 5 percent since the turn of the century, many resource- policy in this regard should address the following issues: makes sense to save part of oil revenues and invest in foreign rich countries (Nigeria, Angola) had negative ANS rates (a) minimize savings-consumption trade-offs through assets, including sovereign bonds in industrialized countries because they depleted resources without exhibiting high appropriate consumption-investment decisions; (b) adopt with high credit ratings. These savings would be used at a returns. Since 1982, Uganda’s ANS has also been negative, borrowing dynamics consistent with acceptable debt limits; later stage when improved investment capacity will enable principally as a result of the depletion of its forests. and (c) isolate the economy from oil price volatility. the economy to adjust gradually to higher investment levels. 40. The discovery of oil in commercial quantities boost- 36. One of the manifestations of the resource curse 38. In Uganda, the Public Finance Management Act 2015 ed Uganda’s total wealth but also raised the chal- is Dutch Disease, which turns poorly managed natu- stipulates that all oil-related revenues will be deposited lenge to report a positive ANS in the future. Starting in ral resource wealth into a mixed blessing and reduces into a holding account overseen by the parliament, which FY2017/18, oil rents will average about 3.4 percent of GNI long-term growth. In fact, although the discovery of oil will be used to finance the budget or will be transferred for over 25 years. In other words, the average wealth of a resources is expected to generate extra resources and spur to a special savings fund called the Petroleum Revenue Ugandan today is about UGX2.7 million higher due to oil investment in physical infrastructure and human capital, Investment Reserve. This savings fund will operate as a discoveries. it is also associated with challenges as it may inhibit the sovereign wealth fund. It will enable the country to save for development of the tradable sectors due to a real appreci- future needs and will smooth government expenditure when 41. To increase its ANS, Uganda should not only ation of the exchange rate (Dutch Disease). Moreover, the oil prices fall. The law, however, does not indicate which consume some of its oil revenue to improve the living lack of diversification and inadequate transformation of nat- share of annual oil revenue will be deposited in the account. conditions of current generations but should also invest ural capital into other forms of capital critical for long-term In Ghana, the law stipulates that each year 15 percent of all strategically to lift the income level of many generations sustainable growth can exacerbate the effects of Dutch Dis- oil revenue should be saved and deposited in a stabilization to come. To achieve this, Uganda needs to build up other ease. Therefore, prudent macroeconomic policies (includ- fund to absorb unexpected oil revenue shortfalls. If Uganda forms of capital as oil reserves are gradually depleted. If ing an inflation targeting monetary policy) are essential to adopts a similar rule, enough savings would be accumulated the depletion of oil reserves leads to increased consumption fight the effects of Dutch Disease and achieve the country’s by the end of 2024/25 to absorb a sudden drop in oil revenue and is not matched with increased investments in other economic diversification objectives. of almost 50 percent. Simulations from a Dynamic Stochastic forms of capital, Uganda’s wealth will decline over time. As xxiii Executive Summary was mentioned before, the development of the oil industry ed in productive projects, and: (iii) the sustainable investing rent domestic revenue reaching 14 percent of GDP, a non- offers many opportunities to raise public investment and approach, which allocates a fraction of the natural resource oil non-grant fiscal deficit target of 5 percent would limit to improve the living standards of the country’s for both proceeds to remove growth binding constraints (such as today’s expenditure to 19 percent of GDP. Set at a prudent current and future generations. infrastructure), while the rest is stored in a Parking Fund level, the NONG fiscal deficit rule could prevent a too rapid for future investments. The sustainable-investing approach increase in expenditure when oil production begins. 42. New oil revenue will enable Uganda’s government to provides an optimal combination of investment and saving accelerate public investment, but it will also create new depending on the size of oil production and the character- 45. In addition to implementing an adequate NONG challenges for the private and the public sectors and istics of the country’s economy. Investment is needed to fiscal deficit rule, the government should deposit each may lead to low investment quality. The case of Angola foster structural transformation but the increase in invest- year a fixed share of oil revenues in a savings account. shows that increasing investment too quickly exacerbates ment should be gradual to mitigate absorptive capacity con- The right level of NONG fiscal deficit depends on expected absorptive capacity constraints in the public sector and trig- straints and Dutch Disease effects. In particular, the grad- oil revenue and the targeted level of government expendi- gers supply-side bottlenecks in a private sector unable to ual scaling-up of investments under this scenario triggers tures. The CEM presents two alternatives. The first option increase the supply of non-tradable products and services. a smaller exchange rate appreciation than the all-investing would set the NONG deficit target at a fixed rate of 5 per- Weak institutional structures for public investment manage- approach, but higher levels of welfare than the all-saving cent of GDP. With expected oil revenue of 1.2 percent of ment often lead to low returns due to poor project selec- approach. GDP and grants of 0.6 percent over the first four years of tion, appraisal, and implementation. Accelerating the pace oil production, the overall deficit would average 3.5 per- of investment will be feasible if the management of public 44. The countries that implement clear fiscal rules on cent, thus enabling Uganda to comply with the 3 percent investment improves and the government implements poli- how initial oil revenue will be spent generally are the deficit target of the EAC monetary union by FY2020/21. cies aimed at stimulating an adequate response of the private most successful in their transition from net oil consumer However, a fixed target of NONG budget deficit does not sector to the resource boom. Background analysis using the to net oil producer. According to its Petroleum Revenue take into account the bell shape nature of the oil production Computable General Equilibrium (CGE) and Overlapping Management Policy, Uganda will use the non-oil non-grant path. It would therefore result in high fiscal deficits in the Generations (OLG) models shows that improved efficiency NONG fiscal deficit as an anchor for public expenditures. early years and very low deficits when oil production peaks in public sector spending would lead to higher GDP growth This means that total spending will be limited to the sum of by the mid-2020s. Alternatively, the proposed NONG fiscal rates. domestic non-oil revenue and the deficit target. With cur- deficit limit would be revised every 3-5 years in line with the inflow of oil revenue. 43. To maximize the socioeconomic impact of new reve- nue, Uganda should increase investment levels gradually 46. Resource-rich countries use a wide variety of fiscal and save some of its oil revenue in the early years of oil rules to promote sound fiscal management of natural production. Investing abroad gives time to consider which resources. In 1994, Botswana adopted a Sustainable Bud- domestic investments should be undertaken. The CEM get Index (SBI), which provides that the ratio of non-educa- compares three alternative strategies using a DSGE built for tion, non-health recurrent expenditure to non-mining reve- Uganda, that is, (i) the all-saving approach, in which natu- nue should not exceed unity. Implementation of the policy ral resource proceeds are totally saved (only the return on prevented excessive spending and ensured fiscal sustain- grown by UGX 2.7 savings is used to finance the domestic economy), (ii) the million each due to ability in anticipation of the depletion of diamond deposits.1 all-investing approach, in which all the proceeds are invest- the discovery of oil Both the fixed and the flexible fiscal deficit rules presented 1. Kajo (2010): “Diamonds Are Not Forever: Botswana’s M. rm Fiscal Sustainability” xxiv Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility in the previous paragraph would comply with a Botswana type system. Combined with an explicit savings target for each year, the NONG rule would also have advantages over Stone quarrying for road construction Ghana’s widely praised petroleum revenue management law, which establishes that 70 percent of the benchmark annual oil revenue is channeled to the budget, 15 percent allocated to a stabilization funds and 15 percent saved for future generations. In fact the Ghanaian mechanism does not really limit spending, since the government can comply with the saving rule while borrowing for additional expen- ditures. In effect, since the beginning of oil production in 2011, recurrent spending already rose by 10 percent creat- ing serious risks for Ghana’s near - term economic outlook. Under Uganda’s NONG fiscal deficit rule, such a spending increase would not be possible. b. Borrowing dynamics 47. The government may be tempted to spend in advance some of its future oil revenue through substantial borrowing on the financial markets. This may generate short-term benefits through growth of private consumption but would have negative long-term consequences, as savings are sacrificed. It might also help to smooth investment expenditures over time, taking into account the limited absorptive capacity of the economy. The case of Ghana is the most recent example that illustrates the need to establish safeguards. The coming on stream of oil in late 2010, which coincided with preparations for the 2012 presidential election, fuelled the formation of excessively optimistic expectations, with negative consequences in terms of fiscal prudency. Instead of using initial oil revenues for fiscal consolidation, given Ghana’s high fiscal deficits, the government raised expenditure and used future oil revenues as collateral to increase its debt. xxv Executive Summary 48. Excessive borrowing in Ghana was possible because 51. The volatile nature of oil prices generates boom-bust avoid falling victim of spending pressures often encoun- the revenue management law does not include clauses cycles, which can be prevented through adequate fiscal tered in resource-rich countries. Moreover, Uganda should which ensure that prospective oil revenues will not policy. The rationale is simple: the government can adopt a establish sufficient buffer to smooth out the adverse effects lead to excessive government borrowing. Whereas an counter-cyclical fiscal policy when oil revenues are declin- of price volatility on macroeconomic and financial vari- original draft of the Petroleum Revenue Management Bill ing, thus helping the economy to absorb the shock. Such ables. The implementation of clear fiscal rules involving included a clause that prohibited the use of oil revenues as policy is subject to two conditions. some savings will also be critical in this regard. collateral for loans (that is, oil-backed loans), the clause was dropped during the drafting process. Consequently, 52. First, the government should have sufficient reserves C. Public sector management issues the country is tapping heavily into international capital to finance such policy, which raises the question of how much oil revenue should be saved, not for future genera- 54. Sound public sector management is essential to markets to frontload investments which expanded from 15 tions, but to act as a buffer in case of negative shocks. The harness the potential of extractive industries and speed percent of GDP in 2007 to 26 percent in 2013. Moreover, second condition is that the countercyclical fiscal policy can up the socioeconomic transformation of resource- in 2011 the government signed a US$3 billion loan with have an impact on the real economy. This requires some rich countries. The design of an effective public sector the Chinese Development Bank, which explicitly commits knowledge about the magnitude of fiscal multipliers and management strategy should deal with: (a) the efficiency future oil revenues as collateral. Under the agreement, their heterogeneity with respect to boom and recession and the allocation of public spending, (b) the crowding out the Government of Ghana will sell crude oil directly to a cycles. A background paper prepared for the CEM (using of non-oil domestic revenue, (c) public spending pressures Chinese agent to support the repayment of the loan. a sample of 99 countries) shows that spending multipliers and the revenue sharing with local governments, (d) the oil- 49. In Uganda, the Public Finance Management Act are higher for resource-rich countries (ranging from 0.55 aid nexus, and (e) managing population expectations. explicitly prohibits the collateralization of future oil rev- to 0.74), which are more capable of boosting GDP through a. Efficiency and allocation of public spending enues. However, prudent debt management will always be government spending. In addition, spending multipliers required over time. seem to be higher during recessions (0.55-0.59) than during 55. The pace and the quality of investment are critical booms (0.01). In other words, fiscal interventions are more for sustainable long-term growth. Countries that invest c. Volatility concerns effective during recessions in oil-producing countries than a large share of their natural resources wealth grow fast- 50. Oil - dependent countries are exposed to oil price everywhere else. er. However, what matters is not only how much a country volatility, which may be caused by political develop- invests but how well it invests. Because of poor investment 53. In this context, sound planning instruments and quality, some countries are unable to produce returns gener- ments, natural disasters, sudden changes in the global oil expenditure stabilization mechanisms are needed to ating sustainable consumption levels.  Angola and Nigeria demand and other exogenous factors. Commodity price vol- ensure that increased government spending resulting are typical examples of countries that did not fully enjoy the atility, through its impact on export earnings, could affect from positive changes in commodity prices does not benefits of increased oil production (and high prices during the effectiveness of fiscal policy and economic growth in negatively impact macro-stability and delivers value for the oil boom) because of the poor quality of their invest- resource-dependent countries as has been seen during the money. An inflation targeting monetary policy based on ments. recent decline in international oil prices. Lower oil prices export commodity (Product Price Targeting) could increase reduce government revenues and the capacity to finance the effectiveness of countercyclical fiscal policies (Franklin 56. Recent government programs emphasize invest- public spending. 2012). This is a valuable lesson for Uganda, which must ments aimed at improving the country’s deficient xxvi Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Infrastructure projects like road construction require heavy investment, thus the temptation to borrow in anticipation of oil revenue is high infrastructure. Uganda’s infrastructure investment needs Uganda’s primary school enrollment rates are high, overall um and long-term prosperity. Economy-wide simulations (Works and Transport, Energy and Mineral Development, spending per primary school student is below the average in conducted during preparation of the report, suggest that Water and Environment, Information and Communication low-income countries. This may explain the low completion using initial oil revenue to address the most urgent infra- Technology) are estimated at US$21 billion (until 2025). rates as compared with similar countries. Better schooling structure needs, notably in energy and transport, will have Public investment in infrastructure increased significantly outcomes and increasing the share of students transitioning a stronger growth impact than increased spending on edu- since the adoption of the first National Development Plan from primary to secondary education will require addition- cation and health. Allocating oil revenue to infrastructure (NDP1). Road construction and maintenance increased from al funding. Health sector expenditures will also need to during the first four years of oil production would lead to 2.4 percent to 3.1 percent of GDP from 2009 to 2013. At the increase over the long-term. a 0.8 percentage point higher increase in the GDP growth same time, public spending in education and health declined rate than if all resources are allocated to human develop- from around 6.5 percent of GDP in 2003/04 to 4.5 percent in 57. The CEM argues that investments in infrastructure ment. Focusing efforts on infrastructure also yields better FY2012/13 and social services are under pressure. Although and human capital are both critical for Uganda’s medi- outcomes for the MDGs. All the 2015 MDG targets would xxvii Executive Summary be met by 2020, with the exception of Universal Primary go only to Ugandans who are adequately trained and edu- at increasing the tax revenue - to - GDP ratio to 18 percent Education. cated, but the number of Ugandans with the necessary tech- - the average ratio for low-income countries estimated by nical skills is insufficient. The skills shortage goes beyond the International Monetary Fund (2010) - would result in 58. In the long run, however, education and health the oil sector and is a binding constraint for a modern econ- higher long-run growth of about 3.3–3.7 percentage points. spending will have more impact on growth than spend- omy. The implementation of the recently developed Oil & Consequently, Uganda needs to pursue ongoing efforts to ing on infrastructure. A study prepared in the context of Gas Skills Development Strategy and Plan will be crucial improve tax collection. These efforts should be accompa- this report, which exploits the features of an overlapping to harnessing the benefits of oil and gas for the citizens of nied by fiscal rules that incentivize improvements in tax generation (OLG) growth model, concludes that a 3 per- Uganda. administration and collection. In fact, one of the advan- centage points increase in the share of government spend- tages of a NONG fiscal deficit rule is that the incentive to b. Crowding out of non-oil domestic revenue ing on health and education would have a long-term growth mobilize non-oil domestic revenue remains high even when impact of about 0.7 percentage points compared to only oil revenues start to flow. Using a NONG fiscal deficit as 60. Increased fiscal space due to oil revenue may lead to 0.4 percentage points for a similar increase in spending on a fiscal anchor implies that a drop in non-oil tax revenue lower tax mobilization in other sectors. Many resource- infrastructure. The study explains that while an increase in would need to be accompanied by an equivalent reduction rich countries experience a decline in non-oil tax revenue the share of infrastructure spending would have indirect in expenditure. With a credible limit based on an enforced when the government begins to receive a substantial inflow effects on human capital accumulation and the production NONG fiscal deficit rule, the government would be encour- of oil-related revenue. A decline in tax revenue would have of health services, it would also have congestion effects aged to continue ongoing efforts, widen the tax base, and negative macro-fiscal implications. If for instance recent that mitigate the initial benefits of a higher public capital improve the administrative efficiency of tax collection. efficiency gains were to disappear when oil production stock. These findings support the strategy of the govern- begins, the ratio of non-oil tax to non-oil GDP would fall c. Public spending pressures (including subsidies) and ment which wants to allocate most of the initial oil revenue from 13 percent today to less than 10 percent in the medi- Revenue sharing with local governments to infrastructure, but recognizes that neglecting the social um term. The government would therefore need to reduce sectors would have a growing opportunity cost in the medi- expenditure to meet the 3 percent deficit ceiling of the EAC 62. In many oil-producing countries, domestic produc- um to long-term. and GDP growth rates would be significantly lower than in tion of oil and gas created pressures to lower domestic the baseline scenario. By the end of the projection period, petroleum prices below international levels. Several 59. The social sector plays an important role in deter- the GDP would be 35 percent lower than in the baseline factors could help the Ugandan government manage these mining the distributional impact of GDP growth. The scenario. pressures. First, at this stage Uganda does not have substan- build-up of human resources through education and training tial fuel subsidies (except for kerosene) and domestic pric- is not only good for growth, but it will help diversify since 61. Improving domestic revenue mobilization will have es generally follow international prices. Second, Uganda manufacturing and modern services depend on a well-edu- critical long-term growth effects. Using the overlapping repeatedly suffered from prolonged fuel shortages and price cated labor force. This is especially relevant for a country generation growth framework developed for Uganda, it is spikes due to: (i) limited fuel storage capacity (equivalent like Uganda where only 20 percent of the labor force has estimated that increasing the tax revenue-to-GDP ratio from to 20 days, one of the lowest in the region), and (ii) the completed secondary education, compared with 50 percent 12.7 percent of GDP to 15.1 percent - the average ratio for country’s dependency on fuel imports from the Momba- in Ghana. Investments in education are important to ensure low-income countries estimated by Baldacci et al. (2004) sa refinery. Third, as Uganda is a landlocked country, the that Uganda’s youth is prepared for new job opportunities in - would lead to a 1.5 percentage points increase in the cost of transporting petroleum products is very high (it is the emerging oil industry and other sectors. These jobs will growth rate. A more ambitious tax reform program aimed true that as the country invests in infrastructure, the cost of xxviii Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility ic management challenges often experienced by resource - rich countries. Given its weak governance practices and institutions, Uganda’s oil riches is not likely to substantially decrease its access to foreign aid. A recent paper (Dobro- nogov et al. 2014) discusses how donors should respond to potential windfalls in their client countries. It argues that while complementing other available self-insurance mech- anisms (for example, Sovereign Wealth Funds and facili- ties from International Monetary Fund), the International The revenue Development Association (IDA) could be structured to pro- mobilisation perfomance will need vide a larger degree of insurance against major declines in to be improved prior resource prices. to the first flow of oil revenues D. Policies to promote private sector development transportation will decrease, leading to lower prices at the at optimizing the benefits to be derived from oil and other 65. The private sector is the most powerful instrument pump). In this context, the best option may be to introduce extractives. of economic development. It creates economic growth, an automatic price adjustment mechanism (see the system d. Oil revenue and aid generates government revenue, provides employment, mod- adopted by South Africa), that organizes a full pass-through ernizes technology, trains staff, develops skills and reduces of international prices but provides for a smooth adjustment 64. Recent research argues that the growing number of the costs associated with hiring expatriates. Oil and min- of domestic prices, by limiting the magnitude of any single hydrocarbon discoveries in low-income countries could eral development brings new opportunities for private sec- price change per week or per month.  reduce the need for foreign aid (Arezki and Banerjee, tor development. Together with growing urbanization and 2014). However, empirical evidence shows that there is no overall economic growth, it expands demand for food and 63. Many resource rich countries have grappled with significant statistical relationship between oil discoveries other services. Increasingly international oil companies out- this complex issue. No clear, effective and field tested and the level of foreign aid. Many analysts argue that while source a number of specific tasks, ranging from construction formula seems to be available at this stage. In addition the often sizable stream of new income from the exploita- to food provision. This is a good opportunity for domestic the distribution of oil revenue to local governments should tion of natural resources will relax budget constraints in suppliers to obtain contracts and participate in the supply take into account macroeconomic and financial stabilization developing countries, donors have many strategic reasons chain of oil production. Cheaper oil could also stimulate the issues influencing the management of both central and local to continue providing aid (Alesina and Dollar 2000). These emergence of energy intensive industries, including fertiliz- governments. Economic and financial stabilization policies include: (i) ensuring access to oil and energy produced by ers, chemicals, metal products and cement. will always remain one of the principal functions of cen- the recipient nation (to address the energy needs of the donor tral authorities. The study of the Nigerian experience may countries); and (ii) facilitating access for major Western oil 66. Several factors, however, affect the capacity of the provide useful examples of what should be done and what companies to oil extraction contracts. In addition, foreign Ugandan private sector to take advantage of these should be avoided. Most of these issues will be addressed aid is critical to address the governance and other econom- opportunities. First, the current business environment is as the government develops a more detailed strategy aimed xxix Executive Summary erential treatment for goods produced in the country. This applies not only to oil companies but also to contractors and sub-contractors that constitute the supply chain. The gov- Value addition ernment should also include in future oil contracts provi- to agricultural sions aimed at promoting socioeconomic development (use produce at Flona Commodities, a of local suppliers, support for training and local skills devel- pineapple farm in opment programs, priority for Ugandan citizens). Bugerere 69. The final success of local content policies will largely depend on the capacity of local suppliers to deliver prod- ucts and services on time at a competitive cost. The role of the government and private enterprises should, therefore, be to select sectors and sub-sectors in which local capac- ity is available or can be developed through appropriate training and financial support. A high priority should first be given to the construction phase. International investors are expected to spend approximately US$10.8 billion (39 percent of 2014’s GDP) in the next 4-5 years and to create almost 13,000 direct jobs during that phase. This is a unique opportunity that should not be missed by Uganda. not very favorable. According to the most recent Glob- first priority should be to pursue ongoing efforts to improve Part III: Government Actions Necessary to Address al Competitiveness Index, Uganda ranks 129th out of 148 the business climate, address the most critical infrastruc- Specific Implementation Issues countries. Corruption, inadequate access to finance and ture deficiencies, including electricity, communications and 70. Achieving the short and long-term objectives of the deficient infrastructure are viewed as the main constraints. transport, and support public and private initiatives aimed at proposed strategy will require a series of actions, includ- The number of registered firms is growing but more than improving access to long-term capital. Strengthening exist- ing (a) improving public sector management (PFM, PIM, 90 percent of these firms are microenterprises. As a result, ing enterprises and encouraging small and medium - size public sector incentives), (b) improving the role of the pri- Uganda’s potential suppliers may lack the capacity to meet firms to grow and join the formal sector should be an essen- vate sector and the civil society, (c) leveraging the possible the quality standards of international oil companies. Finally tial component of that policy. impact of regional integration while mitigating associated low backward and forward linkages with other sectors may 68. Perhaps the most effective instrument of the pub- risks (for example, in the context of the monetary union), limit the positive impact of the oil industry on the country’s lic sector in that area is likely to be the introduction of and (d) managing expectations of the population. private sector. effective local content policies in order to promote new 67. In this context, government policies should address linkages between the oil industry and the domestic private a wide variety of private sector development issues. The sector. Uganda’s petroleum law already provides for pref- xxx Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility A. Improving public sector institutions ny could obscure the division of labor between the Ministry 74. In summary, while close coordination between and management of Energy and the Ministry of Finance and could strengthen MFPED, Energy, URA, the Bank of Uganda and oth- the influence of other institutions. Such problems would be er institutions is vital for effective management of oil a. Institutions difficult to correct at a later stage in an environment which revenue, the development of a comprehensive capacity may be dominated by rent-seeking behavior. building program for the O&G sector also is of high 71. Managing oil resources involves many different priority. In this context, the recent preparation of a skills aspects of economic management, including energy, 73. The strengths and weaknesses of each institution development strategy and actions plan (SDSP) for the O&G finance, labor, industrial policy, land, infrastructure should be assessed and addressed through hiring the sector is a positive initiative. and social services. Seven key institutions - the Minis- most appropriate expertise (domestic or foreign) and try of Finance, Planning and Economic Development, comprehensive local capacity building programs. Most b. Management the Ministry of Justice, the Bank of Uganda, the Uganda of these institutions need specialized expertise to perform Revenue Authority, Energy (PEPD), National Evironment new tasks in the oil sector. Highly skilled technical person- 75. The government should design an oil revenue man- Management Authority (NEMA) and Office of the Auditor nel is also needed to help the Ministry of Finance design agement strategy dominated by transparency and General (OAG) - will play a major role in formulating and and use effective oil revenue spending and saving mecha- accountability, including information of the public implementing the government’s oil sector strategy. Two nisms. Each year, MFPED sends two public sector agents through joint briefings on oil sector revenue involving other institutions - the Petroleum Authority and the Nation- abroad to study oil and gas management issues. This is not the government and the oil companies. The government al Oil Company are in the process of being created.  The sufficient to remedy the lack of specialized MFPED staff in should also strengthen its PFM systems and, in particular, creation of NOC is critical to shield the state from direct that area. The Ministry of Justice also needs skillful negoti- improve its public investment management capacity, with liability. Other institutions in the social and infrastructure ators to negotiate the best possible deals with international special emphasis on more effective implementation. Ugan- sectors (the Ministry of Education, the Ministry in charge of oil companies and maximize the share of oil revenue accru- da’s performance is good with respect to budget transparen- labor and gender, the Ministry of Health, and the Ministry ing to the government. The Ministry should use experienced cy (ranking 18th out of 100 countries), but its PFM systems of Works and Transport) also play a significant role, nota- consultants and develop local capacity through staff train- are weak in terms of budget credibility, budget execution bly with respect to the formulation and implementation of ing abroad and in the country. The URA will also need addi- controls (particularly payroll), procurement compliance and policies and strategies concerning infrastructure and skills tional technical staff specialized in reporting, auditing and legislative scrutiny of external audit reports. development in the O&G sector. taxation of the oil and gas sector for its recently established 76. The recently approved PFM law introduced a Con- Natural Resource Management unit. NEMA should review 72. The government should clarify the roles and respon- tingencies Fund to finance unforeseen, but urgent and its guidelines taking into account the special characteristics sibilities of its institutions. The lack of clear definition of unavoidable expenditures without destabilizing other of complex oil-related environmental issues. OAG itself is the respective roles of the Petroleum Authority, the Ministry components of the budget. This is already a positive step concerned with its lack of technical knowledge with respect of Energy, the National Oil Company and other agencies toward improving budget credibility. However, additional to the auditing of oil and gas institutions. In effect, the gov- involved in oil management is particularly important for measures are necessary to enhance the effectiveness of the ernment should address weaknesses in the accountability the development of a promising oil sector. Creating all the PFM system. These measures include: (i) accelerating the chain, including staffing and specialized technical skills, as necessary oil management institutions and clarifying the complete roll out of IFMS to all entities, interfacing IFMS well as legal, case management, and political interference roles of the existing ones must be done before production with IPPS and extending it to funds with specific conditions issues. begins. For instance, the absence of a National Oil Compa- (for example, donor projects), as 77 percent of expenditures xxxi Executive Summary going through the IFMS leave a substantial gap that can term economic and social development of their citizens. The aging the densification of the industrial landscape to enable be exploited; (ii) introducing the Treasury Single Account goal of multinational corporations (MNCs) and other pri- firms to benefit from economies of agglomeration. An effec- (TSA) to promote greater transparency and accounts recon- vate enterprises is to generate profits for their shareholders tive collaboration between the public sector, the private sec- ciliation; (iii) improving on unpredictable and late release and maximize returns on investments. However, to achieve tor, and the civil society will be particularly critical. Such a of funds which often lead to under-spending or to rushed their objectives, governments need to create an environment collaboration should take place at three levels: (a) during the spending at year-end, making procurement less competi- favorable to private sector investment. At the same time, design of the strategy: the private sector should be involved tive and more costly (70 percent of public expenditures go private enterprises recognize that the sustainability of their in the development of the legal and institutional framework through procurement systems); (iv) reviewing parliamenta- activity depends on effective cooperation with governments, and should also participate in negotiations. In this context, ry processes for a more efficient handling of audit reports donors and the civil society in support of common objec- the government should be able to capitalize on the influ- and strengthening inter-institutional linkages between OAG tives. In fact, close collaboration between the public and the ence of pressure groups such as the Uganda Chamber of and its partners (investigation bodies and other regulators/ private sectors and also with the civil society is a win-win Mines and Petroleum; (b) during implementation of the auditors including PPDA) to improve coordination and for Uganda as it creates substantial benefits, including train- strategy: through various interventions such as PPPs, joint focus reporting on risks and impact; and (v) developing the ing, import of technology (through MNCs), joint infrastruc- infrastructure projects, training, transfer of technology, and capacity of public servants in PFM functions, and introduc- ture (through PPP),  and accountability (through improved community help; and (c) for the monitoring of the strategy: ing incentives and performance management frameworks demand for good governance). joint mechanisms (for example. EITI) will be crucial for an (pay reform and performance appraisal). Incidentally, pub- effective monitoring of this trilateral collaboration.   lic sector wages stagnated and are now low compared to 79. Despite a mediocre business environment, the num- private sector equivalents. ber of registered enterprises tripled during the 2000s, C. A sound approach to regional but the business landscape is dominated by micro-enter- integration   77. Public Investment Management (PIM) systems also prises. Oil production will stimulate private sector develop- need to improve, in terms of strategic guidance for public ment, but the lack of linkages between the oil industry and 81. The report discusses the consequences of oil projects (alignment on NDP priorities and adoption of min- other sectors, and the incapacity of smaller firms to meet development on the ongoing regional integration effort imum technical and financial standards), project selection, the high standards of international oil companies may lim- and on the future creation of a monetary union. Oil budgeting and implementation (integration into the budget it the positive impact of oil development on other sectors. production will provide an opportunity to expand regional cycle and medium-term expenditure frameworks), project Nevertheless, the agricultural sector should benefit from infrastructure and promote regional integration but it will audit and evaluation. The most urgent measure to strength- the higher demand for food. Uganda should also be able also complicate the coordination of macroeconomic and en PIM systems is the development of a Public Investment to develop agro-processing and light manufacturing and the fiscal policies at the regional level. Regional integration Methodology for Project Appraisal which is forthcoming country has the resources necessary for the development of is crucial for a landlocked country like Uganda. As an with support of a Bank technical assistance project financed a competitive tourism industry. example, Uganda needs a pipeline through Kenya or by the DfID trust fund. Tanzania to export most of the expected oil production. 80. In this context, the main priorities for public sector Subsequently, priority should be given to using oil revenue B. Participation of the private sector interventions are: (i) improving the business environment to enhance connectivity across countries, notably (but not and involvement of civil society and helping small enterprises manage crises; (ii) promoting only) with Kenya which is Uganda’s natural gateway to regional integration and open trade policies; (iii) increasing global markets. Efforts should also focus on the central 78. Governments and corporations have different goals. the competitiveness of strategic sectors; (iv) supporting the corridor linking Uganda to Tanzania in order to diversify The main goal of good governments is to promote the long- growth of larger formal sector enterprises; and (v) encour- trade routes.  Oil revenues will provide an opportunity to xxxii Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility remove some of the infrastructure bottlenecks since the cost cial intermediation and limited scope for changes in interest 86. In this context, the development and implementa- of upgrading or building new connectivity infrastructure rates to affect the behavior of households and firms. Fourth, tion of an effective communication strategy is a high pri- (such as ports on Lake Victoria, railways, and regional the timing of the oil and gas production in the region is still ority. This strategy should define clear responsibilities for roads) is very prohibitive. The effectiveness of regional uncertain and production will not start at the same time. It nation-wide communications on the oil and gas sector. The infrastructure developments will also depend on the is probable that Uganda will export oil before Tanzania pro- ultimate goal of the strategy will be to empower citizens by removal/reduction of soft infrastructure barriers, including duces gas on a large scale. educating them on pertinent issues concerning the prospects non-tariff constraints and logistical services. It should and the possible impact of oil, gas and other mining activ- also be noted that the resource endowment of many EAC 84. In this context, the CEM recommends that: (i) EAC ities, and to encourage them to participate in the ongoing countries gives an opportunity to a country like Uganda to countries should adopt sound fiscal policy (including clear dialogue on the future use of oil and gas revenue. This will invest in the provision of specialized skills which could then fiscal rules) to minimize changes in the price levels in East also encourage transparency and accountability. be utilized in other countries. Africa’s new commodity exporters, relative to their neigh- bors and, (ii) the process of integration should be slow and 87. Ultimately, the success of Uganda in optimizing the 82. On the macroeconomic front, regional cooperation, reversible, as Uganda builds on its experience on infla- benefits from oil will be largely determined by the coun- including the move towards monetary union will be tion targeting monetary policy management. Meanwhile, try’s capacity to set up the stage for a non-oil economy complicated by the emergence of oil and gas resources the other members of the East African Community should in the longer term. Successful countries have been those among regional economies. Abandoning independent establish a network of stable, pegged exchange rates - ideal- that have used non-renewable resources to diversify their monetary policy at the national level and transferring ly through harmonizing interest rates rather than accumulat- economies by a combination of policies and actions aimed that function to a regional entity comes with a number ing foreign reserves at least until the resource expenditure at building the stock of physical and human capital and of advantages. First, it may be the best way to create an stabilizes. implementing an effective social policy to protect vulnera- independent and credible central bank which no national ble groups. Simply put, Uganda’s success will be measured government can dominate. Second, a regional monetary D. Managing expectations by its capacity to go up the ranking in the human capital authority is less likely to import recessions since monetary index, the doing business indicators, and access to basic 85. Given the numerous uncertainties associated with policies do not need to be linked to countries outside the infrastructure over time. the oil sector, the eventual development of the sector and area. Third, creating a single currency can significantly the possible emergence of additional government reve- reduce trade costs if the members of the union are also nue should not significantly change the overall goals of major trade partners. the government strategy. Efficiency gains and economic 83. EAC countries will face four major challenges as diversification must continue to dominate Uganda’s strate- they move towards a single monetary policy. First, the gic objectives. Efficiency can provide fiscal space virtually additional oil-financed demand will trigger an increase equal to the expected levels of oil revenue. More impor- in relative prices in commodity-rich countries which will tantly, despite the role oil production and revenue can play make them more vulnerable to commodity-price shocks. in Uganda’s future, the country should not abandon other Second, there will be a big difference between resource-en- available development and economic diversification oppor- dowed countries (Uganda, Tanzania, and Kenya) which will tunities. In fact, future oil revenue will be best used if inte- grow faster than the other countries (Burundi and Rwanda). grated into Uganda’s current development objectives and Third, the value of independent monetary policies may be partnerships. limited in developing countries, where there is little finan- xxxiii Executive Summary Table 1: Summary of CEM Recommendations Coverage Recommendation Timeline Setting up of the right Channel the revenue generated by resource rents into human capital (through education and training), social capital, institution Short to medium term institutions building, good governance and transparency and keep rent seekers at bay Design an efficient oil revenue management strategy emphasizing transparency and accountability through better information of the public on the role of the State in the management of oil resources and through regular, joint briefings on oil sector reve- Short to medium term nue, involving both the government and the oil companies Cooperation of the government, the civil society and the private sector in the design of a national resource charter aimed at Short to medium term assessing progress achieved in addressing institutional gaps in the management of the oil sector Clarify the respective roles and responsibilities of institutions involved in the management of the oil sector (including Petroleum Short to medium term Authority, Ministry of Energy, National Oil Company and other institutions involved in oil management) Develop a strategic framework to promote the co-existence of oil and tourism during the lifecycle of oil exploration Short to medium Develop and implement an effective national communication strategy for issues related to the prospects, possible impacts of oil, Immediate to short term gas, and other mining activities Improving performance of Additional efforts to promote economic diversification through communicating the virtues of diversification Immediate existing institutions Address weaknesses in the chain of accountability, including staffing, resources, specialized technical skills, legal and case man- Short to medium term agement issues, and political interference Guide stakeholders, including CSOs and the private sector, including through regulations. For the promotion of development activities in line with the country’s development goals. One of the objectives of these regulations would be to prevent and fight Short to medium term abuse by businesses and other stakeholders Improve public investment management and strengthen PFM systems Short to medium term Address constraints to growth, exploit forward and backward linkages, and stimulate business development Short to medium Improve product complexity through training, skill development, FDI and/or joint venture with foreign firm Immediate, short-medium term Adopting the right set of Maintain macroeconomic stability through inflation targeting monetary policy and prudent fiscal policy involving spending Short to medium term policies constraints/limits Design and implement a set of business friendly policies in the areas in which Uganda may have a comparative advantage (food Short to medium term processing, construction materials and other labor intensive industries) xxxiv Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Coverage Recommendation Timeline Invest in infrastructure, with special attention to horizontal and vertical inequality, and invest in human capital to promote a Short to medium term larger long-term growth impact Adopt a fiscal rule based on non-oil fiscal deficit for the use of resource proceeds in order to mitigate the effects of oscillating oil Short to medium term prices and oil revenue Strengthen domestic revenue mobilization to ensure that increased oil revenue is not offset by declining tax collection in other Short to medium term sectors (large or small, local or foreign businesses) Firm commitment to sound macroeconomic policies (including monetary and fiscal policies) as the East African Community prepares the creation of the monetary union. This is critical to avoid the risk of cross-border spillovers of negative macroeconom- Short to medium ic impacts caused by poor economic management of resources Improve the quality and competitiveness of trade and transport infrastructure and logistics, which are essential to reduce Short to medium cross-border transaction costs Streamline domestic regulatory regimes to improve the efficiency of regional infrastructure and create effective regional markets Short to medium term for services Design an effective oil revenue sharing formula with local governments Immediate to short term xxxv Part I An Economic Development and Diversification Strategy - Main Goals Part I focuses on the importance of economic diversification for Uganda and on the prospects/challenges of oil and mineral development. It addresses successively the following three issues: (a) Why diversification is important for economic development. (b) Where Uganda stands in that area and why it should give a new impetus to its diversification strategy. (c) What are the prospects, possible impact, and challenges associated with oil and mining development for Uganda’s economy. It is structured as follows: Chapter 1 provides an overview of the salient features of the Ugandan economy including the country’s development strategy and economic diversification dynamics. Chapter 2 examines the prospects and impact of oil and other extractives for Uganda. Chapter 1 Uganda’s Economy: Key Messages and Conclusions: Recent developments, current economic structure, Recent economic developments. Until 2011, the g o v e r n m e n t s t r a t e g y, o p p o r t u n i t i e s f o r e c o n o m i c combination of sound economic policies, pro-market reforms, and a surge in development assistance diversification accelerated economic growth which averaged 7.3 percent during the first ten years of this century. Although growth slowed down over the past few years, the GDP per capita more than doubled since 2000 and Road construction work the headcount of poverty fell from 33.8 percent to 19.7 percent. Structure of Uganda’s economy. Uganda remains a low-productivity economy dominated by agriculture and a mainly informal services sector. The agricultural sector employs 66 percent of the workforce, but contributes only 22 percent of GDP. The industrial sector (23 percent of GDP) is dominated by agro- processing and construction. Most of the country’s recent economic growth came from the services sector (47 percent of GDP). Tourism accounts for only 5 percent of GDP but is viewed as a promising subsector. The government strategy. To achieve its ambitious socioeconomic transformation goal that would make Uganda an upper-middle income country in 30 years, the government wants to promote a culture of economic diversification. This is a sound objective. International experience shows that countries that successfully diversified also achieved strong and sustainable economic progress. The main goal of economic diversification in a country rich in natural resources should be to transform exhaustible natural I. Recent Economic Developments resources into other forms of capital (physical and intangible), which are crucial for long-term development. Uganda’s diversification policy should 1.1. Uganda’s GDP growth rate averaged 7.3 percent (3.9 percent in per capita terms) from FY1999/2000 to FY include agro-processing, mining, and tourism. The 2009/10. Political stability following a long period of conflict is a major factor. Catching up from a low base, the economic country should also promote industrial policies based recovery was also supported by a surge in development assistance. In addition, sound macroeconomic policies implemented on the results of past international experience. since 1987 promoted liberalization, and pro-market reforms, and stimulated private investment (which rose from 8.1 percent of GDP in 1992/93 to 18.3 percent in 2010/11), and exports (which increased from 5.7 percent of GDP to 15.4 percent 3 One Chapter 1 Figure 1.1: GDP Per Capita Growth Figure 1.2: Real GDP Growth Across (Annual Percent) Selected Sectors (Index 2003/04=100) Key Messages and Conclusions: The report describes two paths to diversification. The first one aims at expanding productive capabilities. Over the past twenty years, 60 new products appeared in Uganda’s export basket, including cooking oils, processed fruit and vegetables, fish, flowers, wood, minerals, chemicals, high-value leather, and construction materials. Accelerating Uganda’s economic transformation, however, will also require expanding productive knowledge beyond existing productive capabilities. The report outlines a methodology for the selection of increasingly complex products that Uganda may wish to promote in the context of a longer-term development strategy. Conclusions: Elements of a short- and long-term strategy: Uganda Sub Saharan Africa (developing only) The short-term diversification strategy would focus Lower middle income on developing existing capacity. It would include manufactured exports that Uganda is most capable Source: World Development Indicators; Uganda Bureau of Statistics. Source: World Development Indicators; Uganda Bureau of Statistics. of exporting: (i) light manufacturing industries (garments, leather, and wood products); (ii) over the same period). Following initial productivity last decade. The average annual growth rate of services strengthening existing agriculture-related processing industries (cereals, dairy products, cooking oils, and gains in the 1990s, growth was largely driven by factor exceeded 10 percent during the last decade. In addition, the sugar products); and (iii) a few chemicals and metal accumulation. In fact, 90 percent of growth variations in growth of a labor-intensive manufacturing sector averaged products for which Uganda’s capabilities could be the 1990s are explained by total factor productivity (TFP) 7 percent during the same period. fostered. Implementation of the short-term strategy will growth (capturing reform dividends). Increased physical, generate a pool of industrial skills that are essential and human capital was the main driver of growth during the 1.3. Prudent macroeconomic management dominated for the development of more complex manufacturing capabilities. 2000s, as reforms attracted investment in two key sectors the government performance. Consumer Price Index (agriculture, and services). (CPI) Inflation (end of year) averaged 4.9 percent per The focus of the long-term strategy would, therefore, annum from FY1999/2000 to FY2008/09. Improved fiscal be on new and more complex products, including: (i) dairy and footwear products; (ii) processed meat; (iii) 1.2. Uganda’s economy has begun to diversify. management led to a decline in the fiscal deficit (including more sophisticated wood and metal products; and Agriculture remains a major economic sector, employing grants) from 7.6 percent of GDP in FY1999/2000 to (iv) expanding the production of chemical products, about 66 percent of the workforce, and accounting for 1.5 percent in FY2006/07–2008/09.1 The successful based on the local availability of minerals and unprocessed chemicals. over 22 percent of GDP (compared to 24 percent a decade implementation of reforms undertaken in the context of the ago). However, an expanding services sector, notably transport, telecommunications, and financial services, has 1. A similar pattern is observed with respect to the fiscal deficit (excluding grants), which declined from 14.8 percent of GDP in FY1999/2000 to an average become the main driver of economic growth during the of 5.3 percent in FY2006/07–FY2008/09. 4 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 1.3: Uganda’s Recent Growth Lower than Figure 1.4: Uganda’s Recent Growth Lower than Long-term Average Comparators Source: World Development Indicators; Uganda Bureau of Statistics. Source: World Development Indicators; Uganda Bureau of Statistics. Heavily Indebted Poor Countries (HIPC), and Multilateral ing constraints to growth (for example, energy projects that Debt Relief Initiative (MDRI) also contributed to a drastic could help reduce manufacturing costs by 25 percent). Mac- decline in external debt, from an average of 63.5 percent roeconomic stability was also affected by a significant rise of GDP in FY1999/2000–2005/06 to 12.6 percent in in inflation to an average of 11 percent (CPI end of period). FY2006/07–2009/10. This helped provide additional fiscal In addition, the fiscal deficit (including grants) increased by space to cater to the country’s development needs, including 1 percentage point from 3.1 percent of GDP in FY2000–09 human capital, and infrastructure. to 4.1 percent in FY2009/10–2012/13. 1.4. Since 2011, a combination of internal, and exter- 1.5. Halving poverty is the first MDG Goal. In this area nal factors, including spending pressures following the Uganda is a top performer. GDP per capita almost tripled Most families in Uganda 2011 elections, successive droughts, inefficient utilization from US$253 in FY1999/2000 to US$635 in FY2013/14, do not rely on a stable of public resources, the financial crisis in Europe, and and the poverty headcount ratio fell from 33.8 percent in financial income and therefore remain at a high the United States, and political instability in the sub-re- FY1999 to 19.7 percent in FY2012/13. However, rates of risk of sliding back into poverty gion, slowed down economic growth, which declined from inequality, and vulnerability remain high. Three out of four an average of 7.4 percent (4.1 percent in per capita terms) poor (in the bottom 40 percent) live in the Eastern, and in FY1999/2000–2008/09 to 5.5 percent in FY2009/10– Northern regions, and in case of shock, most of these house- 2012/13. This thwarted government efforts to address bind- holds risk falling back into poverty. 5 One Chapter 1 b. Domestic absorption dominates total demand of Table 1.1: Poverty Trends, 1992–2013 goods, and services; exports account for 12 percent of Year National Rural Urban Central East North West total demand. Poverty headcount c. The share of the primary sector is declining but still 1992 0.564 0.603 0.288 0.46 0.59 0.73 0.53 accounts for 30 percent of total added value; Uganda’s 1999 0.338 0.374 0.096 0.2 0.35 0.64 0.26 agriculture is labor intensive but worker productivity 2002 0.388 0.427 0.144 0.22 0.46 0.63 0.33 is abysmally low. 2006 0.311 0.342 0.137 0.16 0.36 0.61 0.2 2009 0.245 0.272 0.091 0.11 0.24 0.46 0.22 d. The agriculture sector, which employs two-thirds of 2013 0.197 0.228 0.093 0.05 0.25 0.44 0.09 the labor force, produces only 20 percent of total out- Gini coefficient put. The unit cost of farm labor is very low, and the 1992 0.3574 0.3282 0.3919 0.3851 0.3249 0.3438 0.3175 wage bill of the sector is less than 15 percent of the 1999 0.3850 0.3319 0.4240 0.4065 0.3449 0.3384 0.3210 total wage bill. 2002 0.4174 0.3617 0.4792 0.4499 0.3611 0.3483 0.3558 e. The industrial sector accounts for 23 percent of 2006 0.3992 0.3618 0.4281 0.4087 0.3504 0.3277 0.3395 total value added; the two dominant subsectors are 2009 0.4158 0.3731 0.4434 0.4436 0.3169 0.3645 0.3725 agro-processing (8 percent), and construction (7 per- 2013 0.4003 0.3585 0.4201 0.3936 0.3427 0.3779 0.3324 cent). The gradual modernization of the agricultural Source: Authors’ tabulation based on several Uganda National Household Surveys (UNHS). sector should expand agro-processing, and the devel- opment of the oil sector will stimulate construction. 1.6. Several factors explain improvements in rates of II. Salient Features of the Ugandan Economy f. With 47 percent of total value added, services (mostly poverty, including (i) a sustained period of economic informal) now dominate. Tourism accounts for a mod- growth and, (ii) a micro-enterprise boom, which trig- 1.7. To better understand the structure of Uganda’s est 5 percent of added value but is viewed as a promis- gered migration of labor from low-productivity agricul- economy, the World Bank, in cooperation with a govern- ing sector. ture to low productivity services. It should also be noted ment team, constructed two versions of a Social Account- g. The taxation structure shows that a few sectors, that any small increase in agriculture productivity always ing Matrix SAM. The first one is a macro-SAM based on including agriculture, and services (excluding tele- has a strong positive impact on poverty since the sector national accounts identities. The second one is an interme- communications) contribute little to the financing of employs many Ugandans, who are close to the poverty line. diate micro-SAM, which disaggregates activities, commod- government services. Reduced poverty in rural areas was due to: (a) improved ities, factors of production, and institutional accounts, and yields; (b) higher crop prices; (c) improved marketing prac- reveals the micro-economic structure of macro-totals by h. Neighboring countries are the main trading partners tices; (d) diversification into new crops; (e) the emergence sector of activity. The main findings are as follows: of Uganda. About 15 percent of imports come from of non-farm activities, including trade, tourism, and mining; Kenya, and 41 percent of exports are going to South and (f) remittances from the urban areas. Sudan, The Democratic Republic of Congo (DRC), a. Domestic production dominates the aggregate supply Kenya, Rwanda, and Burundi. of goods, and services; imports account for only 10 percent of total supply. i. The linkage analysis shows that a few sectors (tour- ism, agro-processing, vegetables/bananas, and some 6 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility services) have significant backward and forward link- Table 1.2: Structure of Production and Factor Intensity (In Percent) ages. Stimulating these sectors should have a signifi- cant positive impact on the rest of the economy. GDP factor Gross output Labor Capital Land cost share share A. The supply side of the economy   Primary sector 30.4 19.9 14.5 20.2 97.5 1.8. Uganda’s domestic production largely dominates Extractives 1.2 1.2 0.2 1.3 2.5 the total supply of goods and services. Figure 1.5 presents Agro-processing 8.1 13.1 7.0 10.5 0.0 the structure of total supply as derived from the aggregat- Other manufacturing 7.0 8.5 5.5 9.2 0.0 ed (macro) SAM of Uganda 2009/10. This corresponds to Construction 6.6 11.3 6.5 8.2 0.0 the second column of the macro-SAM (under Commodities Trade 8.1 9.2 1.8 12.4 0.0 account, see Table 1A in Appendix 1). Figure 1.5 shows that Transport 2.5 2.3 5.3 2.0 0.0 domestic production accounts for 73 percent of total supply Hotels 4.8 6.7 3.3 6.5 0.0 while imports account for only 10 percent. Market margins Other services 31.2 27.8 56.0 29.7 0.0 account for 13 percent and indirect taxes for 4 percent. The  Total 100.0 100.0 100.0 100.0 100.0 sectoral contribution to GDP reveals a pattern common to Overall 22.7 62.4 14.9 many developing countries, that is, the relative importance Source: 2009/10 Uganda aggregated (macro) Social Accounting Matrix (SAM). of the primary sector and the (mostly informal) tertiary sec- tor, and the weakness of the manufacturing sector. Figure 1.6 shows the aggregate contribution to GDP of the primary Figure 1.5: Structure of Aggregate Supply Figure 1.6: Sectoral Contribution to GDP sector, extractives, agro-processing, other manufacturing, construction, tourism, and other services (including trade and transport). 1.9. The (declining) primary sector accounts for 30 per- cent of total added value, but for a small share of total wage bill given low unit cost of labor in the sector. The manufacturing sector accounts for 22 percent of total added value; the two dominant subsectors are agro-processing (8 percent) and construction (7 percent); the gradual modern- ization of the agricultural sector should expand agro-pro- cessing; the development of the oil sector will stimulate construction. With 47 percent of total value added, services have become the dominant sector of Uganda’s economy; tourism accounts for a modest 5 percent of added value but Source: 2009/10 Uganda aggregated (macro) Social Accounting Matrix (SAM). 7 Chapter 1 is viewed as a promising sector. Table 1.2 also indicates the 1.10. The low labor factor intensity in the primary sector converge with middle-income countries (MICs), and other share of factor payment across activity. Sixty six percent of seems to contradict the fact that the sector employs more oil producers. The large agriculture sector did not progress the total wage bill in the economy is claimed by combined than 60 percent of the labor force. Not only does the pri- significantly towards better yields and marketable crops. services activities, but the primary sector activities account mary sector have low unit cost of use, but many of the agri- Agricultural employment is typically in low-productivity for only 15 percent. Construction, agro-processing, and oth- culture activities use family labor. The importance of capital subsistence agriculture, which explains the productivity gap er manufacturing account for about 6–7 percent each. While income in the primary sector indicates that this could be a illustrated below. Uganda’s labor force is largely unskilled. services-related activities account for about 46 percent of mixed income. The high cost of financing could also explain total capital payments, industry-related activities (agro-pro- the importance of capital payments in the value added. 1.12. Agriculture and services (excluding telecommuni- cessing, other manufacturing, construction) claim about 28 cations) contribute little to the government’s total tax percent. The primary sector also claims about 20 percent of 1.11. Uganda’s labor productivity is extremely low and revenue. Commodity and import taxes account for about capital payments. With respect to land payments, the prima- shows few signs of improvement (Figure 1.7–1.8). Worker 70 percent of Uganda’s total tax income. Figure 1.9 shows ry sector accounts for 98 percent of total land factor pay- productivity remained flat over the past decades and fares that commodity taxes account for 38 percent of tax revenue, ments, which indicates that land is a critical factor input for significantly below that of other resource-rich countries. while imports account for 32 percent and direct taxes for that sector. Uganda will need rapid and substantial productivity gains to 27 percent. Activity taxes represent only 3 percent of total Figure 1.7: Labor Productivity in Oil-producing Figure 1.8: Sector Employment in Uganda Figure 1.9: Taxes Structure (In Percent) Nations Source: 2009/10 Uganda SAM. Source: 2009/10 Uganda aggregated (macro) SAM. Source: 2009/10 SAM. 8 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility tax revenue. Table 1.3 shows the sectoral breakdown of and other fines related to the production process. Overall, taxes. It shows that other services contribute 20 percent of refined petroleum products represent 36 percent of total total activity taxes while construction and financial services indirect taxes, while telecom products account for 21 per- contribute 13–17 percent. These taxes include license fees cent. Agro-processing and other manufacturing products Table 1.3: Structure of Indirect Taxes by Activity (In Percent) Activity taxes Commodity taxes Import taxes Total Agriculture 0.1 0.0 2.9 1.3 Livestock 0.0 0.1 0.0 0.0 Forestry 0.0 0.0 0.0 0.0 Fishing 0.0 0.0 0.0 0.0 Extractives 0.5 0.0 0.2 0.1 Agroprocessing 2.9 12.3 18.8 14.7 Textiles 0.0 0.2 1.5 0.7 Oil refinery 0.6 27.3 50.7 36.3 Other manufacturing 10.5 9.6 25.9 16.8 Utilities 1.7 3.6 0.0 1.9 Construction 17.1 0.0 0.0 0.8 Trade 3.9 0.0 0.0 0.2 Transport 6.3 0.0 0.0 0.3 Hotels and restaurants 3.1 0.4 0.0 0.4 Telecommunications 9.4 40.0 0.0 21.0 Financial services 13.2 2.5 0.0 1.9 Public administration 0.0 0.0 0.0 0.0 Education Public 0.2 0.0 0.0 0.0 Education - Private 9.1 0.0 0.0 0.4 Health - Public 0.7 0.0 0.0 0.0 Health - Private 0.9 0.0 0.0 0.1 Infrastructure 0.0 0.0 0.0 0.0 Other services 19.7 3.9 0.0 2.9 Workers on Masindi-Kampala Highway Total 100.0 100.0 100.0 100.0 Source: Author’s calculations based on 2009/10 Uganda SAM. 9 One Chapter 1 also claim 15–17 percent of these taxes. Moreover, ser- Figure 1.10: Structure of Aggregate Demand vices (excluding telecommunications) account for about 6 aggregate demand within each sector. It shows that private percent of total indirect taxes, while agriculture represent consumption largely dominates the demand for textiles, about 1.3 percent. These sectors are dominated by informal utilities, agro-processing, hotels and restaurants, and private sector activities. education and health services. B. The demand-side of the economy 1.15. The private sector saves more and invests more than the public sector. Table 1.6 shows the savings/invest- 1.13. Domestic absorption dominates total demand ment nexus for Uganda. Private savings account for 77 of goods and services. It accounts for 88 percent of percent of total savings, public sector savings for only 2.4 aggregate demand.2 Table 1.4 shows that private con- percent, and foreign savings for 21 percent. Public invest- sumption represents 62 percent of Uganda’s aggregate ment stands at 19 percent of total investment while private demand (excluding intermediate consumption and mar- investment represents a commanding 81 percent of total keting margins) while government consumption claims investment. about 5 percent. Investment and export account for 21 percent and 12 percent of total demand in 2009/10. Source: 2009/10 Uganda SAM. 1.14. Intermediate consumption and private consump- tion are the largest contributors to aggregate demand Table 1.4: Resources-Uses Equilibrium of GDP and GDP. The structure of aggregate demand in Figure 1.10 Value Value (which includes intermediate consumption and marketing Uses (Billion UGX) Percent Resources (Billion UGX) Percent margins) shows that intermediate consumption accounts for Private consumption (1) 28, 967,712.7 61.5 GDP at market price 37, 573,923.5 79.8 35 percent of total demand followed by private consump- tion (32 percent). Marketing margins claim about 13 percent Government consumption (2) 2, 323,084.7 4.9 Import 9, 523,441.7 20.2 of total demand while investment represents 11 percent, Investment (3) 9, 943,923.3 21.1 exports 6 percent, and government consumption 3 percent. Domestic demand (1)+(2)+(3) 41, 234,720.6 87.6 The structure of GDP using an expenditures approach is Export (5) 5, 862,644.6 12.4 presented in Table 1.4. Private consumption accounts for 62 percent of GDP. The second most important item is invest- Total uses = resources 47, 097,365.2 100.0   47, 097,365.2 100.0 ment which accounts for about 21 percent of GDP, followed Source: 2009/10 Uganda SAM. by public consumption at 5 percent. Incidentally, Uganda experienced a substantial trade deficit in 2009 (about 10 percent of GDP). Table 1.5 provides a detailed structure of 2. The structure of aggregate demand (including intermediate consumption and marketing margins) is presented below. 10 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility C. Trade orientation 1.16. The main imports are secondary goods and the Table 1.5: Sectoral Structure of Aggregate Demand (In Percent) main exports are primary goods and services, which illustrates the largely agrarian nature of Uganda’s Intermediate Marketing Private Government Investment /change in Exports economy. Uganda’s production is mostly in the prima- inputs Marging consumption consumption stocks ry and service sectors, which explains Uganda’s current Agriculture 41.8 0.0 46.3 0.0 0.0 12.0 trade dynamics. Figure 1.11 presents the share of output Livestock 71.8 0.0 24.2 0.0 1.1 3.0 that is used for export and, therefore, identifies Uganda’s Forestry 57.7 0.0 42.2 0.0 0.0 0.1 most export-focused sectors. Agricultural goods dominate; Fishing 40.7 0.0 26.4 0.0 0.0 32.9 coffee and manufactured tea are the main exports (techni- cally, manufactured tea could be considered a secondary Extractives 97.2 0.0 0.0 0.0 0.0 2.8 product, but the minimal complexity of production makes Agro-processing 20.3 0.0 71.2 0.0 0.0 8.5 Textiles 22.4 0.0 74.5 0.4 0.0 2.6 Oil refinery 77.9 0.0 20.3 0.0 0.0 1.8 Other manufacturing 45.6 0.0 21.4 0.0 22.4 10.6 Utilities 22.4 0.0 74.5 0.4 0.0 2.6 Construction 4.6 0.0 0.0 0.0 95.4 0.0 Trade 0.0 100.0 0.0 0.0 0.0 0.0 Transport 64.0 0.0 27.2 0.0 0.0 8.8 Hotels and restaurants 14.7 0.0 65.0 0.0 0.0 20.3 Telecoms 96.3 0.0 3.7 0.0 0.0 0.0 Financial services 90.1 0.0 8.7 0.0 0.0 1.2 Public administration 0.0 0.0 0.0 77.3 0.0 22.7 Education Public 0.0 0.0 0.0 100.0 0.0 0.0 Education - Private 0.0 0.0 100.0 0.0 0.0 0.0 Health - Public 9.5 0.0 0.0 90.5 0.0 0.0 Health - Private 9.5 0.0 90.5 0.0 0.0 0.0 Infrastructure 0.0 0.0 0.0 77.3 0.0 22.7 Other services 27.9 42.9 25.6 1.9 0.0 1.7 Total 35.0 13.5 31.8 2.5 10.9 6.3 Transit cargo at a border post await clearance Source: 2009/10 Uganda SAM. 11 Chapter 1 Figure 1.11: Output Share of Exports (In Percent) Table 1.6: Savings-Investment Nexus Savings % of Total % of GDP Investment % of Total % of GDP Public 2.4 0.6 Public 19.0 5.0 Private 76.6 20.3 Private 81.0 21.4 Foreign 21.0 5.5 Source: 2009/10 Uganda SAM. it a quasi-primary product). Textiles and metal products are D. Linkages analysis the other two main secondary export sectors. Figure 1.12 shows Uganda’s main imports which are dominated by the 1.18. Stimulating agro-processing, production of vegeta- secondary production sector, including transport equipment bles and banana, and other services would have a signifi- (largely automobile), refined oil, and chemicals. In fact, all cant impact on other sectors as well as on the economy as the main imports can be viewed as advanced manufactured a whole. This conclusion is based on the analysis of sectoral Source: UNCOMTRADE goods. linkages, that is, the relative strength of forward and back- ward sectoral relationships, which is founded on a method- 1.17. Neigboring countries are Uganda’s main trad- Figure 1.12: Sectoral Share of Imports (In Percent) ology called the Rasmussen linkage index. In an integrat- ing partners (see Table 1.7). The highest percentage of ed economy, a sector is linked to other sectors by its direct Uganda’s imports originates from Kenya (about 15 per- and indirect purchases and sales. A backward linkage is the cent). This is due to the geographical location of the two linkage of a sector through its direct and indirect purchases. countries. Kenya offers landlocked Uganda access to goods To produce textiles products, the textiles sector purchases imported by sea from Asia and the Middle East. Together, cotton from the export crops sector and services from the Asia and the Middle East provide 43 percent of Uganda’s trade sector. A forward-linked sector is a sector related to imports, with smaller amounts coming from Europe.3 Ugan- other sectors through direct and indirect sales to them. The da’s major exports are destinated to bordering countries and textiles sector could be forward-linked to exports crops if 37 percent of all exports go to Sudan, DRC, Kenya, and export crop workers use clothing produced by the textiles Rwanda. Most of the remaining exports go to Europe while sector. Thus, backward and forward linkages are two ways a small percentage go to the Middle East and other areas. of looking at the relationships between sectors. Depend- ing on the importance of its linkages with the rest of the economy, a sector is classified as key sector if both its Ras- mussen’s backward and forward linkage indexes are higher 3.Table 1.7 does not include all Uganda’s trade partners. It covers 68 percent of than one. A sector is weak if both indexes are below unity. A Source: UNCOMTRADE imports and 67 percent of exports. 12 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility sector can be classified strongly forward linked but weakly Table 1.7: Uganda’s Trade Partners backward linked if its forward linkage index is higher than Rank Import Partner % of Imports Export Partner % of Exports one while its backward linkage index is below one. A sector can also be strongly backward linked but weakly forward 1 Kenya 14.79 Sudan 10.87 linked. All these results are presented in the four-quadrant Democratic Republic of 2 China 11.33 9.62 diagram displayed in Figure 1.13. Congo 3 United Arab Emirates 10.31 Kenya 9.33 4 Japan 7.92 Rwanda 7.79 1.19. The following conclusions can be derived from the 5 Saudi Arabia 6.21 Netherlands 6.50 linkage analysis (based on the SAM multiplier model), 6 Germany 3.83 United Arab Emirates 6.30 which is presented in Figure 1.13: 7 India 3.79 Germany 5.91 a. A number of key sectors (hotels/restaurants, some 8 United Kingdom 3.62 Belgium-Luxembourg 4.27 agro-processing industries,4 vegetables and bananas, 9 Netherlands 3.52 Other Areas 3.78 cereals, and other services) have significant backward 10 Indonesia 2.89 Burundi 3.07 and forward linkages with the rest of Uganda’s econ- Total 68.21 67.44 omy. Stimulating these sectors should have a positive Source: UNCOMTRADE. impact on other economic sectors and help sustain economic growth. Figure 1.13: Linkage Analysis of Uganda, 2009/10 b. Livestock, financial, and trade services are borderline sectors as their backward and forward linkages index- es are both close to 1. c. A number of sectors, including meat and fish process- ing, oil refinery, fishing, utilities, forestry, cash crops, infrastructure services, public administration, and tex- tiles, are borderline backward oriented sectors as their backward linkage indexes are close to 1. d. Trade, livestock, and, financial services are strongly forward linked but weakly backward linked. e. Finally, other mining, private education, other manu- facturing, private health, public education, transport services, telecom, construction, crude oil, and gas are referred to as weak sectors that cannot be stimulated 4. Excluding meat and fish processing. Source: SAM multiplier model based on 2009/10 Uganda SAM. 13 Chapter 1 significantly by other sectors and cannot stimulate six 5-year NDPs. The first National Development Plan other sectors. (NDP 1) covers the period 2010/11 to 2014/15. It empha- sizes growth, employment, and socioeconomic transfor- Box 1.1: Implementation Challenges III. The Government Strategy mation for prosperity and sees diversification as critical for achieving the economic transformation of the country. NDP 1.20. In 2007, the government approved a National The efficiency of public sector institutional structures and 1 advocates diversification within eight primary growth systems was affected by lack of inter, and intra-sector Vision Statement aimed at transforming Ugandan soci- sectors, including agriculture, forestry, tourism, mining, linkages in development planning and budgeting to ety from peasant to a modern and prosperous country oil and gas, manufacturing, information/communications facilitate coordinated implementation of the NDP. More within 30 years. The statement led to the formulation of the serious efforts are required to strengthen public sector technology, and housing. It is focused on a variety of broad Vision 2040 approved by the parliament in 2012. The goal is management. objectives, including: (i) increasing household incomes to make Uganda an upper-middle-income economy through and promoting equity; (ii) enhancing the availability and There is need to strengthen and implement public service a combination of policy measures and programs addressing quality of gainful employment; (iii) increasing the stock reforms aimed at developing an administrative system the main development bottlenecks identified in the Vision. and improving the quality of economic infrastructure; (iv) that is mission oriented, creating organizational capacity to improving access to quality social services; (v) enhancing promote and sustain a climate of creativity and innovation, 1.21. Implementation of the Vision relies on a series of and ability to deliver quality goods and services. With competitiveness through promoting science, technology, regard to procurement and the reformed PPDA Act, the government needs to address the complexity of the legal framework and procedure and provide special consideration to areas such as infrastructure, including shortening the time of delivering inputs for investments. There was a very high level of ambition regarding the number of core projects that could be implemented in the course of the NDP and many of these projects did not move forward as planned. This is due to a number of factors: (i) lack of planning, prioritization, and sequencing of investments; (ii) limited technical analysis and appraisal before to inclusion of projects in the NDP; (iii) limited analysis of the financing requirements of individual projects before inclusion in the NDP; (iv) weak technical capacity in Ministries, Departments, and Agencies (MDAs) to develop, manage and implement complex projects;and (v) slow procurement. Based on Midterm Review report on NDP 1 implementation. Livestock at Rubona Stock Farm 14 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 1.22. Modest results were achieved during the NDP 1 tainable production, productivity, and value addition in key period. Growth rates remained below the 2011/12 targets of growth opportunities; (ii) increasing the stock and quality GDP growth (7.3 percent), and per capita GDP (US$837). of strategic infrastructure to accelerate the country’s com- Human and social capital objectives were not met. Litera- petitiveness; (iii) enhancing human capital development; cy rates and Human Development Index (HDI) indicators and (iv) improved mechanisms for quality, effective, and remained lower than expected. Competitiveness is limited efficient service delivery. NDP 2 prioritizes three sectors and the governance environment did not improve. Pover- (agriculture, mineral, oil and gas, and tourism) and two ty rates declined from 28.5 percent in 2008/09 to 19.7 per- development fundamentals (Infrastructure and Human and cent in 2012/13 but this did not improve the distribution of Social Capital) due to their important role in exploiting household incomes and the Gini coefficient increased from the opportunities identified in the respective value chains. 0.426 in 2009/10 to 0.431 in 2012/13. The lack of well-pre- pared projects and weak links between the budgets and IV. Economic Diversification : A Sound NDP priorities contributed to a sluggish implementation Objective performance. Many analysts in Uganda argue that weak links between NDP 1 and the budget result from inadequate 1.25. Long-term development and economic diversifica- consultations among key stakeholders during preparation of tion are two sides of the same coin. Economic development the plan. is typically a process of structural transformation through which the production of a country moves from ‘poor-coun- 1.23. Economic diversification remains central in the try goods’ to ‘rich-country goods’.5 Modern mixed econo- formulation of the new national development plan (NDP mies need broadly based manufacturing, trade, and services 2). The second National Development Plan (NDP 2) will to be able to offer people steady improvements in their stan- Giraffes in the National Park. Uganda’s tourism industry cover the 2015/16–2019/20 period. It argues for the priori- has the potential to boost the nation’s revenue and drive dard of living. An important part of a country’s economic development tization of growth opportunities and interventions through: success is defined by its ability to produce goods and ser- (i) value chain analyses of agriculture, tourism, mineral, and vices that it can sell abroad-that is, goods and services that innovation and ICT; (vi) developing human capital; (vii) human capital development; (ii) alignment of sector prior- households and firms in other countries want to buy. Figure improving governance, defense and security; and (viii) pro- ities and budgets with the plan; (iii) appropriate financing 1.14 and 1.15 illustrate this relationship between diversifi- moting sustainable population growth and sustainable use modalities for priority interventions; and (iv) addressing the cation and national income. High levels of manufacturing of environmental and natural resources. The objective of challenges of weak public sector systems. The main goal of exports are associated with high per capita GNI. Similarly, NDP 1 is to unlock the country’s most critical constraints NDP 2 is to increase Uganda’s competitiveness for sustain- as illustrated in figure 1.15, high degree of export diversi- to development, including: (i) weak public sector manage- able wealth creation, employment, and inclusive growth, fication (as measured by 1 minus the Herfindahl index)6 is ment and administration; (ii) inadequate financial services; which will enable the country to achieve middle-income correlated with higher levels of GNI per capita. Hence, the (iii) inadequate human resources (quantity and quality); (iv) status by 2020. inadequate physical infrastructure; (v) gender issues, neg- 5. For instance, a wide variety of empirical literature comments on the evidence ative attitudes; (vi) low application of science, technology 1.24. NDP 2 will track economic diversification through of a positive effect of export diversification on per capita income growth (Leder- man and Maloney, 2007; Heiko Hesse, 2007) and innovation; and (vii) limited access to critical produc- progress on the share of manufacturing in total exports. 6. The Herfindahl index measures by how much the composition of a county’s tion inputs. NDP 2 will give a stronger emphasis to diversification and export basket deviates from the world average. The index ranges from 0 to 1, where values closer that a country’s export basket is highly concentrated in a few will be focused on 4 strategic objectives: (i) increasing sus- products while values closer to 1 indicate higher export diversification. 15 Chapter 1 need to find ways to diversify economic activity away from Box 1.2: Country Experiences on Diversification once-dominant agriculture-that keeps the rural population in poverty - and from too much dependence on a few natural The following examples of successful diversification suggest that industrial policy is not always doomed to failure (Rodrik, resources - that sometimes delay the advance of modern 2004). It is not true that industrial policy never works. It is true that picking winners seldom works, but even so, cutting manufacturing and services. losses can be fruitful. Industrial policy is prone to political capture and corruption, but so is privatization. Generally, it pays to encourage new industries in line with the country’s comparative advantages, and available expertise in public administration 1.26. Economic diversification encourages efficiency and rather than try to break new ground; to follow the market rather than try to take the lead. A promising industrial policy strategy needs to be based on general principles and tailored to specific circumstances, not one-size-fits-all; simply more of the same is growth by channeling economic activity away from pri- unlikely to succeed (Hausmann et al., 2014). mary agricultural production or excessive reliance on a few natural-resource-based industries. Such a transition The Republic of South Korea: South Korea’s export-oriented diversification strategy helped catapult the country from rags to is welfare-improving as it helps workers or their children riches in 50 years, in stark contrast to the import substitution strategies followed by several Latin American countries which to transfer from low-paying jobs in low-skill-intensive yielded less impressive results. In 1960, Korea’s exports of goods and services amounted to 3 percent of GDP compared with 8 percent in Argentina. In 2012, Korea’s exports of goods and services amounted to 57 percent of GDP compared with farming or mining to more lucrative employment in more 20 percent in Argentina. Manufactures constituted 85 percent of Korea’s merchandise exports compared with 32 percent high-skill-intensive occupations in manufacturing and ser- in Argentina. As a result, Korean manufacturers knew how to produce things that households and firms in other countries vices. This is how countries become rich. Technological demand, and today, the purchasing power of Korea’s per capita GNI is more than twice that of Argentina. advances release workers from agriculture. With technical Botswana: When it gained independence in 1966, Botswana had only 12 kilometers of paved roads, 22 college graduates, progress in modern societies, it takes only a tiny proportion and 100 secondary-school graduates. Today, diamonds (discovered in 1967) provide tax revenue equivalent to 33 percent of of the work force to feed the population, a task that used to GDP, giving Botswana the highest per capita GNI in Sub-Saharan Africa. How did Botswana manage to achieve the world’s occupy most of the labor force (Box 1.2 presents country highest rate of economic growth over the past 50 years? The short answer is good policies, good institutions, and democracy. examples of diversification and the importance of industrial Botswana assigned mining rights away from the tribes toward the state to head off tribal contestation for revenue. It paid civil policy). servants well, and hired foreign experts when needed (Gelb, 2011). Furthermore, Botswana emphasized quality appraisals of public investment projects. Even so, Botswana’s economy is not yet well diversified. In 2006, manufacturing accounted for only 1.27. The lack of diversification in exports is a major fea- 4 percent of GDP while 30 percent of the work force remained in agriculture, which, due to low productivity, accounts for only 2 percent of GDP. Services, including government services, employ 55 percent of the labor force and account for 52 percent of ture of many low-income countries (LICs), particularly GDP. Botswana spends more money on education relative to GDP and is less corrupt according to Transparency International if they are rich in natural resources. The more a country than any other African country (Botswana 64, Mauritius 52). concentrates its exports in sectors with limited scope for productivity growth and quality upgrading, such as primary Other Country Examples: commodities, the lower will be its broad-based and sustain- • Indonesia: The authorities provided help to the low-cost textiles and footwear industry with good results. able growth ( Papageorgiou and Spatafora 2012). In this con- • Thailand: The authorities put in place a strategy that successfully diversified its agriculture. text, the emergence of exhaustible natural resources can be • Malaysia: The country welcomed foreign direct investment and became a successful producer of manufactures, including an opportunity and also a challenge for a country’s develop- electronic equipment and cars. ment. If poorly managed, natural resources (for example, oil • Chile: The authorities encouraged farmers to branch out into wine and salmon production like New Zealand had done in and gas) can thwart ongoing diversification efforts through the 1980s, also with good results. for instance Dutch Disease. The lack of diversification in • Mauritius: Frankel (2012) shows how Mauritius managed to reduce its reliance on its main export commodity (sugar), by resource-rich countries may also exacerbate the exposure to expanding foreign trade and education. adverse external shocks, macroeconomic instability and the Gylfason et al. (2014) “Diversification, Dutch Disease, and Economic Growth: Options for Uganda” CEM background paper. 16 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 1.14: Manufacturing Exports and GNI Figure 1.15: Export Diversification and GNI multiple aspects of what is called the resource curse. Figure 1.16 illustrates the strong inverse cross-country relationship between exports of manufactures, measured by the average share of manufactures in total merchandise exports (from 1962 to 2012) and natural capital in 126 countries. Coun- tries endowed with natural resources tend to be less diver- sified in the structure of their exports. Moreover, Figure 1.17 shows an inverse cross-country relationship between export diversification on average from 1996 (the earliest year available from United Nations Conference on Trade and Development - UNCTAD) to 2012 and natural capital, measured as before in a group of 126 countries (Pearson correlation = –0.70). 1.28. Although most of the resource-rich countries have Source: Authors’ computations based on World Bank, World Development Indicators, as well as on updates of data in World Bank (2006). developed their economies and enjoy high standards of Note: Each observation is presented as a bubble proportional to country size rather than as a weightless dot. This way, the visual impression living as shown by their GDP per capita (PPP), the most conveyed by the figure reflects people rather than countries, giving more weight to large countries than to small ones. Even so, the regression successful ones are the few that were able to diversify, as estimates presented are not weighted by population size. indicated by their low share of oil exports in total exports. In Figure 1.16: Natural Resources and Manufacturing Figure 1.17: Natural Resources and Export Malaysia, Indonesia, and Mexico, oil exports now account Exports Diversification for less than 13 percent of total exports, but the GDP per capita of Indonesia and Malaysia increased at least fivefold between 1970 and 2010. With shares of oil exports ranging from 20 percent to 31 percent, Canada, Trinidad and Toba- Manufactures sxports 1962-2012 (% of total) go and the United Arab Emirates are other successful expe- riences of diversification among oil-rich countries. Their GDP per capita doubled or tripled during the same period (Table 1.8). 1.29. This report makes the case that Uganda must diver- sify to achieve its ambitious objective of transforming its economy and society in the next decades. With oil and other extractive industries come additional macroeconom- ic and fiscal challenges that could affect macroeconomic Source: Authors’ computations based on World Bank, World Devel- Source: Authors’ computations based on World Bank, World Develop- opment Indicators, as well as on updates of data in World Bank ment Indicators, as well as on updates of data in World Bank (2006). (2006). 17 Chapter 1 Table 1.8: Diversific tion among the Oil-rich Countries GDP Per Capita (US$ PPP) Share of oil revenue Share of oil exports Country in total revenue in total exports (per- 1970 2010 (percent) 1970 cent) 2010 Kuwait 102,997 41,240 81.7 86.2 Qatar 79,555 136,248 64.7 74.8 Saudi Arabia 16,829 20,189 81.8 83.1 United Arab Emirates 24,062 60,175 80.6 30.5 Angola 2,313 5,108 80.2 96.5 Canada 17,726 37,104 – 19.5 Indonesia 816 3,966 17.7 8.6 Iraq 2,779 4,537 91.2 97.2 Libya 26,814 19,491 96.0 96.8 Malaysia 2,046 11,956 – 10.3 Mexico 6,821 11,939 – 12.2 Nigeria 1,572 1,695 80.1 91.6 Trinidad 11,110 30,749 49.3 28.4 Venezuela 9,366 9,071 30.4 94.0 Source: Cherif et al. (2007). stability. Thus, the need for further diversification becomes could use similar intermediate inputs and capabilities as its even more urgent. This chapter discusses two approaches current exports. It finds many but those that it recommends to evaluate Uganda’s options for export diversification. The have to pass several tests and have the potential to push the first approach is conservative because it searches for nascent country towards exporting a more sophisticated basket of Subsistence farmers till the land in preparation for planting. exports in which Uganda has recently become or is becoming products. The cautious approach relies on the Revealed Com- There is need to shift from over reliance on low-skilled labor intensive agriculture to lucrative high skilled technical competitive, and recommends these for scaling up. The sec- parative Advantage (RCA) methodology while the bolder production ond approach is bolder and more ambitious because it allows approach relies on the Product Space (PS) methodology. us to look beyond Uganda’s export basket for products that 18 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 1990s, about 60 new products with an export value of at Table 1.9: Uganda’s Top 5 Historical Export Products least US$10,000 each, have appeared in Uganda’s export 1980–84 1990–94 2010–12 basket in the last 20 years. First, products such as cook- 711 Coffee green 93.2% 711 Coffee green 73.9% 711 Coffee green 33.0% ing oils, processed fruits, and vegetables, and fish, which 2631 Cotton, not carded 2.1% 2631 Cotton, not carded 5.0% 2631 Cotton, not carded 6.3% add value to existing agricultural products, are increasingly 2111 Bovine hides 0.9% 2225 Sesame seeds 3.0% 9710 Gold 6.2% being exported from Uganda. Second, several subsectors 2911 Bones, ivory, horns 0.6% 2111 Bovine hides 2.6% 440 Maize, unmilled 6.2% have emerged: flowers, wood, minerals, and chemicals. 2114 Goat and kid skins 0.2% 344 Fish fillets, frozen 1.8% 344 Fish fillets, frozen 3.7% Third, albeit still in an early stage, two types of manufac- Total Share 97.1% Total Share 86.3% Total share 55.4% tured products have become part of Uganda’s export bas- ket: light manufactures including processing of skins and Source: Chandra et al. (2015). hides into high-value leather, and heavy manufactures com- posed of construction materials made from iron and steel. V. Lessons For Uganda - How Far Can Uganda 1.31. A high degree of concentration in about five prod- Although iron and steel are still imported, the emergence Diversify? ucts has historically been the hallmark of Ugandan of light and heavy manufactures could signal that Uganda’s exports. While the total share of the top five products has economy is becoming more industrialized. A. Nurturing existing productive declined since the 1980s, it is still high and exposes Ugan- 1.33. A concerted policy effort will be needed to nur- capabilities da’s economy to external shocks, be they price- or weath- ture these emerging product champions to make them er driven. The share of the top five exported products has 1.30. Due to trade expansion, economic diversification the avant-garde of Uganda’s industrialization. This will decreased from about 97 percent in the early 1980s, to about increases in the world, including in Uganda. In Sub-Sa- also increase the sophistication of Uganda’s products, if 86 percent in the 1990s and further to 55 percent in 2010– haran Africa, the share of manufactures in total merchan- measured by the product complexity index (PCI), a recent- 12. Most remarkably, even after nearly three decades, the dise exports increased from 12 percent in 1974 to 27 per- ly developed metric to assess the technological sophistica- dominance of coffee and cotton, - Uganda’s leading exports, cent in 2012, down from 32 percent in 2002 (World Bank, tion required to produce a range of products (see Box 1.3), remains firm (Table 1.9). World Development Indicators). In Latin America and the Uganda’s traditional exports, including the top 5 since the Caribbean, the share of manufactures in total merchandise 1980s or earlier, have some of the lowest PCI rankings 1.32. Recently, Uganda’s export basket shows an ini- exports increased from 8 percent in 1962 to 46 percent in while its emerging exports such as cooking oils, metal tial trace of structural transformation. Several Ugandan 2012. Likewise, the average share of manufactures in total products, chemicals, leather and certain fish products have products have become more competitive on the internation- world exports rose from 59 percent to 69 percent over the significantly larger PCIs (see Figure 1.18). Fostering these al market, as measured by a product’s revealed comparative same period. In Uganda, the share of manufactures in total nascent sectors could increase the average PCI of Uganda’s advantage.7 From being virtually nonexistent in the early merchandise exports rose from 2 percent in 1994 to 34 per- production capabilities, which Hausmann et al. (2011) call cent in 2012, which is a good sign for future growth. In 7. The RCA measures the share of a particular product in a country’s export a country’s overall economic complexity. 2012, the manufacturing share of exports was 35 percent basket relative to the share of the product in the world’s export basket. An RCA value of 1 or greater denotes that a country has a comparative advantage in a in Kenya, 25 percent in Tanzania, and 9 percent in Ghana. product and an increasing RCA indicates that the exporting country is gaining global market share in that product. 19 Chapter 1 Figure 1.18: Uganda’s Traditional Exports Have the Lowest PCI, Its Manufactured Exports the Highest Box 1.3: Product Complexity Index (PCI) The PCI measures the complexity of a good based on its ubiquity (that is, the number of countries that make it) and the diversification of the countries exporting that product (that is, the number of other products that they make) (Hidalgo and Hausmann, 2009; Hausmann et al. 2011). A product that requires significant tacit knowledge will be hard to make and hence will be produced by few countries. However, if these countries have a large stock of tacit knowledge, they should be able to use it to make more products and hence should be more diversified. A product with a high PCI requires more complex know– how in order to be produced/exported. The PCI used in this paper ranges from 0 to 10 and higher numbers reflect greater sophistication. The correlation between the two technological sophistication measures is not monotonic. On average, primary products have the lowest PCI while low-tech products can have a PCI that is lower or higher than resource-based products. Source: Chandra et al. (2015). 1.34. International experience shows that economic tradable sectors, making further investments in agro-pro- B. Expanding export possibilities complexity is strongly associated with higher per capita cessing and light manufacturing less likely. Although the income (see Figure 1.19). Yet, as a share of total exports in discovery of oil resources is expected to generate extra 1.35. Recent diversification in processed agricultural 2010–2012, processed agricultural products accounted for resources and spur investment in physical infrastructure products, small metal products for construction, and a only 6 percent, and the combined share of wood, metals and and human capital, it is also associated with challenges as few chemical products is welcomed by many as a posi- chemical products, and light manufactures was only about 4 it may inhibit the development of the tradable sectors due tive sign that Uganda is already on its way to becoming percent. This may be too small to enable Uganda to become to a real appreciation of the exchange rate (Dutch Disease). an exporter of manufactured products. However, con- an industrial, upper middle-income economy in the near A more ambitious approach to widen Uganda’s production tinuing to stay the current course is unlikely to transform future. Moreover, the development of Uganda’s hydrocar- frontier will therefore be needed. This is discussed in the Uganda’s exports from farm-to-firm-based exports fast bons sector may have a negative impact on these emerging next section. enough to achieve the country’s Vision 2040. The conser- 20 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 1.19: Economic Complexity and GDP Per Capita move from products that they are making to new products that are nearby in terms of the productive knowledge they require. Arguably, it is easier to move from shirts to blouses than it is to move from shirts to engines. In terms of pro- ductive knowledge, shirts are more similar to blouses than to engines. 1.37. The largest opportunities for the development of new production lines are those that require a similar productive knowledge as the existing production lines. While it would be desirable for Uganda to diversify into particularly sophisticated products, this could be costly and time-consuming. A better option is to identify products that are somewhat more complex but require similar production capabilities as existing products. 1.38. The Product Space (PS) of Nation can be used to guide Uganda in optimally balancing the capabil- ity-complexity tradeoff. A team of researchers led by Ricardo Hausmann recently developed an Atlas of econom- ic complexity, which depicts how products are connected to Source: Atlas of Economic Complexity and Haussman (2013). each other in terms of capabilities required in the production process.8 A visual representation of this proximity of two vative approach described in the previous section proposed 1.36. Accelerating Uganda’s economic transformation products is provided in Figure 1.20. In this illustration, two options for export diversification by identifying and scal- will require expanding the country’s productive knowl- products with similar production process are close to each ing up its emerging exports which are relatively small in edge beyond existing productive capabilities if it wants other, sometimes forming close knit communities, which value and in which it has gained a comparative advantage to grow its product complexity. This means that in addi- are identified by different colors. Communities form when in recent years. Value addition through agro-processing tion to strengthening existing product lines, Uganda also products share a common set of distinct productive knowl- of fruits, vegetables and grains is important but the recent needs to find new products which it can export competitive- edge.9 experience of countries in Asia and sub-Saharan Africa ly to the world market. However, this gives rise to a “chick- points to many other low hanging fruit that less-skilled, en and egg” situation where there are scant incentives to 8. Formally, the proximity of two products is measured in terms of the likelihood labor-abundant countries like Uganda can harvest to trans- accumulate new productive knowledge in places where the that both products are co-exported. It is assumed that if two goods require form into an industrial economy. industries that demand it do not exist. It is impossible to roughly the same knowledge, this should show up in a higher probability of a country having comparative advantage in both products in relation to other develop new industries if the requisite productive knowl- countries. This proximity index ranges from 0 to 1; where a value close to 1 reflects closer proximity between two products. edge is absent. To solve this problem, countries tend to 9. This idea is somewhat different from the idea of industries or clusters as being 21 Chapter 1 Box 1.4: A Short-term Export Diversification Strategy Overall Strategy: Diversify first into those potential manufactured exports (including processed raw materials) that Uganda is capable of exporting (high capabilities). This may not lead to the most sophisticated exports in the short term, but it will nurture industrial/manufacturing skills that are a prerequisite for accelerated diversification into more sophisticated products. This strategy will lay the foundations for the large-scale development of skills necessary for a larger manufacturing sector. An important part of a similar process in Asia involved skills development through learning by exporting factory-produced products. This pattern of diversification was the stepping stone to Asia’s competitive edge in manufacturing today and has helped several Asian countries attain middle- income status in record time (for example, Malaysia, China, Vietnam, Sri Lanka) Product Focus: • Three new light manufacturing industries; garments, leather and wood products - are flagged by the PS approach as opportunities for Uganda. Evidence from Asia and sub-Saharan Africa (Lesotho, Ethiopia) shows that even landlocked countries can have competitive light manufacturing industries that use imported inputs when domestic ones are unavailable. Uganda has local raw materials - hides and skins, and wood - for the leather and wood related manufactured exports listed in these industries. • Several agriculture-related processing industries including cereals, dairy products, more types of cooking oils, and new sugar products could be strengthened. Some similar ones are already being exported in small amounts. Most potential ones are distinct from Uganda’s current new exports because they involve some degree of manufacturing, have reasonably high levels of sophistication, and Uganda’s high capabilities in these industries can be instrumental in diversifying in them. • A few chemicals and metal product industries which have sophistication levels that are lower than many current exports but for which Uganda’s capabilities are higher could, be fostered. They could be promising stepping stones to more sophisticated diversification in the longer term. Plantation workers harvesting tea in Fort Portal 22 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 1.39. Uganda’s current presence in the PS is on the periphery, which suggests that its current products are Box 1.5: A long-term Export Diversification Strategy far away from potential new products at the center of the PS which have a high complexity (see Figure 1.20). The Overall Strategy: The most critical factor for Uganda’s longer term diversification in sophisticated and complex majority of manufactured products require inputs that are manufactures (machinery, auto parts) is a sufficiently large pool of industrial skills/capabilities that can graduate it from quite different from those used in Uganda’s current exports. a farm-to-firm- produced exporter. Unlike other inputs, manufacturing skills for any type of sophisticated industry can neither be imported nor developed in a short period of time. The proposed short term strategy can generate a pool of The closest product to coffee, for example, is gold with a industrial skills/capabilities that are an essential input/foundation for the production of more complex manufacturing skills proximity index of 0.398 followed by leather of hides and necessary for any country to graduate from agricultural and light manufactured exports to sophisticated manufactured skins with an index of 0.385. Fresh fish exports offer more and services exports (beyond tourism). scope for diversification as the proximity to frozen fish is Product Focus: 0.61, to salted fish 0.58, and fish fillet 0.47. One poten- tial avenue to accelerate Uganda’s move towards the core • Focus on dairy and footwear products. However, this assumes that Uganda’s capabilities in exporting leather as of the PS are metal products which Uganda has started to per the short term strategy will enhance its skills to levels suitable for footwear production in the longer term. Experience in exporting leather from local skins and hides could help develop a local supply chain that sources export. For example proximity of metal products to simple, milk for sophisticated dairy product exports, meat for local consumption, and skins and hides for leather, and in the non-electrical vehicles is 0.62, to furniture parts 0.57 and to longer term leather for footwear exports. aluminum products 0.56. • In spite of a large stock of live animals, processed meat is identified as a potential export. In contrast to a 1.40. The key challenge for Uganda is therefore to iden- conventional approach, mechanical value addition as a path of diversification, that is, from live animals to meat, tify those products that can take it closer to the core in then skins, and then leather and so on, is not a trait of PS analytics which is based on global trade patterns. Global trade flows show that meat, a technologically sophisticated product, is exported by only a small number of high the PS despite the currently limited productive capabili- income countries which have stronger capabilities in them. ties. In the universe of about 800 products that comprise the PS, there are around 740 that Uganda does not yet export. • Sophisticated wood and metal product exports are promising potential export products for the longer term. Like Policy makers should therefore strategically decide which footwear, the feasibility of these potential export industries hinges on the manufacturing skills developed in the short term. Thus, from the small step Uganda recently took by exporting simple metal products, the country could of these 740 products it should nurture through the targeted branch - in the longer term - into more sophisticated wood and metal products for use in homes, construction and provision of the necessary public goods. For example, pub- other industries for domestic and export markets. lic inputs for the leather industry (land for cattle breeding and tanneries, veterinary services, skills training) are differ- • The production lines of chemical products could be strengthened. Uganda already exports a small number of chemical products. The local availability of more minerals and unprocessed chemicals opens possibilities ent from those needed for petrochemicals (mining/drilling for diversification in a variety of heavy chemical industries including those related with petrochemicals. All are sophisticated products and Uganda’s currently low capabilities suggest that these heavy industries are better vertically related through input-output connections in the value chain. In the candidates for the longer term. Global experience shows that if the other inputs, especially heavy industry product space, even if two products are closely connected in the value chain, infrastructure is in place, chemicals and petrochemicals-based industries do not require large pools of industrial they could easily belong to two distinct communities because they require different productive knowledge and can be readily transported and stored. For skills. To a large extent, they are similar to enclave industries that can thrive with foreign technical and managerial example, while textiles are part of the garments value chain, the capabilities professionals and a relatively small pool of locally available industrial skills. They typically do not create large-scale required to competitively make textiles are quite distinct from those required to industrial jobs but they are the backbone of an industrial economy. make garments, and thus they form two distinct communities. 23 Chapter 1 Figure 1.20: Uganda’s Product Space in 2011: Coffee’s Dominance Had Given Way to Other Agricultural Products (Raw and Processed). Traces of Manufactures Figure 1.20: are Starting to Emerge 2011 Cocoa   Live  plants beans Flowers Bananas Hides,  skins,   Coffee Palm  oil leather Iron  tubes   Sugar Cane   Fish     Coal  &   Base   &pipes sugar cluster water  gas metals Wood   Iron   Gold Artificial products Tobacco   Petroleum  jelly products plastics family Iron  coils Varnishe Organic   Vegetables s-­‐lacquer chemical Vegetable   s Stationary roots Notebooks Decorative   Wood   Steel   Plastic   wood boxes wire products Woven  fabrics Seamless   iron  tubes Plywood Mineral   Cotton  &   working  tools Vegetable   cotton  seed oils Oil  seeds Tea Tin Sand Cereals Source: Chandra et al. (2015). Figure 6.2: Export Transformation Dynamic within EAC 100% 80% Medium and high technology permits, oil and gas pipelines, safety standards) which are more advanced knowledge that is not yet which require manufactures 60% different from those needed for the garment industry (con- available in Uganda the focus of a longer term should be manufactures Low technology 40% nectivity to coast/airports for exports and imported fabrics, strategy. The results are summarized in Box 1.4 and 1.5. Resource-based manufactures 20% zones with electricity, water and waste water industrial facilities and so on). 1.42. In order High Value to tackle Primary the Products various issues discussed in the 0% of macroeconomic CEM, a series Primary Products models were developed Burundi 1988-90 Burundi 2008-10 Kenya 1988-90 Kenya 2008-10 Rwanda 1988-90 Rwanda 2008-10 Tanzania 1988-90 Tanzania 2008-10 Uganda 1988-90 Uganda 2008-10 1.41. Based on the selection of the closest 5 products of including a macroeconometric model (MacMod-UG), a each of the 62 products that Uganda currently exports, it Computable General Equilibrium (CGE-MAMS) model, is possible to define a short and long-term export strate- a Dynamic Stochastic General Equilibrium (DSGE) mod- gy. This includes a set of 300 potential new export products. el and an Overlapping Generations (OLG) model. Box 1.6 Of these 300 products, those for which existing productive discusses the rationale for the use of the various macroeco- Oil well in the Albertine   Western Uganda region, capabilities are most readily available should be the focus nomic models.   of a short term export diversification strategy while those         24 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility     Box 1.6: Rationale for the Use of Macroeconomic Models in the Uganda CEM The CEM estimates the potential contribution of oil production to economic growth at the beginning of oil exploitation as well as the resulting structural economic transformation in the medium and long run. In so doing, the CEM relies on a macro-modeling framework (MacMod-UG) that uses Uganda macroeconomic and financial data to project a growth path for the economy. This framework, which belongs to the IS-LM-AS (aggregate supply) models family, takes into account interrelation between real domestic sectors, government financing, balance of payment, and monetary situation.1 MacMod-UG is a macro-econometric model, which is mainly characterized by its capacity to estimate the growth rate of each sector by using specific produc- tion function of each key sector. This allows the model to incorporate the new oil sector comprehensively in the framework although exoge- nously. In fact, a separate module specific to oil sector provides key macroeconomic information (including value of oil production, investment, domestic sales, exports, government revenue…), which is captured in the core MacMod-UG. This model also puts in coherence production sector and government financing. Thus, the framework is adequate for analyzing fiscal rule scenarios related to the efficiency use of extractive proceeds as well as evaluating the macroeconomic costs of front-loading infrastructure investments as recommended in the second National Development Plan (NDP 2) under preparation. The MacMod-UG framework also includes the Medium-Term Expenditure Framework (MTEF) derived from NDP that is appropriate to assess the optimal impact of an exogenous shock (for example, emerging oil production) on multi-year government spending. In addition, the CEM uses a Dynamic Stochastic General Equilibrium (DSGE) model to analyze the structural transformation of the Uganda economy beyond the first flow of oil as well as the impact of various shocks such as commodities price, productivity in each sector, and fiscal and monetary policies. The DSGE is based on a synthesis of new-keynesian and new neoclassical models. It accounts for the rational expectations of economic agents.2 To capture adequately the effects of a potential Dutch Disease, the DSGE model, calibrated on Uganda data, distinguishes three production sectors (traded, non-traded, and oil sector). This model accounts for several important features that are common in new keynesian model and developing countries, including Dutch disease, investment inefficiencies and weak tax systems. Moreover, the DSGE compares three alternative policies: (i) the all-saving approach; (ii) the all-investing approach; and (iii) the sustainable investing approach. Furthermore, the CEM addresses distributional issues by using a standard Dynamic Recursive Computable General Equilibrium (CGE MAMS) model. This model uses as baseline the macroeconomic outlook derived from the MacMod_UG and analyzes the impact of various uses of oil proceeds on economic growth, household income, and MDGs.3 Finally, the impact of policy change and shocks on long-run economic growth (steady state) is examined by the way of an over- lapping generations (OLG) model calibrated to Uganda macroeconomic and social data. This model emphasizes, among other issues, the importance of public investment efficiency and improved revenue mobilization performance on long-term growth even before oil production. 1. The MacMod framework shares a number of common features with (i) the family of general equilibrium models which emphasizes intersectoral linkages (for example, Input-Output and Social Accounting Matrix SAM multiplier models, and CGE models), and (ii) Consistency framework built around the flow of funds (for example, Financial programming, and RMSM-X). However, it differs from these classes of models on the structure of the database (longitudinal data), and the degree of endogeneity of key macroeconomic aggregates, including GDP and the general price level. 2. It has been implemented following the influential papers of Christiano, Einchenbaum and Evans (2005), and is now used by many in the analysis of Dutch Disease. 3. Distributional issues were also addressed through partial equilibrium regression analyses. This is the case for the analysis of using oil proceeds to reduce inequality and on the impact of subsidies. 25 Chapter 2 Development of Oil and Other Key Messages and Conclusions: Extractives: Prospects of the oil sector: Intensive exploration activity started in the early 2000s, essentially in three areas: P r o s p e c t s o f O i l a n d M i n i n g S e c t o r, M a c r o e c o n o m i c EA1 (Total), EA2 (Tullow), and EA3 (CNOOC). Uganda’s oil reserves are modest. Recoverable reserves are and Fiscal Impact estimated at 1.2/1.7 billion barrels. Production may begin in 2018 in EA3, followed by EA1, and EA2 two years later. A small refinery would process 30,000–60,000 barrels/ day for the local, and regional markets. A pipeline with a capacity of 200,000 barrels/day would export (through Kenya) the crude oil not processed in the refinery. Total oil production would peak at 225,000 barrels/day around 2025, and would then decline to end in 2044. The timing of the project will depend on world market prices. With a Brent price of US$50 per barrel, only EA1 production would yield a 10 percent return after taxes. Projections in this report are based on a long-term price averaging US$90 per barrel (with a 15 percent discount for Uganda’s oil due to high viscosity). Prospects of the mining sector: Recent geological, and mining studies concluded that 17 minerals (including phosphate, copper, cobalt, and rare earth elements) have potential for commercial exploitation. In addition, 50 sites are favorable to uranium exploitation. Chinese companies control the largest concessions. Although the growth of the mining sector averaged 9.8 percent in recent years, its contribution to GDP remains modest (0.3 percent). Macroeconomic/fiscal impact: Oil production is the Contractors handling lifting equipment at an exploration site in western Uganda main factor that will influence short- and medium-term economic performance. Real GDP growth would average 8.8 percent until 2025 (2.2 percentage points higher than without oil). The development of the oil industry, and increased public investment would enable I. The Development of the Oil Sector Uganda to reach its US$1,000 GDP per capita goal by the end of this decade. On the basis of production 2.1. In the early 1900s, geologists documented the occurrence of surface oil in the Albertine Graben. These findings sharing agreements negotiated with oil companies, 70 did not lead immediately to increased exploration activity. World War II and political instability in the decades fol- percent of the net present value of oil production would lowing Uganda’s independence also delayed the development of the oil sector. Ongoing political, and economic reforms accrue to the government, and the largest contribution of in the 1990s began to attract foreign investors. Drilling activity intensified along the Albertine Graben in the early 2000s with a special focus on three exploration areas (EAs) described in Box 2.1. 27 Chapter 2 Figure 2.1: Major Oil Producers in the World Key Messages and Conclusions: the oil sector would be in the form of increased public investment, notably in three key sectors (infrastructure, health, and education). Oil-related government revenue would average US$2. 1 billion/year (2/3 of domestic revenue in FY2013/14). Conclusions: • The main policy challenge for the government will be to avoid/mitigate the resource curse. The first aspect of the resource curse is the Dutch Disease. The exploitation of oil, and other natural resources increases the supply, and drives down the price of foreign exchange in the domestic market, thus triggering an appreciation of the local currency in real terms. Rising currency values undermine exports of manufactures, and services, and slow down the growth of non- resource sectors. In Uganda, it would reduce the profitability of agricultural exports, and undermine the development of tourism. Another aspect of the resource curse is the volatility of oil prices. Volatility produces fluctuations in exchange rates, export earnings, output, and employment that discourage Source: International Energy Agency (2012). investment, and growth. Countries rich in natural resources may not give enough priority to the development of human capital through education, 2.2. Uganda’s discovered oil resources are currently esti- 2.3. Reserve levels of 1.2–1.7 billion barrels of oil could and training. They may also be less attentive to the quality of their investments. Finally, abundant mated at 6.5 billion barrels, yet only part of the prov- support production of 100,000–225,000 barrels per day natural resources may crowd out financial capital en reserves will be recoverable. As production increases, over 20–30 years, depending on the speed of extraction. and government resource revenue may also crowd out non-resource revenue. and the resource is depleted, the pressure in the subsoil oil Uganda’s reserves are comparatively modest. As shown in reserves decreases, and the marginal cost of production Table 2.1, reserves, and expected production are far below • Moderating the growth of public spending, increases. The oil industry uses sophisticated extraction that of many other oil producing, and exporting countries. investing part of the oil revenue in foreign wealth funds are some of the most appropriate techniques that maintain pressure at high levels, but these Nevertheless, future oil production has a significant trans- instruments to mitigate the resource curse. At the techniques are costly, and their economic viability depends formation potential, and could help the country achieve the same time, sound investments in infrastructure, Vision 2040 objective of making Uganda an upper-middle and human capital are essential to remove binding on the long-term price of oil. In fact, extracting all the oil income country in three decades. constraints to growth, and increase productivity. available in a given oil field is generally not economical. These are some of the complex issues that will be Current estimates assume that only 1.2–1.7 billion barrels of discussed in more details in future chapters of the 2.4. Since the discovery of oil in 2007, the development report. oil will be recoverable in Uganda out of the 6.5 billion that of Uganda’s oil industry has moved at a slow pace. The have been found to date. discovery of economically viable oil reserves called for sub- 28 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Box 2.1: Three exploration areas in the Albertine Region Exploration Area 1: The EA1 concession, which covers the area along the river mouth of the Victoria Nile flowing into Lake Albert, was granted in 2004. The first significant oil discoveries proving the commercial viability of the oil field in EA1 were made in 2009 at the Ngiri, Jobi, Rii wells. The area is currently operated by Total E&P, a Ugandan subsidiary of the French multinational Total SA. The area is believed to hold the largest share of Uganda’s oil reserves (over 70 percent of total recoverable reserves). Exploration Area 2: The government conceded the exploration rights over the current EA2 in 2001. It covers the Northern parts of Lake Albert and the Buliisa district North of the town of Masindi. The first oil discoveries showing that commercial production was feasible were made between 2006 and 2007 at the Mputa, Waraga and Nziz wells. The area is estimated to hold up around 20 percent of proven recoverable reserves and is operated by Tullow Uganda Ltd. a subsidiary of Anglo-Irish Tullow Oil PLC. Exploration Area 3: EA3 covers the southern parts of Lake Albert and the Simliki Basin in Bundibugyo and Ntoroko Districts. The government conceded this area in 1997, and it was the first to undergo substantial drilling in the early 2000s. However, what was discovered was not found to be commercially viable. EA3 was then split into three separate exploration areas (EA3A, EA3B, and EA3C). So far, only EA3A, which covers the southern part of Lake Albert, has proven, commercially viable oil reserves. Operated by the state-owned Chinese National Offshore Oil Company (CNOOC), EA3A was deemed ready for production in 2013 when the government granted the first oil production license in the country. Oil production is now expected to begin Source: Bayphase Limited: Block III presentation on Block III, DRC dated September,14, 2010. in 2018. EA3A is believed to hold about 10 percent of total proven reserves. Table 2.1: Oil Reserves in Sub-Saharan Africa stantial reforms in governing laws of the sector. The gov- piped. In 2012, the government commissioned a feasibility ernment, therefore, imposed a moratorium on the allocation study which showed that the construction of a refinery was Total Reserves End 2012 Share of Total of new exploration licenses, pending the adoption of a new financially viable. The project could cater for the region- (in billion of Barrels) law. At the same time, the interest of foreign investors in al demand of refined petroleum products in Burundi, the Nigeria 37.1 54.0% Uganda’s oil went through a consolidation exercise with eastern region of the Democratic Republic of Congo, South Angola 12.7 18.4% the number of companies active in the oil sector declining Sudan, and Rwanda. Early 2014, oil companies, and the gov- South Sudan 3.5 5.1% from five to three. The approval of upstream, and midstream ernment signed a memorandum of understanding (MOU) Uganda 1.2–1.7 5.1% petroleum laws in 2013 was a milestone in the development about the construction of a refinery with a maximum capac- Gabon 2.0 2.9% of Uganda’s oil sector. Improved transparency, and legal ity of 30,000–60,000 barrels/day. The output of the refinery Equatorial Guinea 1.7 2.5% security should attract new investment as 60 percent of the will be supplemented by a pipeline that will export crude oil Albertine Graben area has not been explored. when daily production exceeds the 30,000–60,000 barrels Republic of Congo 1.6 2.3% to be processed in the refinery.1 Although final plans for the Chad 1.5 2.2% 2.5. As a landlocked country, Uganda also needed to pipeline are still under discussion, its capacity is likely to Sudan 1.5 2.2% decide how it would overcome the logistical challenge Uganda 1.2–1.7 1.7%–2.5% of marketing its oil through the construction of a local 1. Three alternative routes are envisaged for the pipeline. The first one would Total Sub–Saharan connect Uganda’s oil fields with the Lamu port in Kenya, which is being Africa 68.8 100% refinery or through exports of crude oil to foreign mar- upgraded. The second one would link Uganda’s oil fields to Mombasa, through Source: BP Energy Statistics. kets. The issue was complicated by the high viscosity of an existing pipeline (from Mombasa to Eldoret in Eastern Kenya) which would need to be upgraded. A third alternative through Tanga in Tanzania is now also Uganda’s oil, and the need to heat its crude oil for it to be being evaluated. 29 Chapter 2 Figure 2.2: Projected Oil Production reach 200,000 barrels/day. The MOU has paved the way for the final steps in the development of Uganda’s oil produc- tion. Construction of the refinery has been awarded. It will 250 be operated under a Public Private Partnership with the gov- 200 ernment holding a 40 percent interest. A detailed feasibility of the pipeline has been commissioned. 150 100 2.6. Uganda’s oil production is expected to follow the bell shaped path shown in Figure 2.2. Total production 50 is projected to peak at 225,000 barrels/day around 2025, 0 and would begin to decline by the end of the 2020s. The 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 starting date for oil production, however, continues to be EA3 EA2-South EA2-North EA1 Downstream Capacity highly uncertain. Currently EA3 is the only area for which a field development plan - a binding document establishing the timeline to make an area fit for production - has been Source: Oil & Gas Mega Model for Uganda. agreed between Uganda’s oil companies, and the govern- ment. The field development plans for EA1 and EA2, which Figure 2.3: Economic Viability of Oil Areas Based on Varying Oil Prices contain over 90 percent of Uganda’s reserves, still need to be defined. This delay is partly explained by the sharp decline in world market oil prices, which negatively affects the economic viability of Uganda’s overall oil project. Fig- ure 2.3 illustrates how different oil prices affect the after-tax of rate of return (ROR) of the different exploration areas. To achieve an after-tax rate of return of 10 percent, the devel- opment of EA1 would require the Brent crude oil price to hover around US$50 per barrel, but EA3A would require a price of over US$80 per barrel. In fact, at the current price of around US$50–60 EA2, and EA3A would both generate an after-tax ROR of less than 10 percent. 2.7. If oil prices recover, Uganda’s oil project will be via- ble, but its timing may be affected. In line with the World Bank’s commodity price forecast, the report assumes that Source: Oil & Gas Mega Model for Uganda. 30 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 2.4: Sector Contribution to GDP (In Percent of Overall GDP) the oil price will recover in the medium-term, making up for much of the drop in 2014 and 2015. It is projected that oil production at EA3A will come on stream in FY2017/18, but oil production from the smaller EA3A is not expected to exceed 20,000–30,000 barrels/day. Due to the delay in the approval of field development plans for EA1, and EA2, production from the largest reserves is unlikely to start before FY2019/20. Since the construction of the refinery, and the pipeline will take at least 3–4 years, oil production from EA3A may start 1 or 2 years before the downstream capacity (refinery, and pipeline) is in place. The government indicated that it might use extracted crude oil to generate electricity, and meet the growing local demand for power. A summary of the specific assumptions about future oil pro- duction, and the development of the oil sector is provided in Box 2.2. Source: MacMod Uganda. Box 2.2: Basic Assumptions for the Projection of Future Oil Production • Stock Tank Oil Initially In Place (STOIIP)1 of 6.5 billion barrels, of which 1.3 billion is recoverable (923 million in EA1, 231 million in EA2 and 134 million in EA3A). • Oil production will begin in FY2017/18 as EA3A comes on stream, followed by EA1 and EA2 in FY2019/20. Production will peak in 2025, decline gradually thereafter and end in FY2044/45. • Total downstream capacity will reach 230,000 barrels/day, including 30,000 barrels/day processed by the refinery (which will begin production in 2019) and 200,000 exported through the pipeline. • Initial production of crude oil will be used for power generation until the downstream capacity is in place. • Thirty thousand barrels/day will be reserved for the refinery. Surplus production will be exported through the pipeline. • Total capital expenditures for the development of oil fields will reach US$7.6 billion. The construction of the refinery and the pipeline will cost US$4.5 billion and 3 billion, including a government equity contribution of US$2 million to the overall project (field development, refinery, and pipeline). • The long-term price of oil will average US$90 per barrel, with a 15 percent discount for Uganda’s oil due to high viscosity. • The pipeline will charge US$ 10.18 for each barrel of oil piped to the Kenyan coastline. This includes a US$0.18 transit fee. 1. The volume of oil in the reservoir prior production . 31 Chapter 2 Figure 2.5: Impact of Oil Price on projected Government Petroleum Revenue (US$ Million) II. The Macroeconomic and Fiscal Impact of Oil Production - A Baseline Scenario 2.8. Oil production will have a significant impact on the Ugandan economy. Yet the precise impact will depend on US$ Million a range of uncertain factors such as the development of the international price of oil, the government’s use of oil reve- nue, and future exchange rate movements among many oth- ers. To this end, a macro-econometric model was calibrated encompassing the key features of the Ugandan economy. This sub-chapter discusses the baseline scenario, and its key assumptions which reflect the current policy thinking. A summary table of key macro-economic variables for the baseline scenario is provided at the end of the sub-chapter. Source: Oil and Gas Mega Model for Uganda. 2.9. The direct contribution of upstream oil activities during the life of the oil fields will be less than in other Figure 2.6: Source of Government Petroleum Revenue (at US$90 Per Barrel) oil producing countries. Not only Uganda’s reserves are relatively modest, but the growth of the non-oil economy continues to be robust. Oil fields are expected to generate 5,000 ($mil) Government Upstream Revenue (US$ mil) US$85 billion in revenue for the Ugandan economy over the 25-year life of the resource. Oil will generate a cash flow 4,000 totaling US$72.3 billion, net of all expenses, i.e. US$14.1 3,000 billion in net present value.2 Total value added by the oil US$ Million sector is expected to reach 9 percent of GDP by the mid 2,000 2020s (see Figure 2.4). Most of the impact will be indirect. 1,000 The oil sector will become a source of growth for other businesses linked directly or indirectly to oil activities. This 0 could stimulate the creation of new, and higher paying jobs, 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 and benefit the overall Ugandan community. Income Taxes Dividend Withholding Tax 2.10. The largest share of total oil revenue will accrue to the government. On the basis of production sharing agree- Source: Oil and Gas Mega Model for Uganda. 2. The NPV assumes a 10 percent discount factor. A lower discount factor would result in a higher NPV. 32 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 2.7: Uganda’s Real GDP Growth Path (With and Without Oil) ments concluded by the government, and the oil companies, and assuming a long-term price of oil of US$90/barrel, 70 percent of the net present value of oil production will go to the government. This is in line with agreements in other new oil producing countries. In Ghana, the government’s share of the net cash flow of offshore oil fields is about 69 percent.3 2.11. Oil production in Uganda is expected to generate a significant stream of additional revenue for the gov- ernment, yet the magnitude of this revenue stream will largely depend on the future price for crude oil. Reve- nue projections are very sensitive to the assumed oil price (Figure 2.5). Before oil prices started declining heavily in mid-2014, the price for one barrel of oil had hovered around Source: MacMod Uganda. the US$100 mark for several years. At this level, oil revenue for the government would average close to US$2.5 billion a year between 2017/18, and 2044/45. If the price for one Figure 2.8: Uganda’s Per Capita GDP (With and Without Oil) barrel of oil remains at US$50, average oil revenue will only amount to about US$800 million a year. Furthermore, the current low barrel price of below US$50 will generate much lower additional government revenue and growth. In line with the World Bank Commodity Markets Outlook, the CEM assumes that oil prices will recover in the medi- um-term to an average of US$90. In total this would gener- ate US$57 billion in government revenue between 2017/18 and 2044/45, through the government share of oil profits, royalties, income taxes, dividends, and interest on the 15 percent government equity in oil fields (see figure 2.6). Additional government revenue will average US$2.1 bil- lion/year (two-thirds of domestic revenue in FY2013/14), and will reach US$4 billion in peak production years. Source: MacMod Uganda. 3. See World Bank (2009). 33 Chapter 2 2.12. The largest contribution of Uganda’s petroleum Figure 2.9: Uganda’s Trade Balance (With Oil) will therefore be in the form of additional public invest- ment in such key sectors as infrastructure, health, and education. Oil revenue will offer a great opportunity to meet some of the most important public spending needs, and ease some of the country’s key economic constraints. For example, a recent cross-country study based on firm level data suggests that low productivity in Uganda can largely be attributed to inadequate infrastructure.4 In addi- tion, public spending in education, and health (in share of GDP) declined from around 6.5 percent of GDP in 2003/04 to 4.5 percent in 2012/13. The result is growing pressure on public services as high population growth rates lead to overcrowded classrooms, and health facilities in many parts of the country. Source: MacMod Uganda. 2.13. Consequently, a recent increase in public invest- Figure 2.10: Uganda’s Nominal and Real Exchange Rate ment is expected to continue during implementation of the Second National Development Plan (NDP 2). During the first National Development Plan (NDP 1), total develop- ment expenditures rose from 7.7 percent of GDP in 2011/12 to 8.5 percent in 2013/14, mainly thanks to an increase in domestic development, and investment expenditures aver- aging 24 percent/year. The same trend is likely to continue during NDP2. However, the government has to meet the 3 percent fiscal deficit limit (under the East African Monetary Union convergence criteria that become binding in 2021). Uganda will therefore need to slow down the growth of pub- lic investment expenditures, thus allowing oil revenue to be used for fiscal consolidation rather than to increase invest- ment. Total public expenditure is thus projected to increase gradually in line with rising oil revenue from the current 19 4. Escribano et al. 2010. Source: MacMod Uganda. 34 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility public investment (see Figure 2.7). al average of 3 percent of its value against the U.S. dollar. Assuming this rate of depreciation remains constant, US$1 2.15. The second impact is related to trade balance will trade at UGX 3,700 by 2024/25 compared to an aver- effects of oil which should be sequential. In fact, as FDI age value of UGX2,600 in FY 2013/14. It is worth noting increases when firms are focusing on the construction phase that between 2014 and 2015 the shilling depreciated by 27% as well as other oil related imports, growth in total imports against the U.S dollar, standing at UGX3301.77 at the end of is expected to accelerate from 4.5 percent in 2014/15 to an December 2015. In contrast, the real exchange rate, which average of 12.5 percent over the period 2017/18 to 2020/21. corrects for different levels of inflation in Uganda vis-a-vis Subsequently, annual import growth will gradually decline, the rest of the world, will appreciate by a modest 14 percent Much of Uganda’s oil deposits are in reaching 7 percent in 2030/31, as the need for imported between 2013/14, and 2024/25. areas with tourism potential inputs diminishes, and construction phase in the petroleum sector winds out. At the same time, oil exports will increase 2.17. This divergence in real and nominal exchange rates percent of GDP to 21 percent by 2024/25 (a more ambitious gradually from a very insignificant level in 2017-20 to 6.6 is commonplace in natural resource economies. Angola, scenario in which public expenditure is frontloaded ahead percent of GDP in 2024-30. In line with these developments, Ghana, and Nigeria, for instance, all saw their real exchange of oil production is discussed in Chapter 4 ). The country’s the country’s trade balance (as share of GDP) will first dete- rate appreciating during the commodity boom that started gross debt to GDP ratio will continue to increase, peaking riorate slightly from a deficit of 9.7 percent in 2014/15 to in the mid 2000s. Their respective nominal exchange rates, at 35 percent in FY2015/16 shortly before oil production is 17.9 percent on average over the period 2017/18 to 2020/21 however, fell during that period. An underlying reason for expected to begin. but will improve significantly thereafter due to the stron- this divergence in nominal, and real exchange rates is that ger performance of oil and non-oil exports. In contrast, the commodity booms fuel domestic inflation, which in turn 2.14. The emergence, and development of Uganda’s oil current account will not improve over the next decade, as causes the real exchange rate to appreciate. The apprecia- industry, and the capacity of the government to increase Uganda’s income account deteriorates when international tion of the real exchange rate has a negative impact on the public investment will have a major impact on GDP oil companies repatriate profits, and aid inflows decline. country’s competitiveness lowering non-natural resource growth during the next decade. Figure 2.6 illustrates Therefore, by 2025 the current account deficit is projected exports. The literature refers to this as Dutch Disease, which Uganda’s growth path with, and without oil. If oil price to reach 10 percent compared to the 9 percent today. The is often identified as one of the key challenges of econo- recovers to its pre-crisis level and assuming that oil produc- government is expected to deposit a small share of its oil mies with large natural resource sectors (see section V. for tion comes on stream in 2017/18, and that public investment revenue to a sovereign wealth fund abroad. Yet, compared a more detailed discussion of Dutch Disease). One of the continues to accelerate during the next decade, real GDP to the rise in imports these savings will be small. Foreign ways countries can regain competitiveness is by allowing growth is expected to average 8 percent annually between exchange reserves are thus projected to exceed about 6 their nominal exchange rate to adjust freely through a nomi- 2015/16 and 2024/25, i.e. 1.7 percentage points higher than months of imports. nal depreciation of their currency. The emerging oil, and gas in a scenario without oil, and a more limited investment sector in Uganda will be relatively small compared to the surge. In per capita terms, the emergence of the oil sector, 2.16. Without a marked change to Uganda’s current rest of the economy. Assuming that Uganda maintains an and a continued emphasis on public investment would allow account, the Ugandan shilling is projected to continue open capital account with a floating exchange rate regime, Uganda to reach by 2021/22 a GDP per capita of US$1147, its downward trend observed during the last decade. it is therefore unlikely that the onset of oil production will 14 percent higher than in a situation without oil, and less Over the last ten years the Ugandan Shilling lost an annu- exert significant upward pressure on real exchange rate. 35 Chapter 2 Table 2.2: Selected Economic and Financial Indicators – Baseline Scenario Source: World Bank Staff Estimates using MacMod Uganda. 36 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 2.18. The overall impact of the emerging oil sector will 2.20. A gradual return to political stability since 1986, number of international conferences (including the Africa be significantly smaller, if oil prices remain low. The base- and strong government support helped revitalize the Down Under in Perth, Western Australia, and Indaba Mining line scenario assumes that the international price of crude mining sector. During 2003–2008, the Sustainable Man- in South Africa). The number of licenses (prospecting, explo- oil recovers in the medium term from its current levels of agement of Mineral Resources Project (SMMRP) financed ration, retention, location, mining, and mining dealers) went below US$50 per barrel to an average of US$90. This is a comprehensive geological, and mining study covering 80 up from 66 in 2005 to 867 by the end of FY2012/13. based on the most recent World Bank Commodity Outlook, percent of the country. The remaining 20 percent (essen- which foresees a crude oil average spot price of US$91.5 tially the Karamoja region) could not be covered due to 2.23. Geological studies/surveys have identified 27 min- between 2021 and 2025. If oil prices were to remain at their security concerns at that time. The pacification of the area, erals in deposits with potential for commercial exploita- current levels this would significantly limit the ability of the and the disarmament of Karamajong warriors enabled the tion (Table 2.3). This, however, depends on the results of government to increase investment spending. For instance, government to carry out airborne, and geological surveys, the ongoing process of evaluating the mineralization, and the sum of upstream revenue of the government (excluding and geological mapping of the region. quantification of most minerals. The recently completed pipeline, and refinery) over the lifetime of the oil fields would SSMR project concluded that 17 minerals (copper, cobalt, fall from US$57 billion to US$37 billion. The summary 2.21. The Department of Geological Surveys, and Mines gold, iron ore, columbite tantalite, tin, titanium, tungsten, results of the baseline simulation are provided in Table 2.2. (DGSM) also embarked on a community sensitization limestone/marble, phosphate, vermiculite, rare earth ele- campaign (aimed at stimulating local interest in the ments. kaolin, gypsum, salt, glass sand, and dimension project) in the Karamoja region, where 50 different high stone) had potential for commercial exploitation.6 III. The Development of Uganda’s Mineral value minerals are available (MEMD 2014). Today, Arti- Sector sanal, and Small Scale Mining (ASM) already accounts for 2.24. Recent airborne, and geophysical reconnaissance more than 90 percent of mineral production in the country. surveys conducted under the SMMR revealed that 50 2.19. Uganda had a rich mineral industry that started sites are geologically favorable to uranium exploitation It provides direct employment to more than 200,000 peo- with iron ore, and salt mining before colonial times. Arti- (MEMD 2014). The government plans to make the infor- ple, and more than 1.5 million people benefit from back- sanal, and Small Scale Gold mining (ASGM) is a recent mation on all the sites available in order to promote urani- ward, and forward linkages to the mineral sector (UNEP phenomenon (UNEP), but industrial mining began much um exploitation. It also plans to formulate national policies, 2012). With almost the totality of the country surveyed, and earlier. Uganda’s mining production (copper, cobalt, and issue regulation, strengthen national capacity, and carry out mapped, the mineral sector is ready for take-off. tin) peaked between the 1950s, and the 1960s, when the sec- a detailed assessment of uranium resources including its tor contributed 15 percent of the country’s export earnings 2.22. Access to organized geo-science information is viability for nuclear energy. The government will promote (Tuhumwire). Political, and economic instability in post-in- essential for the exploitation of natural resources. Over health, and safety measures, and safe management of radio- dependence Uganda led to a rapid decline in the production the past few years, DGSM improved its geo-science data, active related waste. It will acquire specialized machinery, of the mining sector. and its information management system in order to promote and equipment for an efficient exploitation of the resource. the mining sector through the creation of an enabling envi- ronment based on easy access of investors to information 6. Other minerals such as - zinc, silver, diatomite, kyanite,and feldspar are still (MEMD 2010/11). Availability of mineral geo-data, and the undergoing evaluation by the DGSM. Studies are under way to establish the commercial viability of other minerals such as beryl, chromite, lead, lithium, silver, introduction of a cadastral map enabled Uganda to showcase zinc, feldspar, kyanite, and diatomite. Reserves of nickel, and the platinum group 5. World Bank 2015 “.Commodity Markets Outlook”- World Bank Quarterly Report, of metals have not yet been identified, but verification work is ongoing in the its mineral wealth to the international mining industry in a April 2015, Washington DC. Western, and Karamoja regions. 37 Chapter 2 Table 2.3: Mineralization, Reserves and Project Status No Minerals Status of Reserves Project Status 1. Copper 6 million tons at 1.77% Cu. Leased to Tibet Hima to develop copper resources at Kilembe Mines. Grade of 1.7% at Boboong. Reserves at Kitaka and Kampono under evaluation. Reserves at Kitaka and Kampono under exploration 2. Cobalt 5.5 million Tons with Grade of 0.17 of cobalt. Kasese cobalt company Limited has been processing cobalt stockpile, which is nearly exhausted 3. Gold Five (5) million ounces of gold in Mubende District by Anglo Uganda Corporation; One (1) million ounces Four (4) Mining Leases Granted of gold estimated at Mashonga; 500,000 ounces of gold estimated at Tiira, Busia; and Over 500,000 ounces estimated at Alupe in Busia; 139,000 ounces and possible reserves of 160,000 of gold at Nakabat in Moroto District. 4. Iron Ore 50 million tons at Muko, Kabale; 2 million tons in Mugabuzi, Mbarara; 23 million tons at bukusu and Four (4) Mining Leases granted for development of iron ore resources. 45 million tons at Sukulu, Tororo District; 48 million tons at Buhara in Kabale District (New discovery); 8 million tons in Bufumbira, Kisoro (New Discovery); 55 million tons at Butogota in Kanungu District (New Discovery). 5 Columbite 130 million tons of Niobium at Sikulu. The Sukulu Phosphate deposit is potentially the most important Tantalite 3.5 million tons of Columbite –tantalite estimated at Kagango in Ntungamo District. source of Niobium. 6 Tin 1 million tons at 2.5% tin estimated in Ntungamo. Under-developed 2.5 million tons in Isingiro District Two Mining Leases granted. 7 Titanium Grade of titanium is 22% TiO2 and 13% TiO2 in Bukusu and Sukuru respectively. Underdeveloped. 8 Tungsten Kirwa wolfram resources estimated at 801,300 Metric Tons of average grade of 68.67% WO3 Three Mining Leases granted. One (1) million tons and possible reserves of 355 million tons at Nyamuliro with ore grade at 0.1% 9 Rare Earth 73.6 million tons of rare earth elements at Sukulu with grade of 0.32% La205. Aluminous clays that are Unexplored, though Sukulu is now under exploration. Elements (REE) enriched in Scandium, Gallium, Yttrium and REE in Makuutu area estimated at 3 billion tons. With grades of 23% REE and 27% Alumina. 10 Phosphates 230 million tons at Sukulu with grade of 13.1% p2o5. Investment in fertilizer manufacturing is viable. 50 million tons at Bukusu with grade of 12.8% p2o5 Apatite with magnetite, vermiculite, pyrochlore, bbarite, zircom, uranium, titanium, Niobium and rare earth elements. 11 Limestone/Mable 14.5 million tons at Hima Kasese and 11.6 million tons at Dura, Kamwenge. Production on large scale in Kasese, Tororo and Moroto. Over 300 million tons of marble in Karamoja region. 12 Vermiculite 54.9 million tons at Namekhara. Mine developed at Namekhara Investment in fertilizer manufacturing plant viable. 13 Kaolin 2.8 million tons at mutaka, Bushenyi District. Ready domestic market. One million tons at Kisai (koki), Rakai District. 14 Gypsum 2 million tons in Kibuku. Available Market 15 Salt 22 million tons of trona at Katwe and Kasenyi, Kasese District. Mined for both animal and human consumption. Industrial production opportunities available. 16 Glass Sand The highest quality 99.9% SiO2 at Kome Islands, 2 million tons at Dimu and Bukakata (99.93% SiO2) Viable Investment 17 Dimension Stones Over 300 million tons of marble in Karamoja (Rupa, Kosiroi, Tank Hill, Forest Reserve, Matheniko, Oule and A Mining Lease granted for building majesties (u) Ltd (BML) to process Lolung). granites in Mubende into dimension stone. Source: MEMD (2014). 38 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility IV. The Macroeconomic, and Fiscal Impact of Figure 2.11: An illustration of the Dutch Disease the Mineral Sector 2.25. The contribution of the mining sector to the coun- try’s GDP, exports, and government revenue remains modest. The growth of the mining sector averaged 9.8 per- cent in recent years, but its contribution to GDP averaged only 0.3 percent. Government revenue increased from UGX 134 billion in 2010/11 to UGX 185 billion in FY2012/13 but did not exceed 2–3 percent of total government reve- nue.7 Mineral exports (mostly gold, iron ore, silver, tin, tungsten, vermiculite, cobalt and copper) accounted for 1 percent of total exports in 2012/13.8 2.26. Prospects, however, are positive and could be lev- eraged through the promotion of linkages to the rest of the economy. Uganda’s rich mineral wealth is virtually untapped, but political and economic stability in the coun- try, availability of geo-data, high world prices of minerals and growing global demand, notably from emerging coun- tries like China and India, led to significant increases in FDI for the sector. To harness the exploitation of its miner- al resources, the government must adopt a comprehensive development-driven policy, focused on the value of the derived demand through the mineral value chain. The Afri- can Union argues that the contribution of the mining indus- try to broad-based development will improve if the sector is integrated through linkages into the national and regional socio-economic fabric. 7. Revenue from mining includes non-tax revenue from prospecting license fees, exploration license fees and rents, location fees and rents, mining lease fees Investing in infrastructure including urbanization and rents, import permit fees, blaster certificates/ gold-smiths, license fees, and will promote the development of non-oil sectors mineral royalties, as well as other revenue generated by internal consumption of mineral ores - and imports/exports of mineral products. 8. According to Yager (2010), the shares of mineral exports in total value of exports were 4.4 percent for cement; 3.3 percent for iron ore and steel; 1.9 percent for gold; and 1.1 percent for cobalt. 39 Chapter 2 2.27. The development of the mining sector depends not a relocation of production factors from the non-resources B. Macroeconomic foundations of the resource only on a sound legal and regulatory framework but tradable sector to the resource sector and the non-tradable curse/Dutch Disease also on addressing a number of other major issues. The sector. This accelerates the decline of economic growth. Fig- country must address at the earliest possible stage a number ure 2.11 presents an illustration of Dutch Disease phenome- 2.30. Dutch Disease is a manifestation of the ‘resource of critical challenges, including human capital deficiencies, non with a contraction of non-resource export accompanied curse’, which turns poorly managed natural resource notably in knowledge-intensive areas, and infrastructure by increased activity in the non-tradable sector. wealth into a mixed blessing through reduced long-term inadequacies. Oil revenue could be used for that purpose. growth (Sachs and Warner, 1995). The resource curse Foreign investment will make a major contribution to the 2.29. A boost in foreign exchange earnings caused by the works through different mechanisms, including (i) an over- development of the mineral sector. As in other mineral-rich exploitation of natural resources increases the supply of valuation of the currency of resource-rich countries, and African countries, most of the new capital investment will foreign exchange in the domestic market, drives down (ii) the volatility of key economic aggregates, including come from China. Chinese companies already control the the price of foreign exchange and triggers an apprecia- exchange rates, export earnings, and output. The follow- largest concessions in terms of market capitalization, includ- tion of the local currency in real terms. Total exports will ing paragraphs analyze various macroeconomic channels ing Sukulu Phosphates, Rare Earth Elements in the East, rise massively as a result of resource exports, but non-re- through which Dutch Disease could affect Uganda. and the Copper and Cobalt project at Kilembe in Western source exports will fall as they cannot compete effectively in a. Exchange rate Uganda. The regional dimension will also play a role. As foreign markets because of the rise in the value of the local Uganda is a landlocked country, the mining equipment, the currency. A higher value of that currency reduces local cur- 2.31. Poorly managed, Dutch Disease could impact the machinery, the spare parts and the skilled labor required for rency gains from each foreign currency unit (for example, agriculture and the tourism sectors. Agriculture will con- the development of the sector will come through the neigh- dollar or euro) earned through exports. Consequently, rising tract overtime, in terms of manpower and share of GDP, boring countries of Kenya and Tanzania. currency values in natural resource-rich countries under- as farmers adopt modern methods that necessitate fewer mine exports of manufactures and services, and weaken the working hands to feed the population. The process could V. Oil and Competitiveness long-run economic growth potential of the country, even if a be quickened by a rising exchange rate that would reduce boost in total export earnings fuels economic activity in the the profitability of farm exports. Tourism does not face the A. Dutch Disease: A textbook explanation short-run. Just as increased consumption at the expense of same natural constraints, apart from environmental consid- national saving increases output in the short-run but reduces erations. However, its profitability may decline as a result 2.28. The fear of the Dutch Disease is often exaggerated. the rate of growth in the long-run, the discovery of natural of: (i) a real term appreciation of the shilling, and (ii) price Nevertheless, policymakers in resource-rich countries resources or a commodity price boom can boost short-term hikes for services triggered by expatriate workers in the oil must do what is needed to minimize the risk. Dutch Dis- economic activity while undermining efficiency and growth sector. ease derives its name from the overvaluation of the guilder potential over the long haul. Figure 2.12, however, shows following a natural gas boom experienced by the Nether- b. Import protection or subsidies for natural resource- that addressing binding constraints to growth and increas- lands in the 1960s. It refers to a situation in which an oil/gas based industries ing productivity through investment in infrastructure may export boom leads to increased public and private spend- prevent de-industrialization even if the country continues ing, which in turn causes a sharp appreciation of the real 2.32. Dutch Disease often manifests itself through import to experience some appreciation of its real exchange rate. exchange rate and increases the relative price of non-tradable protection or subsidies which reduce the demand for to tradable. The result is a decline in non-resource exports foreign exchange, lower the price of foreign currencies, and slower economic growth. Higher factor prices lead to contribute to an appreciation of the local currency, and 40 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Containers loaded with crude oil ready for refining 41 Chapter 2 may have a strong negative impact on export firms and ble capital that matter for long run sustainable growth, can g. Social capital also local industries competing with imports. Often the exacerbate the effects of Dutch Disease. same political forces favor the protection of selected domes- 2.37. The lack of social capital also negatively affects e. The role of human capital tic industries against foreign competition and the indirect productivity improvement measures critical to alleviate subsidization of natural resource based industries by not some of the macroeconomic risks of the Dutch Disease. 2.35. Countries rich in natural resources may lose sight charging them enough for their extraction rights. Taxing the Social capital is the societal infrastructure that keeps eco- of the need to build up human capital through educa- resource revenue of these domestic industries too lightly nomic activity humming along efficiently, including good tion, training and health. Human capital is critical for sus- can lead to a significant overvaluation of the currency and governance, an independent judiciary, freedom of press, tainable long-term growth. Yet, there is some evidence that associated balance of payment and external debt problems. trust, equality, and the absence of corruption and political resource-rich countries tend to allocate a smaller share of This aspect of the Dutch Disease brings fiscal policy into the oppression (for a survey, see Paldam 2000). There is some their national income to education. They send fewer chil- story. It often takes a fiscal correction to create conditions evidence that countries rich in natural resources get low- dren and adolescents to school than countries with the same for establishing a competitive value of the local currency. er scores in terms of governance (see the Ibrahim index of general income level but fewer natural resources. A possi- African governance),9 and corruption (Transparency Inter- c. Volatility of commodity prices ble explanation is a false sense of economic security that national) than countries with less natural resources. There influences the mindset of the authorities and segments of is also evidence that resource-rich countries tend to be less 2.33. Since 1960, oil-exporting countries withstood sharp the population and make them lose sight of the high priority democratic. Finally, income inequality as measured by the price volatility, due to several exogenous factors includ- of building up human capital. Incidentally, wealthy parents Gini coefficient seems to be greater in resource-rich coun- ing, political developments in oil-producing countries, sometimes find it difficult to convince their children to work tries than in countries with less natural resources (Ross hurricanes in the Gulf of Mexico, and growing global and acquire an education. 2001). demand for petroleum products. Volatility of commodity f. Physical capital prices produces fluctuations in exchange rates, export earn- h. Financial capital ings, output, and employment, and discourages investment 2.36. The poor quality of investment in resource-rich and growth (Aghion and Banerjee, 2005). Export price vol- 2.38. Abundant natural resources may also crowd out countries can reduce productivity gains. This may be atility is another reason why natural-resource rich countries financial capital by holding back the emergence of a a case of intellectual myopia. Countries rich in natural may be prone to sluggish investment and slow growth. Sim- well-developed financial system, and producing an inef- resources may be less attentive to the quality of their invest- ilarly, high and volatile exchange rates slow down invest- ficient allocation of savings across industries and firms. ments than countries with fewer resources (resource-poor ment and growth. This reduces the efficiency of capital by weakening incen- countries can ill afford to make mistakes). Improving the tives to save and invest. When a significant part of a coun- d. Microeconomic foundations of the resource curse/Dutch efficiency of public investment management (PIM), in terms try’s national wealth takes the form of natural resources Disease. of project appraisal, selection, implementation and evalua- (renewable or non-renewable), there is less need for banks tion, would increase the fiscal space available to develop- 2.34. The literature on economic growth has identified ing countries to invest in vital infrastructure projects much 9. Of the twelve African countries that produce oil in commercial quantities, six several other channels through which natural resource needed for growth and development. For Uganda, the effi- are in the bottom 20 percent in the Ibrahim ranking of governance that includes Safety and Rule of Law, Participation and Human Rights, Sustainable Economic wealth may prove to be a mixed blessing. Lack of diver- ciency of public expenditure will be crucial to better prepare Opportunity, and Human Development (Ampratwum and Ashon, 2012). Of the 52 African countries ranked by the Ibrahim index in 2013, Uganda ranks number sification and inadequate transformation of natural capital the country for an optimal use of new resources generated 18, compared with 21 for Kenya, 17 for Tanzania, and 7 for Ghana. On a scale of 8 into other stocks of capital, including tangible and intangi- by oil production and other extractive industries. (Somalia) to 83 (Mauritius), Uganda scores 56, Kenya 54, Tanzania 57, and Ghana 67. 42 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility and other financial institutions to facilitate everyday trans- Figure 2.12 : Hydrocarbon and Non-hydrocarbon Revenues (In Percent of GDP), 1992-2012 actions. The country can save through less rapid depletion Norway or more rapid renewal of natural resources, or it can spend 40 through more rapid depletion of the resource (Arezki and Gylfason 2011; Gylfason and Zoega 2006). In the OPEC states, savings are stored as deposits in foreign banks, mak- Non-hydrocarbon revenue 30 Russia ing domestic financial intermediation less important. Yet, when savings are accumulated at home in the form of phys- ical capital, domestic banks and stock markets play a major Vietnam 20 Ecuador role. By connecting domestic savers and investors, the Trinidad and Tobago Kazakhstan Kuwait Mexico domestic banking system contributes to a more efficient allo- Syria Azerbaijan Venezuela Qatar Cameroon Gabon Indonesia cation of capital across sectors and firms. In sum, an abun- Chad Iran Yemen Algeria Libya Oman 10 United Arab Emirates Congo, Rep dance of natural resources can hamper the development of Sudan Bahrain Nigeria Equatorial Guinea Angola Brunei Saudi Arabia the financial system, thus distorting the allocation of capital and reducing economic growth due to the negative impact 0 of shallow financial markets on the quantity and quality of 0 10 20 30 40 50 saving and investment. There is empirical evidence that Hydrocarbon revenue indicators of financial development are significant sources Source: Belinga et al. (2014). of economic growth, physical capital accumulation, and improvements in the efficiency of capital allocation (King attitude. Rising transparency is the main objective of several increase in resource revenue (in percent of GDP) will lead and Levine 1993a, 1993b). If so, dependence on natural recent international initiatives, including: (i) the Extractive to a decline in non-resource revenue of the government by resource may go along with financial backwardness, thereby Industries Transparency Initiative (EITI) which sets global 0.2–0.3 percentage points.10 Tax collection, which is one of hindering efficient capital deepening and economic growth. transparency standards in oil, gas, and mining, (ii) the Reve- the main sources of revenue for governments; is very weak nue Watch Institute (RWI) which promotes responsible man- in developing countries. Over the past two decades, tax per- agement of oil, gas, and mineral resources, and (iii) the Natu- formance (measured by the tax-to-GDP ratio) was only 12 C. Other Issues ral Resource Charter (NRC) which defines principles for the percent in low-income countries compared to 32 percent a. Rent seeking behavior management of natural resources. Like Ghana and Tanzania, in advanced economies (IMF 2011). This is due to several Uganda should become an EITI compliant member country common factors: (i) many sectors are difficult to tax, includ- 2.39. Rent seeking is another practice which hampers and meet all the requirements of the EITI standard. ing international services and the informal sector which rep- economic efficiency and growth in countries with abun- b. The Risk that Resource Revenue Crowds out Non-Re- resents on average 40–60 percent of GDP; (ii) heavy reliance dant resources. Rent seeking, especially when accompa- source Revenue on receipts from multinational enterprises, whose tax plan- nied by ill-defined property rights, imperfect markets and ning and management ability is a growing challenge; (iii) the lax legal structures, tends to divert resources away from 2.40. Empirical evidence suggests that resource revenue socially beneficial economic activity. Transparency can help 10. Recent developments suggest that revenue from natural resources-par- crowds out non-resource revenue in resource-rich coun- ticularly in Sub-Saharan Africa (SSA) plays a significant role in improving tax by increasing public awareness of counterproductive behav- performance. For instance, Keen and Mansour (2010) find that over the period tries (Figure 2.12). In other words, a 1 percentage point ior, and providing incentives for rent seekers to change their 1980–2005, resource-rich countries within SSA have had better revenue collec- tion performance. 43 Chapter 2 Table 2.4: Pre–Tax and Post–Tax Subsidies for Petroleum Products in 2011 (Percent of GDP) Country GDP per capita(US$)* Income Pre–tax Subsidies Post–tax Subsidies Refinery inside the Subsidy Reform Level*** country Year Change Algeria 5,304.2 UM 4.30 6.11 Yes Angola 5,144.0 UM 1.30 2.51 Yes Cameroon 1,230.5 LM 1.69 2.49 Yes Chad 891.7 Low 0.00 0.00 No DRC 3,713.8 LM 1.20 2.08 Yes Egypt, Arab Rep. 2,970.4 LM 6.74 8.60 Yes 2013 Partially removed oil subsidies High (non Equatorial Guinea 14,660.8 0.28 1.88 No OECD) Gabon 10,653.7 UM 0.16 0.74 Yes 2013 Planned to Remove oil subsidies Ghana 1,528.9 LM 0.62 1.85 Yes 2013 Complete Removed oil subsidies Jordan 4,674.7 UM 2.15 5.27 Yes 2013 Complete Removed oil subsidies 2014– Announced subsidies removal before Libya 5,691.3 UM 6.40 8.81 Yes 16 2016 Nigeria 1,490.1 LM 1.42 2.04 Yes 2012 Partially Removed oil subsidies Uganda 477.5 Low 0.00 ** 0.20** No     High (non Saudi Arabia 20,504.4 7.46 13.27 Yes OECD) South Africa 8,066.1 UM 0.01 1.06 Yes Sudan 1,982.5 LM 1.37 2.26 Yes 2013 Increased oil prices by 75 percent World     0.30 1.26       Source: Compiled by World Bank staff. Notes: GDP is expressed in current U.S.$ per person. The figures of the pre–tax and post–tax subsidies in Uganda are for 2012. UM: Upper middle; LM: Lower middle. 44 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility poor performance of state-owned enterprises that abuse or Nigeria, and US$2.53 in Norway. It can be compared with oil revenue to local governments should take into account ignore the tax system; and (iv) weak revenue administration US$0.97 in the United States and US$1.23 in Botswana. macroeconomic and financial stabilization issues influenc- combined with poor governance (IMF 2011). Gasoline prices per liter were US$1.31 in Uganda, US$1.37 ing the management of both central and local governments. in Kenya, US$1.42 in Tanzania, and US$0.92 in Ghana Economic and financial stabilization policies will always 2.41. Belinga et al. (2014) re-examined the hydrocarbon (World Bank, World Development Indicators). The capaci- remain one of the principal functions of central authorities. and non-hydrocarbon revenue nexus using a panel of 30 ty of governments to resist the temptation to reduce energy The study of the Nigerian experience may provide useful resource-rich countries for the period 1992-2012. They prices at home (to impress voters) signals a strong commit- examples of what should be done and what should be avoid- found that while a rise in hydrocarbon revenues induces a ment to sound natural resource management and socially ed. Most of these issues will be addressed as the government decline in non-resource revenues (Figure 2.12), high quali- efficient macroeconomic policies. develops a more detailed strategy aimed at optimizing the ty institutions are critical to reduce the likelihood of such a benefits to be derived from oil and other extractives. crowding out to occur. 2.44. Although oil subsidies are politically popular, they c. Spending pressures (including subsidies) and revenue have several adverse consequences for government sharing with local governments finances, and an inefficient use of energy. Large subsidies divert public expenditures from more productive spending 2.42. Many oil-rich countries subsidize gasoline, at a high or contribute to unsustainable budget deficits affecting long- cost in terms of inefficiency and associated deadweight term growth. According to a IMF (2013), the benefits of gas- losses (Aguinaga et al. 2014). Selling fuel at cost price at oline subsidies are most regressively distributed, with over Oil-rich countries are home rather than at world market prices including taxes, is 80 percent accruing to the richest 40 percent. With respect to tempted to subsidize fuel prices at their own peril equivalent to a fuel subsidy. Subsidizing fuel is inefficient subsidies of diesel and liquefied petroleum gas (LPG), more since selling domestically produced fuel at a lower price than than 65 to 70 percent of benefits go to the highest income could be fetched in the world market deprives producers of groups. Although the consumption of kerosene is more even- revenue and reduces national income. Inexpensive fuel dis- ly distributed across income groups, kerosene subsidies still courages firms and households from conserving energy and benefit high-income households and, in Africa, more than 45 invites waste. In addition, this indirect subsidy discriminates percent of these subsidies benefit the top two income quin- against: (i) recipients who might have preferred other goods tiles (Coady et al., 2010). Table 2.4 presents pre-tax and post- if a cash subsidy had replaced the fuel subsidy, and (ii) those tax subsidies (in percent of GDP) for 16 major oil-exporting who do not use much fuel (perhaps because they cannot countries in the MENA and Sub-Saharan Africa regions, and afford a car). A tax on petrol that would bring fuel prices at in Uganda. Only Chad and Uganda - two low-income coun- the pump close to world market prices would raise revenue tries - did not subsidize petroleum products in 2011. Uganda to help finance education, health care, and infrastructure. started to subsidize petroleum products through tax exemp- Using the proceeds of the tax to improve education means tions in 2012. that an education subsidy replaces the fuel subsidy. 2.45. Many resource rich-countries have grappled with 2.43. Fuel prices at the pump vary a great deal, even the complex issue of revenue sharing with local govern- among oil producing countries. In 2012, the cost of gas- ments. No clear, effective and field tested formula seems oline at the pump was US$0.16; US$0.23 and US$0.62 in to be available at this stage. In addition the distribution of 45 Part II Policy Priorities Around Four Building Blocks Part II discusses how Uganda’s oil should be used as a tool to promote further economic diversification. The report proposes an action plan organized around four building blocks: (i) Measures aimed at strengthening the benefits that the country expects to receive from its untapped oil and mineral potential by enhancing exploration and negotiating good contracts with investors, while minimizing the negative social and environmental impacts of oil and mining production. (ii) Macroeconomic and financial policy considerations (savings and consumption trade- offs, borrowing and volatility concerns). (iii) Public sector management, including allocative and financial efficiency of public expenditure, and efforts to minimize the possible crowding out of non-resources expenditures and aid. And (iv) Policies to promote private sector development. Chapter 3 discusses the strategic implications of oil and other extractives in the short and medium term. Chapter 4 highlights the strategic implications of extractives in the long term. 47 48 Chapter 3 Strategic Implications of Oil and Key Messages and Conclusions: Mineral Sector Development: Chapter 3 deals with the short- and medium-term objectives of an appropriate strategic response to the development of the oil and mineral sector. S h o r t a n d M e d i u m - Te r m O b j e c t i v e s The first short-and medium-term objective is to support the growth of the oil and mining sector. This can be achieved by financing and implementing the type of geological studies that helped identify oil and mineral Telephone masts in trading centre near Kasemene 1 exploration site resources in the Albertine Graben and other regions. The second objective is to maximize the economic and fiscal benefits to be derived from oil and mining production. This can be achieved by: (i) introducing a fully transparent exploration licensing system that reduces corruption and favors the best proposals; (ii) strengthening the government bargaining position in contract negotiations by hiring independent expertise and developing local skills; (iii) mobilizing the largest possible tax take for the government; and (iv) introducing realistic local content policies – based on international experience – to encourage backward and forward linkages between the oil sector and other industries. The third objective is to minimize the negative environmental impact of the oil and mining industry. This can be achieved by requiring oil companies: (i) to perform environmental impact assessments before the beginning of the exploitation; and (ii) to ensure the full restoration of polluted areas at the end of the production cycle. The fourth objective is to minimize the negative impact of oil and mining on the competitiveness of other I. Supporting the Growth and, Extending the Life of the Oil and Mining Sectors economic activities. To that end, the government should implement prudent fiscal and monetary 3.1. Five key objectives – four short-and medium-term and one very long term – should dominate Uganda’s stra- policies in order to control inflation, avoid a possible tegic response to the challenges of oil and mineral sector development. The four short and medium-term objectives overvaluation of the currency, and fight the Dutch are: (i) supporting the growth of the oil and mining sectors; (ii) maximizing the economic benefits to be derived from Disease. oil production; (iii) minimizing the negative impact of the sector; and (iv) using the oil revenue to reduce poverty and inequality. The very long-term objective is to ensure the sustainability of economic and fiscal benefits for future gen- erations. This chapter deals with the four short- and medium-term objectives. The longer term sustainability objective will be discussed in Chapter 4. 49 Chapter 3 Key Messages and Conclusions: 3.2. Chapter 2 describes the generally positive impact ing. The adoption of downstream and upstream laws in of oil production on economic growth, the external 2012 clarified the legal framework for the development of The fifth objective is to use oil revenue to reduce accounts and government revenue. Supporting the growth the oil sector and paved the way for a new round of explo- poverty and inequality. This can be achieved by and extending the life of the oil and mining sectors is there- ration licenses. However, more efforts are needed to attract improving access to infrastructure and services, notably in the very poor northern region. A few other fore of high priority. There is a lot that the government additional FDI resources, facilitate the exploration and countries have also used direct cash transfers to the can do to achieve that objective. With the assistance of its exploitation of the country’s natural resources and create a poorest population, some unconditional, others linked development partners, it can finance and implement the type business climate favorable to the development of domestic with measures taken by poor households to improve of geological studies that helped identify oil and mineral economic activities linked with, or independent from, the health and education. resources in the Albertine Graben and in other regions of oil and mineral sector. Conclusions: the country. As already mentioned, more than 60 percent of the oil-rich Albertine Region remains unexplored and much II. Maximizing the Economic and Fiscal • Uganda should be able to maximize the economic and fiscal benefits of its oil resources and to more needs to be done to assess and develop the totality of Benefits to be Derived from Oil and Mining minimize the negative environmental impact of Uganda’s mineral potential. Exploitation the industry with a number of relatively simple measures that can be implemented – or at least 3.5. Transparent exploration licensing systems, compe- 3.3. In this context, the government should create and initiated – immediately. tent contract negotiations, appropriate taxation/profit maintain an environment attractive for private inves- • More complex are the policy actions that should sharing arrangements and sound local content policies tors. This is essential not only to promote the country’s eco- be envisaged to stimulate the development of are the most effective instruments to maximize the econom- nomic diversification policy1 but also to support the long- other non-resource activities, first by encouraging ic and fiscal benefits of oil/mining production. forward and backward linkages with the oil term growth of the oil and mining sectors. The exploration industry and second by adopting prudent of oil and minerals requires large investments and state of macroeconomic and fiscal policies aimed at A. Transparent exploration and production the art technology. It is economically risky and most of the controlling inflation and avoiding an overvaluation licensing systems of the local currency. developing countries need the help of foreign investors to access the most appropriate exploration technology. 3.6. A transparent system of license allocations reduc- • Oil revenue-financed public spending (infrastructure, health and education) can play a es corruption, guarantees fair and competitive license 3.4. Despite the relatively high cost of doing business in major role in supporting policies aimed at reducing bidding, and eliminates special treatments. Uganda’s poverty and regional inequality. Unconditional Uganda (which ranks 132nd out of 189 countries in this government has already taken some positive measures in transfers to the poor seem to be less realistic. area),2 the country was able to attract foreign invest- Testing the relative efficiency of various types of this area. Official publications clearly indicate where the oil ment for the development of its oil sector. Private FDI conditional transfers aimed at promoting sound companies have exploration rights. Nevertheless, the cur- flows are among the highest in East Africa3 and keep grow- health and education practices on the part of poor rent system of allocations of licenses is not totally trans- households seems to be worth considering. parent, and oil companies do bribe government officials 1. In terms of business environment, Uganda’s performance is relatively good with respect to getting credit and resolving insolvency, but it is much weaker to acquire oil licenses. The impact is negative if licenses with respect to getting electricity, trading across borders and starting new businesses. are issued to companies that pay more, rather than to the 2. Doing Business 2014, The World Bank. most beneficial activities. In addition, these practices dis- 3. UNCTAD World Investment Report, 2012. courage investors. Uganda should therefore establish a fully transparent licensing system and fight unfair license bid- 50 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 3.1: Status of Licensing C. Mobilizing the largest possible tax take for the government 3.9. A wide variety of contracts govern relations between oil companies and governments. They include conces- sions, in which governments grant the right to produce (Norway), and (ii) other arrangements in which govern- ments keep the title but sign either a production-sharing agreement (Indonesia) or a service agreement (Peru). Inde- pendently of the taxation/profit-sharing regime established, governments want to capture the economic rent from the resource. They achieve this through: (i) royalties levied on gross production revenues, (ii) taxes on profits (after recov- ery of exploration costs), or (iii) sharing the profits with the production company. Production Sharing Agreements (PSA) are the most common arrangement in oil producing Source: Ministry of Energy and Mineral Development, Petroleum Exploration and Production Department (PEPD). countries. Under a PSA, international oil companies invest and extract oil without any financial contribution from the ding. Incidentally, licenses should not transfer ownership of complexity of the process, governments should use inde- government, which later on gets a share of the profit oil. petroleum, as petroleum is property of the state. A license pendent expertise to negotiate on their behalf as, in most should only provide the right to use the land for a specific cases, they have little or no experience in the industry. 3.10. Uganda’s profit-sharing regime is based on Indone- number of years. sia’s PSA model and includes a basic royalty levied from 3.8. The bargaining power of oil companies is reinforced the start on gross revenue per barrel of oil produced. B. Competent contract negotiations by their vast experience in the field. Hiring independent What remains after royalty and cost recovery is called profit expertise would strengthen the negotiating position of the oil and is shared by the government and the company. The 3.7. The drafting of oil contracts has become very chal- government and would help obtain the best possible out- company’s profit oil is then subject to an income tax of 30 lenging as a wide variety of complex issues need to be come. At the same time, the government should invest in percent. In Uganda, as discussed in Chapter 2, the overall taken into consideration. Many oil-producing countries, building institutions that will educate local staff on various government take (in present value terms) is estimated at a notably in Africa, face the principal-agent problem, do not aspects of the oil and gas industry so that the country will relatively high 70 percent. Setting up an effective tax system fully control all the procedures and have to deal with the not always rely on outside experts. The government should is one of the most complex measures in the management of uncertainty of the resource. The task is also complicated also include provisions in oil contracts ensuring socio-eco- the oil industry. Effective taxation systems also entail close by the fact that different types of contracts (concessions, nomic development interests (see sub-section D on local monitoring of tax payments by oil companies. Too often tax production sharing agreements, association contracts) and content policies). departments rely on self-reporting by oil companies and this institutional arrangements may co-exist. Considering the 51 Chapter 3 can have a negative impact on the country’s fiscal position government also plans to invest in tax administration, partic- diate expansion in local content4 (for example, the percent- and development program. ularly in specialized audit and transfer pricing investigation. age of local employment in the sector), but also with actions that will lead to longer-term development, including the pro- 3.11. Once oil investment enters Uganda, the tax system 3.13. The use of oil resources and the selection of appro- vision of training for the local labor force or the promotion should be ready to ensure that the revenue benefits are priate public investment policies are also critical to max- of business development skills for local suppliers. retained (by reducing the risk of leakage through inter- imize economic and social benefits. This issue will be national tax planning and profit shifting). These practices addressed in Chapter 4 in the context of discussions regard- 3.16. It is critical for policy-makers to facilitate the devel- are a threat to revenue mobilization, not only from multi- ing long-term sustainability. opment of competitive, capable, and sustainable local national petroleum companies, pipeline companies or their skills and supply industries, rather than simply drive an international subcontractors, but also from cross-border increased share of local content. Given the relatively low flows across all sectors. Through aggressive transfer pric- D. Encouraging linkages through realistic level of direct employment in the exploration and production ing, thin capitalization, deductible costs against tax liabil- Local Content policies (E&P) of oil and gas, the development of domestic suppli- ities and inter-company payments of interest and dividends ers is one of the possible benefits of petroleum exploitation. 3.14. The government should include in its oil contracts at favorable rates, multinational companies can reduce their Most petroleum codes and contracts require that the holders provisions to ensure that oil companies support the overall liability globally. In developing countries, the profits of petroleum E&P rights give some preference to domestic country’s socio economic development i.e. use local sup- of large international petroleum companies will be at risk goods and services. Policies for local sourcing fall into three pliers, provide training, develop local skills, give priority of cross-border leakage, undermining the country’s revenue broad categories: setting of local content targets, specifying to Ugandan citizens and create enterprise centers. Oil mobilization efforts. a margin of preference for domestic suppliers, and adjust- companies should also organize local participation in deci- ing the process of contract award and execution to benefit 3.12. Consequently, Uganda needs to review its Dou- sion making and ensure that the indigenous communities are local suppliers. The development of local capacity needs to ble Tax Agreements (DTAs), strengthen its capacity adequately compensated to avoid further complications that be addressed alongside these policies. A number of coun- to identify and enforce anti-avoidance provisions and could affect national interests. tries established comprehensive local content development also strengthen its audit capacity. Uganda’s tax laws and programs through the creation of enterprises development 3.15. Local Content Policies (LCPs) are government regulations were improved to provide for treatment and centers and other initiatives. interventions aimed at increasing the share of employ- documentation of transfer pricing and include a general ment or sales that is supplied locally at each stage of anti-avoidance clause, but more can be done to strengthen 3.17. When designing LCPs, it is important to recognize the value chain. To be effective, the design of LCPs must the legal framework and its enforcement. For example, the that policy instruments used to address general market ensure that requirements are commensurate with existing national budget for FY2014/15 proposes to strengthen the failures are different from those used to promote specific and future local supply capability and the life of the petro- thin capitalization rule, which reduces the scope for deduc- sectors. The government could be interested in horizontal leum sector. Incorrectly designed LCPs can encourage ing interest on inter-company loans or for more sophisticat- interventions (support to specific activities: R&D, training, unproductive practices, higher costs, lower quality, restrict- ed mechanisms coming from non-associated entities. The ed competition, and longer timeframe for the completion of use of UN provisions (on the basis of the model tax trea- 4. Local content can refer to jobs or value added anywhere in the domestic econ- tasks. LCPs need to be used with caution and be backed by omy as a result of the action of an oil and gas company, or it can more narrowly ty) for future negotiations may also help Uganda capture a refer to activity created in the specific locality of the oil fields. Local content can solid analysis. LCPs are concerned not only with an imme- also refer to the provision of infrastructure that is intended to benefit the local greater share of the value of activity sourced in Uganda. The population. 52 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Box 3.1: Development of Local Industrial Capacity: Malaysia Oilfield Services and Equipment - A Regional Hub Creation Strategy LCPs in the oil and gas sector are an integral part of Malaysia’s economic transformation plan. In its 2010 Economic Transformation Program, the government of Malaysia laid out a comprehensive package of measures to transform the nation into a regional hub for oil field services and equipment (OFSE) industry.1 The Asian market for OFSE has been growing by 20 percent a year over the last decade and the sector outlook is bright. The regional market for OFSE is fragmented, with players setting up operators in Malaysia, Indonesia, Singapore and Vietnam (unlike Europe and North America, where OFSE operators concen- trate their activities in a few centers: Aberdeen, Stavanger and Houston). This creates an opportunity for Malaysia, which has a competitive domestic workforce, technically challenging domestic reserves that drive a growing local demand for OFSE, and geographical proximity to resource-rich countries in Asia and the Middle East. To capitalize on these advantages, the government set out a strategy of complemen- tary LCPs to incentivize the rationalization of local fabricators and the establishment of joint ventures with OFSE MNCs in critical value-adding activities. The objective is for Malaysia to become a regional hub in 2017. Some of the entry point projects (EPPs) identified by Malaysian government include: - Attracting MNCs to bring a sizeable share of their global operations to Malaysia. Malaysia’s objective is to attract 10 to 20 major international companies which would bring approximately 10 percent of their business to the country, thus creating over 20,000 jobs. A government body called Oil Field Services Unit was set up to oversee that development. - Consolidating domestic fabricators. Domestic fabricators in Malaysia lack scale and are not cost-competitive, compared to major regional players. For example, domestic companies often hire large cranes because the limited size of the market precludes purchasing them. Therefore, consolidation of major offshore structure fabricators in Malaysia would create around 5,000 jobs and would require PETRONAS to award licenses to a few domestic fabricators. - Developing capabilities and capacity through strategic partnerships and joint ventures. At present there are considerable gaps in the domestic OFSE industry. Malaysian companies lack capabilities and experi- ence particularly in engineering and installation, which limits their ability to gain a strong share in the regional market. The objective is to incentivize domestic companies to form joint ventures with world class companies to build their capabilities and track records. Malaysia’s ambition is to gain 15 percent of the shallow water and 50 percent of the deep water market in Asia by 2020 and create some 15,000 jobs. Since the policy goal envisaged for the petroleum sector is to transform Malaysia into a regional hub for OFSE, the measure of local content levels in the OFSE sector would fall short of the government’s objective. Instead, the following three performance indicators are monitored: (1) the amount of investment made by OFSE multinationals; (2) the number of successful mergers of fabricators; and (3) the number of JVs between multinationals and local OFSE companies. Previous policies focused on maximizing local content levels and not on value addition, competitive advantage and sustainable growth2. Therefore a combination of measures building the capacity of local suppliers and attracting FDI is a recipe for success. Since inception of the program, consolidation of domestic fabricators established three sizeable Malaysian EPC entities out of eight small and medium-sized fabricators. Malaysia will now focus on helping these companies take on the global stage. Aberdeen Drilling School set up a learning center in Malaysia to provide customized training in drilling practices and technology, cost reduction/unscheduled events prevention, safety, communication and leadership. Aberdeen’s long-term plan is to use Malaysia as a base for its regional expansion. Several local companies linked JVs with foreign specialists, giving them access to technology and gaining experience that better position them for future jobs and new markets. To attract more foreign MNCs, plans are underway to present Malaysian OFSE companies at international con- ferences such as Offshore Europe and the World Gas Conference.3 1. The OFSE sector includes land drilling services, offshore drilling services, geophysical services, operations and maintenance and other services. Some of the players include Schlumberger, Abbot Group, and Baker Hughes. 2. Tordo S., Warner M., Manzano O., Anouti Y. Local Content Policies in the Oil and Gas Sector. The World Bank. 2013. 3. Economic Transformation Program. Annual Report. 2013. 53 Chapter 3 basic infrastructure, business climate) or in vertical inter- ventions (support of sectors). Because sectoral interven- Box 3.2: Financing of Oil Projects in Brazil tions involve the selection of sectors, they are more prone to capture by lobbies. Horizontal interventions are usually To support the development of local industry, the Brazilian1 government through the Brazil National Bank for Social and Economic less subject to political pressures and are generally preferred Development (BNDES) and Petrobras offers several funding sources. “Brazil Major Plan” was launched in 2011 by the government by economists. However, it is important to note that the oil with approximately US$ 70 billion in credit for investment. BNDES provides a number of funding options. and gas sector demands inputs from specific sectors, and as such, LCPs are unlikely to be sector neutral. • BNDES O&G Structuring. A credit line, originated in the “Brazil Major Plan” aims to create and expand the productive capac- ity of suppliers of goods and services related to oil and gas, to support mergers and acquisitions of companies, upgrading of 3.18. The strategic shift in capacity of oil companies businesses, technological investments etc. leading to massive outsourcing to service providers and • BNDES – Investment Support Program. A credit line is aimed to stimulate production, acquisition and export of capital contractors provides an opportunity for local suppliers. goods and technological innovations. While the oil companies used to have capacity and carried • BNDES FINEM. A credit line supports projects for the development and production of oil fields and installation, expansion out most of the steps in the value chain, today their core and modernization of refineries. competence is often restricted to the exploration process • BNDES Proengenharia. This line supports engineering projects in a number of sectors, such as defense, automotive, oil & combined with the ability to manage risk and raise financ- gas, chemical, petrochemical. ing. Consequently, the oil companies have numerous sup- • FINAME Program. Supports financing of parts and components, including electronic, locally manufactured, provided by pliers frequently organized as a hierarchy of subcontractors, manufacturers registered with the BNDES, for incorporation in machinery and equipment at the production stage. or a supply chain. This development has a large impact on • Progressive Nationalization Plan (PNP). Funding is provided to manufacturers of products with reduced local content. national content issues and influences the approach that Products can be submitted to the PNP if they present a minimum local content percentage (40 percent) with commitment should focus on suppliers at the bottom of the supply chain. to reach 60 percent within 3 years. Since governments interact with them indirectly through the Another important initiative, Progredir Financing Program, allows companies within the Petrobras supply chain and its subsidiaries IOCs, it is important to ensure that IOCs take responsibility to obtain loans from accredited banks using supply contracts signed with Petrobras as guarantees. The program was created in for national content efforts throughout their supply chains. partnership with the six largest retail banks in Brazil (Banco do Brazil, Bradesco, Caixa Ecônomica Federal, Itaú, HSBC, and Santand- er) and with the National Oil and Natural Gas Industry Mobilization Program (Prominp). The program was officially launched in 3.19. LCPs can help develop industrial clusters and 2011 after completing a pilot phase/ It primarily targets SMEs. In the first 18 months of operation, loans worth $1.9 billion were regional trade synergies. Collaboration among IOCs, inte- extended to 404 businesses. In order to improve financial and risk conditions, Petrobras is the anchor of Progredir and transfers its grated service providers, national oil companies and local better credit perception in the market to participants. Requests for funding are submitted through the Progredir Gateway to all of the participating banks, implying an increase in competition between the banks. Progredir Portal stores information on supply suppliers are critical for the sustainable development of a contracts, financing and individual performance data on each supplier, allowing the banks access to supplier track record data. local industrial capacity. Geographical and sector clusters Implementation of this innovative program had the effect of reducing the financial costs for the suppliers by 20-50percent have been used by some governments as a means to accel- erate the development of local enterprises and to strength- 1. The Brazilian Oil and Gas Industry. PricewaterhouseCoopers Brazil Ltd. 2013 en the national system of innovation. Some countries even supported trade synergies through regional hubs with the 54 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility There is need for local Box 3.3: Localization in Brazil enterpreneurs to develop capacity to provide outsourcing services to the international oil companies Following the completion of a competitiveness diagnos- tic study in 2003, an action plan was prepared to address competitiveness and capacity gaps. Strategies were designed taking into consideration the relevance of each subsector of the oil and gas industry, the level of local production capacity and the competitiveness of the subsector. For example: (1) where local supply capacity existed but was inadequate—such as in marine vessel fabrication, engineer- ing services—strategies were designed to incentivize foreign contractors to partner with Brazilian firms; and (2) where local capacity did not exist or could not be developed – as in the manufacturing of centrifugal compressors and diesel engines – international firms were encouraged to establish subsidiaries in Brazil, bundle together work packages and use repeatable designs to increase returns and reduce commer- objective of providing the economies of scale necessary medium-sized contractors working for BP and its affiliates. cial risks to investment in Brazil. to sustain local comparative advantages. The example of In Brazil, a robust program has been designed to provide Malaysia in Box 3.1 shows how the country has become a access to finance for oil and gas suppliers (see Box 3.2). In Uganda, a similar approach could be used. For goods and regional hub for oil field services and equipment. services not available in Uganda, MNCs would be encour- 3.21. Uganda’s petroleum legislation encourages local aged to set up subsidiaries, without a requirement to form joint ventures. For subsectors which already exist in Uganda, 3.20. Provision of financing is one of the key elements content and has a number of positive features.5 For establishing joint ventures would be more feasible and the of the supplier development programs. No matter how example, the requirement to give preference to local con- government should facilitate the development of relation- good the skills of the suppliers are, they will not be able tractors is set not only for IOCs themselves but also for the ships between local suppliers and foreign firms. Nevertheless, to win contracts with the IOCs unless they have access to whole supply chain, that is, contractors and subcontractors. we would not argue for a specific percentage of ownership, working and investment capital. A lot of countries designed The Act provides for preference for goods produced in as the interest of a foreign company to form a joint venture specialized programs to provide financing for oil and gas Uganda, and does not restrict the provision to indigenous would depend on unique circumstances. suppliers, especially SMEs. In Angola, for example, Zimbo firms, thus opening opportunities for FDIs. Finally, IOCs Fund was established by Total and the Angolan Bank Ban- co Totta to provide partial credit risk guarantees to SMEs. 5. Articles 125-127 of the Petroleum Exploration, Development and Protection In Azerbaijan, a supplier credit facility of US$15 million Act (Upstream Act) set requirements for the provision of goods and services by Ugandan entrepreneurs, training and employment of Ugandans and technology was funded by the IFC. British Petroleum (BP) and Micro transfers. Articles 53-55 of the Petroleum Refining, Conversion, Transmission and Finance Bank of Azerbaijan provide financing for small and Midstream Storage Act (Mid-Stream Act) include similar provisions, with only minor differences. 55 Chapter 3 are required to notify suppliers of upcoming contracts, to 3.23. The government’s national content policy for oil to incorporation of local subsidiaries, it does not necessarily report on achievements in utilizing Ugandan goods and ser- and gas favors nationalization, rather than localization. preclude the award of contracts on an uncompetitive basis vices during the calendar year, and to propose a detailed pro- Even Brazil and Malaysia that have relatively sophisticated if, for example, goods and services on the restricted list are gram for recruitment and training of Ugandans. economies appreciate the effects of localization on the trans- available in-the country at prices and quality that are com- fer of skills and technology that eventually leads to a strong petitive with international suppliers. Nevertheless, margins 3.22. Nevertheless, the Upstream Act suffers from some national system of innovation. Box 3.3 illustrates some of of preference entail distortions and inefficiency, which need weaknesses, particularly in the definition of preference Brazil’s best practices in this area. to be carefully analyzed and weighed against alternative for local services and ownership rules. First, the require- approaches. ment to “give preference” to local firms is very broad. It 3.24. The present legislation does not define which local is easy to avoid and difficult to enforce. Second, while sourcing model should be implemented. In the absence 3.26. Finally, the government may wish to implement the Act requires IOCs and their EPCs to inform suppliers of specific definitions, IOCs develop their own rules. local sourcing policies through contract awards and con- of upcoming contracts as early as practicable, there is no According to local suppliers, IOCs and their contractors add tract execution. To facilitate local sourcing, some countries specific timeline, and IOCs can provide this information 10 points for local content in their bid evaluations, regard- reduced pre-qualification criteria for vendors, created spe- too late for suppliers to be able to act on it. Third, the Act less of the percentage of ownership or the type of indus- cific tender evaluation criteria/weightings, and vetoed con- does not provide the definition of an indigenous company try. The Petroleum Exploration and Production Department tract awards on the basis of insufficient local content and/ for the calculation of national content. When reporting on (PEPD) is in the process of developing regulations for or inadequate local content plans. Introducing flexibility in national content, IOCs use their own definition, which may national content, and specific targets may be defined. If the prequalification criteria is important. Some criteria can be be biased. Fourth, the Upstream Act requirement on share targets are consistent with local capacity, they can be benefi- relaxed without sacrificing quality and safety and this would capital of joint ventures with Ugandan companies may be cial as local suppliers will be capable of supplying the goods open the door for a number of strong local suppliers. The too restrictive. The Act stipulates that when the goods and and services in adequate quality and quantity. Nevertheless, challenge is to strike the right balance between quality and services required by the contactor or licensee are not avail- an analysis will be needed to determine realistic targets. flexibility. Supplier databases detailing local capabilities able in Uganda, they shall be provided by a company hav- would be useful to check the availability of local suppli- ing formed a joint venture with a Ugandan company, whose 3.25. The government should draw lessons from the expe- ers and decide whether pre-qualification criteria should be share is at least forty eight percent of the joint venture. This rience of many local sourcing policies involving margins reduced. The vetoing of contract awards is a controversial may prevent the creation of joint ventures, if local com- of preference and local content targets. Brazil and Ghana policy, as it will be hard to determine that the veto was exer- panies do not have enough capital. It may also encourage defined specific targets for a certain volume of goods in a cised with due regard to the principle of internationally com- questionable practices (for example, shell companies) rather particular industry to be sourced from local suppliers, but petitive bidding. than address the goals of national economic development. so far no conclusive results are available to determine if Ownership of a company is less important than the content these targets benefited the economy or led to unproductive 3.27. Opportunities for Ugandan entrepreneurs to get provided. A multinational company which does not have any practices. Angola and Ghana used 10 percent as the margin involved in the petroleum sector will be available for a local shareholding may still provide technology transfer, of preference for domestic suppliers. A more stringent form very short time, but local constraints may prevent local employment and sourcing of local goods/services to carry of domestic preference places restrictions on operators and entrepreneurs from seizing these opportunities. CNOOC out production. More flexibility needs to be given to attract only national firms are eligible to tender for certain cate- was awarded a production license last year and the award of such firms. gories of goods and services. While this policy may affect licenses to Total and Tullow is underway. Consequently, the the decisions and strategies of the companies with respect construction phase during which most of the contracts will 56 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility be tendered is approaching. If local suppliers are unable to offer competitive terms, large and small contracts will go to foreigners. Most of the local firms operate in low value-add- ed, labor intensive areas,6 and find it difficult to compete on international markets. Total factor productivity in the manu- facturing sector is lower in Uganda than in most of the oth- er SSA countries. It is also lower than in African and East Asian countries that were able to enter the export-oriented manufacturing market. The country is also lagging behind SSA averages in agricultural productivity. Finally, as shown in the Global Competitive Index 2013-14 Report and in the World Bank’s Doing Business reports, the business envi- ronment in Uganda is not sufficiently conducive to private sector development. 3.28. Uganda’s national content initiatives already address some of the constraints faced by suppliers of the oil and gas industry, but additional support is required. Strategic studies and policies and the organization of round- table dinners for national content stakeholdersidentified innovative proposals for leveraging oil and gas education services and guiding roles and responsibilities for future government collaboration with the private sector. In addi- tion, Joint Venture Partners (JVPs) started a number of national content initiatives recommended by the IBS. More can be done in these areas. For example, JVPs need to com- municate projected demand in a timely manner. Access of oil and gas suppliers to short- and long-term capital needs to be improved to enable local enterprises to participate in this activity. Funding support instruments used in other coun- Men working on a rig tries include credit lines channeled through banks, partial at an Oil Exploration site in Western Uganda 6. An Assessment of the Investment Climate in Uganda). The World Bank. 2009. According to national accounts data, agricultural output expansion over the past two decades has come from the rapid increase in the agricultural labor force and area expansion, rather than productivity growth. Enhancing National Par- ticipation in the Oil and Gas Industry in Uganda, Ministry of Energy and Mineral Development, 2011. 57 Chapter 3 Table 3.1: Mapping of Constraints and Ongoing Initiatives in the Oil and Gas Sector # Constraints Ongoing Initiatives Additional Support Required 1 Information asymmetries – JVPs initiative to communicate demand PEPD to ensure that information is communicated to suppliers in due course lack of visibility in projected Efforts of the government, JVPs and international donors to establish Ensure that the industry enhancement center is established and becomes demand and current an industry enhancement center operational opportunities for local Particular attention to making sure that suppliers at the very bottom of the suppliers, especially Small and supply chain (e.g., SMEs) are aware of opportunities and are able to partici- Medium Enterprises (SMEs) pate in the oil and gas industry 2 Access to investment and Discussions regarding the establishment of a partial credit risk guar- A detailed diagnostic of access to financing challenges of oil and gas working capital for oil and gas antee fund, role of Uganda Development Bank suppliers. Appropriate interventions designed, and support provided to the suppliers Efforts of the government, JVPs and international donors to establish suppliers an industry enhancement center to help suppliers prepare business Explore opportunities to assist local suppliers in forming joint ventures with plans and apply for financing. foreign companies 3 Quality mismatch - High quality Establishment of Technical Committee 16 (TC16) to document re- TC16 capacity to be strengthened to ensure that the process is completed in standards of the oil and gas quired standards of each company to aid suppliers to comply the near term industry and lack of consistency Efforts of the government, JVPs and international donors to establish Matching grants needed for enterprises in priority sectors for national con- among standards of the JVPs an industry enhancement center tent development and to acquire certifications operating in Uganda 4 Challenging business Support provided through the Competitiveness and Enterprise More support is needed to improve aspects of business environment to environment Development Project (CEDP) business environment and land adminis- alleviate constraints for local and foreign investors tration reform 1 5 Poor infrastructure Support from Albertine Region Sustainable Development Project to More support to remove bottlenecks throughout the country. upgrade roads in the oil development area2 Build essential infrastructure in the Albertine Region 6 Low skill and capacity - Lack Efforts of the government, JVPs and international donors to establish The government needs to prioritize sectors for national content develop- of skilled oil and gas workers an industry enhancement center ment and provide support leveraging the efforts of the IOCs. Enterprises in and low capacity of oil and gas Skills Development Project key sectors need to be supported through addressing their unique needs suppliers Capacity Needs Analysis for the Oil and Gas Sector in Uganda in infrastructure, access to finance, acquisition of required certifications and Establishment of UPIK and implementation of its Institutional De- other issues. velopment Plan under Albertine Region Sustainable Development Efforts to attract international companies to set up operations in Ugan- Project da and form joint ventures with local companies to facilitate technology Initiatives of the JVPs to support specific sectors transfer Establishment of the supplier database and talent register 7 Unfair award of contracts – PEPD carries out audits of awarded contracts to identify possible Increase capacity of PEPD to monitor contract awards (in terms of number particularly for local suppliers irregularities of staff and robustness of the process) Monitoring to be performed at different stages of the procurement process to ensure that appropriate procedures are followed and appropriate remedi- al actions are taken in a timely manner 8 Large contracts are a barrier to Regulations need to ensure full, fair, and reasonable access to procurement small suppliers – large contracts opportunities for domestic suppliers prevent small local suppliers Efforts need to be made to unbundle large contracts to enable more suppliers to from bidding even when they compete are technically qualified Source: World Bank Staff. 58 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility credit guarantees, and joint ventures. It is also essential to and implement regulations in this area through the work of rent-seeking behavior. identify the capacity-building needs of aspiring suppliers the National Environment Management Authority (NEMA), to ensure that they know how to prepare the documents and NEMA encourages oil companies to conduct EIAs 3.33. Prudent macroeconomic policies are essential to required by financial institutions. Table 3.1 below provides before starting oil exploration. fight the effects of the Dutch Disease and achieve the a map of identified constraints limiting ongoing activities. country’s economic diversification objectives. Fighting B. Impact of oil and mineral resources on other the tendency to an overvaluation of the currency can be III. Minimizing the Negative Impact of Oil and economic sectors and foreign aid challenging since a rise in the value of the shilling would Mineral Resources reduce inflation in the short term. It is therefore essential to 3.31. At peak, oil production will generate annual rev- keep inflation under control through other means (includ- 3.29. The development of oil production can have a neg- enue of about US$5 billion of which 60 percent will ing fiscal and monetary policies) without resorting to a real ative impact on the country’s environment and on the accrue to the government. This will be a major source of appreciation of the shilling. Continuing with an inflation long-term growth of non-resource sectors. These two fiscal space that will enable the government to address bot- targeting monetary policy would be appropriate. Inciden- critical issues need to be addressed vigorously in the gov- tlenecks to long term growth and development. However, tally, since 1986, the Ugandan shilling depreciated by 18 ernment strategy. the creation of additional fiscal space by oil revenue does percent/year, against 6 percent in Kenya and 14 percent in not necessarily mean that public spending should increase Tanzania. A. Impact of oil and mineral resources on the at the same pace. Should the government raise expendi- environment tures as soon as possible by frontloading public investment? 3.34. Fiscal and monetary policies ought to be Should the increase in public expenditures be more gradu- countercyclical. Budget constraints are often mentioned 3.30. If not properly monitored and managed, the oil al? Should one take into account the volatile nature of oil among the main factors underlying pro-cyclical fiscal and gas industry can create significant damage for the resources which makes the macro and fiscal management of policies. Franklin (2011) argues that an inflation targeting environment. The Lake Albert region is the richest region in oil revenue particularly challenging? Raising expenditures monetary policy based on export commodity (Product Price vertebrate species-and one of the most bio-diverse areas of too quickly may create supply-side bottlenecks and increase Targeting) could render countercyclical fiscal policies more the African continent. Measures should be taken to mitigate public sector inefficiencies. Sound planning instruments effective. He proposes that countries adopt fiscal policies the environmental risks associated with the exploration and and expenditure stabilization mechanisms are needed to based on the Chilean example. Chile was able to avoid over- extraction of natural resources. The licensing system should ensure that increased government spending does not impact spending in boom years while allowing deviations from a provide for an Environmental Impact Assessment to eval- negatively macro-stability and delivers value for money. target surplus in response to permanent commodity price uate the effects of future oil activities on the environment. changes. The Ugandan government indicated that following Restoration of polluted areas by the oil companies should be 3.32. In some countries the exploitation of natural an interim period during which public investment would mandatory. The government should integrate the best inter- resources led to a spending spree that generated short- increase sharply to rehabilitate and improve the country’s national practices, including the Equator Principles, which term benefits through growth of private consumption, infrastructure, it would use the interest on assets saved in a provide a risk management framework to assess and man- but proved to be detrimental in the long term as sav- petroleum fund to finance additional public investment and age environmental and social risks in projects and include ings were sacrificed. In addition price volatility can lead other high priority public expenditures. a minimum due diligence standard to support responsible to cycles of boom and bust that are very damaging. Uganda risk decision making. Any company that does not respect needs to establish an effective fiscal management system 3.35. Recent research argues that the growing number of the standards should be fined and the fines should be high including clear spending and savings rules and guidance hydrocarbon discoveries in low-income countries could enough to act as a deterrent. Uganda has been trying to issue on how to shield the economy from revenue volatility and reduce the need for foreign aid (Arezki and Banerjee, 59 Chapter 3 Figure 3.2: Horizontal Distribution of Poverty by Gini Coefficient rise.7 The share of the population living below the pover- ty line in northern Uganda currently stands at 44 percent compare to a national average of 19.7 percent (Chapter 1). Although northern Uganda is the poorest region in the coun- try, it also exhibits one of the highest Gini coefficients even above the national average (Figure 3.2). 3.37. Isolation and the lack of access to services often contribute to poverty. Several studies have shown that the lack of access to healthcare and education contributes to the transmission of poverty from one gen- eration to the next (Deininger, 2001; Deininger and Oki- di, 2003). Other studies have shown that the lack of safe Source: World Bank Staff Calculations using Uganda National Household Surveys. water and sanitation affects chances of survival for children 2014). However, empirical evidence shows that there is no Sovereign Wealth Funds and facilities from International as well as nutrition and morbidity more generally (CPRC, significant statistical relationship between oil discoveries Monetary Fund), the International Development Association 2004). To measure the extent to which different commu- and the level of foreign aid. Many analysts argue that while (IDA) could be structured to provide a larger degree of nities in Uganda have access to services, an index was the often sizable stream of new income from the exploitation insurance against major declines in resource prices. constructed using data from the Uganda National House- of natural resources will relax budget constraints in hold Survey which measures whether households have developing countries, donors have many strategic reasons access to public services such as health centers, schools, to continue providing aid (Alesina and Dollar 2000). These IV. Using Oil Revenue to Reduce Poverty and roads, or electricity. As illustrated in Figure 3.4 there is a include: (i) ensuring access to oil and energy produced by Inequality strong correlation between access to services and house- the recipient nation (to address the energy needs of the donor hold expenditure, as well as between access to services 3.36. Uganda made great strides in reducing rates of and poverty (Figure 3.5). Moreover, the distribution of ser- countries); and (ii) facilitating access for major Western oil poverty, which more than halved from over 50 percent vices changed little over time across Uganda’s geography companies to oil extraction contracts. In addition, foreign to below 20 percent over the last two decades. Yet a and continues to be highest in the central region and lowest aid is critical to address the governance and other economic majority of those that have managed to grow out of poverty in the Northern and North-Western regions (Figure 3.3). management challenges often experienced by resource - are still highly vulnerable to sudden economic shocks, such rich countries. Given its weak governance practices and as the death of a family member, a drought, or the loss of institutions, Uganda’s oil riches is not likely to substantially a job. In addition, there are still vast differences between decrease its access to foreign aid. Dobronogov et al. (2014) 7. The national Gini coefficient rose from 0.36 in 1992 to 0.40 in 2002 and to 0.40 regions (horizontal inequality) and the disparity in living in 2013. We also checked for the evidence of gender inequality on poverty sta- discusses how donors should respond to potential windfalls standards between urban and rural dwellers is also on the tistics but found the poverty rate among female population decreased from 56.2 in their client countries. It argues that while complementing percent in 1992 to 21.6 percent in 2013 compared to a decline from 56.5 percent to 19.1percent for households with a male head. The test of statistical differences other available self-insurance mechanisms (for example, was not significant for 1992, 2002, 2009 and 2013.. 60 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 3.3: Access to Services Index by Sub-Region Source: World Bank Staff Calculations using Uganda National Household Surveys. Figure 3.4: Consumption and Access to Services Index by Sub-Regions Figure 3.5: Headcount Poverty and Access to Services Index Using some of the oil proceeds as conditional cash transfers could improve asset accumulation of the poor. Source: World Bank Staff Calculations using Uganda National Household Surveys. Source: World Bank Staff Calculations using Uganda National Household Surveys. 61 Chapter 3 Table 3.2: Addressing Horizontal Inequality and Poverty through Cash Transfers Policies, 2012/13 Unconditional cash transfer to aged going kids (6 to 15 ) (monthly transfer)   Poverty Poverty Gap Gini Baseline 25,000 50,000 Baseline 25,000 50,000 Baseline 25,000 50,000 North East 74.5 67.8 64.3 32.3 26.2 20.8 0.4279 0.3981 0.3744 West Nile 42.0 33.7 25.9 11.7 8.2 5.6 0.3369 0.3199 0.3065 Mid-North 35.6 31.1 24.5 10.2 7.3 5.1 0.3636 0.3477 0.3345 Others 13.0 13.0 13.0 2.8 2.8 2.8 0.3888 0.3888 0.3888 Uganda 19.5 18.2 16.9 5.2 4.4 3.8 0.4003 0.3944 0.3893 Budget (in billion UGX)   36.0 72.0   36.0 72.0   36.0 72.0 Conditional cash transfer to aged going kids (6 to 15 ) (monthly transfer)   Poverty Poverty Gap Gini Baseline 25,000 37,500 Baseline 25,000 37,500 Baseline 25,000 37,500 North East 74.5 62.4 53.9 32.3 18.3 12.7 0.4279 0.3553 0.3326 West Nile 42.0 28.1 19.6 11.7 5.7 3.9 0.3369 0.2992 0.2857 Mid-North 35.6 23.2 16.0 10.2 4.5 2.8 0.3636 0.3242 0.3088 Others 13.0 13.0 13.0 2.8 2.8 2.8 0.3888 0.3888 0.3888 Uganda 19.5 16.8 15.1 5.2 3.7 3.2 0.4003 0.3884 0.3834 Budget (in billion UGX)   62.0 93.0   62.0 93.0   62.0 93.0 Source: Authors’ tabulation from UNHS (2012/13). 3.38. There have been repeated calls on governments to ments financed by oil earnings will also benefit the poor. tries.8 Excluding the contributions to the Public Service Pen- distribute oil earnings directly to households in the form Below, are the results of a simulation using a partial equilib- sions Fund, Uganda spends around 0.4 percent of GDP on of lump-sum transfers based on the Alaska distribution rium framework about the impact on poverty and inequality social protection schemes compared to 2–3 percent in other model. The proponents of such argument are motivated by of a cash transfer distributive policy. developing countries. Increasing spending on social protec- the lack of trust in political leaders for the management of tion would enable the poor to better participate in the growth oil earnings on behalf of the population. In the case of Ugan- 3.39. The increase in fiscal space due to the coming on da, the horizontal and vertical inequality is so serious that a stream of oil would enable the government to increase 8. We have also simulated the case of a conditional cash transfer on primary school attendance, which revealed similar but improved patterns of poverty mix of policies may seem appropriate. However, the gov- social protection programs in Uganda. Uganda spends less reduction and decline inequality. However, the budgetary implications are larger ernment is right when it argues that infrastructure improve- on social protection than most of the other developing coun- since the cash transfer is commensurate to the number of children (6-15) going to school. 62 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility process as Uganda transforms itself into a middle-income country. It would also reduce vulnerability. Experience in other countries over the past decade shows that large- scale social protection programs, if well-designed, can have a tremendous impact on the conditions of the poorest, at affordable fiscal cost. For instance, the Brazil and Mexico programs targeting low income dwellers are conditioned on actions of households in support of their children’s welfare. Simulating the impact of providing monthly cash transfers of about UGX 25000 targeted towards households in the North East, the West Nile, and the Mid-North regions would contribute to a significant reduction in poverty rates from 74.5 percent to 67.8 percent in the North, from 42 percent to 33.7 percent in the West Nile, and from 35.6 percent to 31.1 percent in the Mid-North. These regions would also experi- ence a reduction in inequality (Table 3.2). We estimated the fiscal implications of such interventions, which are not sup- posed to affect the proposed fiscal rules or the debt situation of the country. Earnings from oil could drastically improve Uganda’s quality of life rating if good resource redistribution policies are put in place and implemented efficiently 63 Chapter 4 Strategic Implications of Oil and Key Messages/Conclusions: Mineral Sector Development: Chapter 4 discusses the long term objective of ensuring the sustainability of benefits for future generations. The goal is to offset the gradual L o n g - Te r m O b j e c t i v e a n d S u s t a i n a b i l i t y depletion of non-renewable resources, by investing into other forms of capital capable of generating a sustainable stream of income. A wealth analysis is the appropriate instrument to assess progress towards sustainability. It measures produced capital (equipment, urban land), natural capital (agricultural land, forests, and minerals) and intangible capital (human and social). Some resource-rich countries were able to invest rents from non-renewable resources in physical/human capital and foreign assets. Botswana which adopted a Sustainable Budget Index limiting public spending to less than recurrent non-mineral revenue (excluding investment, education and health expenditures), was able to expand its physical and human capital and increase its wealth, but a wealth analysis would show that that the net savings of fast growing Nigeria and Angola during the last decade were in fact negative if the depletion of natural resources is taken into account. The case of Uganda. So far, GDP growth was driven by investment in produced capital. The development of the oil industry will change the situation. Oil Newly constructed road to the Mputa exploration site revenue should be used to build up long-term capital. Accelerating public investment, however, is not necessarily the most appropriate response. In Angola, a sharp increase in public investment created inefficiencies due to absorptive capacity I. Measuring the Growth of Long-term Capital – A Wealth Analysis constraints. Uganda should increase investment levels gradually and some of its oil revenue should 4.1. The discovery of oil and gas improved the prospect for accelerated economic transformation of the country. be saved and invested abroad. However, the exploitation of oil and gas will not automatically make Uganda’s people richer, if the new resources are The report discusses the merits of alternative not invested in other forms of wealth that will generate a sustainable stream of income in the medium and long-term. saving and investing approaches. The Sustainable- Natural resources are a finite source of revenue which cannot sustain high levels of income for a very long period of time. Investing approach combines savings and In resource-rich countries the ultimate policy goal must be to find ways of transforming the temporary increase in revenue 65 Chapter 4 into a long-lasting source of income.1 Uganda should invest for example, used the rents from non-renewable mineral Key Messages and Conclusions: strategically its oil revenues to ensure that they will not only resources (mainly diamonds) to invest in other forms of benefit the present generation but will also lift the country to capital (including physical, human, and foreign assets) by investment. Investment is needed to foster structural a new type of development for many generations to come. adopting a Sustainable Budget Index (SBI) rule. The SBI, economic transformation and build long-term capital, which is the ratio of public spending (excluding investment, but the increase is gradual to mitigate absorptive 4.2. Three different types of wealth can be distinguished: education and health) to recurrent non-mineral revenue, capacity constraints. Accelerating investment may become more feasible if public investment produced capital, natural capital and intangible capital must be less than unity. Under the SBI rule, Botswana was management improves and policies stimulate a (which includes human capital). Produced capital covers able to greatly expand its total stock of produced capital strong response of the private sector. machinery, structures, equipment and urban land. Natural (buildings, roads, machinery) and intangible capital (knowl- The quality of investment is critical. Sound project capital includes agricultural land, protected areas, forests, edge and human capital). selection and efficient implementation are essential minerals and energy. Intangible capital measures human, to maximize the benefits of increased investment social and institutional capital. While produced capital and 4.4. In many other resource economies the depletion spending. So far, Uganda gave priority to natural capital can be observed, intangible capital is derived of natural capital did not lead to an increase in other infrastructure (mainly roads). Economic simulations suggest that, initially, using oil revenue to address as the residual of the net present value of consumption forms of capital, thus triggering a decline in overall lev- urgent infrastructure needs, notably in transport and according to the equation described in Box 4.1. Using this els of wealth. To measure to which extent countries save energy, may have a stronger impact on growth than wealth accounting framework, it is possible to determine and invest in a sustainable manner, the wealth accounting education and health spending. However, the social sectors influence the distributional impact of growth. whether countries are transforming their natural resources framework uses the concept of adjusted net savings (ANS), In addition, building up human capital is essential into other forms of wealth which will allow them to continue which takes into account investments in different forms to support the country’s economic diversification to grow in the future. Compared to the GDP which mea- of capital and their depreciation. Apart from the deprecia- agenda. Manufacturing and modern services depend sures the flow of income accruing to a country within a year, tion of (produced) physical capital, the calculation of the on the availability of a well-educated labor force. wealth accounting measures the stock of assets a country ANS also considers the effects of educational expenditures, Conclusions: uses to generate its income.2 depletion of natural resources and damage to the environ- • Clear fiscal rules are essential. Uganda plans ment due to pollution. Educational expenditures are seen as to use the NONG fiscal deficit rule, with total 4.3. In many parts of the world, natural resources great- investments in intangible capital and depletion of natural spending limited to the sum of domestic non-oil ly contribute to faster accumulation of wealth and make resources as a negative investment in the natural capital of revenue and the agreed deficit target. This is people permanently richer. This is what happens when a country.3 While Sub-Saharan Africa grew robustly at an a sensible approach if the target is fixed at a governments and citizens invest the rents from diminish- average annual rate of 5 percent since the turn of the century, prudent level. ing natural resources in other forms of wealth. Botswana, many resource rich countries have negative ANS rates. For • A fixed share of oil revenue should be deposited instance, the average GDP growth rate of Botswana, Nigeria into savings accounts. In 2015, Uganda decided 1. This argument was first put forward by Hartwick in the 1970s. He argued that that all oil revenues should be deposited into a in resource economies, the declining stock of non-renewable resources had to and Angola was more than 4 percent over the last decade holding account used to finance the budget or a be offset by an increasing stock of other forms of capital to ensure that a society (due to rising natural resource commodity prices), and, as would be able to maintain its standard of living indefinitely. special savings fund. The act does not specify the share of oil revenue to be saved. 2. Another relevant measure of income flows is the Gross National Income (GNI). GNI is the sum of value added by all resident producers plus net receipts 3. Adjusted net saving approximates the changes in wealth over shorter periods. of primary income from abroad. It is often very similar to GDP, but in Uganda’s ANS is estimated using the formula: ANS = GS = DFC + EDU – DNR – PD, where case large transfers from abroad (in the form of grants) mean that there may be ANS is Adjusted National Savings, GS is Gross Savings, EDU is Education Expendi- significant differences between GDP and GNI. ture, DNR depletion of Natural Resources and PD is Pollution Damages 66 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 4.1: Average Adjusted Savings for Botswana, Nigeria and Angola (1995-2012, Percent of GNI) Box 4.1: Wealth Estimates - A Brief Note on Methodology The idea of wealth can be conceptualized in the same way as GDP. However, some components are not observable and must be deducted. Total wealth is the present value of future consumption, and the sum of all the wealth components must equal this value. A basic decomposition of wealth may look like this: Total Wealth = K+V+NFA+IC, Where: K is produced capital, including machinery, equipment, Source: World Bank World Development Indicators. structures and urban land; V measures natural capital (energy resources, minerals, timber, forest, crop land, pasture land and shown in Figure 4.1, the three countries exhibited positive oil) amounted to US$7,190. This is below most of its peers protected areas); NFA stands for net foreign assets and IC for gross and net saving rates. However, the saving rates of in East Africa, and well below the largest economies in intangible capital. The latter can be estimated as a combina- tion of human capital and rule of law. In practice it is calculated Angola and Nigeria are negative once the depletion of nat- Sub-Saharan Africa. In addition, the share of intangible and as the residual of the above equation when total wealth is ural resources is taken into account. In other words, growth produced capital in total capital is considerably lower than estimated as the present value of future consumption, was robust in the Sub-Saharan Africa region, but it was not in other more advanced economies. While this reflects the ∞ ∫ C (t ) ∗ e − ρ ( s −t ) s d equally sustainable in all the countries. reliance on agriculture, it also highlights the need to invest t in physical and human capital that can deliver higher and It is important to note that future consumption is not easy to 4.5. Uganda’s total wealth per capita grew by over 30 more sustainable income levels. measure. Therefore, in practice the estimate for present value percent between 2000 and 2010. Most of the increase came of future consumption is calculated in a way to mimic a situ- from a rising stock of natural and produced capital. Ugan- 4.6. The discovery of oil in commercial quantities will give ation where the economy is on a sustainable path (i.e. where da’s natural capital benefited from a rising size and value a boost to Uganda’s total wealth. Starting in FY2017/18, savings offset capital depletion). In order to do this, researchers use 5-year averages centered on the year of interest (in order of its crop and pasture lands, which grew by an average oil rents will average about 3.4 percent of GNI annually to smooth out any irregularities in consumption) and after- annual rate of 4.9 percent per capita since 2000.4 Produced for over 25 years. Figure 4.2 shows by how much this will wards adjust the savings/ consumption breakdown to reflect a capital grew by an average annual rate of 6.4 percent per increase Uganda’s total wealth per capita. In the absence of sustainable consumption path. capita. Intangible capital, which includes human capital, oil, Uganda’s total wealth per capita would have risen by remained constant. Despite recent growth, Uganda’s total only 12 percent in real terms from 2009/10 to 2014/15. If For a more detailed discussion of the methodology used to estimate wealth, please see Annex A in the World Bank publica- wealth is low compared to other countries in Sub-Saharan the discovery of oil is taken into account, Uganda’s wealth tion: “The Changing Wealth of Nations.” 2011 Africa. In 2010 Uganda’s total wealth per capita (excluding (measured as the discounted per capita consumption expen- diture over the next 25 years) grew by 26 percent in real terms during the same period. Today the average wealth 4. Partly offset by deforestation and a reduction in forest wealth. 67 Chapter 4 Figure 4.2: Uganda’s Total Wealth per capita after the oil discoveries it invests. Despite high levels of public investments, but because of their poor quality, some countries are unable to produce the returns that would generate sustainable con- sumption levels. In 2002, after the end of the civil war, Angola took advantage of increased oil production and high oil prices to embark on a multi-year reconstruction plan aimed at replacing its decimated infrastructure. Between 2003 and 2007, the Angolan government increased its capi- tal expenditure almost sixfold. Yet, due to absorptive capac- ity constraints and poor investment management capabil- Source: Wealth of Nations Database and authors’ calculations ities, the increase in public investment was accompanied by wasteful spending. About US$1.3 billion, equivalent to of a Ugandan is around UGX2.7 million higher due to oil investments in other forms of capital but leads to an increase 5 percent of the country’s GDP, was lost each year due to discoveries than it would have been without them. Figure in consumption, Uganda will experience a decline in its inefficiency.5 In addition, supply–side bottlenecks in the 4.2 also shows that the direct contribution in the form of overall wealth in the long run. construction sector and the rise in public expenditure con- government oil revenue is significantly smaller than indirect tributed to high levels of inflation and appreciation of the contributions in the form of oil sector linkages with the rest 4.8. The development of Uganda’s oil industry will also real exchange rate which damaged Angola’s non-resource of the economy and the induced effect due to higher gov- offer many opportunities to raise public investment and export sector.6 Nigeria is another example of an investment ernment spending. to improve the living standards of the country’s current boom gone awry. Nigeria’s ports experienced massive and and future generations. This will crucially depend on the costly congestion as a result of a spending boom, following 4.7. The discovery of oil will provide an opportunity to country’s ability to transform its oil rents into: (i) foreign the oil price increase in the early 1970s (Sachs 2007). raise produced and intangible capital in future years. assets held abroad which will generate returns benefitting Uganda’s GDP has been growing at an annual average of current and future generations; (ii) intangible capital in the 4.10. Resource-rich countries pursue different invest- 7 percent since 2000, but unlike most of the other Sub-Sa- form of a more educated and healthier population (thus ment strategies for their oil proceeds. Brazil used natural haran Africa countries with similar growth patterns, the making Uganda’s workforce more productive, increasing resource rents to expand its stock of foreign assets. Botswa- country’s economic growth was not driven by the depletion wages and improving living standards); and (iii) produced na’s priorities were more focused on building its stock of of non-renewable natural resources, but by high rates of capital through a better physical infrastructure which bene- intangible and produced capital. investments in produced capital. Rents from non-renewable fits economic activity and raises economic opportunities in natural resources over the last decade remained almost neg- the country. 4.11. Judgments about the absorptive capacity of the ligible, amounting to less than 0.001 percent of GNI in 2012. domestic economy and decisions about the appropri- The beginning of oil production at the end of this decade is II. Size and Pace of Investment – Domestic and ate pace of investment are the main factors that should changing the situation. Oil prospects boosted Uganda’s total External Assets determine the selection of foreign or domestic assets for wealth by 17 percent. To maintain this new level of wealth the investment of revenue from oil and other natural 4.9. The pace and the quality of investment are critical in the long run (that is, beyond the 25 year horizon used resources. Oil revenue will enable Uganda’s government for sustainable long-term growth. Countries that invest a to calculate total wealth), Uganda needs to build up other large share of their natural resources wealth tend to grow forms of capital as oil reserves are gradually depleted. If 5. See World Bank (2011) for a full country infrastructure diagnostic for Angola. faster over longer periods of time. However, what matters the depletion of oil reserves is not matched with increased 6. Also see Sala-i-Martin and Subramanian (2003) who investigate the role of is not only how much a country invests but also how well public investment in the case of Nigeria. 68 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Box 4.2: Angola Case Study When four decades of civil war ended in 2002, Angola became Africa’s second oil producer and third largest economy. Between 2002 and 2012 Angola’s oil production increased eight fold reaching about 630 million barrels/year in 2012. Increased production, higher crude oil prices, growing oil revenue and additional financing from China - backed by future oil revenues – allowed the government to embark on a wide-ranging investment program, focused on rebuilding the country’s physical infrastructure devastated by the civil war. Public investment in infrastructure grew from around 5 percent of GDP in 2002 to over 14 percent in 2008 and Angola’s GDP grew by an average of 15 percent every year during that period. However, the acceleration of public investment spending created inefficiencies. The public investment management system was not ready for such a rapid increase in spending. According to a 2011 World Bank study, many investment decisions were not optimal. For example, the expansion of generation capacity was not matched by improvements in the transmission and distribution infrastructure that would enable the network to reach a growing number of people and firms. Poor planning, under execution of budgets, operational deficiencies, and under-pricing of services caused inefficiencies that are estimated at US$1.3 billion annually, almost 5 percent of Angola’s current GDP. Increased public investment also created congestion problems at the Port of Luanda, Angola’s main international gateway. Using Luanda’s facilities became so costly that businesses often reverted to the port of Walvis Bay in Namibia more than 2000 kilometers away. Moreover, Luan- da, Angola’s capital, was repeatedly ranked among the most expensive cities in the world. Inflation fell following the end of the civil war but still averaged 20 percent every year between 2004 and 2008. The purchasing power of an Angolan – as compared to a US citizen- fell by 400 percent between 2002 and 2008. Yet the official exchange rate fell by much less and the Angolan Kwanza became increasingly overvalued. All these factors made the country very vulnerable to the global financial crisis of 2008. As international oil prices started to decline, internation- al reserves fell by 1/3 in the first half of 2009 prompting the Angolan authorities to request IMF assistance. A combination of fiscal consolida- tion and orderly exchange rate adjustment backed by tight monetary policy helped stabilize the economy, but also caused a forced reduction in public investment with negative implications for GDP growth. These lessons encouraged Angola to improve public financial management systems and review the management of its natural resources. The collection and reporting of oil revenue became more transparent and a sovereign wealth fund was established in 2013 to insulate the annual budget from volatile oil revenue inflows. 69 Chapter 4 approach, in which all the proceeds are invested in produc- tive projects, and (iii) the sustainable investing approach, which allocates a fraction of the natural resource proceeds to remove some of the growth binding constraints (such as infrastructure), while the rest of the proceeds is stored in a Parking Fund for future investments. 4.13. The main advantage of the All-Savings Approach is to limit the Dutch Disease effects on the economy and to reserve the benefit of oil revenues for future generations when oil reserves will be depleted. In recent years, many African and Middle-East countries established sovereign wealth funds. According to the Dynamic Stochastic Gener- al Equilibrium (DSGE) built for Uganda, this policy would lead to permanent increases in foreign reserves, which Implementing major infrastructure projects like dam building may be challenging given Uganda’s absorptive and implementation constraints would reach around 20 percent of GDP after 10 years. Pri- vate consumption would also increase by 0.03 percent after to accelerate public investment, but it will also create new 4.12. To ensure that new investments have a high two and a half years. Higher private consumption would challenges for the private and the public sectors accustomed socio-economic impact, Uganda should increase invest- lead households to reduce labor supply by about 0.1 percent to smaller investment levels and it may lead to low invest- ment levels gradually, and some of the oil revenue and lower the marginal product of private investment. As ment quality. The case of Angola illustrates the fact that should be saved in the early years of oil production. a result, wages would increase sharply in both the tradable increasing investment too quickly can exacerbate absorp- Investing abroad gives more time to consider which invest- and non-tradable goods sectors. Lower labor supply and tive capacity constraints in the public sector and trigger sup- ments should be undertaken domestically. How much of oil private investment would lead to a decline in non-oil GDP. ply-side bottlenecks in a private sector unable to increase revenue should be saved is an open question. The follow- the supply of non-tradable products and services. Moreover, ing narrative compares three alternative strategies using a 4.14. The All-Investing Approach allows a country to Dabla et al. (2011) show that when institutional structures Dynamic Stochastic General Equilibrium (DSGE) built quickly address its public infrastructure constraints, for public investment management are weak, investment for Uganda (Kopoin et al. 2015). These strategies include: particularly if it suffers from capital scarcity as is the spending often leads to low returns due to poor project (i) the all-saving approach, in which natural resource pro- case in many developing countries. Several studies sug- selection, appraisal, and implementation. In such circum- ceeds are totally saved and only the return on savings is gest that oil producing countries should emphasize invest- stances it makes sense to save part of oil revenues and invest used to finance the domestic economy,7 (ii) the all-investing ment spending over savings if the oil windfall is temporary, them in foreign assets, including sovereign bonds in indus- and small relative to the size of the economy.8 At the same 7. This is generally referred to as the permanent income hypothesis (PIH) trialized countries with high credit ratings. These savings approach, in which the proceeds of oil revenues are equally shred with future 8. Van den Bremer and van der Ploeg (2013) use the example of Ghana to show would be used at a later stage when improved investment generations. The PIH has been recently under scrutiny by researchers, especially, that countries with small and temporary oil windfall should predominantly in the context of developing countries with significant infrastructure deficit capacity will enable the economy to adjust gradually to (“Djiofack and Omgba, 2011”. It implies that public expenditure should equal invest rather than save their oil windfall. Collier et al. (2010) find that the more the non-oil revenue increase of returns on the net present value of all future oil important source of increased growth and private sector investment is the use higher investment levels. revenues). of resource revenues to raise the marginal product of capital, both public and private. 70 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility time, raising investment spending too quickly could exacer- ect implementation and evaluation. Background analysis the contrary, spending on roads increased from 2.4 to 3.1 bate the Dutch Disease effects by driving up domestic pric- using the CGE model reveals that improved efficiency in percent of GDP from 2009 to 2013. The reorientation of es and causing an appreciation of the real exchange rate. In public sector spending would lead to higher GDP growth public spending towards infrastructure is consistent with Uganda, the all-investing approach would induce wealth and rates. In other words, higher growth would be achieved the priorities of the National Development Plan, whose key income accumulation, and would generate more revenue for using fewer resources. These findings are confirmed by the objective is to unlock growth binding constraints, particular- the government. However, the demand for non-tradable long run growth model (OLG), since a 3 percentage points ly infrastructure gaps. goods would increase causing a substantial rise in the price increase in the shares of health and education spending of non-tradable goods and triggering an appreciation of the could lead to, respectively, a 1.5 percentage points and a 2.4 4.18. Despite the priority given to infrastructure, Ugan- real exchange rate. This would reduce the competitiveness percentage points higher long term growth path, if Ugan- da lags behind other countries with similar levels of GNI, of Uganda’s exports and of domestic products competing da’s public spending efficiency rises. Simultaneously, the in terms of electricity supply and provision of running with imports. Imports would become relatively cheaper economy would be more prepared to absorb the increase water.9 Figure 4.3 summarizes Uganda’s investment needs resulting in an increase in total imports of about 0.1 percent in public spending, if the private sector is ready to respond up to 2025. Based on existing public investment plans in and non-oil exports would decline by around 0.15 percent to the additional demand created in construction and other Uganda´s infrastructure sectors (i.e. Works and Transport; (Kopoin et al. 2015). non-tradable services. This can be achieved through specific Energy and Mineral Development; Water and Environment; policies aimed at improving the business environment and and Information and Communication Technology), it is 4.15. The Sustainable-Investing Approach provides an stimulating higher private investment in those industries estimated that US$21 billion will be needed over the next optimal combination of investment and saving depend- that are likely to experience an increased demand stemming decade. This includes an investment backlog accumulated ing on the size of oil production and the characteristics from accelerated public spending (see chapter 6). over the last five years due to slow implementation of key of the country’s economy. Investment is needed to fos- infrastructure projects totaling US$1 billion, according to ter structural economic transformation but the increase in III. Sector Selection: Infrastructure or Human estimates in a recent study by the Ministry of Finance, Plan- investment should occur gradually to mitigate absorptive Capital ning and Economic Development.10 capacity constraints and Dutch Disease effects. Under that scenario the scaling-up of investments would be more grad- 4.17. In recent years, the government emphasized the 4.19. Economic simulations suggest that using initial oil ual, triggering a smaller exchange rate appreciation than the need to improve the country’s deficient infrastructure, revenue to address the most urgent infrastructure needs all-investing approach, but also higher levels of welfare than in the hope that this will stimulate private investment of the country, notably in energy and transport, will have the all-saving approach. and growth. Public investment in infrastructure increased a stronger growth impact than increased spending on significantly since the adoption of the first National Devel- education and health. According to the CGE model devel- 4.16. Accelerating the pace of investment would be fea- opment Plan (NDP1). As shown in Table 4.1, the composi- oped in the context of this report,11 allocating oil revenue to sible if the management of public investment improves tion of public spending changed over the last decade, with infrastructure (at least during the first four years of oil pro- and the government implements policies aimed at stim- growing emphasis on infrastructure, especially roads. The duction) would lead to a 0.8 percentage point higher increase ulating an adequate response of the private sector to the health and education sectors accounted for about 4.4 per- in the GDP growth rate than if all resources are allocated to resource boom. Currently Uganda ranks 46th out of 71 cent of GDP as the Poverty and Eradication Action Plan was countries in the IMF’s public investment efficiency index winding up. Since then, spending on human capital devel- 9. Gable (2014). 10. Musisi and Richens (2014). (PIMI). Its scores are particularly poor with respect to proj- opment remained almost stable at 4.7 percent of GDP. To 11. Matovu and Nganou (2014). 71 Chapter 4 Table 4.1: Historical Government Expenditure at Function Level (In Percent of GDP) 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 Proj Simulation Total Outlays 19.1% 22.3% 17.9% 18.2% 18.2% 18.2% 22.7% 22.7% 22.7% 22.7% 22.7% General public services 4.4% 5.0% 4.0% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% 4.6% Public debt transactions 1.1% 1.1% 1.2% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% Transfers of general character 0.6% 0.6% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% Defense 3.0% 4.6% 2.4% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8% Public order and safety 1.3% 2.0% 1.3% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% Economic affairs 4.5% 4.7% 4.9% 4.6% 4.6% 4.6% 9.1% 9.1% 9.1% 9.1% 9.1% General Economic, Commercial and Labour 0.1% 0.1% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% Affairs Agriculture, forestry, fishing and hunting 0.9% 0.8% 0.6% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% Fuel and energy 1.1% 1.5% 0.9% 0.5% 0.5% 0.5% 2.5% 2.5% 2.5% 2.5% 2.5% Mining, manufacturing, and construction 0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Transport 2.4% 2.2% 3.0% 3.1% 3.1% 3.1% 5.6% 5.6% 5.6% 5.6% 5.6% Communication 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Environmental protection 0.1% 0.0% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% Housing and community amenities 0.4% 0.3% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% Health 1.7% 1.7% 1.4% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% Outpatient services 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Hospital services 0.4% 0.3% 0.3% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% Public health services 0.6% 0.8% 0.5% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% Recreation, culture and religion 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Education 2.7% 2.9% 2.5% 2.7% 2.7% 2.7% 2.7% 2.7% 2.7% 2.7% 2.7% Pre-primary and primary education 1.4% 1.6% 1.3% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% 1.2% Secondary education 0.7% 0.7% 0.5% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% 0.6% Tertiary education 0.4% 0.6% 0.3% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% Social protection 1.1% 0.9% 1.0% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% Source: Uganda MAMS. human development. Focusing efforts on infrastructure (and MDGs. If oil revenue is allocated to infrastructure, all the 4.20. While increased investment in infrastructure may keeping health spending at the current level) not only gen- 2015 MDG targets would be met by 2020, with the excep- be particularly beneficial in terms of overall economic erates more growth but also yields better outcomes for the tion of Universal Primary Education. growth, the social sector plays an important role in deter- mining the distributional impact of GDP growth. For 72 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 4.3: Uganda’s Infrastructure Investment Needs Up to 2025 will require higher expenditures. The spending needs of the health sector will also increase over the long-term. As pop- ulations age, health expenditure is expected to be higher. Uganda must spend more on health to achieve its Vision 2040 objective of becoming an upper middle income coun- try by 2040. 4.23. In the long run education and health spending will have more impact on growth than spending on infra- structure. According to a background study14 for this report that exploits an overlapping generation (OLG) growth mod- el, a 3 percentage points increase in the share of government spending on health and education would have a long-term growth impact of about 0.7 percentage points. The same increase in spending on infrastructure would boost Ugan- da’s long term growth by only 0.4 percentage points. While Source: Authors’ calculations based on sector investment plans. an increase in the share of infrastructure spending would have indirect effects on human capital accumulation and the instance, investments in education are important to ensure depend on a well-educated labor force. This is especially production of health services, it would also have congestion that Uganda’s youth is prepared for new job opportunities relevant for a country like Uganda where only 20 percent effects that mitigate the initial benefits of a higher public in the emerging oil industry and other sectors. According to of the labor force has completed secondary education, com- capital stock. These findings support the strategy of the gov- a recent study, the development of Uganda’s oil fields could pared with 50 percent in Ghana, as illustrated in Figure 4.4. ernment which wants to use initial oil revenue to address the lead to the creation of 13,000 jobs over the next 3-4 years.12 4.22. Since public spending in education and health country’s infrastructure gaps, but recognizes that neglecting These jobs will go to Ugandans only if Ugandans are ade- declined from around 6.5 percent of GDP in 2003/04 the social sectors would have a growing opportunity cost in quately trained and educated. The number of Ugandans to 4.5 percent in FY2012/13, social services are under the medium to long term. with the necessary technical skills is insufficient. A massive training initiative is necessary to maximize benefits in terms pressure. Although Uganda’s enrollment rates in primary IV. Public Finance Implications of Alternative of jobs and improved living standards for the population as education are high relative to countries at similar stages Strategies a whole. The skills shortage goes beyond the oil sector and of development, overall spending per primary school stu- is a binding constraint for a modern economy. dent is below the average in low income countries.13 This 4.24. The government needs a long term fiscal strat- may explain the low primary completion rates in Uganda egy to underpin its investment program and its 4.21. The build-up of human resources through educa- as compared with other countries with similar GNI levels. plans regarding the use of oil revenues for the tion and training is not only good for growth, it will also Better schooling outcomes and increasing the share of stu- help diversify since manufacturing and modern services dents transitioning from primary to secondary education 14. Agenor and Nganou (2014). explicitly accounts for government spending allocation between infrastructure, education, and health, while at the same time capturing the various network externalities associated with infrastructure, as 12. Total 2013: “Industrial Baseline Survey in Uganda”, Kampala, Uganda 13. See Gable et al. (2014). documented in recent research on low-income countries. 73 Chapter 4 Figure 4.5: Total Expenditure and Net Lending Figure 4.4: Education Attainment of Labor Force (Percent of GDP) Source: Uganda MACMOD and authors’ calculations. Figure 4.6: Overall Fiscal Deficit, including Oil Revenues and Grants (Percent of GDP) Source: Uganda Bureau of Statistics. following years. Oil production will allow Uganda to A. Two alternative scenarios increase public expenditures to finance investment needs. An optimal fiscal strategy will balance a set of different 4.25. To examine the implications of different spending trade-offs. Increasing spending too quickly would create paths, we considered two alternative scenarios: (i) the macroeconomic instability if it produces inflation or high- baseline scenario (described in Chapter 2) in which pub- er interest rates (if financed through domestic borrow- lic investment increases gradually and (ii) a frontload- ing). At the same time postponing key public investments ing scenario in which public investment is raised more projects is costly, if it constrains medium-term private aggressively. The baseline scenario assumes that overall sector growth. Therefore, as discussed earlier in this chap- expenditure remains at an average of 19 percent of GDP ter, any increase in public investment should be gradual from FY2015/16 to FY2019/20, allowing the annual fiscal and in line with the country’s investment capacity. deficit to decline from the projected 5 percent of GDP in FY2015/16 to 3 percent in FY2019/20 thanks to the increase Source: Uganda MACMOD and authors’ calculations. 74 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 4.7: Cumulative Spending on Infrastructure Investments in petroleum revenue. The frontloading scenario assumes that Uganda’s capacity to absorb additional investment spending increases, allowing a more drastic rise in domestic development and investment expenditures. In this second scenario, which is more in line with the government’s cur- rent proposal for the NDP 2, total government expenditures average 25 percent of GDP from FY2015/16 to FY2019/20, resulting in an average fiscal deficit of 10 percent every year during implementation of the five year NDP2 (see Figures 4.5 and 4.6). It is assumed that while development expendi- tures accelerate faster in the frontloading scenario, recurrent expenditures grow at the same 10-year average of 15 per- cent/year in both scenarios. Uganda’s investment needs in infrastructure until 2025 have been estimated at US$ 21 bil- lion. In the baseline scenario Uganda’s infrastructure invest- Source: Uganda MACMOD and authors’ calculations. ment needs would be met in 8 years starting in FY2015/16. The frontloading scenario would meet Uganda’s infrastruc- Figure 4.8: Debt-to-GDP Ratio (In Percent) ture gap in 6 years (see Figure 4.7). 4.26. Higher public investment has the potential to crowd-in higher levels of private investment as key infrastructure bottlenecks are reduced, leading to high- er growth in the long-run. Consequently, if infrastructure constraints are eased more slowly (like in the baseline sce- nario), this could be costly to the economy. 4.27. Yet the advantage of frontloading public expen- diture needs to be weighed against the risks of faster accumulation of public debt. In the baseline scenario total expenditure and net lending would rise from an aver- age of 17.4 percent of GDP during NDP 1 (FY2010/11– FY2014/15) to an average of 18.4 percent during NDP 2. The fiscal deficit would increase from an average of 3.6 Source: Uganda MACMOD and authors’ calculations. 75 Chapter 4 Figure 4.9: Oil Savings percent during NDP1 to 3.8 percent during NDP2. Total resource rich countries exhibit higher spending multipliers expenditure and net lending would increase more quickly ranging from 0.55 to 0.74, which shows that these coun- in the frontloading scenario (from 17.3 percent to 25.1 per- tries are more capable of boosting GDP in the short-term cent of GDP), and the average fiscal deficit would widen through government spending.16 However, these spending from 3.6 percent to 10.1 percent of GDP. Consequently, the multipliers seem to be higher during recessions (0.55–0.59) gross debt-to-GDP ratio would rise much faster to exceed and significantly lower (0.01–0.14) during booms. This 56 percent of GDP in the early 2016/17, while it would nev- suggests that fiscal interventions are more effective during er exceed 40 percent in the baseline scenario. recessions, and that fiscal policy is countercyclical for these countries. This is a valuable indication for Uganda, 4.28. Although the overall debt level in both scenar- which must avoid falling victim of spending pressures often ios could appear manageable, neither the baseline nor encountered in resource-rich countries. the frontloading scenarios result in an accumulation of savings to mitigate the effects of a sudden drop in oil B. Clear fiscal rules - Savings and the NONG prices. In both scenarios all oil revenue is invested and non fiscal deficit Source: Uganda MACMOD and authors’ calculations. is saved. Yet, crude oil prices can experience large up and Figure 4.10: NONG Fiscal Deficit down swings from one year to the next. In 2009 the price of 4.30. The countries that have established clear fiscal (Percent of GDP) oil fell by almost 40 percent as a result of the global finan- rules determining how initial oil revenue ought to be cial crisis. Such a sudden drop in prices at peak production spent generally are the most successful in their transition would cause a shortfall equivalent to 2-3 percent of GDP. from net oil consumer to net oil producer. The analysis in Allocating some oil revenue to a savings fund would be section II of this chapter established that it would be optimal necessary in both the baseline and the frontloading scenari- for Uganda to increase investment gradually using some oil os to generate savings that could absorb unexpected revenue revenue to build-up a savings buffer in the early years of shortfalls. oil production. According to its Petroleum Revenue Man- agement Policy, Uganda will use the NONG fiscal deficit 4.29. The volatile nature of oil prices can generate boom- as an anchor for public expenditures. This means that total bust cycles, which can be prevented through adequate spending will be limited to the sum of domestic non-oil rev- fiscal policy. Avoiding booms and busts cycle will require enue and the deficit target. With current domestic revenue some knowledge of the magnitude of fiscal multipliers and reaching 14 percent of GDP, a NONG fiscal deficit target of their heterogeneity with respect to booms and reces- of 5 percent would limit today’s expenditure to 19 percent sions cycles. A recent study conducted for a sample of 99 of GDP. If set at a prudent level, the NONG fiscal deficit countries reveals that estimated spending multipliers could rule could prevent a too rapid increase in expenditure when Source: Uganda MACMOD and authors’ calculations. range between 0.39 and 0.47.15 This study also indicates that 16. The study defines resource-rich country as a country for which the resource 15. See Nganou, Tchuente and Some (2014). rent as a share of GDP exceeds 4.6 percent (the sample median). 76 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 4.11: Overall Fiscal Deficit (Percent of GDP) Figure 4.12: Total Expenditure and Net Lending (In Percent) Source: Uganda MACMOD and authors’ calculations. Source: Uganda MACMOD and authors’ calculations. oil production begins. Yet, it is less clear how the Petro- 15 percent of all oil revenue is to be saved in a stabilization the average overall deficit would amount to 3.2 percent and leum Revenue Management Policy would contribute to the fund to absorb unexpected shortfalls in oil revenue in the would allow Uganda to comply with the 3 percent deficit creation of a savings buffer that would smooth expenditure future. Using a macroeconometric model for Uganda (Mac- target of the EAC monetary union by FY2020/21. However, when oil revenues fall short of what was initially budgeted. Mod-UG), it was estimated that, if Uganda were to adopt a such a fixed target for the non-oil non-grant budget deficit similar rule, by the end of 2024/25 enough savings would would not take into account the bell shape nature of the oil 4.31. The government will have to make sure that on have been accumulated to absorb a sudden drop in oil rev- production path and would result in high fiscal deficits in top of establishing an adequate NONG fiscal deficit rule enue of almost 50 percent (see Figure 4.9). Moreover, the the early years and excessively low by the mid-2020s, when a fixed share of oil revenues is deposited each year in DSGE model estimates that savings rate of 15–30 percent Uganda is expected to reach peak oil production. Alterna- a savings account. The recently enacted Public Finance of oil revenue will optimally minimize the volatility of key tively, a variable NONG fiscal deficit limit would allow Management Act 2015 stipulates that all oil related reve- macroeconomic aggregates such as private consumption, revising the rule every 3-5 years in line with the inflow of nues will have to be deposited into a holding account over- private investment, and total employment (Kopoin et al. oil revenue. Figures 4.10 and 4.11 illustrate the two alterna- seen by the parliament. From there, revenues will either be 2015). tives. In scenario 1, the NONG fiscal deficit is maintained used to finance the government budget or will be transferred at 5 percent over the whole projection. In scenario 2, it is to a special savings fund called the Petroleum Revenue 4.32. The right level of the NONG fiscal deficit rule would gradually revised every three years, first at 5 percent of Investment Reserve. This savings fund will act as a sov- depend on expected oil revenue and the government’s GDP, then at 5.5 percent of GDP, and finally at 6.5 percent. ereign wealth fund allowing the country to save for future targeted level of overall expenditures. One option would needs and to smooth government expenditure when oil be to set the NONG deficit target at a fixed rate of 5 percent prices fall. Yet the law does not establish how much of the of GDP. With average oil revenue and grants (as a share 4.33. Set at the right level, the NONG fiscal deficit limit annual oil revenue will have to be deposited in the account. of GDP) expected to account for respectively 1.2 percent compares favorably to other fiscal rules adopted else- In Ghana, for example, the law established that in each year and 0.6 percent over the first four years of oil production, where in Sub-Saharan Africa. Resource-rich countries 77 Chapter 4 Figure 4.13: Sustainable Budget Index in Uganda adopted a wide variety of fiscal rules to promote sound fis- cal management of natural resources. Botswana, for exam- ple, adopted in 1994 a Sustainable Budget Index, which rules that the ratio of non-education, non-health recurrent expenditure to non-mining revenue should not exceed unity. The policy allowed Botswana to prevent excessive spending and ensure fiscal sustainability in anticipation of the future depletion of diamond deposits.17 As shown in Figure 4.13, both the fixed and the flexible fiscal deficit rules of scenar- ios 1 and 2 would comply with a Botswana type system. Moreover, combined with an explicit savings target for each year, as discussed above, the NONG rule would also have advantages compared to Ghana’s widely praised petroleum revenue management law, which establishes that 70 percent Source: Uganda MACMOD and authors’ calculations. of the benchmark annual oil revenue is channeled to the budget, 15 percent allocated towards a stabilization funds Figure 4.14: Tax Revenue Inefficiency and Non- Figure 4.15 : Real GDP Growth and low tax and the remaining 15 percent saved for future generations. Oil Domestic Revenue (Percent Non-oil GDP) revenue The main shortcoming of this rule is that it does not impose limits on government expenditure. In effect it allows the Ghanaian government to comply with the saving rule while borrowing for additional expenditures. Since the onset of oil production in the 2011, recurrent spending has already risen by 10 percent creating serious risks for Ghana’s near term economic outlook.18 Under Uganda’s NONG fiscal deficit rule, such an increase in spending would not be possible. 17. Kajo (2010): “Diamonds Are Not Forever: Botswana’s Medium-Term Fiscal Sustainability”. 18. The most recent joint IMF and World Bank debt sustainability analysis shows that overall debt vulnerabilities have increased. Whilst total public debt reached 57 percent of GDP in 2013, rising debt service could be absorbing more than 40 percent of government revenue in the long run. Consequently, the spreads of Ghana’s Eurobonds are now the highest among its peers in Sub-Saharan Africa. Source: Uganda MACMOD and authors’ calculations. Source: Uganda MACMOD and authors’ calculations. 78 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility The efficiency of methods of tax collection on non-traditional economic activity like transport will determine if the tax is viable. Uganda still lags behind in tax collection capacity. C. Other issues: mobilization of domestic taxes rich countries experience a decline in non-oil tax revenue of GDP to 15.1 percent - the average ratio for low-income when the government begins to receive a substantial inflow countries estimated by Baldacci et al. (2004) – will lead to 4.34. So far all simulations assume that the government of oil revenue. A decline in tax revenue would have neg- a 1.5 percentage points increase in the steady-state growth will continue ongoing efforts to mobilize more domestic ative macro-fiscal implications. If for instance recent effi- rate. Moreover, a more ambitious tax reform program aimed taxes to ensure that higher oil revenue does not come ciency gains would fall to zero with the coming on stream at increasing the tax revenue-to-GDP ratio to 18 percent - at the expense of non-oil revenue. Although Uganda’s tax of oil production, the ratio of non-oil tax to non-oil GDP the average ratio for low-income countries estimated by the administration performance recently improved, the ratio of would fall from 13 percent today to less than 10 percent in International Monetary Fund (2010) – will result in higher tax revenue to GDP continues to stagnate and Uganda is the medium term (see low revenue scenario in Figure 4.14). long-run growth of the order of 3.3-3.7 percentage points. behind all the other East Africa Region countries in terms of The government would have to reduce expenditure to meet tax collection capacity. It is therefore assumed that improve- the 3 percent maximum deficit of the EAC (see Figure 4.13) 4.37. Consequently, Uganda needs to pursue ongoing ments in non-oil revenue will be gradual, as the tax base is and GDP growth rates would be significantly lower than in efforts to improve tax collection.19 These efforts could be widened and tax exemptions are phased out. Projected effi- the baseline scenario (see Figure 4.15). By the end of the accompanied by fiscal rules that incentivize improvements ciency gains in tax collection for each of the different tax projection period, the GDP would be 35 percent lower than in tax administration and collection. In fact, one of the items are captured in Table 2.2. Overall non-oil domestic in the baseline scenario. advantages of a NONG fiscal deficit rule is that the incen- revenues would increase from 13 percent of GDP today to tive to mobilize non-oil domestic revenue remains high around 15 percent in the medium term. 4.36. Improving domestic revenue mobilization will when oil revenues start to flow. Using a NONG fiscal deficit have critical long-term growth effects. Using the OLG as a fiscal anchor implies that a drop in non-oil tax reve- 4.35. Increased fiscal space due to oil revenue may lead framework developed for Uganda, it is estimated that to lower tax mobilization in other sectors. Many resource- increasing the tax revenue-to-GDP ratio from 12.7 percent 19. Belinga et al. (2014) found that it would take significant efforts in institutional strengthening for Uganda to prevent a reduction in its tax effort. 79 Chapter 4 Uganda has sufffered from unstable and usually high fuel prices. Motorists will have high expectations of low fuel prices when production begins 80 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility nue will need to be accompanied by an equivalent reduction in expenditure. With a credible limit based on an enforced Table 4.2: Effectiveness of Various Programs Reaching the Poor NONG fiscal deficit rule, the government would have to Program / Subsidy Benefit-Targeting Actual Vs. Simulated continue ongoing efforts to widen the tax base and improve Potentially well targeted programs the administrative efficiency of tax collection. Free uniforms at the primary school 1.24 Simulated General funding for education 1.21 Simulated D. Other issues: spending pressures General funding for health service 1.54 Simulated Free access to reproductive health 1.07 Simulated 4.38. In many resource-rich countries social protection Subsidies with limited benefits for the poor programs have also taken the form of subsidies to sen- Kerosene 0.79 Simulated data sitive products such as basic foodstuffs, electricity and/ or refined petroleum products, yet these are not always Poorly targeted subsidies effective in reaching out to the poor. Table 4.2 provides Electricity 0.05 Actual data the key results in terms of the targeting performance to the Petrol/Diesel 0.02 Simulated data poor of various simulated social programs including energy Source: World Bank Staff estimates based on UNHS 2012/13 (Aguinaga et al. 2014). subsidies. The benefit-targeting indicator is the ratio of the share of total benefits received by poor households to the way. Therefore, the government should consider financing products will help avoid fuel shortage and price spikes. proportion of households that are poor. If the value of the social programs in education and health rather than petro- Third, given that Uganda is a landlocked country without indicator is unity, the scheme is neutral and the poor receive leum subsidies. Improvements in the access and quality of pipelines, the cost of transportation of petroleum products benefits in proportion to their numbers. A value greater than education and health services are key for Uganda to achieve is very high. However, given that the country is going to unity is progressive but a value lower than unity is regres- the middle-income level status and implement its growth invest a sizable amount of resources in infrastructure sive, with non-poor households receiving a larger share of and development agenda. improvement, the cost of transportation of oil will decrease the total subsidy pool than their proportion in the popula- in the coming years, leading to lower prices at the pump. 4.40. As observed in many oil producing countries, tion. Programs like general funding for health service, free domestic production of oil and gas may create expecta- 4.41. A second best option would be to introduce an uniforms at the primary school level, general funding for tions and pressures to keep domestic petroleum prices automatic price mechanism to smooth the adjustment education, and free access to reproductive health would be low, and even below international levels. There are three of prices by limiting the magnitude of any single price potentially well-targeted. main factors that could help the government manage expec- change (per week or month), but still ensure full pass- 4.39. Energy subsidies are particularly costly and regres- tations in terms of oil subsidies once production starts. First, through over the medium term. Although this would sive. Subsidies on the price of electricity and petroleum Uganda does not currently have substantial fuel subsidies; reduce domestic price volatility, it would also lead to great- products such as diesel and petrol would benefit mainly the in fact, the only subsidy is the exemption of excise duty on er fiscal volatility. Avoiding subsidies also requires smooth- richest segment of the population. Other programs like kero- kerosene. In general, domestic prices follow international ing when international prices decline without a full pass- sene subsidies would benefit the poor, but a high proportion prices, and as such non-subsidized prices are standard. Sec- through to consumers. Looking at examples of automatic of the benefits would accrue to the richest households. The ond, Uganda has repeatedly suffered from prolonged fuel price mechanisms, the only successful and lasting case is opportunity cost of petroleum subsidies would not only be shortages and price spikes due to its limited fuel storage South Africa. The transparency and credibility of the auto- foregone government revenue, it would also be the missed capacity equivalent to 20 days (one of the lowest in the matic pricing process in South Africa contributed to its opportunity of funding social programs that reach the poor region) and its dependency on fuel imports from the Mom- durability since 1950s. and contribute to poverty eradication in a more efficient basa refinery. Therefore internal availability of petroleum 81 Part IIi Government Actions Necessary to Address Specific Implementation Issues Part III discusses the necessary actions to be taken by the policymakers to implement a strategy aimed at maximizing the benefits of oil and other extractives while minimizing associated risks at the same time. The report argues that these actions will include (a) improving public sector management (PFM, PIM, public sector incentives); (b) improving the role of the private sector and the civil society; (c) leveraging the possible impact of regional integration while mitigating associated risks (for instance, in the context of the monetary union); and (d) managing population expectations. It is structured as follows: Chapter 5 discusses the importance of strengthening public sector management as a key ingredient of the Government’s implementation strategy in harnessing the benefits of oil, gas and other extractives. It also discusses issues related to managing the expectations of the population. Meanwhile, Chapter 6 emphasizes the role of the private sector and Chapter 7 brings forward the role of regional integration as another key element for the implementation of proposed strategy in the short, medium and long term. An effective implementation of the government’s strategy will depend on three types of institutions: Uganda’s public sector agencies, private enterprises operating in the country and EAC institutions. The quality of Uganda’s public sector institutions will be the main factor. However, the private sector, including large international corporations, and the regional institutions of the East African Community will also influence the final outcome. 83 84 Chapter 5 Implementation of the Strategy: Key Messages and Conclusions: The Role of Improved Public Sector Management Sound public sector management is critical to speed up the socio-economic transformation of resource-rich countries. Poor public sector management encourages the voracity effect (pressures from special interests for increased spending on non-productive activities) and exacerbates the Dutch Disease. In Uganda, seven key institutions (Finance, Justice, Bank of Uganda, Uganda Revenue Authority, Energy and Mineral Development, Buliisa General Hospital in Buliisa District National Environment Management Authority and Office of the Auditor General) play a major role in formulating/ implementing the government strategy. Most of these institutions need specialized technical expertise to perform new functions linked with the development of oil production and the management of oil revenue. To develop their capacity, they need to recruit outside expertise, and organize comprehensive training programs locally and abroad. Two institutions envisaged in the National Oil and Gas Policy of 2006 – the Petroleum Authority and the National Oil Company – are not yet in place. The National Oil Company is essential to shield the state from direct liability. Its creation is underway. Corruption is a serious problem in many resource- rich countries. Uganda’s governance indicators are similar to what is found in other SSA countries, but corruption is a major concern. Existing anti-corruption laws and oversight institutions are strong on paper, but implementation is weak. While the performance of audit institutions is relatively good, the exercise of the I. Strengthening Uganda’s Public Sector Institutions investigative and sanctioning functions is inadequate. Efficient public financial management is critical. 5.1. Sound public sector management is essential to harness the potential of extractive industries and speed up the Uganda’s PFM is satisfactory in terms of transparency socio-economic transformation of resource-rich countries. Too often, economic growth in resource-rich countries was but inadequate in terms of budget credibility, controls hampered by interventions of interest groups and pressures for substantial transfers to these groups. This is the “voracity and compliance. The introduction of the Treasury Single Account will further improve transparency. Quarterly effect” described by Tornell and Lane (1999). Increased public spending goes to non-productive activities. This reduces the cash flow forecasts and the issuance of quarterly productivity of capital and ultimately lowers economic growth. Sala-i-Martin and Subramanian (2003) and Budina et al. (2007) provide empirical evidence of this voracity effect in Nigeria, Africa’s largest oil producer. They argue that the neg- 85 Chapter 5 Key Messages and Conclusions: ative impact of the Dutch Disease and the volatility of oil growth and improve living standards. The country’s GDP resources were exacerbated by greed. The oil boom of the per capita became higher than that of Cameroon. Despite ceilings for MDAs will strengthen cash management. 1960-70s triggered an increase in demand for direct trans- an oil boom experienced by Cameroon in 1979-1985, the So far, only 77 percent of public expenditures go fers to Nigerian elites. The increase in central government income gap between the two countries widened, and nowa- through the Integrated Financial Management System. public expenditures created rigidities which made it diffi- days Botswana’s GDP per capita (US$7028) is far superior The PFM reform program will complete the roll-out of the IFMS to all entities. cult to lower public spending when oil prices began to fall. to that of Cameroon (US$991.6). The rapid transformation This led to an accumulation of public debt that had disas- of Botswana is attributed to the strong quality of its institu- Improved management of the public investment trous consequences for the Nigerian economy (Budina al. tions, which is better than the Sub-Saharan Africa average program is essential for a productive use of future oil revenue. Uganda’s performance in that area is weak. 2007).1 It is argued that about two-thirds of Nigeria’s public (Acemoglu et al. 2001). Sector strategies should be better coordinated with investment during the 1965-2000 period was hijacked by a NDP objectives and plans. Introduction of projects in corrupt elite (Sala-i-Martin and Subramanian, 2003). Simi- 5.3. To improve the performance of its public sector, the PIP are not based on adequate project appraisals Uganda should act on two fronts: (i) strengthening pub- lar predatory behavior was found in Cameroon where only and feasibility studies. Poor project selection affects implementation. 46 percent of total oil-related government revenue between lic institutions, and (ii) improving managerial practices 1977 and 2006 was transferred to the national budget, while (both public finance and public investment manage- The development and implementation of an effective ment). This section will discuss public institutions strength nationwide communication strategy for oil and gas the rest remained unaccounted for (Zeufack and Gauthier sector is a high priority. 2011). while the following section will elaborate on the issues of managerial practices in the public sector. Conclusions: 5.2. Comparing the recent performance of Botswana • Completing the creation of the institutions and Cameroon – two countries where similar conditions 5.4. The Oil and Gas Policy (NOGP) of 2006 defines envisaged in the National Oil and Gas Policy and prevailed before oil/mineral production began – shows Uganda’s legal and institutional framework for the man- building the capacity of all the agencies involved agement of oil and gas resources. According to the NOGP, the importance of sound public sector management. in implementing the government strategy. When Botswana became independent in 1966, its real GDP the government should update the regulatory framework • Improving the performance of audit and other per capita (constant 2005 prices) was US$468, that is, much by enacting three new oil laws: (i) the Petroleum (Explo- anti-corruption institutions. ration, Development and Production) Act, now called the lower than in Cameroon (US$734.7). Cameroon, however, • Strengthening cash management systems and was unable to use its oil wealth to improve living standards, Upstream Act, which was approved by the Parliament in extending the IFMS to all the government bodies. while Botswana leveraged diamond-related revenue wind- December 2013 and regulates the licensing and participa- falls and achieved remarkable results. The diamond boom tion of commercial entities in the oil sector; (ii) the Petro- • Better preparation of projects before introduction in the PIP. of the 1970s enabled Botswana to stimulate economic leum (Refining, Conversion, Transmission and Mid-Stream Storage) Act, now called the Mid-Stream Act, which was 1. According to Sala-i-Martin and Subramanian (2003), Nigeria should have approved in February 2013; and (iii) the Public Finance Act, earned US$350 billion in terms of cumulative net income over the period 1965- which was approved by Parliament in November 2015 , and 2000. However, Nigeria per capita GDP increased from US$336 in 1965 to only US$440, in 2006 (WDI 2008). Nigeria, therefore, is viewed in the literature as a deals with the management of oil sector revenue. good illustration of the failure of countries with natural resources (Van der Ploeg, 2007). 86 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 5.5. Three key institutions – Finance, Justice, and the Bank of Uganda – play a major role in formulating and implementing the government’s oil sector strategy. i. In addition to its broad macroeconomic and public finance management functions, the Ministry of Finance (MFPED): (i) is involved in the formulation of laws reg- ulating oil and gas revenue; (ii) participates in the nego- tiation of profit sharing agreements; (iii) manages petro- leum revenue; and (iv) provides policy guidance for the management of the petroleum fund. The most important issue to be addressed by the Ministry in this context is a macroeconomic policy issue that is, ensuring an appro- priate balance between spending and saving to maintain macroeconomic stability. To achieve that objective, the Good management of oil and gas resources will greatly improve the government should decide each year which percentage quality of life of average Ugandan of oil revenue goes to a sovereign petroleum fund, or should allocate a fixed percentage of oil revenue to sav- ings. The main advantage of the second option is to help 5.6. Four other institutions – URA, PEPD, NEMA, and iii. The National Environment Management Authori- resist political pressures for excessive spending. OAG – also play a critical role in the management of the ty (NEMA) ensures that oil companies manage waste ii. The Ministry of Justice and Constitutional Affairs: (a) oil and gas sector. properly at all stages (from production to final disposal). provides guidance for the preparation of the petroleum It issues regulations and guidelines, delivers waste man- i. The Uganda Revenue Authority (URA): (a) collects rev- agement licenses, and monitors activities in the Alber- legislation; and (b) participates in the negotiation and enue from the oil and gas sector; and (b) monitors the tine Graben area. administration of profit sharing agreements. economic impact of oil and gas revenue, in close coop- iii. The Bank of Uganda: (a) advises the government on the eration with the Bank of Uganda. iv. The Office of the Auditor General (OAG) carries out impact of oil and gas production on the national econo- management audits of public institutions (and some pri- ii. The Ministry of Energy and Mineral Development, vate enterprises). Financial audits are performed by the my; (b) ensures that oil and gas activities do not affect and notably the Petroleum Exploration and Production Ministry of Finance and URA. negatively monetary policies and macroeconomic man- Department (PEPD), represents the state in the manage- agement; and (c) is responsible for managing/adminis- ment of the petroleum sector, and deals with a combina- 5.7. All these institutions need additional specialized tering the petroleum fund. tion of technical, regulatory and legislative issues. expertise to perform new tasks related to the manage- ment of the oil and gas sector. 87 Chapter 5 i. Highly skilled technical personnel is needed to help Finance design and use effective oil revenue spending and saving mechanisms. Each year, two public sector agents are sent abroad to study oil and gas management issues. This is not sufficient to remedy the lack of spe- cialized MFPED staff in that area. ii. The Ministry of Justice needs skillful and experienced negotiators to negotiate the best possible deals with international oil companies and maximize the share of oil revenue accruing to the government. It should use experienced consultants, while developing local capaci- ty through staff training abroad and in the country. iii. PEPD has developed its knowledge of the oil sector during the preliminary development phase and URA has already created its own Natural Resource Management unit. However URA will need additional technical staff specialized in reporting, auditing and taxation of the oil and gas sector. iv. An OAG audit of NEMA has shown that the institution should review its guidelines taking into account the spe- cial characteristics of complex oil-related environmen- tal issues. v. OAG itself is concerned with its lack of technical knowledge for the auditing of oil and gas institutions. 5.8. In other words, for most of these institutions, an appropriate combination of outside expertise and staff training – locally and abroad – is necessary to develop local capacity. Part of Kampala Road , the main street in the Kampala city 5.9. Two institutions, envisaged in the NOGP, have not been created. 88 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 5.1: Natural Capital and Corruption Figure 5.2: Corruption and Income oil management institutions before production begins. For instance, the absence of a National Oil Company could obscure the division of labor between the Min- Log GNI per capita 2012 (USD, ppp) istry of Energy and the Ministry of Finance and could Corruption perceptions index 2013 strengthen the influence of other institutions. Such prob- lems would be difficult to correct at a later stage in an environment which could be dominated by rent-seeking Uganda behavior. ii. Close coordination between MFPED, Ministry of Ener- gy, URA, the Bank of Uganda and other institutions is vital for effective management of oil revenue. The Natural capital as % of tangible capital 2005 development of a comprehensive capacity-building pro- gram also is of high priority. iii. Finally, transparency is critical. The Ministry of Finance and other public sector institutions should share information on the size and use of oil revenue with Source: Authors’ computations based on World Bank, World Development Indicators, updates of World Bank data (2006) and data from Transparency civil society organizations and the public at large. International. Note: Each country is represented by a bubble the size of which is proportional to the country’s population in 2012. Consequently China and India II. Improved Governance, Public Finance are easy to identify in the Figure.1. - “Natural Capital” goes beyond “Natural Resources”. This explains Uganda’s very high share of natural capital as Management, Public Investment per the 2005 Figures which do not include oil (i.e. natural capital represents 84 percent of tangible capital). Performance, and Management of Expectations i. The role of the Petroleum Authority will be to monitor tion and indicates in which areas reinforcement is need- and regulate petroleum exploration, development and ed. A. Governance, corruption and accountability production. i. Despite progress made, the present institutional set-up 5.11. Uganda’s public sector management practices are ii. The National Oil Company (NOC) will deal with the is incomplete. The lack of clarity with respect to the broadly similar to what is found in most of the other commercial aspects of the oil industry. Its creation is respective roles of the Petroleum Authority, the Min- countries in Sub-Saharan Africa. According to the latest underway. The existence of NOC is critical to shield the istry of Energy, the National Oil Company and other World Governance Indicators data base, Uganda’s scores state from direct liability. institutions involved in oil management may affect the are above the SSA average (see Table 5.2) but the country’s sound development of a promising oil sector. It is essen- record is poor on fighting corruption and patronage. 5.10. Table 5.1 summarizes the oil and gas sector institu- tial not only to clarify the responsibilities of each entity tional structure, describes the functions of each institu- but also to accelerate the establishment of appropriate 89 Chapter 5 Table 5.1: Summary Institutional Assessment Name Function Key Challenges • Manage petroleum revenue and design mechanisms to • Lack of technical staff specialized in petroleum ensure adequate balance between saving and spending. management issues. Ministry of Finance, Planning and Economic • Negotiate Production Sharing Agreements (PSAs). • Needs to organize effective cooperation with other Development (MoFPED) • Formulate tax policy. institutions (MoE, URA, BoU, and OAG). • Provide guidance for the management of the petroleum fund. • Prepare draft petroleum laws. • Shortage of oil and gas lawyers. Ministry of Justice and Constitutional Affairs • Negotiate Production Sharing Agreements (PSAs). • Need to enhance negotiating capacities. • Effective coordination with MoFPED, URA, and Parliament. • Ensure that the institution has the capabilities required • Provide advice on the economic impact of the oil sector. for an efficient management of oil revenue. • Ensure oil activities do not affect negatively monetary Bank of Uganda (BoU) / Petroleum Fund • Improve capacity to manage the Petroleum Fund and policy and macroeconomic stability. provide risk management and investment advice. • Manage and administer the Petroleum Fund. • Effective coordination with the OAG and URA. • Need to hire technical personnel for audit of oil and gas Uganda Revenue Authority (URA) • Collection of revenue from oil and gas activities. operations. Ministry of Energy and Mineral Development (MEMD) • Address technical and legislative issues regarding the / Petroleum, Exploration and Production Department management of the oil sector. • The role of the institution needs to be clarified (PEPD) • Approve future regulations and negotiate the terms of • Insufficient checks and balances to limit the authority of Minister of Energy licenses and agreements. the Minister. • Need to clarify mandate and operational boundaries. National Oil Company • Oversee commercial aspects of the oil industry. • Need to spell out arrangements concerning the company’s financial management. • Its ability to implement its oversight role is restrained • Monitor and regulate exploration and production of The Petroleum Authority of Uganda by its obligation to comply with instructions from the petroleum. Minister of Energy. 90 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Name Function Key Challenges • Audit all the institutions involved in the oil and gas • Lack of technical knowledge with respect to audits of oil Office of the Auditor General (OAG) industry. and gas institutions. • Inadequate environmental guidelines for the sector. National Environment Management Authority • Ensure/ monitor compliance of oil and gas activities with • Lack of appropriate technical and financial capacity for (NEMA) environmental guidelines. the monitoring of the sector. • Adopt petroleum legislation. • The Parliament does not have the power to hold the • Monitor performance in the petroleum sector through Minister of Energy and other oil institutions accountable, Parliament policy statements and annual budgets. most notably regarding the approval of model contracts • Confirm nominations for the PA. and the opening of new exploration areas. Public Accounts Committee (PAC) • Examine the audited accounts of public expenditures. • Lack of a strategic approach in dealing with the case load. • Under resourced and inadequate staff levels. • Control of corruption. Inspectorate of Government (IG) • Case backlog. • Enforcement of Leadership code. • Low investigation and prosecution skills. Central Intelligence and Investigation Department • Intelligence gathering and investigation of corruption • Lack of clear strategy and agreed approaches for the (CIID) cases. management of corruption cases. • Capacity gaps among magistrates. Anti-Corruption Division of the High Court (ACD) • Handle corruption cases. • Limited skills with respect to complex corruption cases. • Lack of forensic expertise and institutional weaknesses in terms of investigation. Department of Public Prosecution (DPP) • Handle and prosecute criminal cases. • High staff attrition rate. • Political interference. Local governments • Manage oil royalties for the benefit of communities. • Lack of governance structures to manage oil revenues. Source: World Bank Staff Summary. 91 Chapter 5 Table 5.2: Governance Indicators (Percentile Rank), 2012 Figure 5.3: Implementation Gaps in Corruption Uganda SSA Government Effectiveness 32.5 27.2 Political Stability and Absence of Violence/Terrorism 18.9 34.9 Regulatory Quality 44.0 30.1 Rule of Law 45.4 29.0 Voice and Accountability 33.6 31.6 Control of Corruption 17.7 30.5 Source: World Bank Worldwide Governance Indicators (WGI 2013) Figure 5.4: Accountability Chain Source: Adapted by the authors. Source: Global Integrity (2011). 5.12. Corruption is a serious problem in many resource- income shown in Figure 5.2 suggests that honesty is good national, as compared to 27th for Kenya, 33rd for Tanzania, rich countries. According to the corruption perception index for growth.3 and 46th for Ghana (again, higher scores suggest less corrup- of Transparency International - on a scale of one (corrupt) tion). A recent survey conducted in Uganda by Afrobarome- to 100 (clean) – the corruption index of 18 of the 22 larg- 5.13. In the case of Uganda, corruption was a significant ter (2012) reveals that 53 percent of the surveyed population est oil-producers ranges from 16 (Iraq) to 69 (United Arab macroeconomic concern, even before the beginning of oil does not believe that most of the future oil revenue will ben- Emirates). Only four major oil producers (United States, production. Since then Uganda did not make much progress efit ordinary people.4 Either the Ugandan population is not United Kingdom, Canada, and Norway) have indices higher as compared to other African countries. Uganda is at the 17th well informed of official priorities concerning the use of oil than 70.2 Figure 5.1 provides a snapshot of cross-country percentile, while the average African country is around the money, or there is a lack of trust in the capacity of the gov- evidence linking corruption to natural resources and eco- 30th percentile. Uganda is rated 26 by Transparency Inter- ernment to use oil proceeds to provide public goods. nomic growth (an increase in the corruption perceptions index means less corruption and more honesty). The positive 3. Depending on data availability, there is a slight variation in the number of correlation between high corruption perceptions indices and countries covered by each chart in the text. Data for corruption and natural cap- 4. Round 5 of Afrobarometer survey in Uganda 2012. On the representative ital exist for 142 countries. Liberia and the Republic of Congo were not included survey of 2400 adults (over 18 years) in Uganda between 2nd December 2011 in the left panel of Figure 2 because of their extremely high values for the natural and 27th February 2012, investigators asked the following question: How much capital share, well above 100 percent. Natural capital estimates exist for 1995, of the oil revenue do you think will be used by the government for the benefit of 2. A fuller discussion of these issues is presented in T. Gylfason and Nganou (2014). 2000, and 2005. all Ugandans? 92 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 5.14. Uganda’s corruption problem is mainly an imple- (46th percentile) by the end of the period. Since 2006, Ghana is relatively good, thanks mainly to the work of OAG, the mentation gap. The laws adopted and the oversight insti- substantially improved its performance and its corruption exercise of the investigative (CHD, IGG) and sanctioning tutions created to promote good governance and minimize indicators always stayed above the 50th percentile (reaching (ACD, IG, DPP, MoPS and MDAs) functions is inadequate. corruption are very strong on paper, but actual implementa- the 60th percentile in 2010 before returning to 55 in 2012). This is due to the lack of political incentives for the applica- tion leaves much to be desired. According to an assessment The Revenue Watch Institute recently noted that the Ghana- tion of administrative and criminal sanctions. Deficiencies by Global Integrity, Uganda has an implementation gap of ian oil fund performed well in terms of governance and met in the accountability chain help develop a culture of impu- 47 points. As shown in Figure 5.3, Uganda’s legal frame- 13 of the 16 good governance fundamentals of the Institute.5 nity which creates risks for the materialization of positive work has been given a good score of 98 but the rating of development outcomes. implementation is only 51). 5.17. Opportunities of corruption will multiply in Ugan- da when oil production increases the amount of public 5.19. Accountability in the oil sector should create an 5.15. The government should address the weaknesses rents. To overcome potential problems, Uganda should: (i) institutional environment that will effectively mitigate in its accountability chain, notably with respect to the ensure that information is readily available to the public, (ii) the risks of political capture. To achieve this goal, the application of sanctions for misuse of public funds. Three enforce the existing legislation, and (iii) strengthen agencies structures in charge of the audit function (including the stages dominate the accountability chain: (i) detection in charge of the fight against corruption that is, provide them Office of the Auditor General) should be reviewed and (OAG, PAC), (ii) investigations (CIID, IGG), and (iii) crim- with the financial, material and human resources they need, given new directions with respect to auditing oil revenue inal/administrative sanctions (ACD, IG, MoPS, MDAs) together with an appropriate framework for implementing management. This means enhancing available technical (see Figure 5.4 below). While detection is the strongest link existing procedures.6 Uganda should also join the Extractive and financial skills in the new departments of the Office of in the chain, Uganda’s record with respect to administrative Industry Transparency Initiative (EITI). The experience the Auditor General. In this environment, the strengthening and criminal sanctions is poor. It should be noted, however, of Tanzania – which became EITI compliant in December of the judicial and administrative system (independence/ that a review of specific institutions reveals major differ- 2012 – shows that transparency and EITI compliance have a autonomy of the judiciary and administrative bodies in the ences, with OAG as the strongest institution and IG as the strongly positive impact on government oil revenue. fight against corruption) and a reassessment of the role of weakest (ILPI, 2013). According to an assessment conduct- Parliament based on more assertiveness on the part of its ed by the (International Law and Policy Institute ILPI), the 5.18. An effective operation of the accountability chain members, would improve the system of checks and balanc- most common problems result from three main inadequa- in Uganda would require: (i) OAG audits focused on mis- es in the management and use of oil revenue. cies: (i) lack of specialized technical skills, (ii) inadequate management; (ii) reviews of OAG reports and recommen- staffing and resources, and (iii) case management and legal dations for follow-up action by PAC; and (iii) administrative B. Public finance management constraints. Political interference and corruption also ham- and criminal sanctions by the IG, criminal sanctions by the CHD, the DPP and the ACD; and administrative sanctions 5.20. An important aspect of oil revenue management per performance improvements. by the MoPS and MDAs/IG. While the audit performance will be the integrity of the fiduciary systems. This is espe- 5.16. Ghana, one of the most recent examples of a new cially true given that government decided to manage oil rev- oil producing country, should be an appropriate bench- 5. http://www.revenuewatch.org/news/press_releases/ghanas-us450-million-pe- enue through existing government systems, whenever feasi- troleum-funds-score-well-governance-assessment mark for Uganda. In 2007, the discovery of the Jubilee ble. Effective Public Financial Management (PFM) is also oil field brought Ghana’s oil production to 80,000 barrels 6. The Inspectorate of Government notes several impediments to be removed essential for efficient service delivery and for execution of in order to efficiently fight against corruption. This includes: “inadequacies in per day in 2012 (EIA 2013). With respect to corruption, the existing legal framework, limited human and financial resources, negative public projects. It is also essential for planning and imple- societal attitudes and resistance to implementation of Inspectorate Government Ghana’s indicators varied a great deal during the period recommendations, court delays, poor record keeping and lack of computerized menting activities needed to bring about diversification and 1996–2005 and remained slightly below the 50th percentile data in other institutions and high cost of renting office premises” (Inspectorate achieve the economic objectives of the government. Good of Government Report 2013). 93 Chapter 5 PFM also creates additional fiscal space by reducing wasted Good budget planning should help deliver national econom- spending. During FY2013/14 cash management improved resources and enabling better targeting of funds to where ic development objectives. However, there is significant through quarterly cash flow forecasts and issuance of quar- they are needed most. Key aspects of a good PFM system divergence between NDP goals and budget allocations, and, terly ceilings to MDAs. Approved supplementary requests include macro-fiscal control and stability (macroeconomic in practice, security, public administration, justice, law and declined to less than 4 percent of the originally approved management), budget planning and execution (including order and interest payments tend to exceed planned alloca- budget. However, the capacity of the new Cash and Debt monitoring and evaluation), procurement, cash and debt tions, at the expense of priority economic and social sectors. Management Directorate of MoFPED will need to be management, financial systems and accounting, internal strengthened to develop better cash flow forecasts and real- controls and external oversight. 5.23. The PFM Act 2015, will introduce a Contingencies ize the full benefits of the TSA. Fund which will finance unforeseen, unavoidable and 5.21. Uganda’s performance in PFM is strong on trans- urgent expenditures without destabilizing other com- 5.26. Strengthening control and compliance in fiducia- parency but weak on budget credibility, controls and ponents of the budget. However, unpredictability in the ry systems. Oil revenue, drawn from the Oil Fund into the compliance. As indicated in the Public Expenditure and budget is often due to a lack of internal controls and poor Consolidated Fund will finance the budget through the TSA. Financial Accountability (PEFA) assessment of 2012, Ugan- planning for expenditures such as utilities, taxes and other Under a TSA arrangement, comparing expenditures with da’s performance is satisfactory in the following areas: bud- recurrent costs. The government’s output-based planning budget allocations is done through the Integrated Financial get documents are comprehensive; the general public has system provides a lot of information on outputs linked to Management System (IFMS). While unspent balances are access to key fiscal information, tax payers’ obligations and expenditure items, but monitoring and feedback is required swept back into the main account, spending agencies cannot liabilities are transparent, good accounts are kept, report- to review cost estimates, tackle arrears, establish unit costs spend beyond their budget ceilings and only for the items ing systems are adequate and external audits are extensive and develop a methodology for the planning of the recurrent appropriated by the Parliament and entered into the IFMS. and of high quality. Internationally, Uganda is doing well cost implications of investment expenditures. Strengthen- In order to track expenditures and monitor budget execu- in terms of budget transparency (ranking 18th out of 100 ing the linkage between immediate outputs and results (out- tion, IFMS needs to generate customized reports to demon- countries) but its PFM systems are weak in terms of budget comes) at the sector level is needed to assess the effective- strate that funds were spent for the intended purposes, even credibility, budget execution controls (particularly payroll), ness and efficiency of the budget. with respect to funds with specific conditions (for instance, procurement compliance and legislative scrutiny of external donor projects). audit reports. In most of these areas, Uganda’s performance 5.24. Cash and debt management. The introduction of is below its East African neighbors. The Auditor General’s the Treasury Single Account (TSA) should promote greater 5.27. Some entities do not operate through IFMS and annual reports regularly identify weak compliance with transparency and accounts reconciliation. The TSA should therefore through the TSA. Excess spending is possible PFM regulations, resulting in avoidable or wasteful expen- also facilitate a shift from a cash rationing system to more for transactions carried out outside the system and/or with diture, build-up of arrears, inadequate accountability and, active cash and debt management. Cash rationing is due to respect to spending non-tax revenues without authority. in some cases, the risk of fraud or misappropriation. Chal- budget unpredictability. Weak internal controls, and inade- With only 77 percent of expenditure going through IFMS, lenges and opportunities in these areas are discussed further quate forecasting of revenue and expenditures, lead to bud- there remains a substantial gap that can be exploited. Even below. get cuts (through cash limits) which become necessary to within IFMS, the recent OPM case highlighted a number of finance rising expenditures through the fiscal year. security issues that could lead to more fiduciary risks. There 5.22. Improving the quality and credibility of budget is also evidence that some MDAs charge expenditures to the planning will help achieve national economic objectives, 5.25. The government is trying to break the cycle of wrong codes to be able to spend outside budgeted alloca- and will improve budget execution and service delivery. inadequate budget planning and excessive recurrent tions without formal transfers. As noted in the Auditor Gen- 94 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility tracts, including payments for goods or services that were not delivered. The quality of contract management is weak. Often established procedures are not implemented and only 21 percent of contracts have complete procurement records. 5.30. There is evidence of improvement in the perfor- mance of the contracts audited by PPDA (in FY 2013, 46 percent of contracts were rated satisfactory compared to 27 percent in 2011). Reforms aimed at better budget planning and predictability should improve procurement Audit House, the practices. Nonetheless, ongoing efforts should be consid- headquarters for the office of the Uganda Auditor erably strengthened and extended more widely across all General, on Apollo Kagwa government entities to improve the overall effectiveness Road in Kampala of procurement systems. One should find the right balance between efficient and simple processes and effective con- trols and transparency. The government is committed to eral’s special investigation report on OPM, more needs to a strengthened internal audit system, which has been grant- implement bulk purchases and standardized unit costs (to be done to address the lack of integration between account- ed more independence and a Directorate status in the new realize economies of scale), and to enhance institutional ing and budgeting systems, which leads to weak controls PFM Act. There is a need to ensure that the roll outs of capacity for the management of the project cycle. It is also on the release of funds due to numerous manual interven- these fiduciary systems are properly understood and imple- assessing the feasibility and potential benefits of introduc- tions and lack of proper reconciliation (OAG 2014). Some mented, through increased monitoring, reviews and audits. ing e-Procurement to improve reporting and transparency. of the most significant risks of wastage, errors, delays and Additional change management training, sensitization and An e-Procurement system should be interfaced or integrat- fraudulent losses are found in payroll and pensions man- communications will ensure that responsibilities are well ed with other systems, including IFMS, and accompanied agement. The government is committed to rolling out the understood. More regular monitoring and more effective by change management to reap efficiency and compliance Integrated Payroll and Pension System (IPPS), interfacing incentives and sanctions will also improve compliance. benefits. IPPS with IFMS, introducing biometric payroll records for civil servants and decentralization of the payroll to improve 5.29. Public Procurement. Around 70 percent of public 5.31. Quality and independence of oversight. Reforms to accountability. expenditures go through procurement systems that are crit- enhance the independence of external audits improved the ical for effective service delivery, but are affected by poor quality of audits produced by the Office of the Auditor Gen- 5.28. Through the PFM reform program (FINMAP), practices. Unpredictable and late release of funds can either eral (OAG). The OAG was awarded the Swedish National the government is committed to completing the roll lead to under-spending or to rushed spending at year-end, Audit Office Prize for the Best Performance Audit Report of out of IFMS to all entities over the next 3–4 years. IT making procurement less competitive and more costly. 2013 and 2011. Audit findings are discussed more frequent- audits are also stepped up to tackle system weaknesses (like This has been identified as a key obstacle to efficient use ly in the press and other forums, including the Parliament. use of passwords, assignment of responsibilities, defense of available funds, which affects the credibility of the bud- However, there is a significant backlog of audit reports that against cyber attack,...) These issues will be addressed by get. Furthermore, there is evidence of wastage within con- are not debated in the Parliament. In addition reports are 95 Chapter 5 not published, creating a missing step in the accountabili- is a very critical measure, but the government will need to ensure that future oil revenue will not be wasted. ty cycle and preventing the appropriate follow up with the ensure its enforcement. executive. Parliamentary processes need to be reviewed for 5.36. The following paragraphs review the main compo- a more efficient handling of audit reports. In addition, the C. Public investment management nents of an effective reform of public investment man- inter-institutional linkages between OAG and its partners agement. 5.34. The management of Uganda’s public investment (investigation bodies and other regulators/auditors includ- program is weak. Uganda ranks 46th out of 71 countries a. Strategic Guidance and Project Appraisal. Strategic ing PPDA) need to be strengthened to improve coordination in the IMF’s public investment efficiency index (PIMI), guidance for public investment is an important compo- and focus reporting on risks and impact. with relatively poor scores in project implementation and nent of the project preparation and selection process. In 5.32. Other Public Sector Management Issues (PSM). evaluation. A breakdown of the index shows that Uganda is 2012, the government adopted the Vision 2040 which In addition to developing appropriate PFM systems, it is performing well in terms of project selection (compared to defines an ambitious thirty year structural transforma- critical to ensure that individuals operating these systems Tanzania and Kenya). However, with respect to implemen- tion strategy aimed at making Uganda a modern society and following rules and procedures understand their respon- tation and evaluation of public projects, Uganda is behind and a prosperous economy. Five-year National Devel- sibilities and can carry out their functions effectively. The Tanzania and Kenya. A recent IMF report (2013) noted that opment Plans will be the main instruments of the Vision. capacity of public servants in PFM functions should be Uganda’s public investment performance is characterized The first NDP ended in June 2015, while the implemen- developed. Basic accounting, audit, cash management, pro- by poor planning, delayed procurement and under-execu- tation of the second (2015/16 to 2019/20) is ongoing. curement, monitoring, reporting, management and supervi- tion. The government needs to improve its public invest- Many sectors have adopted strategic plans, which, how- sion capacities are needed to perform ongoing PFM func- ment management in preparation for a major inflow of oil ever, need to be more consistent with national plans. tions and implement reforms. revenue. The work of planning units in line ministries should be better coordinated with the plans, policies and strategies 5.33. Incentives and performance management frame- 5.35. Higher allocations to development expenditures did defined by the National Planning Authority, the Ministry works (pay reform and performance appraisal) should not increase spending. The domestically financed devel- of Finance, and the Office of the Prime Minister. be developed. A number of public service reforms were opment budget was under-executed by almost 40 percent implemented in the 1990s and technical investments in IPPS in FY2011/12 and FY2012/13. Actual development spend- b. Improved coordination. This will ensure that individ- will improve efficiency of financial management. However, ing remained well below the levels envisaged in the NDP. ual projects will be in line with key priorities identified public sector wages stagnated and now are low compared to As a result, the backlog of planned infrastructure invest- in the NDP. Effective PIM systems include procedures private sector equivalents. Uganda’s wage bill accounts for ments increased by over US$1 billion, on top of planned eliminating projects that do not meet minimum techni- about 4 percent of GDP, compared to an African average of new investments totaling about US$ 9 billion for the next cal and financial standards. In Uganda, project propos- about 6.5 percent for the Central Government and 9.8 per- five to seven years.7 To increase spending on infrastructure, als are first approved by sector working groups before cent for all government entities. The PFM Act provides that Uganda will need to strengthen its public investment man- they are submitted to the Development Committee of Accounting Officers will sign annual budget performance agement capacity in order to deliver value-for-money and the MFPED, which reviews all the proposals before contracts with the Secretary to the Treasury, involving bind- integration into the Public Investment Plan (PIP). How- ing obligations to deliver activities in the work plan. This 7. Musisi and Richens (2014). ever, feasibility/pre-appraisal studies are not systemat- 96 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility ically carried out by MDAs before submitting project mentation delays and cost overruns. In Uganda, the DC D. Managing population expectations proposals to the Development Committee, which often often approves projects that do not provide a detailed fails to perform a cost/benefit analysis before approving implementation and procurement plan, assigning man- 5.37. Given the numerous uncertainties associated with projects. Feasibility studies are often carried out once agement responsibilities to specific units or agencies. In the oil sector, the eventual development of the sector and the project has already been included in the PIP. addition the absence of clear organizational structures the possible emergence of additional government reve- responsible for reporting/monitoring projects during nue should not significantly change the overall goals of c. Project selection and budgeting. The project selection implementation leads to a lack of oversight and account- the government strategy. Efficiency gains and economic needs to be integrated with the budget cycle and the ability in planning institutions and implementing agen- diversification must continue to dominate Uganda’s strate- medium-term expenditure framework. Uganda’s recent cies. There is no formal mechanism to track the status gic objectives. Efficiency can provide fiscal space virtually experience in implementing the first NDP shows how of PIP projects, and inform the DC about progress of equal to the expected levels of oil revenue. More impor- difficult it is to maintain a sound and stable macroeco- implementation, including changes in project design, tantly, despite the role oil production and revenue can play nomic framework and implement the country’s invest- delays and reasons for these delays. Consequently, inter- in Uganda’s future, the country should not abandon other ment priorities. Often the Development Committee nal controls on project implementation are often dys- available development and economic diversification oppor- overemphasizes availability of financing at the expense functional. The Budget Monitoring and Accountability tunities. In fact, future oil revenue will be best used if inte- of technical viability and economic priority. Often fea- Unit in the MFPED has the mandate to monitor and ver- grated into Uganda’s current development objectives and sibility studies and pre-appraisals take place once the ify the implementation status of government programs partnerships. project has been included in the PIP and not as a condi- through on-site visits, but there is little evidence that the tion for its inclusion. This means that there is no inven- reports of this unit influence the budget process and are 5.38. In this context, the development and implementa- tory of ready-to-go projects which can be approved used to enforce on time delivery of planned projects. tion of an effective communication strategy is a high pri- and implemented when financing becomes available or ority. This strategy should define clear responsibilities for when the government wants to re-direct public spend- e. Project audit and evaluation. A basic project imple- nation-wide communications on the oil and gas sector. The ing towards a specific sector. This is a serious obsta- mentation review and ex-post evaluation would build ultimate goal of the strategy will be to empower citizens by cle to any short-term increase in public investment. In capacity and create knowledge on public investment educating them on pertinent issues concerning the prospects addition, sound project budgeting requires detailed and management that would feed back into the preparation and the possible impact of oil, gas and other mining activ- realistic cost estimates, which take into account both the and implementation process for new projects. It could ities, and to encourage them to participate in the ongoing capital and the recurrent costs necessary to operate and also build up public support for government interven- dialogue on the future use of oil and gas revenue. This will maintain existing assets. tions by showing that past projects had a substantial also encourage transparency and accountability. impact on the country’s economy and citizens. In Ugan- d. Project Implementation. In general, project imple- da, basic comparisons of project costs with estimates are mentation problems result from poor project selection only performed for large projects. Completed projects and lack of oversight monitoring and accountability. are not systematically evaluated. Value for money audits Poor project selection and inadequate integration into carried out by the Auditor General seldom lead to follow the budget process lead to poor procurement plans and up. Consequently, poor project implementation is not a contract management procedures, which cause imple- cause for concern. 97 Chapter 6 Implementation of the Strategy: Key Messages and Conclusions: The Role of the Private Sector The private sector is the most powerful instrument of economic development. Governments, NGOs and development financing institutions increasingly emphasize the role of private enterprises in the implementation of their development objectives. Global demand for energy and raw materials encourages multi-national corporations to give a higher priority to A modern recreation facility in Jinja Uganda developing countries that now receive more than 50 percent of their foreign direct investments. In addition, a growing number of MNCs include development and corporate social responsibility in their agenda. Uganda’s business environment (129th out of 148 countries in the Global Competitiveness Index) is not favorable to a strong performance of the private sector. The number of registered enterprises almost tripled during the 2000s, but the business landscape is dominated by microenterprises. Oil production will increase average incomes and stimulate private sector development, but limited backward and forward linkages, inadequate access to financing, incapacity of small enterprises to meet the standards of oil companies may reduce the overall impact of the oil industry on the other sectors. The agricultural sector could be a major beneficiary of oil development. Rising national incomes and urbanization will increase the demand for food. Uganda may also have the capacity to develop agro-processing and light manufacturing. Uganda could produce and export products of higher I. The Private Sector as A Development Agent value, building on those it is already exporting within the region. Uganda is exporting plastics, iron and steel, chemicals, paints, cosmetics, construction materials, 6.1. Traditionally, governments, multinational institutions and NGOs are viewed as the main actors in international pharmaceuticals and processed food and could tap into development and little attention is given to the development role of the private sector. Today, however, businesses other products of similar capabilities. (notably multinational corporations) begin to be recognized as credible and resourceful partners in the implementation of the international development agenda. For Koffi Annan in June 2005, “It is the absence of broad-based business activity, not its presence that condemns much of humanity to suffering.” 99 Chapter 6 6.2. Indeed the private sector is the most powerful 6.5. Four reasons justify a more assertive role of the instrument of economic development. It creates econom- private sector in development. First, multinational com- Key Messages and Conclusions: ic growth, pays taxes, and generates government revenue. It panies (MNCs) expand their markets in developing coun- provides employment, modernizes technology, trains staff, tries where a young and growing population demands for- Mining and tourism offer potential for private develops skills and reduces the costs associated with hiring eign products and services. Second, increased demand for sector development. The potential of the mining expatriates. Thanks to health benefits provided by employ- energy and raw materials induces MNCs to reorient part sector is substantial and Uganda is rich in the type of tourism resources that are essential for the ers, employees are healthier and productivity increases. of their operations towards developing countries, which development of a competitive tourism industry. received more than half of global foreign direct investment 6.3. Nevertheless, there is still considerable mistrust on (FDI) in 2011 (OECD, 2012). Third, the media, consumers, Conclusions: the part of the general public and public sector institu- and civil society organizations put pressure on companies • To improve the business environment and tions regarding the priorities of MNCs and other pri- to act responsibly and be accountable for their social and help small enterprises manage crises and vate enterprises. Development is not the main objective environmental impacts. Fourth, as NGOs and donor orga- survive. of the private sector. The goal of private businesses is to nizations seek new sources of funds and innovative ways • To promote regional integration and open make sound investments, with good returns, and to generate to solve complex economic development issues, involve- trade policies. substantial benefits for their shareholders. Yet, their survival ment of the private sector becomes more common. This is • To increase the competitiveness of strategic also depends on their capacity to create a positive economic especially true in the case of large-scale projects requiring a sectors. and social environment that will help them manage crises multi-stakeholder approach. • To support the growth of larger formal sector and ensure the sustainability of their activity. enterprises. 6.6. The response of the private sector is generally pos- 6.4. Consequently, donors increasingly emphasize the itive. A growing number of companies incorporate devel- • To encourage the densification of the industrial role of the private sector and public-private partnerships opment in their business agenda and many multination- landscape and enable firms to benefit from economies of agglomeration. (PPPs) and cooperate with philanthropists to address als include corporate social responsibility (CSR) in their key development issues. A good example of this trend is practices. For some businesses (microfinance banks, “bot- the plan of the Department for International Development tom-of-the-pyramid” operations and social entrepreneurs) (DFID) to prioritize involvement of the private sector, as development is fully integrated into their core operations. indicated in a report entitled: ‘The engine of development: Public responsibility strategies include both corporate The private sector and prosperity for poor people’. The UN philanthropy and activities aimed at filling the gaps caused has also taken a firm stance on the role of business in devel- by the absence of government initiatives. Donating money opment. The UN Global Compact seeks to strengthen the to an existing medical facility is philanthropy but financ- role of corporate responsibility, and the UNDP Growing ing the creation of a medical facility in an area deprived of Inclusive Markets Initiative promotes inclusive business health services would be a more relevant example of pub- models. lic responsibility. One should, however, emphasize that the private sector creates shared value only if its contribution is 100 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility consistent with local needs and organized in collaboration Kaiso Primary School in Hoima, with local stakeholders. constructed with assistance from Tullow Oil 6.7. Within the private sector, corporate social respon- sibility (CSR) leads efforts to improve accountability of firms with respect to social and environmental impacts. Although CSR and governance are two different concepts, they overlap in terms of holding management and senior leadership accountable for their actions. While corporate governance seeks to protect the rights of the shareholders; CSR looks at a wider environment and includes a larger number of stakeholders. 6.8. Instances where companies successfully combine profits and social benefits are rare. However, several large-scale initiatives and standards are gaining traction in this respect (e.g., Council on Mining and Metals, Sustain- able Forest Initiative, Sustainable Fisheries, Global Mining associations are crucial to introduce and implement stan- ranked: (i) 134th in terms of basic requirements (institutions, Initiative, World Business Council for Sustainable Devel- dard operating norms in a sector/industry, thus avoiding the infrastructure, macroeconomic environment, health and opment). More emphasis should be placed on finding syn- need for formal regulation. primary education); (ii) 111th for efficiency enhancers; and: ergies between businesses and sustainable development. (iii) 107th for innovation and sophistication. According to Businesses need to be more aware of the potential benefits II. Current Situation and Prospects of the report the most negative factors are corruption, access to (both economic and social) of CSR for this change to hap- Uganda’s Private Sector finance and inadequate infrastructure. pen. A. Current situation 6.11. Despite a mediocre business environment, the num- 6.9. Incidentally, one way of overcoming the challenge ber of business establishments grew very fast during the of a weak institutional environment is the creation of 6.10. Uganda’s current business environment is not 2000s. However, the average size of enterprises is small business networks and associations. This includes formal favorable to a strong performance of the private sector. and declining. The number of registered businesses almost networks like the Business Council for Africa, and infor- A number of studies and surveys undertaken by the World tripled from 165,000 in 2001 to 458,000 in 2009, but the mal networks like a local women’s entrepreneur network. Bank and other donors lead to the same conclusion. In the business landscape is dominated by a large number of very These networks utilize the power of collective knowledge Global Competitiveness Index 2013-14 Report, Uganda is small firms. The average size of enterprises fell from 3.41 and joint action to support businesses in delivering both ranked 129th out of 148 countries.1 More specifically, it is employees in 2001/02 to 2.35 in 2010/11, and more than 93 financial results and social benefits. Business networks and 1. Down from 123 in the 2012-13 report percent of business establishments on the 2010/11 register 101 Chapter 6 Figure 6.1: Top Ten Business Environment Constraints for Firms in Uganda ing to the WEF Global Competitiveness Report 2013-14, the overall quality of local suppliers is very low (in that area, Uganda is ranked 130th out of 148 countries). Not surprisingly, very few local businesses in Uganda comply with high oil and gas industry standards or even know which certification is needed and how it can be obtained. The challenge is exacerbated by the fact that three IOCs, coming from three different countries, have different standards. In addition, the costs of certification are often prohibitive for local suppliers. Some Ugandan suppliers involved in logistics report that local companies needed to team up to fly in a representative of a certification com- pany from the UK to conduct a certification, as there was no local office in Uganda. The situation improved since February 2011, when Lloyds British Testing Uganda – a Source: Enterprise Surveys in Uganda (2013). subsidiary of Lloyds British Testing – set up an office in Uganda as a base for its operations in East Africa. were categorized as microenterprises (engaging less than 5 shift. With appropriate measures, there is a great potential workers). Wholesale and retail enterprises account for about to generate a “pull” effect for some sectors, take them to the 6.15. Financing is a particularly critical constraint 63 percent of business establishments, before hotels and next level in terms of quality and quantity of production, for potential suppliers of the oil and gas industry. To food services (14 percent) and manufacturing (7 percent). and enable enterprises in these sectors to effectively serve be competitive in this capital-intensive and quality-con- Employment data show a significant reallocation of man- other industries in Uganda and outside. scious industry, local suppliers need access to investment power from the traded sectors (agriculture and manufactur- and working capital on reasonable terms. For an industry ing) to the non-traded service sectors. 6.13. In Uganda, however, the backward and forward where it is common to purchase materials, fulfill purchase links of the oil and gas sector with other sectors are low- orders, perform the work and then wait for 30 days or B. Prospects er than in other countries. By 2007, Uganda’s ranking for more to get paid, cash flow is a critical factor. The lack the extent of linkages was still low and only 18 of 54 sectors 6.12. Oil production will increase average incomes, as a of access to affordable long-term investment capital also appeared to have direct backward links with the oil and gas share of oil revenue is used to buy goods and services on prevents local suppliers from taking advantage of invest- sector (compared to 52 for the Philippines). Like in most of the domestic market. Although this will mainly concern ment opportunities offered by the oil and gas industry. the other countries, the forward links of the oil sector with non-tradable goods and services, it will also affect tradable For instance, investments that should be made in food other sectors are relatively strong, but still lower than in oth- goods that can be produced competitively. With its massive processing plants may never materialize due to lack of er countries like Bahrain and Nigeria. demand for infrastructure, goods and services, the oil sector funding. To increase their capacity and meet the grow- can become a powerful driver for specific activities, which 6.14. Uganda’s oil and gas suppliers may also be unable ing demands from the oil industry, road construction and so far did not have sufficient demand to achieve a major to meet the high quality standards of the IOCs. Accord- rehabilitation companies need sizable investments in 102 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility earth moving equipment and bitumen. In the transportation cent) is declining. The government argues that the small- and logistics industry, domestic capacity is also below the holders who dominate the sector face many constraints Box 6.1: Economic Transformation Requires a projected demand of the IOCs and investments need to be including unpredictable climatic conditions, poor quality Combination of Improved Industrial and Em- ployment Policies made to increase the fleet of trucks and the number of ware- inputs, pests and diseases, inadequate storage facilities, lack housing and storage facilities. of relevant knowledge and use of inappropriate technology. Economic transformation goes through the following path. First, 6.16. Another challenge is the fact that a large number 6.18. Rising national incomes, rapid urbanization, the we have a mostly agrarian society, which becomes more indus- try driven, before moving on to a third cycle in which services of Ugandan suppliers, especially SMEs, are at the bot- growth of regional export markets and the development are the engine of growth and employment (Kuznets 1959). Even tom of the supply chain. They are second- or even third-ti- of the oil industry create potential for increased agricul- in developed countries where the share of manufacturing in er suppliers and do not have a direct interaction with the tural production and productivity. Oil production, in GDP is declining, there is evidence that manufacturing creates IOCs. For instance, local suppliers of food will not discuss particular, will lead to a drastic increase in the demand more production links with other sectors and transfers more contracts with the IOCs procurement department, but with for food. More than 13,000 workers will be employed in the production skills than the non-manufacturing sectors. Between the catering company contracted by the IOCs. Although the Albertine region, as the country prepares for oil production. 1950 and 2005, the share of manufacturing in GDP doubled in the fast-growing Asian economies (Republic of Korea, Malaysia, IOCs may wish to promote local content and incorporate This is a major opportunity for Uganda’s agricultural sector, Singapore, and Taiwan), but stagnated in Latin America and clauses to that effect in their agreements with the Engineer- and a gateway out of poverty for smallholders. However, Sub-Saharan Africa. ing Procurement and Construction (EPCs), local suppliers increased incomes will also lead to a growing demand for Another key channel through which manufacturing contributes face a lot of challenges in their interactions with the EPCs, processed products, such as beef, dairy, fruit and vegeta- to economic development is learning by doing, first through which may not be ready to go an extra mile to support local ble products. Introducing modern cultivation techniques, imitation and then through innovation activities (Agénor and content. diversifying production and expanding the agro-processing Dinh 2013). This is how the industrial revolution spread from industry will dominate future government policies for the Great Britain to other countries in Western Europe, the United III. Specific Sectoral Issues development of the agricultural sector. States, Russia, and Japan (Chandra, Lin, and Wang 2013). However, other crucial inputs will be required to enable the A. Agriculture transition from imitation to innovation in industry. These include B. Manufacturing public assets, such as: (i) a responsive training capacity, which 6.17. The agriculture sector could become a major ben- 6.19. Uganda has already taken some steps to diversify is in tune with the latest technologies and driven by the needs eficiary of the development of the oil industry. Currently, of the employers (with respect to occupational profiles and production, exports and the sources of employment for job performance standards); (ii) good governance, that is lack Uganda’s agricultural economy is based almost exclusive- its labor force. The process may have been accelerated by of corruption and a friendly regulatory framework for industry ly on millions of smallholders, working on 2-3 hectares of falling prices for Uganda’s main agricultural exports (cof- and trade, with a minimum of red tape for licenses, real estate land, and using traditional methods of cultivation and fami- fee, cotton and tea). So far, the bulk of the diversification transfers, clearing imports and exports; (iii) a functional justice ly labor. Although the sector employs more than 65 percent went to other peripheral primary products, particularly fresh system with robust sanctions; (iv) public infrastructure, that is, of the country’s labor force, it grows slowly, at an average fish. However, some non-traditional industries, such as cut reliable power and water supply at reasonable cost, broadband rate 4.1 percentage points below the national average since access, roads and ports; and (v) government-driven financial flowers, plastics and metal products, are also increasing reforms, facilitating access to low-cost capital and new forms of 2007.2 As a result, its contribution to GDP (currently 21 per- their exports, albeit from a low base. Therefore the question financing (from simple lease purchase of equipment to venture becomes how can Uganda support further diversification? capital). 2. Ministry of Finance Planning & Economic Development, Background to the Budget 2013/14, June 2013 103 Chapter 6 6.20. In the context of a new approach to structural transformation of economies, Ricardo Hausmann et al. Box 6.2: The Product Space View: Uganda Can Move to Higher Value Exports (2014)3 explored the possibility for Uganda to diversify into new products by assessing the country’s efficiency frontier, underpinned by the distance, the complexity, and the opportunity gains of products in the product space (see Box 1.3 in Chapter 1). Uganda has a signifi- cant presence in many peripheral communities, notably tree crops and flowers, food processing, animal products, fish and seafood. Yet Uganda has made few inroads into the larg- er, more complex and more connected communities such as garments, construction materials, chemicals, and machin- ery. The analysis of Uganda’s efficiency frontiers suggest that, the closest community along the efficiency frontier is food processing in which Uganda already has some pres- ence. Construction materials and equipment would be the next. This community offers a sizable opportunity value without being prohibitively distant. Other communities, such as garments, offer sufficient opportunity gains, but do not represent an improvement over Uganda’s average level of complexity. Others such as metal products and textiles Source: Hidalgo et al. (2007). are either less complex for the same distance, or more dis- tant for the same complexity. Finally, some communities, According to Hausmann and Klinger (2006), the possibility of export diversification in any country can be mapped in the product such as machinery and chemicals, offer both high complex- space. The product space is like a forest of all possible products that countries export. Each product is like a tree and a firm or ity and a large opportunity value, but they are prohibitively country that produces the product is like a monkey located on its tree. Firms can jump from one tree to another, depending on distant given Uganda’s current productive knowledge. their capabilities. The red nodes represent a product. Similar products form a cluster. Some clusters such as coffee, cocoa, tea and tobacco, are 6.21. Uganda can produce and export products of higher relatively far from the core of the product space. But products in clusters at the core are usually manufactures and make it easier value, building on those it is already exporting within for a country to jump from one to another, and expand to other manufactures. Few cotton exporters export textiles or garments the region. Transiting from low to higher value exports (distance is long). But many textiles exporters also export garments (distance is short). Uganda’s manufactured exports (plastics, requires building production capabilities and capacities. iron and steel products, processed foods, and fruits) place the country closer to the clusters. But Uganda’s current exports must be close to a number Why shouldn’t Uganda look at the possibility of producing motor vehicle parts or toys that are being imported into the region of products already produced elsewhere in the world (the today? 3. R. Hausmann, Matovu J, Osire R and Wyett K. (2014); How Should Uganda grow? ESID Working Paper No. 30, January 2014 104 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Steel   Plastic   wood boxes wire products Woven  fabrics Seamless   iron  tubes Plywood Mineral   Cotton  &   working  tools Vegetable   cotton  seed oils Oil  seeds Tea Tin Sand Cereals so-called forest of products).4 Existing value exports, like low and medium technology manufactures, will provide the Figure 6.2: Export Transformation Dynamics within EAC basis for increased vertical specialization and will enable Figure 6.2: Export Transformation Dynamic within EAC Uganda to participate in regional production chains, where 100% trade in parts and components (“trade in tasks”) can be a 80% great opportunity. These results are consistent with Chandra Medium and high technology 60% manufactures et al.(2015) who proposed an export diverstification strateg- Low technology manufactures yat two steps (short and medium term), focusing on current 40% capabilities of Uganda, and long term strategy (see Chapter Resource-based manufactures 20% 1). High Value Primary Products 0% Burundi 1988-90 Burundi 2008-10 Kenya 1988-90 Kenya 2008-10 Rwanda 1988-90 Rwanda 2008-10 Tanzania 1988-90 Tanzania 2008-10 Uganda 1988-90 Uganda 2008-10 6.22. If Uganda is already exporting manufactured Primary Products exports such as plastics, iron and steel, chemicals, paints, cosmetics, construction materials, pharmaceuticals, and processed foods, then it can tap into other products of similar substitutable or adaptable capabilities. Uganda has been the fastest country in the EAC region in the tran- Source: World Bank staff calculations base on Lall (2000) using mirror export data from Comtrade / WITS. sition to higher value exports (Figure 6.2). Informal exports   concentrated in industrial products accelerated that trans- years. Why can’t the plastic utilized to manufacture jerry  tor, in particular manufacturing and services, employs formation.5 Existing exports are an entry point to leverage   cans be used to substitute for plastic imports from China a small share of total labor force. Even so, policies to other higher value export products, notably resource-based/   and expand regional markets? shift Ugandan workers from relatively low-productivity   agro-industrial products for Sudan and the DRC. They  agricultural and non-agricultural informal sector activities also represent an opportunity to tap into other products of 6.23. In brief, Uganda can compete with a more indus-  need to start with that sector. The low productivity of Ugan- similar substitutable or adaptable capabilities. Since Ugan- trialized Kenya, especially to serve the rising regional  dan firms is confirmed by past investment climate surveys, da is already producing plastics and steel products; why demand for manufactured goods. Because of distance, which give very low grades to Ugandan firms, compared to shouldn’t it look at the possibility of producing motor vehi- Uganda may not have a competitive edge6 in manufactured most of the other countries in Sub-Saharan Africa (SSA). cle parts? Opportunities for import substitution across the goods. This issue will need to be addressed through better Although wages in Uganda are low, total factor productivity region are also expanding fast, driven by external factors. connectivity to bring imported raw materials more cheaply, is lower in the manufacturing sector than in the African and With rising labor costs, China may not be producing toys or and through lower cost of doing business in order to place East Asian countries that achieved success in the area of other similar low value manufactured goods in the next ten Uganda in a competitive position with its coastal neighbors, export-oriented manufacturing. especially for the regional market. 4. Hausmann R and B. Klinger (2007) changes in the revealed comparative 6.25. Improvements in firm productivity are constrained advantage of nations are governed by the pattern of relatedness of products at 6.24. As in other parts of Africa, Uganda’s formal sec- by many factors including the high cost of energy and the global level. 5. Some of the industrial products are re-exports from Kenya and China, but over transportation infrastructure and the lack of access 60 percent of informal exports are Ugandan made, including plastics, cement, 6. Kenya is at a higher level of industrialization than Uganda and hence produces to finance, land, business development services, and and iron sheets. most industrial goods more competitively than Uganda. 105 Chapter 6 skilled labor. Despite ongoing government interventions, broad based development, the mining industry must be inte- the supply chain and the induced effects of households business surveys continue to highlight high transport and grated into the national and regional socio-economic fabric spending earned wages. This figure compares with US$2.3 energy costs, lack of access to finance, limited business ser- through linkages. of GDP generated by one dollar’s worth of traditional vices and lack of skilled labor, as major constraints to firm exports.7 Uganda’s main tourism resources include productivity growth. A recent study by the Government of 6.28. The development of the mining sector hinges on renowned national parks and wildlife.8 The Murchison Falls Uganda also shows how skill gaps, poor management prac- addressing a series of challenges beyond the adequacy National Park (MFNP), which attracts the largest number tices and weak governance have constrained firm growth of the legal and regulatory framework. To harness link- of visitors, is also the region where 40 percent of the oil and job creation. These constraints have different levels of age opportunities, challenges such as deficiencies in human reserves are located. Total operates in two areas located in impact depending on the size of the firm and on whether or capital formation, particularly in knowledge intensive the northwestern part of the park. not it is a newly established business. areas, and infrastructure inadequacies must be addressed at the earliest possible time. A good utilization of oil rev- 6.30. Oil exploration is a long and complex process C. Mining enue could provide that opportunity. But, the role of for- involving different activities at each phase and the eign investment will be key to materializing the potential impact on tourism is different during each of these 6.26. Uganda has more than 27 mineral commodities of the mineral sector. In fact, like many other mineral rich phases. The impact of oil exploration will not be limited to in deposits with potential for commercial exploitation, African economies, most of the new capital investment in natural capital, but will also concern human capital, services including copper, cobalt, gold, iron ore, columbite tanta- Uganda comes from China. Chinese companies have dug and the regional economy. The entire oil exploration and lite, tin, titanium, tungsten, limestone/marble, phosphates, in, over the past 2 years, and now control the largest mining production cycle spans over about 20–50 years. During this vermiculite, rare earth elements, kaolin, gypsum, salt, glass concessions by market capitalization (Sukulu Phosphates, long period, oil will play a significant role in the Ugandan sand and dimension stones. Rare Earth Elements in the East and the Copper and Cobalt economy. However, the economy of the Albertine region project at Kilembe Mines in Western Uganda). The region- where oil has been discovered also depends on agriculture, 6.27. Despite the current underperformance of the min- al dimension could also be instrumental in developing the fishing and tourism. These sectors not only diversify the ing sector, there are positive prospects that could be lev- Ugandan mining sector (see Chapter 7 on Regional Integra- economy during the oil extraction period, but also contrib- eraged through the promotion of linkages with the rest tion). In fact, as a landlocked country, all the mining equip- ute to the sustainability of the regional economy and to the of the economy. The relative political and socio-econom- ment, machinery spare parts and skilled labor required for prosperity of the local community. A holistic plan support- ic stability of the country, high mineral commodity pric- the development of the sector will come through neighbor- ed by an effective monitoring system should be in place to es, increased global demand for minerals from emerging ing Kenya and Tanzania. minimize the negative impact produced by each phase of oil economies like China and India and availability of geo-da- exploration. ta, stimulated a significant increase in FDI in the sector. If D. Tourism minerals are to be harnessed for sustainable development and poverty eradication the government must adopt com- 6.29. Uganda is rich in the type of tourism resources 7. Economic and Statistical Analysis of Tourism in Uganda. The World Bank, June prehensive, development-driven policies that move beyond that are essential to create a tourism industry capable of 2013 8. Uganda’s 10-year tourism master plan was prepared by UNWTO in 2013. a narrow focus on the extractive industries sector and look competing internationally and sustainably. The economic Making sustainable use of natural assets was highlighted in the vision of this for the value of the derived demand from mineral products analysis of tourism in Uganda shows that each dollar of plan. In addition to the nature resources, strengthening of the wildlife product in the main national parks is recognized as an effective way to diversify tourism through the mineral value chain (Annex 7). The African expenditure by a foreign tourist generates US$2.5 of gross products. The strategy also recommends that visitors’ experience be upgraded to reflect the iconic nature of attractions, particularly in MFNP where the overall Union (2009) indicated that to improve its contribution to domestic product, including the indirect value added along tourism image is already being negatively impacted by oil exploration activities. 106 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 6.31. The government and Total are implementing plans to minimize the negative impacts of oil exploration and A thorough environmental impact assessment of the exploration activities has to be made and findings implemented so as to protect the wildlife that exists within these areas production. Total is committed to respecting the natural and human environment. Environmental and Social Impact Assessments are conducted prior to all activities and this process includes stakeholder consultations. Specific actions have been taken to (i) ensure effective waste management, (ii) develop an oil spill contingency plan, and (iii) restore the locations after activities are completed. In addition, Total developed a tourism stakeholder strategy and adopted the horizontal oil drilling method with a view to reducing its impact on environment and wildlife. On the side of the public sector, the Uganda Wildlife Authority also provid- ed operational guidelines for oil and gas exploration and production in protected areas. However, given that oil E&P involves multiple sectors and authorities, the guidelines should better define roles and responsibilities. The cur- rent guidelines are focused on private sector activities and infrastructural interventions in the Albertine Region, which last long, particularly in terms of damage to a destination’s enforcement procedures are not specified. Another (import- would strengthen supply chains and enable local suppliers brand and its ability to attract future investments and tour- ant) missing component in the operational guidelines is the to participate in the oil industry. ists. Tourists’ perceptions about a destination are difficult spill contingency plan, which prepares the public and pri- to manage and the recovery efforts would require extensive vate sectors to respond quickly to a potential disaster and 6.33. The best practices for a sustainable cohabitation of resources and technical assistance. minimize the negative impact. oil extraction and tourism are to be found in Canada, Australia, and Namibia. In order to foster economic devel- IV. Priorities for Public Sector Interventions 6.32. Even with strategic planning and day-to-day man- opment in both the oil and the tourism sectors, continuous agement, the ongoing oil exploration activities will bring collaboration between different stakeholders is critical to 6.35. In this context, the role of the public sector should both challenges and opportunities for the tourism sec- optimize growth while identifying, avoiding, and mitigating be to improve the business environment to stimulate pri- tor and the local communities. Full-scale oil operations risks. vate sector activity, attract FDIs and develop linkages require improved access and upgraded infrastructure, which between the oil industry and local enterprises. At the will also stimulate the development of the tourism sector 6.34. In a disaster scenario, the scope of impact can go same time, the government should extend and deepen its in the region. The World Bank funded Albertine Region beyond the geographic area where the accident takes cooperation with IOCs and other private enterprises, and Sustainable Development Project is designed to improve place. In addition to the direct impact on travel demand, identify and implement common projects. The best way regional and local access to infrastructure, markets and there is the more extensive impact on the regional economy to make the cooperation effective is for the government to skills development. This project can be leveraged to support and the livelihoods of local communities. The impact can articulate clearly its development objectives and provide guidance to all the stakeholders. 107 Chapter 6 Tourists board a ferry to the islands on Lake Victoria. The oil exploration activities will have benefits and challenges for the tourism industry 108 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility 6.36. Several policy interventions-easier customs clear- often extremely short. Interventions should aim less at ance for tradables, better access to electricity and increasing their size, and more at ensuring that they sur- reduced power losses, improved availability of finance vive. If a larger number of these firms survive, they can and better definition of property rights-could boost drive an expansion in employment opportunities in the production and productivity and increase firms’ partic- formal sector. ipation in export markets. New research (Kiendrebeogo b. Promoting a higher level of integration with regional and Nganou 2015) suggests that the quality of the invest- and global economies through implementation of open ment climate has a major impact on export decisions and trade policies and increasing the competitiveness of export intensity. The likelihood of exporting is high when strategic sectors: Sectors that are integrated with the (i) customs clearance is quick, (ii) power losses are low, (iii) rest of the world economy are not limited by the size access to finance is high, and (iv) access to land is also high. of the domestic market. The manufacturing and modern In Uganda, a reduction of one day for clearing customs is services sectors are characterized by increasing returns associated with an increased likelihood of exporting of 7.4 when they are integrated. This is clearly demonstrated to 8 percentage points. A one percentage point reduction in by the Chinese experience with manufacturing and the power losses increases the probability of exporting by 5.4 Indian experience with services. to 11 percentage points. Similarly, increasing the access to finance and land by one percentage point leads to an c. Supporting the growth of larger firms: Transformative increased likelihood of exporting of 44.7 to 65.1 and 17.7 productivity growth is likely to be driven by middle- to 61.5 percentage points, respectively. As for export inten- and large-size firms, particularly in terms of supporting sity, one day less to clear customs leads to an increase of a higher level of integration with regional and global 7.6 to 10.4 percentage points in the export to sale ratio. An economies. In Uganda a number of sectors – includ- increase of one percent in financial access is associated with ing building materials, metals, fish processing, grain an increase of 10 to 18.9 percentage points of export intensi- products and plastics – have great potential for creat- ty. Improving business licensing and permits by 10 percent ing significant employment opportunities, if they are increases the export-to-sales ratio by 9.5 to 11.1 percentage supported to achieve a higher level of export-oriented points. Improvements in the overall business environment value-added. Building export competitiveness will be could also strengthen the linkages of the oil and gas sector mainly obtained through a focus on larger firms. In sec- with the rest of the economy (see Annex 6). tors with weak value chain linkages, including the agri- cultural sector, it is important for stakeholders along the 6.37. Special efforts are needed to develop the formal value chains (including farmers, traders, and proces- sector. In this area, the policy agenda should focus on: sors) to collaborate and create strong commercial links to maximize gains and accelerate the level of commer- a. Creating an environment that enables small firms to cialization, which is strongly correlated with the level survive and grow: Small firms are the largest source of productivity. of productive employment in the formal sector. The constraints faced by these firms, including high infra- structure costs and lack of access to finance and busi- ness development services, mean that their lifespan is 109 110 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Chapter 7 Implementation of the Strategy: Key Messages and Conclusions: The Impact of Regional Integration Uganda is one of the main beneficiaries of the East African Community. About 25 percent of Uganda’s exports go to other EAC countries. Adding informal trade would double the size of the country’s regional exports. Regional integration helped Uganda diversify production and exports. In the 1990s, Uganda was mainly a food exporter to European countries. Today, the share of Europe is declining, the share of other EAC countries increases and half of Uganda’s regional exports are manufactured products. EAC markets also provide outlets for small firms that otherwise would not be able to export. The development of a regional infrastructure and the reduction of transport and other cross-border trading costs are at least as important as preferential tariff agreements to stimulate regional trade and economic activity, particularly for a landlocked country like Uganda. Uganda relies heavily on the Northern Corridor that connects Burundi, Rwanda and Uganda with the port of Mombasa. The capacity of the corridor is a major concern. Rwanda, Uganda and Kenya give the highest priority to improving road and rail infrastructure along that corridor. Uganda should also support improvements on the Central Corridor (to Dar es Salaam) to reduce vulnerability to monopoly positions on the Northern Corridor. Originally impassible roads have Better transport infrastructure and services should be now been upgraded and made usable combined with improved trade and logistics services, and reduction of non-tariff barriers to trade. Together with its neighbors, Uganda plans to I. Uganda Derives Substantial Benefits from Membership in The East African Community (EAC) build a regional infrastructure for oil processing and transportation. Uganda’s oil refinery will be owned by private investors, Uganda and other EAC 7.1. Uganda is an active member of the EAC since its creation in 2000. In 1999, Uganda signed the EAC treaty whose governments. The pipeline will transport crude from objective is to rebuild the regional institutions created by Kenya, Tanzania, and Uganda in 1967.1 Following the approval Western Uganda to Lamu in Kenya or to Tanga in of the treaty, the EAC members adopted initiatives aimed at extending and strengthening their cooperation: (a) the EAC Tanzania. If the Lamu option is adopted, it will also Customs Union, launched in January 2005, sets common external tariffs; (b) an EAC Common Market protocol, signed in transport crude from Northwestern Kenya and will be connected with another pipeline from South Sudan. November 2009, will allow the free movement of goods, people, and services, increasing opportunities for regional trade 1. That collapsed in 1977. 111 Chapter Chapter One7 Figure 7.1: Export Destinations within Four Major Regional Economic Communities (RECs) Key Messages and Conclusions: EAC countries have decided to establish the foundations of a monetary union and to create a 100% common currency within ten years. A monetary union SADC EAC ECOWAS CEMAC has benefits: a credible central bank, lower transaction 90% costs, harmonized regulations and tax collection 80% systems. The costs are limited capacity of independent 70% monetary policies, and virtual impossibility of reversing Export!to!Non! the move to monetary integration. The recent discovery SSA 60% of oil and gas is a new challenge. The resource boom Export!to! 50% will have asymmetric implications for countries that Other!SSA are resource-rich (Kenya, Tanzania, and Uganda) 40% and resource-poor (Burundi and Rwanda). It will put Export!within! 30% pressure on prices and may create a risk of spill-over of REC the Dutch Disease to other countries. 20% 10% Conclusions: 0% 2000 2003 2006 2009 2012 2000 2003 2006 2009 2012 2000 2004 2008 2012 2000 2003 2006 2009 2012 • So far, the creation of the East African Community had a positive impact on Uganda’s economic ! ! ! ! growth and helped the country diversify production ! and exports. Source: Yoshino (2014). • To maximize the benefits of regional integration, Uganda and its neighbors should give a high and investment; and (iii) in November and the Southern Africa Develop- Intra-EAC exports have been growing priority to building/improving the regional transport 2013, all the EAC members, including ment Community (SADC). The EAC, since 2005 (when the customs union infrastructure, as well as trade and logistics Uganda, signed a protocol creating a COMESA, and SADC are working to was established), and now account services to reduce cross-border transaction costs. monetary union. improve their collaboration and plan to for 21 percent of total exports of EAC • The creation of a monetary union within ten years launch a new East and Southern Afri- countries. Intra-EAC trade is expected will be a major challenge. There will be pressures 7.2. Uganda demonstrated its com- can Free Trade Area. to further increase when the member for diverging growth paths between energy- mitment to EAC by reducing tar- countries move to a common market. exporting countries (Uganda, Kenya and Tanzania) iffs, harmonizing standards, and 7.3. The EAC is the most integrated and Burundi and Rwanda. Prudent monetary and fiscal policies, appropriate fiscal rules, sound supporting the establishment of the RECs in Sub-Saharan Africa. Figure 7.4. Uganda depends more on the public investment management and improved labor East African Legislative Assembly 7.1 compares the level of integration-in regional market than most of the circulation are some of the measures necessary to (EALA). Uganda, however, is also terms of relative size of intra-regional other EAC countries, except Rwan- fight the Dutch Disease and maximize the benefits of the monetary union. member of other regional institutions, exports-in the EAC and in three oth- da. About 20 percent of Uganda’s total including the Common Market for er regional economic communities (formal) trade is with other EAC coun- East and Southern Africa (COMESA) (SADC, ECOWAS and CEMAC). tries, and the share of intra-EAC trade 112 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 7.2: Share of Intra-EAC Exports and Imports (Percent of Total Exports and Imports by EAC Countries), 2012 in Uganda’s total trade is the second highest after Rwanda (Figure 7.2); its exports are increasingly directed to other 45% EAC members, which already receive 25 percent of Ugan- Export Import Export + Import 40% da’s exports. For some products (dairy, oil seeds, cereals, 35% machinery, fats and oils, salt, iron, and steel), EAC coun- 30% tries receive more products from Uganda than from the rest 25% of the world. 20% 15% 7.5. In fact, these figures underestimate the importance 10% of regional trade for Uganda’s economy. Uganda’s trade 5% with neighboring countries includes a significant volume 0% of informal activity. The Bureau of Statistics (UBOS) and Burundi Kenya Rwanda Tanzania Uganda the Bank of Uganda (BoU) estimate the volume and the value of cross-border informal trade between Uganda and neighboring countries every year. Adding informal exports Source: IMF Direction of Trade Statistics. to formal exports would increase Uganda’s exports to neighboring countries by more than 50 percent (Figure 7.3). Figure 7.3: Formal and Informal Exports of Uganda by Destination, 2012 7.6. So far, Uganda’s participation in regional institu- tions had a positive impact on the country’s economic growth and trade. Uganda’s export profile is becoming 450 increasingly diversified in terms of products and destina- 400 Informal Exports Formal Exports tion. Exports within the EAC are one of the drivers of that 350 trend. Fifteen years ago, as shown in Figure 7.4, Uganda 300 was essentially a food exporter to Europe (food products 250 200 accounted for about 90 percent of Uganda’s exports during 150 the 1993–1995 period and 85 percent of these exports 100 went to European Union countries). In 2008-2010, food 50 still accounted for about 67 percent of total exports, but 0 the share of the EU as the destination of Ugandan exports Burundi D.R congo Kenya Rwanda South Sudan Tanzania decreased from 83 percent to 49 percent, while exports of food and manufactured products to other EAC countries Source: Uganda Bureau of Statistics Statistical Abstract 2013. 113 One Chapter 7 Figure 7.4: Share of Ugandan Exports by Destination and by Product (a) 1993–1995 Average (b) 2008–2010 Average increased substantially. In 2008-10, about 20 percent of Uganda’s exports went to other EAC countries and half of these exports were manufactured products. 7.7. Uganda’s trade data show that there is a higher propensity to the creation of new exports in the region- al markets than in markets outside of the sub-region. Based on the decomposition of Uganda’s export growth between 2000 and 2010 (as shown in Table 7.1), 13 percent of the growth is explained by new products or new destina- tions within EAC (the so called extensive margin growth). The EAC is the most prominent contributor to the growth of Uganda’s exports on extensive margin among all the differ- Source: Original estimation by the authors based on UN-COMTRADE/WITS data. ent markets which receive Uganda’s exports. Table 7.1: Decomposition of Uganda’s Export Growth 2000-2010: Intensive Margin vs. Extensive Margin Total EAC SADC Other MENA Europe Asia North Amer- Others SSA ica Intensive Margin 39.7% 11.1% 5.1% 8.1% 0.5% 14.4% -1.15% 1.55% 0.0% o/w - More exports in existing products to existing countries 60.4% 13.6% 7.8% 8.4% 1.1% 23.6% 2.2% 2.0% 1.7% - Less exports in existing products to existing countries -8.3% -1.9% 0.0% 0.0% -0.1% -3.7% -1.4% -0.2% -1.0% - Extinction exports in existing products to existing countries -12.4% -0.5% -2.6% -0.3% -0.5% -5.6% -1.9% -0.3% -0.7% Extensive Margin 60.3% 13.2% 8.0% 8.3% 9.9% 7.7% 8.0% 0.8% 4.4% o/w - More exports in existing products to new countries 45.1% 8.6% 5.7% 5.6% 7.3% 6.6% 7.1% 0.6% 3.5% - More exports in new products to existing countries 14.9% 4.6% 2.3% 2.5% 2.6% 1.0% 0.9% 0.2% 0.8% - New exports in new products to new countries 0.3% 0.0% 0.0% 0.2% 0.0% 0.0% 0.0% 0.0% 0.0% Source: Regolo (2012). 114 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Table 7.1: Decomposition of Uganda’s Export Growth 2000-2010: Intensive Margin vs. Extensive Margin North Total EAC SADC Other SSA MENA Europe Asia Others America Intensive Margin 39.7% 11.1% 5.1% 8.1% 0.5% 14.4% -1.15% 1.55% 0.0% Of which - More exports in existing products to existing countries 60.4% 13.6% 7.8% 8.4% 1.1% 23.6% 2.2% 2.0% 1.7% - Less exports in existing products to existing countries -8.3% -1.9% 0.0% 0.0% -0.1% -3.7% -1.4% -0.2% -1.0% - Extinction exports in existing products to existing countries -12.4% -0.5% -2.6% -0.3% -0.5% -5.6% -1.9% -0.3% -0.7% Extensive Margin 60.3% 13.2% 8.0% 8.3% 9.9% 7.7% 8.0% 0.8% 4.4% Of which - More exports in existing products to new countries 45.1% 8.6% 5.7% 5.6% 7.3% 6.6% 7.1% 0.6% 3.5% - More exports in new products to existing countries 14.9% 4.6% 2.3% 2.5% 2.6% 1.0% 0.9% 0.2% 0.8% - New exports in new products to new countries 0.3% 0.0% 0.0% 0.2% 0.0% 0.0% 0.0% 0.0% 0.0% Source: Regolo (2012). 7.8. In addition, EAC markets provide outlets for firms Figure 7.5: Divisions by Suppliers to Domestic Market of a Resource - rich Country that otherwise would not be able to export. Firm-level data from Uganda Revenue Authority (URA) show that the Price/Cost distribution of EAC markets across exporters is bimodal. A large number of firms ship less than 20 percent of their export turnover to EAC markets but a large number of other Domestic Cost Function firms ship over 80 percent of their exports to EAC markets. The average size of exporters to EAC countries is smaller EAC Neighbor’s than that of firms exporting outside the EAC. Thus, EAC Cost Function markets provide a breeding ground for exports by relative- World Cost Function ly small enterprises which may not have the capability of Trade Diversion Trade Creation exporting to non-EAC markets. (Previously Imported from Outside EAC) (Previously Non- Tradable) Continuum of 7.9. Regional integration can, therefore, be a platform Products Z ϵ [0,1] for economic diversification and inclusive growth. For Imported from Imported example, regional maize markets provide a good opportuni- Outside EAC within EAC Domestically Produced ty for Uganda to generate inclusive, export-led, growth that could help reduce rural poverty, as food demand in the EAC is expected to double in the next fifteen years. Source: Adopted from Venables (2009). 115 Chapter 7 II. Regional Integration Also Depends on Figure 7.6: Average Transport Prices, 2006–2007 Improved Regional Infrastructure and Services Douala (Cameroon) - Ndjamena (Chad) 7.10. The promotion of intra-regional trade depends not only on preferential tariff agreements but also on Mombasa (Kenya) - Kampala (Uganda) substantial reductions in cross-border trading costs. Lome (Togo) - Ouagadougou (Burkina Faso) Combined with lower transport costs, regional integration Durban (South Africa) - Lusaka (Zambia) generates new trade based on traditional non-tradable prod- Western Europe (Long Distance) ucts. Figure 7.5 presents a stylized picture of how lower China transport cost for intra-regional trade (compared to global United States trade) not only diverts imports from outside the sub-region to suppliers in the sub-region, but also creates new trade by Brazil allowing domestic buyers to import from regional suppliers Pakistan goods that traditionally are provided by domestic suppliers. 0 2 4 6 8 10 12 In other words, some traditionally non-tradable products Cents per ton-kilometer can become tradable. Typical examples of such sectors are services. For example, construction services, which tradi- tionally are supplied domestically, could be supplied by Source: Teravaninthorn and Raballand (2008). neighboring countries. Regional integration would trans- form these services into a tradable sector. Table 7.2: Cargo Transit Time along the Northern Corridor (2005 Data) 7.11. Improved regional infrastructure and services Average Days Standard Deviation are particularly critical for a landlocked country like Port of Mombasa 13 9.5 Uganda. Uganda’s regional and international trade uti- lizes two major inter-country transport corridors. The Transit in Kenya 4 2.5 Northern Corridor connects Burundi, Rwanda, Uganda and Border (Malaba) 1 1.5 Kenya with the port of Mombasa. The Central Corridor con- Transit in Uganda 2 1.5 nects Burundi, Rwanda, Uganda and Tanzania with the port Final Rwanda 5 3 of Dar es Salaam. Uganda relies mainly on the Northern Corridor for its exports and imports. Data show that 98 per- Total 25 10.5 cent of Uganda’s imports use the port of Mombasa (Figure Technical mínimum 5 7.7). Most of that traffic is through roads. Road conditions Average Delay 20 between Kampala and Mombasa are adequate thanks to a Source: Arvis, Raballand, and Marteau (2012). series of road rehabilitation projects in Kenya and Uganda. 116 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Figure 7.8: Transit Traffic t ough Mombasa and the Northern Corridor by Destination Source: World Bank Uganda DTIS. In 2013, Kenya, Uganda, and Rwanda created the Coalition and also high variability as reflected in standard deviations of the Willing (COW) to fast-track their integration along along various transit stages from Mombasa to Kigali (Table the Northern Corridor. A simulation analysis based on trade 7.2). CGE model (GTAP) shows that deep integration results in significant gains for EAC countries and extending to multi- 7.13. The capacity of the Northern Corridor is under lateral liberalization double the gains for Uganda (Balistreri, pressure. The transit traffic through the Northern Corridor Tarr, and Yonezawa 2014). more than doubled in the past ten years (Figure 7.8). This is due to two main factors. First, South Sudan’s trade integra- 7.12. Although physical conditions are relatively good, tion with the rest of East Africa progresses. Second, the low transport services along the Northern Corridor are cost- efficiency of the Central Corridor (through Tanzania and the ly and experience delays. According to Teravaninthorn port of Dar es Salaam) pushes traffic from/to inner coun- and Raballand (2008), the average transport price between tries (Rwanda, Burundi, and Eastern DRC) to the Northern Mombasa and Kampala in 2006 to 2007 was 8 cents per Corridor. ton-kilometer (tkm), that is, higher than between Durban There has been massive investment 7.14. Uganda, Rwanda and Kenya want to strengthen in the upgrade of transport and Lusaka (South Africa-Zambia) and in many other parts infrastructure to facilitate easier in the world (see Figure 7.6). Transit time data of 2005 indi- their cooperation to improve the capacity and efficien- movement of goods and services cate average delays of 20 days for transporting products cy of the Northern Corridor, including the rail net- around the country. through the Northern Corridor (from Mombasa to Kigali), work. Most of the traffic on the Northern Corridor is by 117 Chapter 7 Figure 7.7: Uganda’s Import Routes by Corridor: Uganda performs well in terms of timeliness, but continues Table 7.3: Uganda’s Logistics Performance 1999–2009 Average to underperform on tracking and tracing. The country ranks Index 2010 low in terms of logistics. The 2010 Logistics Performance Score Rank Index (LPI) places Uganda among the top ten reformers in Overall LPI 2.82 66 the world.2 However, as shown in Table 7.3, the country Customs 2.84 44 ranks 66th overall and definitely needs to improve its com- Infrastructure 2.35 89 petitiveness in trade-related logistics. International Shipments 3.02 60 Quality Logistics Services 2.59 76 7.18. A number of regional trade-facilitation initiatives, Tracking and Tracing 2.45 114 to which Uganda subscribes, delivered substantial ben- Timeliness 3.52 60 efits in terms of lower trade costs, as demonstrated by Source: World Bank Logistics Performance Index. ASYCUDA data. The modernization of Uganda’s border Source: World Bank Uganda DTIS. management is often quoted as a model, with border-post dwell times cut from three days to three hours. According roads. Uganda, however, is also connected to Mombasa the country’s ability to export competitively bulk commodi- to the Uganda Revenue Authority (URA), this is due to by a railroad, which runs in parallel with a trans-boundary ties like maize or coffee. inter-connectability of Customs ICT systems with neighbor- road route. In 2008, the EAC countries adopted a master ing countries, availability of pre-arrival facilities, prompt plan to strengthen the regional railway system by intro- 7.16. For Uganda, the economic cost of being landlocked handling of assessments, 24/7 operations, and self-assess- ducing a new high-speed high-capacity rail to replace the comes not only from infrastructure bottlenecks but also ment by customs. The government will support additional old narrow gauge system. In August 2013, the presidents from inefficiency in logistics. Arvis, Raballand, and Mar- structural reforms aimed at improving revenue collection, of Kenya, Rwanda, and Uganda announced that the three teau (2010) argue that the efficiency of logistics/trade ser- rolling out e-tax, reducing compliance costs, introducing countries would speed up implementation of the master plan vices for landlocked countries is even more important than electronic cash registers, upgrading ASYCUDA, and facil- and promised to build the new railroad connecting the three massive investment in infrastructure. High costs often come itating tax administration in order to reach informal-sector countries by 2018. The new railroad could introduce more from unreliable and unpredictable logistics services. Build- taxpayers. The government is also committed to improving competition in transport services along the corridor. ing new or rehabilitating existing transport infrastructure service delivery which should also improve tax compliance. should, therefore, be combined with efficient policy and 7.15. More efforts should also be made by the govern- institutional meaures aimed at improving trade and logistics 7.19. A competitive market for logistics services is an ment of Uganda to revive multimodal transportation, services. important factor to maximize the impact of reforms on especially on the central corridor, in order to reduce transport costs and prices. The structure of the logistics the country’s vulnerability to monopoly positions on the 7.17. Uganda’s indicator for “trading across borders” is services industry, including the influence of cartels or syndi- northern corridor. Programs aimed at rehabilitating rail low, with the country ranking 164th in the Cost of Doing cates and formal and informal systems of freight allocations, links have been floundering for years, making road the dom- Business of 2014 (as in the previous year). The number of often affects the quality of services. A simulation conducted inant mode of transportation. This raises the cost of moving documents required to clear exports and imports are in line by Teravaninthorn and Raballand (2008) shows that mea- heavy bulk cargo such as cement and construction materials, with regional averages, but the costs per container are 32 increases the price of non-tradables in Uganda and reduces percent higher for exports and 20 percent higher for imports. 2. Uganda has not been covered for more recent LPIs in 2012 and 2014. 118 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility sures aimed at reducing the time and costs of transportation along international corridors are far less effective without Table 7.4: Simulated Differences of Impacts on Transport Costs and Price a competitive market environment. Also, their impact in terms of transport price will be completely nullified in a Competitive Environment Regulated Environment (in percent) (in percent) regulated environment (see Table 7.4). Change in Change in Change in Change in Change in Change in 7.20. Non-tariff barriers (NTBs) also are a major obsta- Measure transport transport transport transport sales sales costs price costs price cle to a successful implementation of the Customs Union Rehabilitation of Protocol and further expansion of Uganda’s regional corridor from fair to -15 NS -7 to -10 -5 NS 0 trade. Addressing the problem requires close cross-bor- good der collaboration between Uganda and its neighbors. 20 percent reduction in -1 to -2 +2 to +3 -2 to -3 -1 +2 to +3 0 Surveys indicate that Uganda and Kenya impose more border-crossing time NTBs on imports than the other sub-Saharan Africa coun- 20 percent reduction in -12 NS -6 to -8 -9 NS 0 tries included in the surveys. These two countries over-reg- fuel price ulate traffic on safety, and technical issues. Measures were 20 percent reduction in taken to mitigate the impact of NTBs including the creation -0.3 NS 0 -1 NS 0 road informal payments of National Monitoring Committees which report, moni- Source: Teravaninthorn and Raballand (2008). tor and publicize NTBs, but these measures proved to be ineffective. Uganda signed a MOU with Kenya that facil- itates faster treatment of bilateral NTBs. Kenya is Ugan- III. New/Increased Production of Oil, Gas and ment, however, is the discovery of large oil and gas reserves da’s largest regional trading partner and, as it controls the Minerals in Uganda, Tanzania and Kenya in the sub-region, including oil in Uganda and off-shore gas main route used by Uganda’s trade, it is the main source Will Influence the Structure and the Benefits in Tanzania.3 This will have a major impact on the structure of NTBs for Ugandan traders. A high-level task force was of Regional Trade. of regional trade. established to rationalize a mechanism of joint tax collec- 7.21. Most of the countries in East Africa and the Great tion. In April 2012 a destination model for the clearance of Lakes Region are rich in mineral resources. Tanzania is goods was adopted, which organizes assessment and collec- by far the richest (see Figure 7.9). Gold, Tanzania’s top 3. The Tanzanian government reports a total of 38.5 trillion cubic feet (tcf ) of tion of import duties at the first point of entry and transfer gas-initially-in-place (GIIP) as of February 2014. Ongoing exploration may lead to export, accounted for 94 percent of the country’s exports to the destination partner. Uganda also partners with other additional discoveries. Offshore natural gas could have a significant impact on in 2012, and still account for a large share of the coun- the country’s economy. Under the baseline scenario, which assumes a 4-train EAC members to improve the regulatory environment by LNG plant based on 24 tcf of commercially recoverable reserves, more than three try’s export basket. Tanzania also produces iron ore, coal, quarters of the off-shore gas production would be processed for LNG exports. strengthening Sanitary and Phystosanitary (SPS) testing The growth impact of offshore gas development and LNG production could be nickel, tin, gypsum, kaolin, limestone, soda ash, uranium, and verification capabilities, involving private labs in the substantial. It will come in two phases: first, during the construction of the LNG graphite and gemstones (diamond and Tanzanite). Burundi plant; and then at the start of LNG production and exports. The construction process, providing for mutual recognition of conformity-as- of the plant may generate a 9 percent GDP growth rate, while the start of LNG and Rwanda have mineral resources. Mining in Rwanda is production and exports may lead to a GDP growth rate as high as 15.3percent, sessment procedures, organizing stronger NTB monitoring twice the current annual growth rate. Offshore gas production and LNG exports primarily small-scale and focuses on base metals like cas- mechanisms and facilitating action when barriers are iden- would provide an average real GDP gain of 12.5percent during the peak period siterite, coltan and wolfram. Burundi has uranium, nickel, of LNG production (World Bank 2014). tified. cobalt, copper, and platinum. The most important develop- 119 Chapter 7 Figure 7.9: Mineral Rents ( In Percent of GDP) 7.24. The region’s protocol on environment and natu- 8 ral resources management emphasizes the commitment Burundi Kenya Rwanda Tanzania Uganda Sub-Saharan Africa Low & middle income World to develop and harmonize policies, laws and strategies 7 for access to, and exploitation of, mineral resources. Although harmonizing mining policies in the EAC has not 6 begun, member states are committed to implementing the 5 objectives of the Africa Mining Vision (AMV) through sub-regional programs. These commitments need to be 4 enforced with sanction mechanisms for non-compliance 3 (International Study Group 2011). The EAC secretari- at plans to identify and promote collaborative investment 2 initiatives in minerals of commercial significance and 1 with potential for processing and industrial development. Emphasis is being placed on the following indicators: min- 0 eral endowments (reserves), comparative and competitive 2004 2005 2006 2007 2008 2009 2010 2011 2012 advantages, skills requirements and capacity, economies of scale, scope predictability, stability of public policy and Source: World Bank World Development Indicator (August 2014). institutional governance and transparency in enforcement of 7.22. Most of the production of extractive industries nia. The situation will change dramatically within 10 years regulations, energy and infrastructure needs, market avail- is exported globally. Consequently, when the share of when oil in Uganda and natural gas in Tanzania become the ability and barriers and technologies (Precht et al. 2013). extractive products is large in its export profile, a country leading exports of the two countries. 7.25. Together with its neighbors Uganda plans to build trades more with countries outside the sub-region and less 7.23. The EAC countries increasingly recognize the a regional infrastructure for oil processing and trans- with its regional neighbors. Despite South Africa’s exten- relevance of a regional approach to the development portation. The Uganda’s government gives the highest pri- sive commercial networks within the sub-region, miner- of natural resources. Already, the EAC treaty shows the ority to the construction of a refinery, but oil companies are al-rich Southern African countries are less integrated than commitment of member states to creating a supportive envi- more interested in a pipeline. In April 2013, the government East Africa because resource exports to the global market ronment for mining sector investments. This includes the agreed to build both the oil refinery and the pipeline. The oil dominate the trade structure of these countries (World Bank establishment of databases, interactive information sharing, refinery will be constructed in Western Uganda and will be 2011; Isik and Yoshino; 2010, Bonfatti and Poelhekke, high-tech powered platforms and a knowledge and experi- owned jointly by private investors, Uganda, and other EAC 2013). Transport infrastructure also connects mines to the ence sharing framework for the mining sector (International governments. Uganda is cooperating with Kenya to develop coast rather than regional neighbours and so further biases Study Group 2011). The treaty also supports harmonization a pipeline that will transport crude oil from Western Uganda the transport costs of other exports towards overseas, rather than regional destinations (Bonfatti and Poelhekke, 2013). of the region’s mining regulations to promote sound and Within the EAC, the products of extractive industries are environmentally responsible mining practices. not yet major exports, with the exception of gold in Tanza- 120 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility to the Port of Lamu in Kenya.4 The pipeline would also lines, which cannot be used for other commodities. Other transport crude oil from oil fields in Northwestern Kenya literature concludes that regional integration is more bene- Box 7. 1: Macroeconomic Convergence Criteria and would be connected with another pipeline from South ficial to resource-poor neighbors. Typically, the demand for under the EAC Monetary Union Protocol Sudan. Environmental impact assessments were initiated on natural resources is global rather than regional (Fouquim the Kenya side and the procurement process is in progress. et al. 2006). Hence, resource-rich economies, like Southern The EAC single currency is expected to be introduced in A third option for the pipeline through the Southern route of African and Latin American countries, trade globally and 2024 by member states that comply with four primary convergence criteria, complemented by three non-binding Tanga in Tanzania is now being evaluated. export their resources. Promoting preferential trade agree- indicative convergence criteria that will serve as early ments between resource-rich and resource-poor countries warning indicators. 7.26. Uganda and its partners want to build robust may be difficult because, in theory, resource-poor countries growth opportunities around the newly discovered nat- would gain more from such agreements (see Carrer, Gour- Primary convergence criteria: ural resources and bring the three economies to the don, and Olarreaga, 2012, in the context of the Middle East • ceiling on headline inflation of 8 percent next development level. EAC countries want to maximize and North Africa). • fiscal deficit (including grants) ceiling of 3 percent of the impact of a synergy between regional integration and GDP resource wealth through the development of regional val- 7.28. The massive growth of cross-border trade between • ceiling on gross public debt of 50 percent of GDP in NPV terms ue chains and a coordinated approach to the governance oil-rich (post-conflict) South Sudan and (pre-oil) Ugan- • reserves cover 4.5 months of imports agenda. In January 2013, the EALA adopted a report which da is a typical example of what a relatively resource- Indicative criteria: stresses the importance of coordinating and monitoring poor neighbor can gain from regional integration. • core inflation ceiling of 5 percent EAC member countries’ compliance and adherence to good Uganda gained a lot from exporting goods and services to • fiscal deficit (excluding grants) ceiling of 6 percent of governance in managing natural resources and recommend- post-CPA South Sudan. Bilateral trade between Uganda GDP ed that the EAC Secretariat should establish an institutional and South Sudan is highly asymmetric and the volume of • tax- to-GDP ratio of 25 percent mechanism for effective monitoring. exports from Uganda is disproportionately higher than the volume of exports from Sudan to Uganda; it is also large- 7.27. It is not clear which impact the production of oil ly informal (Yoshino, Asebe, and Mgungi 2011). Leading Employees of Flona Commodities, and gas will have on regional trade. Limited research is exports, both formal and informal, from Uganda to South Bugerere available on the interface between natural resource and Sudan include food and other consumer non-durables and demonstrate to regional integration. Recent work shows that mine infra- a visiting team construction materials. The development of Uganda’s oil how pineapples structure, which typically goes to ports and can be used to production may have the opposite effects. Regional integra- are processes for transport other goods, biases transport costs towards over- tion may prove to be more beneficial for EAC resource-poor packing seas rather than regional trade (Bonfatti and Poelhekke, countries than for new resource-rich countries like Uganda 2013). However, this does not hold for oil and gas pipe- and Tanzania. 4. In addition to the pipeline for crude oil, there is also a plan to extend the exist- ing petroleum product pipeline, currently from Mombasa to Nairobi and Eldoret to go beyond the border and connect Uganda and Rwanda. 121 Chapter 7 IV. The Positive and Negative Impact of a Table 7.5: Correlation Coeffici ts of Business Cycles among EAC Countries Future Monetary Union 1990-2010 2001-2010 7.29. The EAC countries have decided to move ahead with monetary integration through the creation of a BI KE RW TZ UG BI KE RW TZ UG monetary union. In November 2013, all the EAC members, Burundi (BI) 1 1 including Uganda, signed a protocol creating the monetary Kenya (KE) -0.1 1 0.5 1 union. They agreed to implement the preliminary stages of Rwanda (RW) 0.3 0.1 1 0.7 0.3 1 monetary integration within two years and to establish the fiscal foundations of a common currency within ten years Tanzania (TZ) 0.4 0.6 0.4 1 0.8 0.7 0.5 1 (in 2024). Box 7.1 outlines the process and describes the Uganda (UG) 0.03 0.7 0.1 0.7 1 0.9 0.6 0.6 0.9 1 convergence criteria for the EAC monetary union. Source: Rusuhuzwa and Masson (2012). 7.30. A monetary union can generate benefits. The main benefits include the creation of a credible central bank, Table 7.6: Correlation Coeffici ts of Terms of Trade Shocks with Medium Future Energy Exports reducing trade costs and minimizing the risk of import- BI KE RW TZ UG ing recessions. The creation of an independent monetary policy-making body makes it more difficult for any individ- Burundi 1.00 ual member government to influence monetary policy deci- Kenya -0.46 1.00 sions. A single currency in a monetary union would also Rwanda 0.89 -0.28 1.00 stabilize nominal prices and lower transaction costs with- in the union. Monetary unions harmonize regulations and Tanzania -0.58 0.93 -0.53 1.00 tax collection systems, and provide freer access to capital, Uganda -0.46 0.97 -0.35 0.97 1.00 and this also reduces cross-border transaction costs. Final- Source: Masson (2012). ly, monetary policy within a union responds to domestic economic conditions, and so would be less likely to import 7.32. Monetary unions are often considered to be best Within a currency union, countries no longer issue debt in recessions than a peg. suited for countries with similar growth paths. The EAC a currency they control. Therefore debt cannot actively be reduced by inflation, and counter-cyclical fiscal policy may countries, particularly the original three members (Kenya, 7.31. A monetary union also comes with costs, including be constrained by concerns about the ability to service debt. Tanzania, and Uganda), have similar growth paths and are limited capacity of independent monetary policies, high- It is also very difficult to reverse the process, once a mone- vulnerable to similar shocks. Table 7.5 shows that, tradi- er risk of sovereign default, and the virtual impossibili- tary union system has been introduced. A good example is tionally, the business cycles of Kenya, Tanzania, and Ugan- ty of reversing the move towards monetary integration. the recent crisis of the Eurozone, where members of a mon- da are closely correlated. Over the past ten years, however, Although a monetary union improves the credibility of the etary union can only adjust relative prices through inflation correlations improved between business cycles in Burun- monetary authority, the benefit is less significant in devel- or deflation and lack other monetary instruments to defeat di and Rwanda on the one hand and Kenya, Tanzania and oping countries with low levels of financial intermediation. the crisis. Uganda on the other hand. 122 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility (See Mundell (1961) for a survey of the literature on the Table 7.7: Labor Migration Policies in East Africa criteria for an optimal currency). Entry Permit Inflow/Out- Overseing organization/ Entry Permit Entry Permit 7.36. Prudent fiscal policy at the regional level, including Extension flow of Skilled Legislation Needed? Length Length Labour proper fiscal rules and public investment management Kenya Kenyan Constitution; govern- YES 2 years 5 years Outflow practices, will be crucial to minimize risks. Sound fiscal ment bureaucraciesk policy means slow, stable, and equitable public spending Rwanda Ministerial Orders; govern- YES 1 year 1 year, up to -- in all member countries. Measures aimed at preventing ment bureaucracies three renewals boom-and-bust in public spending include allocating part Immigration Acts of 1995 and 2 years, máxi- of resource revenues to savings through a sovereign wealth Tanzania 1997; government bureau- YES 3 years mum stay of 5 Inflow cracies years fund. Uganda has already established a wealth fund, and both Kenya and Tanzania plan to do the same for their Immigration Board and Immi- Uganda gration Department YES 5 years 3 years Outflow forthcoming oil and gas revenues. It is critically important to use proper fiscal rules when allocating revenues to these Source: Musonda (2006) and Shitundu (2006). funds. Resource revenues should be spent primarily on cap- Note: The last column indicates the dominant type of flow in each country. ital investments (rather than current consumption) to reduce growth constraints in the economy. There will also need to 7.33. The recent discovery of oil and gas in some EAC losses for the non-energy exporting EAC members (Burun- be some system of automatic fiscal transfers, so that growth countries represents a new challenge for implement- di and Rwanda) (Masson 2012). is shared equitably amongst all members of the union. This ing a monetary union, as the resource boom will have will require a dedicated regional development fund so that asymmetric implications for individual countries and 7.34. A common currency would also create a risk of national governments are aware of the extent of their lia- their growth path. When production begins and revenue spillover of the Dutch Disease. Energy exporting members bilities. Finally, there may need to be some agreement to starts flowing in Kenya, Tanzania, and Uganda, EAC coun- of the EAC are likely to experience an appreciation of their jointly issue debt at an East African Monetary Union level, tries will be subjected to asymmetric shocks. The poten- real exchange rate in the medium term. Since these three to prevent self-fulfilling debt crises. Ultimately, the impact tial asymmetry will be particularly pronounced between countries are much larger than Burundi and Rwanda, they of resource wealth on monetary policy depends on fiscal energy-exporting and other EAC countries (Rwanda and will have more influence on the value of the common cur- policy that is, how revenues are spent. Burundi). A macroeconomic analysis shows that terms of rency. It is through the common currency, that the pressure trade shocks will be positively correlated for Kenya, Tan- for real currency appreciation may spillover from energy 7.37. If labor and capital can move freely throughout zania, and Uganda, and negatively correlated between these exporting to other EAC countries. The common currency the union, they will move where they are most produc- countries and Burundi and Rwanda (see Table 7.6). Oil and will also invite transmission of macroeconomic volatility. tive. This should create some convergence in productivi- gas revenues will expand growth and put upward pressure ty levels within the union. Labor and capital movements 7.35. In this context, prudent fiscal policies, free move- on prices in resource producing countries relative to oth- are important risk-sharing mechanism. Concerted efforts ment of labor and capital, and a gradual approach to er union members. There will be pressures for diverging should be made to reduce and harmonize regulations lim- monetary integration will be essential to maximize the growth paths particularly between resource-exporting and iting labor and capital movements across borders. Today, benefits and minimize the costs of the Monetary Union. other countries. The monetary union may lead to welfare 123 Chapter 7 labor mobility is limited in EAC countries. Labor flows are tightly regulated, and although no overtly discriminatory regulations are in place, government policies aim more at restricting rather than facilitating labor movements (World Bank 2010). Table 7.7 summarizes the labor migration pol- icies in 4 countries of East Africa. These countries do not impose nationality or residency requirements on foreign professionals who provide accounting and auditing services in their territories. However, Kenya, Tanzania, and Ugan- da impose quantitative restrictions on foreign professionals in the form of labor market tests or economic needs tests. There are limits on the initial length of stay in these three countries, but extensions or renewals of visa are permitted (generally on a case-by-case basis). 7.38. Monetary policy should be integrated slowly, and reversibly, throughout the union using a system of exchange rate pegs. Uganda has recently had consid- erable success with its “inflation-targeting lite” regime. It should build on this success by improving its inflation forecasting capacity, entrenching central bank indepen- dence, and promoting the deepening of the financial sec- tor. The other members of the EAC should move towards a system of pegged exchange rates with Uganda, ideally by harmonizing interest rate policy rather than intervening in foreign currency markets. 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Harnessing Regional Integration 128 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Annexes: Annex 1: Non-hydrocarbon Government Revenue for Resource-rich Countries, 1992–2012 % of Total % of Total   % of GDP   % of GDP Revenue Revenue Non- Total Non- Non- Total Non-     hydrocarbon Revenue hydrocarbon hydrocarbon Revenue hydrocarbon Norway 41.87 54.78 76.83 United Arab 11.21 29.14 39.56 Emirates Russia 28.57 36.97 77.63 Yemen 10.59 30.52 36 Vietnam 21.5 23.89 88.79 Chad 10.28 15.07 78.85 Ecuador 18.9 24.55 80.46 Iran 10.28 23.44 45.36 Uganda 17.34 17.34 100 Oman 9.27 42.52 22.18 Trinidad and Tobago 17.25 27.22 64.27 Angola 8.94 43.81 21.05 Kazakhstan 16.41 25.07 66.58 Bahrain 8.46 29.2 29.4 Kuwait 16.17 61.05 27.26 Congo, Rep 8.2 34.42 25.39 Mexico 15.13 19.79 77.54 Equatorial Guinea 7.89 35.39 23.96 Azerbaijan 15.03 30.84 53.66 Sudan 7.83 15.35 59.63 Syria 14.62 26.36 55.67 Nigeria 7.44 32 24.56 Qatar 14.17 37.64 37.52 Brunei 6.6 43.04 16.7 Venezuela 13.43 30.1 45.19 Saudi Arabia 5.53 42.535 13.725 Cameroon 12.91 20.49 68.43 Min 5.53 15.07 13.725 Gabon 12.53 27.09 46.71 Max 41.87 61.05 88.79 Indonesia 11.79 17.61 67.02 Libya 11.74 44.03 31.98 Median 11.765 30.31 45.275 Algeria 11.22 34.9 33.12 Source: Belinga et al. 2014 Notes: Uganda is excluded for the min, max and median calculations. Countries are sorted according to the value of non-hydrocarbon revenues. 129 Annexes Annex 2: Key Features of the Uganda Dynamic Stochastic General Equilibrium (DSGE) Model Basic features: • Small open economy model with optimizing agents and nominal rigidities (Obstfeld and Rogoff 2000; Christiano et al. 2005). • Model accounts for important features of developing countries: Dutch Disease, Investment inefficiency, Weak tax system. • Three economic agents: Household, Firms, and Government. Annexes • Three production sectors: Non-tradable goods, tradable goods, and natural resource. Modeling features: Households • A continuum of households of mass 1, each maximizing a lifetime utility function (1) o where denotes the household’s discount factor and is the inverse of Frisch elasticity of labor supply, whereas (0,1) is the parameter that controls the extent of habit. Finally, denotes the conditional expectation operator evaluated at time 0. • Subject to a budget constraint in units of domestic composite consumption (2) o where and the tax rates on the consumption and labor, respectively. private invest- ment; the domestic government debt, which pays a nominal rate of ; domestic inflation; real wage index expressed in units of consumption goods; government transfers to households; and profits from the non-traded and traded goods sectors; and capital income. • Households are assumed to be able to borrow or lend freely in national financial markets by buying or issuing risk-free bonds denominated in units of consumption goods, and those in the non-tradable goods sector set nominal wage using Calvo’s partial indexation mechanism. No Ponzi game constraints: 130 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility (3) • Consumption basket: composite of tradable and non-tradable goods aggregated using a constant-elasticity-of-substi- Annexes tution (CES) technology (4) o With and denoting the intra-temporal elasticity of substitution and the degree of home consumption bias. Thus, if > 1/2, the representative household has a home bias in consumption. In this framework, (5) • We assume that the composite consumption is the numeraire of the economy and the law of one price holds for traded goods. Accordingly, the real exchange rate st is also the relative price of traded goods to composite consumption. The price of one unit of composite consumption is: (6) o ptN denotes the relative price of non-traded goods to composite consumption. • Supply of labor service, , is a composite of two type of labor: tradable, T and non-tradable, N , and imperfect labor mobility captured by CES (7) o where N is the steady-state share of labor supply in the non-traded goods sector, which also governs labor sectoral mobility in the economy. ( > 0) is the elasticity of substitution between the two types of labor. 131 Annexes • Aggregate real wage index: (8) • Choice variables for the household problem: , and bt for all t 2 [0;1) to maximize lifetime utility function, Ut(.). Annexes Firms: • Non-tradable good firms in monopolistic competition à la Dixit-Stiglitz • Tradable good firms in perfect competition o Intermediate tradable good producers o Final good producers • A representative non-tradable goods firm chooses labor and capital to maximize its profit: (9) • This sector is subject to: o Price rigidity o Wage rigidity • Intermediate good producers • A tradable goods firm produces goods with the same technology in the non-tradable sector (10) • Each tradable firm maximizes its weighted present-value profits: (11) • Final good producers • Aggregate intermediate and imported tradable goods • Output in the natural resource sector follow an exogenous process 132 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility (12) • International commodity price evolves according to the following process (13) Annexes Government (Balanced budget ) (14) Alternative fiscal policy approaches • All-investing (15) • All-savings (16) • Sustainable investing (17) 133 Annexes • Driving forces of the model Annexes (18) where CAt is “current account balance “ 134 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Annex 3: Key Features of the Uganda Macroeconometric Model (MacMod-UG) Basic Features: • The structure of the model is composed of three main blocks: o A macro framework, that projects GDP with its components (uses and sources), national accounts (Government Financial System (GFS), Balance of Payments, and Monetary Aggregates); and debt (internal and external) in the short and medium-term, ensuring the balance of flows of funds. Annexes o A Framework for Medium-Term Expenditure (MTEF), which is connected to the model, allowing to: (i) specify the budget allocations to the ministries in line with the guidelines of the (NDP), (ii) fit all expenditures with the revenues and overall funding capacity to ensure consistency between the structure of the MTEF spending and the GFS. o A “Poverty / MDGs” module, that projects the indicators of poverty and human development (poverty incidence, MDGs, education, and health etc.). • The GDP includes five major sectors, including agriculture and related rural activities (forestry, animal husbandry and fish farming), mining (oil and other mining products), manufacturing, other industrial activities (energy, water, etc.), administra- tion and market services. Mining and administration are the main “exogenous”. • Growth in other sectors is determined by the medium and long-term trends that are based on the factors of production (hu- man and physical productive capital), previous exogenous dynamics, the international situation, and the internal environ- ment. Modeling features: Potential Growth • Per capita GDP Growth: g(yt)= f(g*, Zt, y(t-1)) (1) • Potential Growth: g*t = f (kpt, kft, ht, NMSt/NYt, CIMt) (2) o Where: g*t: Growth of potential per capita GDP ; kpt: Per capita productive capital Stock; kft: Per capita infrastructure capital Stock; ht: Per capita human capital stock; (NMS/NY): Indicator of financial depth (money supply / GDP); CIMt: Openness indicator (import capacity) ; Zt: Vector of short-term fluctuations of factors. 135 Annexes Productive capital and investment • Private Capital Stock (End of Period): Kpt = [1-δ Kp(t-1)] + Ipt (3) • Initial Stock: Kp1 = Ip1/(δ+y*) (4) • Per capita: kpt = Kpt/NPt (5) • Private Investment: IPt = f [g*t, Sp(t-1), IG(t-1), FDI(t-1), NMS/NY, CIMt] (6) Annexes o where: δ: Capital Depreciation rate; y*: Average GDP growth rate in the long term ; Kp1 : Initial Stock; Spt: Private domestic savings; IGt: Public investment; FDIt: Foreign investment flows representing foreign savings; NMS/NY: Financial depth; CIMt: Import capacity. Infrastructure - installed capacity in roads, electricity and telecommunications • Infrastructure Capital Stock: Kft = f(y*, IGFt, FDIFt) (7) o where Kft: Infrastructure stock in terms of roads, electricity and telecommunications; FDIFt: Foreign investment flow in infrastructure; IGFt: Public spending on capital allocated to the infrastructure sector Human Capital • Stock of per capita human capital: ht = f(tsb, evn) (8) • Enrollment rate: tsbt = f (y(t-1), IGSt+CGSt, tsb(t-1)) (9) • Life expectancy at birth: evnt = f (y(t-1), (IGSt+CGSt), sp) (10) o where:Sp: Demographic variable (average age of the workforce); IGSt: Public expenditure in social capital (education and health); CGSt: Current public expenditure in the social sector (education and health). Exogenous Sectors: Mining and Administration • Mining GDP: g(YMIN)t = ž(YMIN)t (11) • Administration GDP: g(YG)t = g[NGWt + NGCKt] – g(Pt) (12) • Fixed Capital Consumption: NGCKt = κ NIGt o Where: ž(YMIN)t: Endogenous growth rate of mining production ; NGWgt: Government spending on personnel (in nominal terms); NGIt Capital expenditures of administration (in nominal terms); κt Share of fixed capital consumption (in capital expenditures); g(P) Growth of the general price level (inflation) 136 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Rural Activities: Exportable and Semi-traded Sectors • Exportable Agriculture GDP: g(YAX)t = f(g*t,g(PAX/P)t,CNAt) (13) • Subsistence Agriculture GDP: g(YAV)t = f(g*t,g(PAV/P)(t-1),CNAt) (14) • Livestock and Silviculture GDP: g(YAE)t f(g*t,g(PAV/P)(t-1)),CNAt) (15) • Forestry GDP: g(YAF)t = ž(YAF)t (exogenous) (16) Annexes o where: ž(YAF)t: Exogenous Growth Rate of forestry production; g(PAX/P)t Growth relative prices in local currency; g(PAV(t-1)) Growth of delayed prices of food products (price instrument); CNATt Climate shocks (e.g. Rainfall) Manufacturing industries (textiles, agro-food, wood): import substitution sectors • Manufacturing GDP: g(YIM)t = f(g*t,P/PM,YND,YREt) (17) o where: P/PMt: Relative price of domestic products to imports (local currency); YNDt: National disposable Income; YREt:Sub regional demand. Non-traded market sectors: Construction, infrastructure services and merchant services • Construction GDP: g(YIBTP)t = f(g*t,IG,Ipt) (18) • Electricity and Water GDP: g(YIEE)t = ž(YIEE)t (exogenous) (19) • Commercial Services GDP: g(YSM)t = f(g*t,(YA+YI+YMINt+YGt)) (20) o where PM/Pt: Relative imports (local currency); YNDt: Disposable national income Exogenous Demand: Public consumption and Investment • Construction GDP: g(YIBTP)t = f(g*t,IG,Ipt) (21) • Electricity and Water GDP: g(YIEE)t = ž(YIEE)t (exogenous) (22) • Commercial Services GDP: g(YSM)t = f(g*t,(YA+YI+YMINt+YGt)) (23) o Where PM/Pt: Relative imports (local currency); YNDt:Disposable national income 137 Annexes Exports • Total Exports: X = XAXt+XAVt+XAEt+XAFt+XIMt+XMIt (24) • Agriculture Exports: g(XAX)t = gcet[PXAXt/Pt,YAXt] (25) • Subsistence Agriculture: g(XAV)t = gcet[PXAVRt/Pt,YAVt] (26) • Livestock and Fishing Farming: g(XAE)t = gcet[PXARt/Pt, YAEt] (27) Annexes • Forestry: g(XAF)t = gcet[PXAFt/Pt, YAFt] (28) • Manufactured Goods: g(XIM)t = gcet[PXIMR/P, YIMt] (29) • Mining Products: g(XMI)t = g(YMI) (30) • Services: g(XS)t = f(g(YSMt)) (31) o where:gcet: Growth function derived from the CET function; PXAX/P Relative price of annuity products exports; PXAVR Relative price of exports of food products to the sub-region; PXAER Relative price of exports of livestock prod- ucts to the sub-region; PXAF Relative price of exports of Forestry; PXIMR Relative price of exports of manufactured products to the sub-region. Imports • Total Imports: M = MALt+MACt+MIPt+MIAt+MKt+MSt (32) • Food Products: g(MAL/NP)t = gces[PMAt/Pt,Yt/NPt] (33) • Other consumption goods: g(MAC)t = gces[PMAt/Pt,Yt/NPt] (34) • Petroleum products: g(MIP)t = gces[PMPt/Pt, Yt] (35) • Other intermediate goods: g(MIA)t = gces[PMIt/Pt, Yt] (36) • Capital Goods: g(MK)t = gces[PMKt/Pt, (IPt+IGt)] (37) • Services: g(MS)t = f(g(MTt-MSt)) (38) o where: gces Growth function derived from the CET function; PMAt/Pt Relative price of import of consumer goods; PMPt/Pt Relative price of import of petroleum; PMINTt/Pt Relative price of import of intermediate goods; PMINVt/ Pt Relative price of import of capital goods. 138 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Level of Prices • General Level: g(Pt) = Ω.g(PMt)+(1-Ω)g(PDt) (39) • Price of domestic products: g(PDt) = Sum[πi.g(Pit)] (40) • Price by sector of production: g(Pit) = f[g(PC)t,{PXit,PMit},EXMt,CNATt] (41) • Cost of factors: g(PC)t = f[CWt,CKt] (42) • Cost of labor: g(CWt) = f[g(CWGt),g(YPt)] (43) • Cost of capital: g(CKt) = g[(1+δ+g(p*)t).PKt] (44) Annexes • Excess Demand: EXMt = {g(NMMSt/MMDt;g(CG+IG)} (45) Price of Uses: • Exported products i: PXit = PWXi.ERt (46) • Total Exports: g(PXt) = sum[xi.g(PXit)] (47) • Imported products i: PMit =PWMit(1+tmi).ERt (48) • Total Imports: g(PMt) = sum[mi.g(PMit)] (49) • Investment: g(PKt) = θ.g(PMt)+(1-θ).g(PIM&BTPt) (50) • Consumption: PC= [NY – PX.X+PM.M]/[Y-X+M] (51) o where: Ω: Share of imports in the total Sources; Θ: Share of imports in the capital good; µi: Share of sector i in the nominal GDP in (t-1); δ: Depreciation rate of capital goods; tmi :Duties and import taxes; xi:Share of product i in the value of exports; mi: Share of product i in the value of imports ERt: Nominal exchange rate (USD value in local currency); PWXit: World price of exported good i (in foreign currency); PWMit: World price of imported good i (in foreign currency); g(CWGt): Progression of the wage index in the public administration; CNATt: Indicator of natural shocks over the agriculture sector; (PXi,PMi): Either, export price (exported goods) or import prices (Imported goods); PIM&BTP: Price of local capital goods “manufacturing and construction” • Agriculture Products Exports: NGRXAX = ft(NXAX) (a) ou =ft(XAX) ; (b) (52) • Forest Products Exports: NGRXAFt = ft(NXAF) ; (53) • Import, Duties and Taxes: NGRMD&T = ft(NMTOT) (54) • Import, VAT: NGRMTVA = ft(NMTOT) (55) • Other Indirect Taxes (Domestic): NGRDTVA = ft(NDABS) or (56) • Tax on Household Income: NGRIRMEN = ft(NY) (57) 139 Annexes • Tax Revenue on Companies: NGRIREP = ft(NY) (58) • Other Revenue: NGRAUT= ft(NY) (59) o where: ft:a function of “taxation” (linear - constant average rate - or constant elasticity); NDABS internal adsorption (consumption + investment). Projected Expenses MTEF • Primary Expenditure: mtef_NGDPRIM* = (tx_GRY*+tx_GSY*).NY* (60) Annexes • Sectorial Expenditure: mtef _NGDTOTi = φi. cdmt_NGDPRIM* (61) • Personnel: mtef_NGDPERSi = ϖi. cdmt_NGDTOTi (62) • Goods & Services: mtef _NGDB&Si =(1-ϖi-ψi).cdmt_NGDTOTi (63) • Capital: mtef t_NGDCAPi = ψi.NGDTOTi (64) • Trans., grants, & comm. Exp.: mtef _NGDAUT=cdmt_NGDPRIM*- sum[i,cdmt_NGDTOTi] Aggregation: o Total personnel: cdmt_NGDPERS = sum(i,cdmt_NGDPERSi) (65) o Total Goods & Services: cdmt_NGDB&S = sum(i,cdmt_NGDB&Si) (66) o Total Capital: cdmt_NGDCAP = sum(i,cdmt_NGDCAPi) (67) Projected Spending – Government Financial System (GFS) Current Expenditure: NGDCOU = NGDPERS+ NGDB&S+NGDTR&S+NGDINTR • Personnel: NGDPERS = ident[cdmt_NGDPERS] (68) • Goods & Services: NGDB&S = ident[cdmt_NGDB&S] (69) • Transf., grants & Comm. Exp.: NGDTR&S = ident[cdmt_NGDTR&S] (70) • Service de la dette: NGDINTR = ident[det_NGDINTR] (71) Capital Expenditure & Net Lending: • Capital Expenditure: NGDCAP = ident[cdmt_NGDCAP] (72) • Net Lending: NGDPNET = [1+gexog(NGDPNET)]NGDPNET(t-1) (73) 140 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Total Expenditures: • Primary: NGDPRIM = NGDCOU-NGDINTR+NGDCAP • Total: NGDTOT = NGDPRIM+NGDINTR Budget Balances and Financing Annexes Budget Balance: • Primary Balance: NGSPRIM = NGRTOT – NGDPRIM (74) • Overall Balance: NGSTOT = NGRTOT – NGDTOT  (75) Financing: • Domestic Financing: NGFITOT=NGFICGOV+NGFIBOND+NGFIAUT (76) • Net Credit to the Government: NGFICGOV = NMMSCGOVt-NMMSCGOV(t-1) (77) • Public Borrowing (bonds & other treasury securities): NGFIBOND= nexog[NGFIBOND] (78) • Others : NGFIAUT = nexog[NGFIAUT] (79) • External Financing: NGFXTOT = NGFXTIRNET+NGFXDON+NGFXAUT (80) • Net Draw: NGFXTIRNET = -NGSTOT-NGFITOT-NGFXDON-NGFXAUT (81) • Draw: NGFXTIR = NGFXTIRNET+NGFXAMTD (82) • Debt Amortization: NGFAMTD = indt[DET_AMTTOT] (83) • Donations: NGFXDON = nexog[NGFXDON] (84) • Others (External Debt): NGFXAUT = nexog[NGFXAUT] (85) GFS Balance: (See net draw) 141 Annexes Projection of Flows of the BoP • Current Account Balance: NXBC =NXBB+NXBS+NXRFT+NXTRF (86) • Trade Balance: NXBB = (NX – NXS) – (NM-NMS) (87) • Net Services: NXBS = NXS-NMS (88) • Net Revenues: NXRFT = NXRFTINTR + NXRFAUT (89) • Interest: NXRFTINTR = ident[NGDXINTR] (90) Annexes • Others: NXRFTAUT = nexog[NXRFTAUT] (91) • Net Transfers: NXTRF = NXTRFG+NXTRFP (92) • NXTRFG = f(NGFXDON) (93) Government: • Others: NXTRFP = nexog[NXTRFP] (94) • Non-Monetary Capital: NXKNMB = NXKNMLT+NXKNMCT (95) • NXKNMLTFDI = nexog[NFDI] (96) Foreign Investment; • Net Debt Flows: NXKNMLTDET = ident[NGFXTOT]-NXTRFG (97) • Short-term Capital: NXKNMCT = f(NXBC) (98) Balance and Financing: • Variation in Foreign Assets NXKMVAEX = - indt[NMMSVAX] (99) • Exceptional Financing: NXFKMGAPF=-NXCOUB-NXKNMB-NXKMVAEX+NXKMGAPF(t-1) (100) Projection of Monetary Stocks Money Demand • Real Demand: MMD = f(Y,p*) (101) • Nominal Base: NMMS = P. MMD (102) Money Supply • Net Foreign Assets: NMMAEX = ν. NMMS (103) • Changes in Foreign Assets: NMMVAEX = NMMAEXt - NMVAEX(t-1) (104) • Credit to the Government: NMMCG = nexog[NMMCG] (105) • Credit to the Economy: NMMCP = f(NY, NMAEX) (106) 142 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Annex 4: Key Features of the Uganda Maquette for MDG Simulations (MAMS) Model Basic Features The MAMS model1 is used to link education policies, skills achievement and employment outcomes. The MAMS is a recursive-dynamic Computable General Equilibrium (CGE) model developed at the World Bank for analysis of medium- to long-run country strategies for low- and middle-income countries, including strategies aimed at improving MDG (Millennium Development Goals) outcomes. Modeling features Annexes Production and commodities Supply side: • Producers maximize profit given their technology and the prices of inputs and output. • The production technology is a two-step nested structure. o At the bottom level, primary inputs are combined to produce value-added using a CES (constant elasticity of substitution) function. o At the top level, aggregated value added is then combined with intermediate input within a fixed coefficient (Leontief) function to give the output. • Profit maximization provides the demand for intermediate goods, labor and capital demand. • The detailed disaggregation of production activities captures the changing structure of growth. • Domestic output is allocated between exports and domestic sales following the assumption that domestic producers maximize profit subject to imperfect transformability between these two alternatives. • The production possibility frontier of the economy is defined by a constant elasticity of transformation (CET) function between domestic supply and exports. Demand side: • A composite commodity is made up of domestic demand and final imports and it is consumed by households, enterprises, and gov- ernment. • The Armington assumption is used here to distinguish between domestically produced goods and imports. o For each good, the model assumes imperfect substitutability (CES function) between imports and the corresponding com- posite domestic goods. 1 Lofgren, H., Cicowiez, M., Diaz-Bonilla, C., 2013. MAMS – A Computable General Equilibrium Model for Developing Country Strategy Analysis. In: Dixon, P.B., Jorgenson, D.W. (Eds.), Handbook of Computable General Equilibrium Modeling. North Holland, Elsevier B.V., pp. 159–276. 143 Annexes o The parameter for CET and CES elasticity used to calibrate the functions used in the CGE model are exogenously determined. Institutions • Three institutions in the model: households, enterprises and government. o Households receive their income from primary factor payments including labor, capital and land. While they pay income taxes as a proportion of their income, they also receive transfers from government and the rest of the world. Savings and total consumption are assumed to be a fixed proportion of household’s disposable income (income after income taxes). Consump- Annexes tion demand is determined by a Linear Expenditure System (LES) function. o Firms receive their income from remuneration of capital, transfers from government, and the rest of the world, as well as net capital transfers from households. Firms pay corporate taxes to government, proportional to their incomes. o Government revenue includes direct taxes collected from households and firms, indirect taxes on domestic activities, domes- tic value added tax, tariff revenue on imports, factor income to the government, and transfers from the rest of the world. The government also saves and consumes. MDG and Employment Module o The MAMS model is well suited for the analysis of the MDGs and employment. o The key MDGs considered in this case include reduction of poverty, primary education attainment, reduction of infant and maternal mortality and increased access to water and sanitation. o This module is critical for this study given the link between employment outcomes and investment in the various stages of education by the government. Macro closure o Equilibrium in a CGE model is captured by a set of macro closures in a model. • Supply-demand balances in products and factor markets are assumed. • Three macroeconomic balances are specified in the model: (i) fiscal balance, (ii) the external trade balance, and (iii) savings-investment balance. • Fiscal balance: government savings is assumed to adjust to equate the different between government revenue and spending. • External balance: foreign savings are fixed with exchange rate adjustment to clear foreign exchange markets. • Savings-investment balance: the model assumes that savings are investment driven and adjust through flexible saving rate for firms. 144 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Recursive dynamics o Following previous studies on Botswana and South Africa (Lofgren 2005, Thurlow 2007), the dynamics is captured by assuming that investments in the current period are used to build new capital stock for the next period. o The new capital is allocated across sectors according to the profitability of the various sectors. o The labor supply path for the various labor categories will depend on the policy interventions to address unemployment issues. Annexes 145 Annexes Annex 5: Key Features of the Uganda Overlapping Generations (OLG) Model Basic features: • Individuals live for (at most) three periods: childhood (period t-1), adulthood (period t) and retirement (period t+1). • The economy produces a homogenous market good that can be either consumed in the period it is produced or stored to yield Annexes capital at the beginning of the following period. • Each individual is endowed with one unit of time in childhood and adulthood, and zero units in old age. In adulthood time is allocated inelastically to market work. Modeling features: Individuals • At the beginning of adulthood in t, each individual produces nt children, who depend on their parents for consumption and any spending associated with schooling and health care. • Raising a child also involves a cost of (0,1) of the individual’s net income. Consumption of children is subsumed in the individual’s consumption. • Wages is the only source of income as all individuals work in middle age (second period of life). • Savings can be held only in the form of physical capital. • Agents have no other endowments, except for an initial stock of physical capital at t = 0, which is the endowment of an initial old generation. Each individual is endowed with et units of human capital. Each unit of human capital earns an effective market wage, wt, per unit of time worked. • Assuming that consumption of children is subsumed in the individual’s consumption, the individual’s utility takes the form (1) 146 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility o where: is total consumption in adulthood (old age), ρ > 0 the discount rate, and pt (0, 1) the proba- bility of survival to old age at the end of adulthood.1 Thus, children bring utility while they are at home.2 o Coefficient measures relative preference for today’s consumption and relative preference for surviving children. • The individual’s budget constraints for period t and t+1 are given by3 Annexes (2) (3) o where: (0, 1) is the tax rate on wages, s saving, r the rental rate of private capital, wt gross wage income, t+1 t+1 and a productivity. t o Combining (2) and (3), the consolidated budget constraint is thus (4) Market Production • Firms engaged in market production are identical and their number is normalized to unity. • Each firm i produces a single nonstorable good, using effective labor, where is average labor productivity in the economy, and , where is average human capital, private capital, , and public infrastructure, . 1 Bauer and Chytilová (2007), in a study of Uganda, found a strong negative association between the level of education and individual dis- count rates; more educated individuals appear to be more patient, even after controlling for other characteristics (age, income group, gender, marital status, and clan linkage). For simplicity, however, the impact of education on individual patience is ignored. 2 Note that we abstract from mortality in childhood. As documented by the World Bank (2009, 2011), Uganda has made significant progress during the past three decades in reducing infant mortality. 3 To abstract from unintended bequests, the saving left by agents who do not survive to old age is assumed to be confiscated by the government, which transfers them in lump-sum fashion to surviving members of the same cohort. The rate of return to saving is thus (1 + rt+2)/p, as shown in (3). See Agénor (2012, p. 73) for a derivation. 147 Annexes • Public capital is subject to congestion, which is taken to be proportional to the aggregate private capital stock, . Thus, the intensive use of public infrastructure assets by firms reduces the availability of those assets for use by all firms. • The production function of individual firm i, takes the form (5) Annexes o where (0,1) and is a network externality parameter, whose determination is discussed later.4 • With the price of the good normalized to unity, and with full depreciation of private capital, profits of firm i in the final sector, are given by where rt is the rental rate of private capital (which is also, as noted earlier, the rate of return on savings). • Using (5), profit maximization with respect to the private inputs (taking , and , as well as factor prices, as given) yields (6) • Given that all firms are identical, and that their number is normalized to 1, and aggregate output is, from (5) and (7) o where: is the public-private capital ratio. 4 Note that, given the (generalized) Cobb-Douglas nature of the production function, the network externality factor can also be interpreted as affecting the efficiency of all production inputs, not only public capital in infrastructure. 148 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Human Capital Formation • Schooling is mandatory, so all children must devote all their time to education.5 Let be the human capital of an individual born in period t and used in period t+1. • The production of human capital requires several inputs, in addition to children’s time. o It depends on the stock of public infrastructure, taking into account a congestion effect measured again by the (aggregate) Annexes private capital stock. This effect captures the importance of infrastructure for education outcomes.6 o Knowledge accumulation depends on average government spending on education per child, , where (0, 1) is an indicator of efficiency of spending and Nt is the number of adults alive in period t, itself given by (8) o Human capital accumulation depends on a parent’s human capital. Because individuals are identical within a generation, a parent’s human capital at t is equal to the average human capital of the previous generation. o Assuming no depreciation for simplicity, human capital in the second period of life is (9) Health Status and Productivity • Health status in childhood, depends on the parent’s health, on access to infrastructure, and the provision of (congested) health ser- vices by the government: (10) o where (0, 1) and . 5 The model therefore abstracts from child labor 6 See Agénor (2012, Chapter 2) 149 Annexes o Health status in adulthood, , is determined entirely by health status in childhood, to account for health persistence: (11) • Adult productivity, at+1, is positively related to health status, with decreasing marginal returns: (12) o where: (0, 1) Annexes Government • The government taxes only the wage income of adults and receives foreign aid. It spends a total of on infrastructure invest- ment, on education, on health, and on unproductive items. All its services are provided free of charge. It cannot issue bonds and must therefore run a balanced budget: (13) o where X > 0 is the fraction of foreign aid in proportion of tax revenues7. • Shares of spending are all assumed to be constant fractions of government revenues: (14) o where: h=E,H,I,U • Combining (13) and (14) therefore yields (15) 7 Given (6), it would make no substantial difference if foreign aid were to be defined as a share of output. Note also that in this specification domestic and foreign resources are additive; there is no “moral hazard” effect, that is, the possibility that aid may have an adverse effect on incentives to col- lect domestic taxes, as discussed in particular in the partial equilibrium literature on fiscal response models (see McGillivray and Morrissey (2001), as well as general equilibrium models (see Agénor et al. (2008)). However, as further discussed below, there is no evidence that aid substituted for domestic revenue mobilization in Uganda in recent decades. 150 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility • Assuming again full depreciation for simplicity, public capital in infrastructure evolves according to (16) o where: (0; 1) is an indicator of efficiency of spending on infrastructure.8 • The production of health services by the government exhibits constant returns to scale with respect to the stock of public capital in infrastructure, , and government spending on health services, Annexes (17) o where: (0; 1), and (0; 1) is an indicator of efficiency of spending on health. This specification cap- tures the fact that access to infrastructure is essential to the production of health services.9 Survival Rate and Network Externalities • Finally, we assume that the relationship between the survival rate and health in adult -A = hood takes a concave form: (18) o with > 0. This specification implies therefore that po=pL and that o • Network externalities are captured by assuming that the degree of efficiency of infrastructure is positively but nonlinearly related to the stock of public capital itself10. Specifically, the network externality variable, qt, is taken to be a logistic function of (19) 8 See World Bank (2010) for a detailed analysis of the efficiency of public investment in Uganda, and Brumby and Kaiser (2013) for a broader discus- sion of public investment management. Empirical estimates of will be discussed in the calibration section. 9 See Agénor (2012, Chapter 3). 10 This specification follows Agénor (2010, and 2012, Chapter 6). An alternative and more “micro-based” definition of network externalities is in terms of the effects on a user of a product or service of others using the same product or service; thus, positive externalities arise if the benefits to the user increase with the number of other users. However, this is more di¢ cult to implement in a macro context. 151 Annexes o where: (0; 1), > 0 is a minimum value, and . Thus, the network externality has a convex-concave shape, bounded between . At low initial levels of the public-private capital ratio, im- provements in access to infrastructure generate strong increases in the efficiency of public capital; beyond a certain point, further improvements in access generate decreasing marginal returns. This accords well with the evidence on network effects. Savings-Investment Balance Annexes • Finally, savings-investment balance requires tomorrow’s private capital stock to be equal to savings in period t by indi- viduals born in t-1: (20) Balanced Growth Equilibrium • As in Agénor (2012), a competitive equilibrium in this economy is a sequence of prices , allocations physical capital stocks , human capital stock , a constant tax rate, a constant share of foreign resources, and constant spending shares such that, given initial stocks > 0 and E0 > 0, initial health statuses > 0, individuals maximize utility, firms maximize profits, markets clear, and the government budget is balanced. In equilibrium, it must also be that et = Et and at = At. • A balanced growth equilibrium is a competitive equilibrium in which and output grow at the con- stant, endogenous rate , the rate of return on private capital is constant, and health status of both children, , and adults, , are also constant. • The solution of the model yields (21) o where the individual’s propensity to save is defined as (22) • The fertility rate is given by11 (23) 11 To avoid convergence of population size toward zero, it is also assumed that n in the steady state. 152 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility • Thus, an increase in the savings rate (resulting from an autonomous increase in life expectancy, for instance) tends to re- duce the fertility rate, for standard reasons12. From (21) the public-private capital ratio is also negatively related with the savings rate. • Let denote the private capital-effective labor ratio. The model can be condensed into a dynamic system in three equations: Annexes (24) (25) (26) o where: , • The steady-state growth rate of output is given by (27) o where: = n( ) and = ( ) are the steady-state solutions associated with (22) and (23), and are the equilibri- 12 See Agénor (2012, Chapter 3). 153 Annexes um values obtained by setting in (24), (25) and (26)13: (28) Annexes (29) (30) o with 13 If the survival rate is constant, a sufficient (although not necessary) condition for dynamic stability of the system (25) and (26) is > 0 154 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Annex 6: Econometric Results of Firm Productivity and Export Analysis Figure A6.1: Productivity Distribution of Exporters vs Non-exporters .3 .3 Annexes .2 .2 Fraction of firms .1 .1 0 0 10 15 20 25 30 10 15 20 25 TFP Labour productivity Non-exporter Exporter Non-exporter Exporter Source: Sebudde et al. 2014. Table A6.1: Two-sample Kolmogorov-Smirnov Test for Equality of Distribution Functions   LP Correlated TFP Correlated Smaller group D P-values D P-values Non-exporter: 0.351 0.000 0.292 0.000 Exporter: -0.005 0.995 -0.011 0.964 Source: Sebudde et al. 2014. Note: a. The first row tests the hypothesis that productivity of exporters is lower than that of non-exporters. The approximate p-value of 0.995 suggests that we should reject that hypothesis. b. The second row tests the hypothesis that productivity of exporters is higher than that of non-exporters. The p-value for this is 0.000 which allows us to accept that hypothesis. c. The third row is the combined test, which tests productivity differences between exporters and non-exporters. The approximated p-value and the correlated p-value is equal to 0.000, which indicates that there are statistically significant differences in firm productivity between export- ers and non-exporters. 155 Annexes N Table A6.2: Determinants of Firm Productivity Labor Productivity (LP) Total Factor Labor Productivity (LP) Total Factor Productivity (TFP) Productivity (TFP) Variables Model 1 Model 2 Model 1 Model 2 Product innovation -0.154 -0.0648 4.860*** 3.812** (0.706) (0.873) (0.006) (0.041) Local ownership -0.808*** -0.875*** -0.668 -0.846 (0.000) (0.000) (0.488) (0.402) Annexes Exporter 0.568*** 0.604*** 3.598*** 4.451*** (0.003) (0.001) (0.001) (0.000) R &D activities 0.388 (0.384) Own website 0.466** 0.501** -2.321** -1.531 (0.030) (0.017) (0.048) (0.207) Firm age 0.006 0.008 0.0477 0.0578* (0.359) (0.207) (0.158) (0.098) Marketing innovation 0.212 0.300 4.212** 3.612* (0.649) (0.461) (0.022) (0.058) Firm size: Medium size 0.252* -0.239 -0.0627 (0.076) (0.759) (0.939) Large size 0.342 -0.473 0.745 (0.227) (0.763) (0.651) Formal training -0.030 6.140*** (0.847) (0.000) Loan duration 0.00292 -0.006 0.001 (0.688) (0.885) (0.977) Manager’s education: Secondary 2.175** (0.014) Postsecondary 1.112 (0.201) Constant 16.490*** 16.570*** 12.540*** 12.190*** (0.000) (0.000) (0.000) (0.000) Observations 607 607 636 636 Source: Sebudde et al. 2014. Note: P-value in parentheses *** p<0.01, ** p<0.05, * p<0. 156 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility Table A6.3: Probit Estimates of Export Probability Table A6.4: Tobit estimates of export intensity Dependant Variable: City-level Industry-level Dependant Variable: City-level Industry-level Export Dummy Determinants Determinants Export Intensity Determinants Determinants Firm characteristics Firm characteristics Foreign ownership 0.012* 0.011 Foreign ownership 0.002* 0.069* (0.006) (0.028) (0.001) (0.039) Size 0.606*** 0.644*** Size 0.121*** 0.079*** (0.127) (0.146) (0.022) (0.034) Total factor productivity 0.144*** 0.135*** Total factor productivity 0.202*** 0.120*** Annexes (0.016) (0.024) (0.063) (0.026) Investment climate indicators (IC) Investment climate (IC) Days to clear customs -0.080*** -0.074*** Days to clear customs -0.104** -0.076* (0.021) (0.017) (0.047) (0.043) Losses from power outrages -0.054** -0.110*** Losses from power -0.005 -0.015* (0.025) (0.033) outrages (0.049) (0.008) Obstacle to access to finance -0.651** -0.447*** -0.100** -0.189** (0.306) (0.144) Obstacle to access to (0.043) (0.049) Obstacle to access to land -0.615** -0.177* finance -0.049 -0.073 (0.265) (0.105) (0.047) (0.277) Obstacle to tax administrations -0.209 -0.086* Obstacle to access to -0.074 -0.034* (0.275) (0.050) land (0.052) (0.019) Obstacle to business licensing & -0.001 0.008 -0.095** -0.111** permits (0.294) (0.063) Obstacle to tax admin- (0.045) (0.047) istrations 0.386 -0.020*** -0.073 -0.085 Political instability (0.283) (0.003) (0.048) (0.208) Obstacle to business -0.258 -0.135 -0.041 -0.024 licensing & permits Corruption (0.251) (0.847) (0.041) (0.037) Political instability 0.449 0.137 0.021 -0.052* Corruption Labor regulations (0.467) (0.154) (0.056) (0.028) Labor regulations City fixed-effects Yes Yes City fixed-effects Yes Yes Industry fixed-effects Yes Yes Industry fixed-effects Yes Yes Firm fixed-effects No No Firm fixed-effects No No Observations 886 886 Observations 886 886 Chi2 57.30 54.99 LR chi2 98.92 71.23 Probability>Chi2 0.000 0.000 Probability>Chi2 0.000 0.000 Pseudo-R2 0.502 0.358 Pseudo-R2 0.531 0.478 Chi2 of IC indicators 38.93 36.04 LR Chi2 of IC variables 61.18 54.44 Probability>Chi2 0.000 0.000 Probability>Chi2 0.000 0.000 Source: Kiendrebeogo and Nganou 2015. 157 Annexes Annex 7: Key Drivers of Mineral Development Annexes Source: Compiled by the Authors based on survey of the literature 158 Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility