Report No: 97146-UG 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 experience 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. 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. 1 Third Message. The report includes a wealth analysis which shows that oil-producing countries should invest to develop the long-term capital (physical 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 2 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 3 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 4 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 5 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 of Program Leader, AFCE1). Helpful comments were provided Petroleum Economist, MEMD), Mr. Edward Isabirye 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. 6 Overview Uganda wants to become an upper middle-income country before EA2 and EA3. Geological surveys also identified 17 competitiveness (Dutch Disease), volatility, distorted public within thirty years. Economic diversification is a key minerals with potential for commercial exploitation. finance management practices, and poverty/inequality. component of the country’s development strategy. This is Negotiations with three major oil companies – Total (France) a) Competitiveness. The massive inflow of FDI during a sound objective. International experience shows a strong for EA1, Tullow (Ireland) for EA2, and CNOOC (China) the construction phase and then the rapid increase correlation between diversification and economic success. for EA3 – are not completed. CNOOC may start production in oil exports (and price hikes) can lead to a sharp A modern economy needs a combination of manufacturing, in 2017/18, Total and Tullow two years later. Current plans appreciation of the country’s local currency with trade and services to optimize the standard of living of involve the construction of a refinery that would process disastrous consequences for farm exports, tourism, the population. Economic development is a process of 30,000/60,000 barrels/day for the local and regional market. other non-oil economic sectors and the diversification structural transformation through which a country moves What is not processed by the refinery would be exported process. from producing ‘poor-country goods’ to ‘rich-country through a pipeline to a seaport in Kenya or in Tanzania. goods.’ b) Volatility. Oil and other commodity prices are Total oil production would peak at 230,000 barrels/day in subject to rapid changes. Extreme volatility produces Uganda’s economic structure changed over the past 2025, then decline to end in 2044. The viability and the fluctuations in exchange rates, export earnings, output three decades, with a gradual shift from agriculture to timing of the project depends on international oil prices. At and employment and discourages investment and manufacturing and services. Coffee and cotton still dominate the current price of about $50, only EA1 would generate growth. the country’s exports (39 percent), but new export products a rate of return higher than 10 percent. Projections in the have emerged, and manufactured products now account for report are based on an international price of $90/barrel. c) Distorted public finance management practices. Many 24 percent of total merchandise exports. The transformation oil countries cannot resist the temptation to accelerate Oil production will have a significant impact on Uganda’s in the output and export structures was not accompanied by public investment by borrowing against future oil economy. Average GDP growth rates could exceed 9 percent a similar shift in the structure of employment. Agriculture revenue. Rapid increases in public investment often over 20 years. The construction phase would create 13,000 employs three quarters of the population. As most of the lead to absorptive capacity constraints, congestions (temporary) jobs. The development of local capacity, new jobs are in informal/low productivity activities, the and inefficiencies. Tax collection is weak in oil- notably in transport and logistics, would then boost growth current pattern of economic growth generates few benefits producing countries. Governments in oil countries and employment. With about 70 percent of the net present for the bottom 40 percent households. Uganda’s oil and gas are also tempted to subsidize local oil prices, with value of oil production accruing to the government, oil potential offers an opportunity to accelerate the economic a negative impact on the environment. Abundant revenue-financed public spending would also stimulate diversification process. The ‘product space’ analysis in the natural resources may also crowd out financial capital economic growth. Additional public investment averaging report shows that Uganda’s diversification strategy should and slow down the emergence of a well-developed $2.1 billion/year would be used to improve infrastructure be focused on light manufacturing. financial system. (transport and electricity) and develop the human capital. Uganda’s oil reserves are modest: about 6.5 billion barrels This is essential to remove constraints to growth, transform d) Despite significant progress, poverty and inequality of which 1.3—1.7 billion barrels are recoverable. So far, natural resources into other forms of wealth, and create new remain a major concern. While the national headcount exploration activity was focused on three areas in the sources of sustainable income. of poverty declined to less than 20 percent, it is as high Albertine Graben region. EA1 has the largest reserves, as 44 percent in the underdeveloped Northern Region. Uganda, however, will face four main challenges: 7 Government policies should include measures aimed at that, initially, investment in transport and energy feasibility studies should improve the quality and maximizing the benefits of oil production. Oil revenue infrastructure would have a stronger impact on growth. efficiency of the country’s development program. should be used to support oil and mineral exploration In the long-term, however, education and health The development and implementation of an effective (so far 60 percent of the oil-rich Albertine Graben region spending will be more effective. Manufacturing and nationwide communication strategy for the oil and gas has not been explored). Government agencies should modern services – and the success of the government’s sector is also a priority. strengthen their capacity to negotiate good contracts with diversification strategy – depend on a healthy and well- b) The private sector is the most powerful instrument oil companies. The licensing process should be transparent educated labor force. of economic development. The agricultural sector (EITI) and include environmental impact assessments. d) Effective private sector development policies are a (demand for food) could be a major beneficiary of However, future macroeconomic and fiscal policies should critical component of an economic diversification oil production. Mining and tourism have potential be focused on ways and means of leveraging the new policy. Improving the business environment, addressing for private sector development. Building on existing resources to stimulate economic diversification, build critical infrastructure deficiencies, improving access capacities, Uganda could expand and diversify its up long-term capital and ensure the sustainability of the to capital, strengthening existing small and medium- manufactured exports. Realistic and effective local country’s wealth. sized firms are some of the main instruments of the content policies would promote linkages between the a) To maximize the socio-economic impact of its new policy. oil industry and the domestic private sector. Their revenue, Uganda should increase public investment success depends on the selection of sectors in which e) Reducing poverty and inequality is essential to promote gradually, and save some of its oil revenue in the early local capacity is available or can be developed. political and economic stability. Future infrastructure years of production. The CEM proposes a sustainable- development programs should give priority to the c) Uganda is one of the main beneficiaries of its EAC investing approach combining investment (to foster poorest/underdeveloped regions of the country. Social membership. Regional integration helped Uganda structural transformation) and saving (to mitigate programs focused on the poor should be designed and increase and diversify its exports. The development absorptive capacity constraints and Dutch Disease implemented. Direct cash transfers to poor households, of a regional infrastructure and the reduction of cross- effects). Uganda plans to use the non-oil non-grant linked with changes in health and education practices border trading costs will be as important as trade fiscal deficit rule which limits total spending (excluding should be considered and tested. preferences to stimulate regional trade and economic investment and social expenditures) to the sum of non- activity. Regional cooperation will play a role in the oil revenue and a specific deficit target. Set at a prudent Implementation of the proposed strategy depends on the development of Uganda’s oil industry (ownership level and used flexibly, the NONG rule could be an capacity and efficiency of three main actors: Uganda’s of the refinery and construction/management of the effective public spending policy instrument. public sector, private enterprises and regional institutions. pipeline). The EAC plans to create a monetary union b) The volatile nature of oil prices generates boom and a) Within Uganda’s public sector, seven institutions within ten years. Substantial benefits are expected but bust cycles that can be prevented through adequate play a major role in formulating and implementing the development of oil and gas production in Uganda, fiscal policy. The government should save sufficient the strategy and managing oil and mineral resources. Kenya and Tanzania and the fluctuations of energy reserves not only for future generations but also to A combination of technical support and capacity prices will have asymmetric consequences on the three finance countercyclical policies when oil revenues development programs should improve the technical main EAC countries and two resource-poor countries decline. An inflation targeting monetary policy could competence of these institutions. Corruption is a (Rwanda and Burundi). Prudent macroeconomic and increase the effectiveness of countercyclical fiscal serious problem. Transparency and accountability, fiscal policies will be essential to prevent a spill-over policies. stronger performance of audit and anti-corruption of the Dutch Disease. agencies and improved PFM systems are essential. c) The quality of investment is critical for sustainable Better public investment planning, based on detailed long-term growth. Economic simulations indicate 8 Part I: An Economic Development and Diversification Strategy - Main Goals The first part of the report focuses on the importance Although many resource-rich countries have developed expansion of construction, fueled by growing investment of economic diversification for Uganda and on the their economies and enjoy higher standards of living and the gradual urbanization process. Some growth was prospects/challenges of oil and mineral development. It over time, the most successful ones are the few that have generated by manufacturing, particularly the emergence of addresses the following three issues: (a) why diversification been able to diversify their production and export base (see agro-processing (including fish fillets, meat processing), is important for economic development; (b) where Uganda Figure 1). Malaysia, Indonesia, and Mexico have all moved metal, and chemical industries (including gold). Although stands in that area and why it should give a new impetus to away from oil dependence by diversifying their exports, the primary sector remains the least-performing sector, its its diversification strategy; and (c) what are the prospects, and witnessed accelerated and sustainable economic growth growth rate improved from 1.3 percent during the second possible impact, and challenges associated to oil and min- over time. By contrast, Angola, Nigeria, Libya, and Vene- half of the 2000s to 1.9 percent in 2011-13. ing development for Uganda’s economy. zuela have not succeeded in diversifying their economies, and reported lower per capita growth over the past three The transformation of Uganda’s economy is visible A. Why is economic diversification decades. through an increased diversification of its trade base. important for economic development? This diversification is both geographical and in terms of Lessons from international experience B. Why should Uganda expand and products. First, Uganda’s trade has become gradually less accelerate its diversification strategy? dependent on Europe and increased its partnership with Economic development is viewed as a process of struc- Asian and regional countries. Fifteen percent of Uganda’s tural transformation through which a country moves The structure of the Ugandan economy changed imports come from Kenya and 41 percent of its exports go from producing ‘poor - country goods’ to ‘rich - country significantly over the past three decades, with a gradual to South Sudan, the Democratic Republic of Congo (DRC), goods’. A modern economy needs a combination of man- shift from agriculture to manufacturing and services. Kenya, Rwanda and Burundi. Second, in terms of products, ufacturing, trade, and services to optimize the standard of The growth in the last decade was largely driven by the trade concentration (as measured by the contribution of five living of the population. Economic success is generally expansion of services, which now account for almost half top products in total export earnings) declined from over 95 reflected by the country’s ability to produce a variety of of the country’s GDP. The share of the primary sector percent in the early 1980s to about 86 percent in the 1990s goods and services that can be sold to other countries. For (including agriculture) declined to 30 percent, while and 55 percent in 2010-12. Although coffee and cotton a country like Uganda, the challenge is therefore to move industry represents approximately 23 percent. Among still dominate Uganda’s exports (39 percent), the country’s away from dominant (subsistence) agricultural activities services, telecommunication, transport, and financial export basket now includes about 60 new products, that keep the rural population in poverty, and from over- services grew by over 7 percent annually over the past three including cooking oils, processed fruits and vegetables, dependence on a few natural resources that may delay the years, reflecting higher local demand and technological and fish. In addition, several new sub-sectors (flowers, expansion of modern manufacturing and services and job changes (the mobile phone revolution). The industrial sector wood, minerals, and chemicals) have emerged. Uganda creation for the majority of the population. grew by 6 percent between 2011 and 2013, reflecting the also exports light manufactures (skins and hides processed 9 Figure 1: Export Diversification 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. into high-value leather), and heavy manufactures, including Consequently, the current pattern of growth has only weakly duction. The existing chemicals and metal product indus- construction materials made from iron and steel. The share benefited the bottom 40 percent of the population. tries can also serve as stepping stones towards more sophis- of manufactures in total merchandise exports increased ticated diversification in the longer term. from 2 percent in 1994 to 34 percent in 2012. This is a good In this context, it is clear that Uganda should scale up The oil and gas potential of the country can offer sign for the future of the country’s industrialization process, its diversification efforts. The product space analysis an opportunity for Uganda to diversify its economy, although the construction sector still relies on imported iron (PS) conducted in the main report, shows that a sound although this needs proper management to avoid a and steel. diversification strategy should be focused on light man- negative impact on other forms of diversification. Oil The gradual transformation in the output and export ufactured exports, such as garments, leather, and wood can help a country diversify through different channels. structures of Uganda was not accompanied by a similar products. These products do not require sophisticated skills, First, oil could help Uganda promote the emergence of an shift in the employment structure. Today, approximately which are not readily available in Uganda, and would use energy-intensive industry, such as chemicals, fertilizers, or three-quarters of Ugandan households continue to report the large pool of unskilled and semi-skilled workers avail- cement. Second, oil will bring substantial revenues to the agriculture as their primary economic activity. While the able in the country. Uganda’s strategy could get inspired by state, which could invest them in infrastructure and human labor force is moving away from farming, most of the new the recent success of Ethiopia and Lesotho in developing capital development. Third, the exploitation of oil could jobs are created in informal and low-productive activities, a vibrant local manufacturing industry. Other opportunities create synergies with local industries through forward and such as trading. The fastest growing sectors of the economy include agriculture-related processing industries (cereals, backward linkages. Successful countries are those which (finance, communication) are not as labor intensive. dairy products, more types of cooking oils, and new sugar have been able to harness those channels over time. products), that can leverage the country’s agriculture pro- 10 C. What are the prospects, potential rels/day in a local refinery for the domestic and the regional The first impact of oil on the local economy will be creat- impact, and challenges of oil and other markets (Burundi, DRC, South Sudan and Rwanda), and ed through the creation of 13,000 jobs during the initial extractive industries in Uganda? (ii) exporting additional output through a pipeline linking phase of construction. The number of permanent jobs in Uganda’s oil fields to the coast line of Kenya or Tanzania. and around the oil industry will decline to about 3,000 when Total production is expected to peak at 230,000 barrels/day production begins, but the development of local capacity a. Prospects of oil and mineral development by 2025, but will decline thereafter and end around 2044. through training and linkages, notably in sectors like trans- portation and logistics, has the potential to boost further Today, the country’s total oil reserves are estimated At this stage, the investment plans are influenced by economic growth and employment. at 6.5 billion barrels (of which 1.3 billion barrels are two important factors that are not entirely under the recoverable), but only 40 percent of the country’s control of the Government of Uganda. The first one is The second impact is related to the sequential trade potential has been explored so far. Drilling activity the construction of the pipeline that will enable Uganda balance effects of oil. In fact, as foreign direct investment intensified along the Albertine Graben in the early 2000s to export its oil through Kenya or Tanzania. The second (FDI) increases when firms are focusing on the construction with a special focus on three exploration areas (EA1 with factor is the medium to long-term price of oil on interna- phase in the petroleum sector as well as other oil-related 923 million barrels of recoverable reserves, EA2 with tional markets. The economic viability of the three main imports, growth in total imports is expected to accelerate 231 million barrels, and EA3A with 134 million barrels). oil areas will largely depend on the future price of oil. from 4.5 percent in 2014/15 to an average of 12.5 percent Beyond oil, Uganda has a rich mineral industry. Geological As illustrated in Figure 3, the rate of returns of the three over the period 2017/18 to 2020/21. Subsequently, annual and airborne surveys conducted since 2003 identified 17 existing areas will exceed 10 percent only if the oil price import growth will gradually decline, reaching 7 percent in minerals (copper, cobalt, gold, iron ore, columbite tantalite, is over US$85. At a price of US$50, only one of the three 2030/31, as the need for significant imported inputs declines tin, titanium, tungsten, limestone/marble, phosphate, areas will generate a rate of return higher than 10 percent. and the construction phase winds out. At the same time, oil vermiculite, rare earth elements, kaolin, gypsum, salt, glass exports will increase gradually from a very insignificant sand, and dimension stones) with potential for commercial b. Impact of oil and mineral development level in 2017-20 to 6.6 percent of GDP in 2024-30. In line exploitation. Today, Artisanal and Small-scale Mining with these developments, the country’s trade balance (as (ASM) provides direct employment to more than 200,000 Oil production will have a significant impact on Ugan- share of GDP) will first deteriorate slightly from a deficit of people and more than 1.5 million people benefit from da’s economy. This report used alternative macroeconomic 9.7 percent in 2014/15 to 17.9 percent on average over the backward and forward linkages to the mineral sector. models to evaluate the (present and future) impact of oil period 2017/18 to 2020/21 but will improve significantly production on Uganda’s economy. Based on an interna- thereafter due to the stronger performance of oil and non-oil In the oil sector, negotiations between the government tional oil price of US$90, our projections show that GDP exports. and international investors began in 2012, but are not yet growth rates could exceed 9.0 percent per year over the next finalized. Three major international oil companies, includ- two decades through a combination of demand and supply Third, oil production will also have a positive (indirect) ing Total (France) for EA1, Tullow (Ireland) for EA2, and effects directly generated by oil activities. This impact will impact on Uganda’s economy through the use of CNOOC (China) for EA3A, are expected to start production however vary over time, depending on production patterns. additional public revenue. On the basis of the production in 2017/18 (CNOOC) and 2019/20 (Total and Tullow). Cur- Those effects are also sensitive to the policies that will be sharing agreements already concluded, and assuming a rent plans include (i) the processing of 30,000-60,000 bar- implemented by the Ugandan authorities. long-term international price of US$90 per barrel, about 70 11 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). percent of the net present value of oil production would go depleted. In brief, an assets diversification strategy which would fall to 4.5 percent from 9 percent under our baseline to the government. The amount of additional public revnue transforms natural capital (including oil) into tangible and scenario. would average US$2.5 billion/year (more than 50 percent of intangible capital is essential for the sustainability of the current government revenue). Based on past experience in country’s wealth. So far, the contribution of the mining sector has remained successful oil-producing countries, and taking into account modest, but prospects are positive. The growth of the sector Uganda’s situation, those revenues should be used to finance The magnitude of the stream of additional oil-related averaged 9.8 percent in recent years, but its contribution to the existing needs in infrastructure and human capital. While government revenue, and therefore its growth impact, will GDP did not exceed 0.3 percent. Mineral exports (mostly smart management will require finding the right balance largely depend on the future price for crude oil. Revenue gold, iron ore, silver, tin, tungsten, vermiculite, cobalt, and between consumption and savings, the current needs are projections are very sensitive to the assumed oil price copper) accounted for only 1 percent of total exports in so high in Uganda that a substantial share of the additional (Figure 4). Before oil prices started declining heavily 2012/13. However, Uganda’s rich mineral wealth is virtually revenues should be used to address current deficiencies. in mid-2014, the price for one barrel of oil had hovered untapped. Political, and economic stability in the country, Access to electricity and connectivity are serious challenges around the US$100 mark for several years. At this level, oil availability of geo-data, and growing global demand, for private businesses but infrastructure investments revenue for the government would average close to US$2.5 notably from emerging countries like China, and India, led would help reduce Uganda’s lag with other low-income billion a year between 2017/18 and 2044/45. Assuming an to significant increases in FDI for the sector. To harness the countries.Concurrently, improvements in education will be international price of oil of US$50 per barrel, average oil exploitation of its mineral resources, the government must particularly critical to boost the stock of human capital in revenue will only amount to about US$800 million a year. adopt a comprehensive development-driven policy, focused the long-term, notably when oil and mineral resources are Similarly, the direct contribution of the oil sector to GDP on the value of the derived demand through the mineral 12 value chain. This includes the creation of a sound legal, This negative effect can even become more important after the authorities and segments of the population. and regulatory framework, and addressing infrastructure the start of oil exports. Rising exchange rates together inadequacies, and human capital deficiencies, notably in with price hikes for services (triggered by oil revenue and The third level of challenges lies in the mix of policies knowledge-intensive areas. Many of the mineral sector expatriate workers’ earnings) would affect the profitability that the government will use to promote private sector developments could be financed through the additional of farm exports and tourism sector. The volatility of oil activities. The government may wish to influence the allo- revenue that the government is set to receive with the onset prices can also have severe negative consequences for oil cation of resources by introducing a complex set of subsi- of oil production. Simulations suggest that the government producers. The volatility of oil prices had a major impact dies and incentives. For example, the government can be will receive an additional US$56 billion in revenue over on Congo, Venezuela, and Nigeria and many other oil- tempted to subsidize local oil prices with the good intent the next two decades, which, if soundly invested, could producing countries. Volatility produces fluctuations in to favor local businesses but this can be detrimental in the also support the minerals sector. This in turn may attract exchange rates, export earnings, output, and employment, longer term as it discourages energy saving behavior and additional FDI which could further boost mining activity in and discourages investment and growth. negatively affects the environment. The government may the years to come.  also wish to indirectly subsidize resource-based industries The second level of challenges concerns public finance. by not charging them enough for their extraction rights. There is little doubt that oil (and other minerals) can It starts with the temptation to borrow against (future) Taxing the revenue of these industries too lightly can lead be a game changer for Uganda. As evidenced above, the oil revenues. Few countries have been able to resist this to overvaluation of the currency and associated balance exploitation of those resources can increase employment, temptation as illustrated by the recent example of Ghana. of payment and external debt problems. Abundant natural government revenues, and exports. These direct positive The government should realize that oil revenues are vola- resources may also crowd out financial capital by holding effects can be magnified through smart policies that will tile and will depend on international oil prices on oil mar- back the emergence of a well-developed financial system, favor the optimal allocation of public revenues towards kets. The establishment of contingent financial reserves is and producing an inefficient allocation of savings across infrastructure, and human capital. However, international important in that context. Often, the availability of oil reve- industries and firms. experience also demonstrates that the management of oil nues reduces the country’s tax effort. A one percentage point brings a full variety of challenges to policymakers. increase in resource revenue (in percent of GDP) may lead These challenges, by nature, are not easy to address. to a decline in non-resource government revenue by 0.2-0.3 In addition, multiple and evolving factors have to be c. Challenges associated with oil and mineral development percentage points. Tax collection is weak in oilproducing taken into account in the decision making process. countries. Uganda will also have to establish a reliable and The oil-producing countries that have been able to opti- These challenges are at different levels. The first level mize the use of their oil resources are those that have transparent public investment management system, which is associated to the project cycle from construction to been able to increase the governance framework over will help the government select and implement an optimal exploitation, and its impact on the country’s main economic time. Countries rich in natural resources are generally get- portfolio of investment projects. Finally, there is evidence and financial variables. The Dutch Disease effect is well ting lower scores in terms of governance indicators (see that resource-rich countries tend to allocate a smaller share known by economists. The massive inflows of FDI in the the Ibrahim index of Africa governance) and corruption of their national income to education. They send fewer chil- phase of construction (even if it is partly compensated by (Transparency International; see also Figure 4). How- dren to school than countries with the same income level higher imports) can lead to a real appreciation of the local ever, the most successful countries have been those that but fewer natural resources. A possible explanation is a false currency that will reduce Uganda’s export competitiveness. were able to improve their scores over time (Figure 5). sense of economic security that influences the mindset of 13 Part II: Policy Priorities Around Four Building Blocks The second part of the report discusses how Uganda’s obviously important, the first stage should be to ensure that resources, facilitate the exploration and exploitation of the oil should be used as a tool to promote further econom- the maximum amount of revenues will be collected by the country’s resources, and create a business climate favorable ic diversification. Our proposal is to adopt an action plan country. This supposes that exploration activities continue to the development of domestic economic activities linked organized around four building blocks. The first building and that contracts with investors are well negotiated by the with, or independent from, the oil and mineral sector. This block includes measures aimed at strengthening the benefits government. Therefore, the government’s agenda should means: (i) additional geological and other surveys, which that the country expects to receive from its untapped oil and include measures aimed at supporting new exploration can be (partially) financed by the public sector with the help mineral potential by enhancing exploration and negotiating in areas with untapped oil and mineral potential and of Uganda’s development partners, and (ii) the creation good contracts with investors, while minimizing the neg- maximizing the economic and fiscal benefits expected from of a stable legal and institutional environment attractive ative social and environmental impacts of oil and mining oil/mining production through good contract negotiations for private investors. The exploration of oil and minerals production. Such actions should be taken at an early stage and promoting more transparency in the licensing system. requires large investments and state-of-the-art technology. of the cycle. The second building block is about macro- At the same time, during those initial negotiations, the It is economically risky and most of the developing economic and financial policy considerations, that is, sav- government should attempt to minimize the negative countries need the help of foreign investors to access the ings and consumption trade-offs, borrowing, and volatility impacts oil and mineral developments may have on the most appropriate exploration technology. concerns. The third building block is about public sector environment and ensure the emergence of a consensus on b. Strengthening capacity in contract negotiations and pro- management, including allocative and financial efficiency how oil revenues will be shared among stakeholders in the moting transparency in the licensing process of public expenditure, and efforts to minimize the possible country. crowding out of non-resources expenditures and aid. Final- First, the government should negotiate good contracts a. Supporting oil and mineral exploration ly, the fourth building block concerns policies to promote with foreign investors. The bargaining power of oil com- private sector development. All these four building blocks Uganda’s government must encourage exploration of panies is reinforced by their vast experience in the field. are important but it is their combination that will ultimately oil and mineral deposits first in the parts of the oil-rich The government should not hesitate to hire independent determine to what extent oil will help Uganda diversify its Albertine Graben region that have not been explored expertise that will strengthen its negotiating position and economy and improve the living conditions of the majority (about 60 percent of the region), and, second, where will help obtain the best possible outcome. So far, oil-re- of its citizens. potentially viable mineral deposits have been identified. lated negotiations have been led by the Petroleum Explo- The adoption of downstream and upstream laws in 2012 ration Production Department of the Ministry in charge of A. Leveraging the benefits of oil and clarified the legal framework and paved the way for a new Mineral Development. A first phase of production sharing extractives for economic diversification round of exploration licenses. As a result, private FDI flows agreements (PSA) has already been negotiated with IOCs are among the highest in East Africa and keep growing. with respect to three main exploration areas (EA1, EA2, and Very often, policymakers focus their attention on how to However, more efforts are needed to attract additional FDI EA3A). use the resources derived from oil. While this question is 14 Figure 4: Higher Corruption (less transparency) in Figure 5: Transparency and Economic Performance Adherence to the Extractives Industry Transparency Natural - Resource Rich Countries in Oil-producing Countries Initiative (EITI) would also send a positive signal to the local and international community about the govern- ment’s commitment to good governance in the oil and mining sector. The recently enacted PFM Law indicates that annual and semi-annual reports of the Petroleum Fund should be submitted to the parliament. Ugandan laws and regulations, however, do not require oil companies to pub- lish information about payments made to the government. The preparation of new regulations for implementing the PFM Act provides an opportunity to introduce mandatory disclosure requirements regarding payments by the oil com- panies (in line with EITI standards). c. Minimizing the impact of oil and mineral development Source: Authors’ computations based on World Bank, World Source: Authors’ computations based on World Bank, World on the environment Development Indicators, updates of World Bank data (2006) and Development Indicators, and data from Transparency Interna- data from Transparency International. tional. Note: ‘Natural Capital’ goes beyond ‘Natural Resources’. This  The risk of environmental damage linked to oil produc- explains Uganda’s very high share of natural capital as per the tion is not immediate but should be addressed as early as 2005 figures which do not include oil (that is, natural capital possible. Environmental impact assessments should always represents 84 percent of tangible capital). be carried out before delivery of exploitation licenses. In Second, the government should establish a Multi-sector on processing production license applications. addition, oil and mining companies should be responsi- team because oil contract involves many different issues, ble for restoring degraded land and polluted resources to ranging from land to labor, taxes and environment. The An important step forward would be to improve account- their original condition. The capacity of local communities second recommendation would be to invest in educating ability by publishing all contracts. The Access to Infor- should be developed to ensure that environmental damages local staff on various aspects of the oil and gas industry so mation Act of 2005 (ATIA) provides that detailed informa- are minimized and to help these communities derive sub- that the country does not need to always rely on outside tion on PSAs and production licenses should be available to stantial benefits from local content policies. experts. Incidentally, some of the national institutions the public, and an online cadaster similar to the one avail- d. Agreement on basic principles of redistribution mecha- dealing with the oil sector, including the National Oil able in the mining sector (which provides detailed informa- nisms Company (NOC) and the Petroleum Authority, are not tion on mineral licenses) should be introduced for the oil yet in place. This could also explain why the Petroleum sector. A growing body of international evidence shows that Oil benefits can vary both in level and utilization. At Exploration Production Department of the Ministry in full transparency regarding the conditions of contracts is an an early stage, it is important that all stakeholders agree on charge of Mineral Development, which is currently leading important pre-condition for accountability. Without trans- basic principles. There is no single blue print applicable negotiations, may be overstretched resulting in long delays parency, natural resource rents may be confiscated and may to all oil-producing countries. Consequently, a dialogue not benefit the rightful owners of the resource. 15 on social protection schemes (excluding contributions to pension funds) compared to 2-3 percent in other developing countries, increasing spending on social protection would enable the poor to better participate in the growth process as Uganda transforms itself into a middle-income Contractors handling country. It would also reduce vulnerability. Experience lifting equipment at an exploration site in in other countries over the past decade shows that well- western Uganda designed large-scale social protection programs can have a tremendous impact on the conditions of the poorest, at affordable fiscal cost. As an illustration of the effectiveness of such programs, we have estimated that the impact of providing monthly cash transfers of about UGX25000 to 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. B. Macroeconomic and financial policy considerations To leverage its new resources for further economic on the issue should be initiated and extensive consultation determine the allocation of oil revenues to finance structural diversification and ensure the sustainability of the mechanisms should be created to avoid future conflicts. investment and to help finance vulnerable groups. country’s wealth, Uganda must transform its natural capital into physical, human, financial, and social The use of oil resources may worsen existing inequality Effective consultation mechanisms should lead to a capital. Maintaining macroeconomic and financial stability and may create conflicts between local interests and sound infrastructure development program that will is an important part of this objective. The government’s national development objectives. It is therefore important assess the above-mentioned trade-offs between the policy in this regard should address the following issues: to set up clear rules of distribution of revenues between national and local governments as well as between (a) minimize savings-consumption trade-offs through the national and local governments. There have also been structural investment projects and cash transfers. The appropriate consumption-investment decisions, (b) adopt repeated calls on governments to distribute oil earnings government may launch specific studies on how oil revenues borrowing dynamics consistent with acceptable debt limits, directly to households in the form of lump-sum transfers can be used to address poverty by targeted programs. It may and (c) isolate the economy from oil price volatility. based on the Alaska distribution model. These proposals want to explore the feasibility of conditional cash transfers are motivated by the lack of trust in political leaders with to low-income households linked with special initiatives for One of the manifestations of the resource curse is Dutch respect to the management of oil earnings. Again, it would the welfare of children and other vulnerable members of the Disease, which turns poorly managed natural resource be essential to agree on the rules of the games that will community. As Uganda spends around 0.4 percent of GDP 16 wealth into a mixed blessing and reduces long-term into a holding account overseen by the parliament, which for over 25 years. In other words, the average wealth of a growth. In fact, although the discovery of oil resources is will be used to finance the budget or will be transferred Ugandan today is about UGX2.7 million higher due to oil expected to generate extra resources and spur investment in to a special savings fund called the Petroleum Revenue discoveries. physical infrastructure and human capital, it is also associat- Investment Reserve. This savings fund will operate as a ed with challenges as it may inhibit the development of the sovereign wealth fund. It will enable the country to save for To increase its ANS, Uganda should not only consume tradable sectors due to a real appreciation of the exchange future needs and will smooth government expenditure when some of its oil revenue to improve the living conditions of rate (Dutch Disease). Moreover, the lack of diversification oil prices fall. The law, however, does not indicate which current generations but should also invest strategically and inadequate transformation of natural capital into other share of annual oil revenue will be deposited in the account. to lift the income level of many generations to come. forms of capital critical for long-term sustainable growth In Ghana, the law stipulates that each year 15 percent of all To achieve this, Uganda needs to build up other forms can exacerbate the effects of Dutch Disease. Therefore, oil revenue should be saved and deposited in a stabilization of capital as oil reserves are gradually depleted. If the prudent macroeconomic policies (including an inflation tar- fund to absorb unexpected oil revenue shortfalls. If Uganda depletion of oil reserves leads to increased consumption geting monetary policy) are essential to fight the effects of adopts a similar rule, enough savings would be accumulated and is not matched with increased investments in other Dutch Disease and achieve the country’s economic diversi- by the end of 2024/25 to absorb a sudden drop in oil revenue forms of capital, Uganda’s wealth will decline over time. As fication objectives. of almost 50 percent. Simulations from a Dynamic Stochastic was mentioned before, the development of the oil industry General Equilibrium (DSGE) model indicates that 15-30 offers many opportunities to raise public investment and a. Savings-Consumption trade-offs percent of oil revenue should be saved to minimize the to improve the living standards of the country’s for both volatility of three key macroeconomic aggregates (public current and future generations. Resource-rich countries pursue different investment strategies for their oil proceeds. Brazil used natural consumption, private investment, and total employment). New oil revenue will enable Uganda’s government to resource rents to expand its savings abroad, while Botswa- In resource-rich countries, the ultimate policy goal must accelerate public investment, but it will also create new na’s priorities were more focused on building its existing be to transform a temporary increase in revenue into challenges for the private and the public sectors and stock of infrastructure and human capital. Judgments about a long-lasting source of income. To measure to which may lead to low investment quality. The case of Angola the absorptive capacity of the domestic economy and about extent countries save and invest in a sustainable manner, the shows that increasing investment too quickly exacerbates the appropriate pace of investment are the main factors that ‘wealth accounting framework’ uses the concept of adjusted absorptive capacity constraints in the public sector and trig- should determine savings and consumption trade-offs. The net savings (ANS), which takes into account investments gers supply-side bottlenecks in a private sector unable to strength of the institutional framework should also be tak- in different forms of capital, including depreciation. While increase the supply of non-tradable products and services. en into account. In weak institutional set ups, investment Sub-Saharan Africa grew robustly at an average annual rate Weak institutional structures for public investment manage- spending leads to low returns due to poor project selection, of 5 percent since the turn of the century, many resource- ment often lead to low returns due to poor project selec- appraisal, and implementation. In such circumstances it rich countries (Nigeria, Angola) had negative ANS rates tion, appraisal, and implementation. Accelerating the pace makes sense to save part of oil revenues and invest in foreign because they depleted resources without exhibiting high of investment will be feasible if the management of public assets, including sovereign bonds in industrialized countries returns. Since 1982, Uganda’s ANS has also been negative, investment improves and the government implements poli- with high credit ratings. These savings would be used at a principally as a result of the depletion of its forests. cies aimed at stimulating an adequate response of the private later stage when improved investment capacity will enable sector to the resource boom. Background analysis using the the economy to adjust gradually to higher investment levels. The discovery of oil in commercial quantities boost- Computable General Equilibrium (CGE) and Overlapping ed Uganda’s total wealth but also raised the chal- Generations (OLG) models shows that improved efficiency In Uganda, the Public Finance Management Act 2015 lenge to report a positive ANS in the future. Starting in in public sector spending would lead to higher GDP growth stipulates that all oil-related revenues will be deposited FY2017/18, oil rents will average about 3.4 percent of GNI rates. 17 To maximize the socioeconomic impact of new revenue, today’s expenditure to 19 percent of GDP. Set at a prudent Resource-rich countries use a wide variety of fiscal rules Uganda should increase investment levels gradually level, the NONG fiscal deficit rule could prevent a too rapid to promote sound fiscal management of natural resourc- and save some of its oil revenue in the early years of oil increase in expenditure when oil production begins. es. In 1994, Botswana adopted a Sustainable Budget Index production. Investing abroad gives time to consider which (SBI), which provides that the ratio of non-education, non- domestic investments should be undertaken. The CEM In addition to implementing an adequate NONG fiscal health recurrent expenditure to non-mining revenue should compares three alternative strategies using a DSGE built for deficit rule, the government should deposit each year a not exceed unity. Implementation of the policy prevented Uganda, that is, (i) the all-saving approach, in which natu- fixed share of oil revenues in a savings account. The right excessive spending and ensured fiscal sustainability in ral resource proceeds are totally saved (only the return on level of NONG fiscal deficit depends on expected oil reve- anticipation of the depletion of diamond deposits.1 Both the savings is used to finance the domestic economy), (ii) the nue and the targeted level of government expenditures. The fixed and the flexible fiscal deficit rules presented in the pre- all-investing approach, in which all the proceeds are invest- CEM presents two alternatives. The first option would set vious paragraph would comply with a Botswana type sys- ed in productive projects, and: (iii) the sustainable investing the NONG deficit target at a fixed rate of 5 percent of GDP. tem. Combined with an explicit savings target for each year, approach, which allocates a fraction of the natural resource With expected oil revenue of 1.2 percent of GDP and grants the NONG rule would also have advantages over Ghana’s proceeds to remove growth binding constraints (such as of 0.6 percent over the first four years of oil production, widely praised petroleum revenue management law, which infrastructure), while the rest is stored in a Parking Fund the overall deficit would average 3.5 percent, thus enabling establishes that 70 percent of the benchmark annual oil rev- for future investments. The sustainable-investing approach Uganda to comply with the 3 percent deficit target of the enue is channeled to the budget, 15 percent allocated to a provides an optimal combination of investment and saving EAC monetary union by FY2020/21. However, a fixed tar- stabilization funds and 15 percent saved for future genera- depending on the size of oil production and the character- get of NONG budget deficit does not take into account the tions. In fact the Ghanaian mechanism does not really limit istics of the country’s economy. Investment is needed to bell shape nature of the oil production path. It would there- spending, since the government can comply with the saving foster structural transformation but the increase in invest- fore result in high fiscal deficits in the early years and very rule while borrowing for additional expenditures. In effect, ment should be gradual to mitigate absorptive capacity con- low deficits when oil production peaks by the mid-2020s. since the beginning of oil production in 2011, recurrent straints and Dutch Disease effects. In particular, the grad- Alternatively, the proposed NONG fiscal deficit limit would spending already rose by 10 percent creating serious risks ual scaling-up of investments under this scenario triggers be revised every 3-5 years in line with the inflow of oil rev- for Ghana’s near - term economic outlook. Under Uganda’s a smaller exchange rate appreciation than the all-investing enue. NONG fiscal deficit rule, such a spending increase would approach, but higher levels of welfare than the all-saving not be possible. approach. b. Borrowing dynamics The countries that implement clear fiscal rules on how The government may be tempted to spend in advance initial oil revenue will be spent generally are the most some of its future oil revenue through substantial successful in their transition from net oil consumer to borrowing on the financial markets. This may generate net oil producer. According to its Petroleum Revenue short-term benefits through growth of private consumption Management Policy, Uganda will use the non-oil non-grant but would have negative long-term consequences, as NONG fiscal deficit as an anchor for public expenditures. savings are sacrificed. It might also help to smooth This means that total spending will be limited to the sum of grown by UGX 2.7 investment expenditures over time, taking into account the domestic non-oil revenue and the deficit target. With cur- million each due to the discovery of oil limited absorptive capacity of the economy. The case of rent domestic revenue reaching 14 percent of GDP, a non- oil non-grant fiscal deficit target of 5 percent would limit 1. Kajo (2010): “Diamonds Are Not Forever: Botswana’s M. rm Fiscal Sustainability” 18 Ghana is the most recent example that illustrates the need to establish safeguards. The coming on stream of oil in Stone quarrying for road construction 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. Excessive borrowing in Ghana was possible because the revenue management law does not include clauses which ensure that prospective oil revenues will not lead to excessive government borrowing. Whereas an original draft of the Petroleum Revenue Management Bill included a clause that prohibited the use of oil revenues as collateral for loans (that is, oil-backed loans), the clause was dropped during the drafting process. Consequently, the country is tapping heavily into international capital markets to frontload investments which expanded from 15 percent of GDP in 2007 to 26 percent in 2013. Moreover, in 2011 the government signed a US$3 billion loan with the Chinese Development Bank, which explicitly commits future oil revenues as collateral. Under the agreement, the Government of Ghana will sell crude oil directly to a Chinese agent to support the repayment of the loan. In Uganda, the Public Finance Management Act explic- itly prohibits the collateralization of future oil revenues. However, prudent debt management will always be required over time. c. Volatility Concerns Oil - dependent countries are exposed to oil price volatil- ity, which may be caused by political developments, natural disasters, sudden changes in the global oil demand and other exogenous factors. Commodity price volatility, through its 19 impact on export earnings, could affect the effectiveness of This is a valuable lesson for Uganda, which must avoid ogy) are estimated at US$21 billion (until 2025). Public fiscal policy and economic growth in resource-dependent falling victim of spending pressures often encountered in investment in infrastructure increased significantly since the countries as has been seen during the recent decline in inter- resource-rich countries. Moreover, Uganda should establish adoption of the first National Development Plan (NDP1). national oil prices. Lower oil prices reduce government rev- sufficient buffer to smooth out the adverse effects of price Road construction and maintenance increased from 2.4 enues and the capacity to finance public spending. volatility on macroeconomic and financial variables. The percent to 3.1 percent of GDP from 2009 to 2013. At the implementation of clear fiscal rules involving some savings same time, public spending in education and health declined The volatile nature of oil prices generates boom-bust will also be critical in this regard. from around 6.5 percent of GDP in 2003/04 to 4.5 percent in cycles, which can be prevented through adequate fiscal FY2012/13 and social services are under pressure. Although policy. The rationale is simple: the government can adopt a C. Public sector management issues Uganda’s primary school enrollment rates are high, overall counter-cyclical fiscal policy when oil revenues are declin- spending per primary school student is below the average in ing, thus helping the economy to absorb the shock. Such Sound public sector management is essential to harness low-income countries. This may explain the low completion policy is subject to two conditions. the potential of extractive industries and speed up rates as compared with similar countries. Better schooling the socioeconomic transformation of resource-rich outcomes and increasing the share of students transitioning First, the government should have sufficient reserves to countries. The design of an effective public sector from primary to secondary education will require addition- finance such policy, which raises the question of how much management strategy should deal with: (a) the efficiency al funding. Health sector expenditures will also need to oil revenue should be saved, not for future generations, but and the allocation of public spending, (b) the crowding out increase over the long-term. to act as a buffer in case of negative shocks. The second of non-oil domestic revenue, (c) public spending pressures condition is that the countercyclical fiscal policy can have and the revenue sharing with local governments, and (d) the The CEM argues that investments in infrastructure and an impact on the real economy. This requires some knowl- oil-aid nexus. human capital are both critical for Uganda’s medium edge about the magnitude of fiscal multipliers and their and long-term prosperity. Economy-wide simulations a. Efficiency and allocation of public spending heterogeneity with respect to boom and recession cycles. A conducted during preparation of the report, suggest that background paper prepared for the CEM (using a sample of The pace and the quality of investment are critical for using initial oil revenue to address the most urgent infra- 99 countries) shows that spending multipliers are higher for sustainable long-term growth. Countries that invest a structure needs, notably in energy and transport, will have resource-rich countries (ranging from 0.55 to 0.74), which large share of their natural resources wealth grow faster. a stronger growth impact than increased spending on edu- are more capable of boosting GDP through government However, what matters is not only how much a country cation and health. Allocating oil revenue to infrastructure spending. In addition, spending multipliers seem to be high- invests but how well it invests. Because of poor investment during the first four years of oil production would lead to er during recessions (0.55-0.59) than during booms (0.01). quality, some countries are unable to produce returns gener- a 0.8 percentage point higher increase in the GDP growth In other words, fiscal interventions are more effective during ating sustainable consumption levels.  Angola and Nigeria rate than if all resources are allocated to human develop- recessions in oil-producing countries than everywhere else. are typical examples of countries that did not fully enjoy the ment. Focusing efforts on infrastructure also yields better benefits of increased oil production (and high prices during outcomes for the MDGs. All the 2015 MDG targets would In this context, sound planning instruments and expen- the oil boom) because of the poor quality of their invest- be met by 2020, with the exception of Universal Primary diture stabilization mechanisms are needed to ensure ments. Education. that increased government spending resulting from pos- itive changes in commodity prices does not negatively Recent government programs emphasize investments In the long run, however, education and health spend- impact macro-stability and delivers value for money. An aimed at improving the country’s deficient infrastruc- ing will have more impact on growth than spending inflation targeting monetary policy based on export com- ture. Uganda’s infrastructure investment needs (Works and on infrastructure. A study prepared in the context of this modity (Product Price Targeting) could increase the effec- Transport, Energy and Mineral Development, Water and report, which exploits the features of an overlapping gen- tiveness of countercyclical fiscal policies (Franklin 2012). Environment, Information and Communication Technol- eration (OLG) growth model, concludes that a 3 percent- 20 Infrastructure projects like road construction require heavy investment, thus the temptation to borrow in anticipation of oil revenue is high age points increase in the share of government spending on force. This is especially relevant for a country like Ugan- when the government begins to receive a substantial inflow health and education would have a long-term growth impact da where only 20 percent of the labor force has completed of oil-related revenue. A decline in tax revenue would have of about 0.7 percentage points compared to only 0.4 per- secondary education, compared with 50 percent in Gha- negative macro-fiscal implications. If for instance recent centage points for a similar increase in spending on infra- na. Investments in education are important to ensure that efficiency gains were to disappear when oil production structure. The study explains that while an increase in the Uganda’s youth is prepared for new job opportunities in the begins, the ratio of non-oil tax to non-oil GDP would fall share of infrastructure spending would have indirect effects emerging oil industry and other sectors. These jobs will go from 13 percent today to less than 10 percent in the medi- on human capital accumulation and the production of health only to Ugandans who are adequately trained and educated, um term. The government would therefore need to reduce services, it would also have congestion effects that mitigate but the number of Ugandans with the necessary technical expenditure to meet the 3 percent deficit ceiling of the EAC the initial benefits of a higher public capital stock. These skills is insufficient. The skills shortage goes beyond the and GDP growth rates would be significantly lower than in findings support the strategy of the government which wants oil sector and is a binding constraint for a modern econo- the baseline scenario. By the end of the projection period, to allocate most of the initial oil revenue to infrastructure, my. The implementation of the recently developed Oil & the GDP would be 35 percent lower than in the baseline but recognizes that neglecting the social sectors would have Gas Skills Development Strategy and Plan will be crucial scenario. a growing opportunity cost in the medium to long-term. to harnessing the benefits of oil and gas for the citizens of Uganda. Improving domestic revenue mobilization will have The social sector plays an important role in determining critical long-term growth effects. Using the overlapping b. Crowding out of non-oil domestic revenue the distributional impact of GDP growth. The build-up of generation growth framework developed for Uganda, it is human resources through education and training is not only estimated that increasing the tax revenue-to-GDP ratio from Increased fiscal space due to oil revenue may lead to good for growth, but it will help diversify since manufactur- 12.7 percent of GDP to 15.1 percent - the average ratio for lower tax mobilization in other sectors. Many resource- ing and modern services depend on a well-educated labor low-income countries estimated by Baldacci et al. (2004) rich countries experience a decline in non-oil tax revenue 21 - would lead to a 1.5 percentage points increase in the pump). In this context, the best option may be to introduce aid is critical to address the governance and other econom- growth rate. A more ambitious tax reform program aimed an automatic price adjustment mechanism (see the system ic management challenges often experienced by resource at increasing the tax revenue - to - GDP ratio to 18 percent adopted by South Africa), that organizes a full pass-through - rich countries. Given its weak governance practices and - the average ratio for low-income countries estimated by of international prices but provides for a smooth adjustment institutions, Uganda’s oil riches is not likely to substantially the International Monetary Fund (2010) - would result in of domestic prices, by limiting the magnitude of any single decrease its access to foreign aid. A recent paper (Dobro- higher long-run growth of about 3.3–3.7 percentage points. price change per week or per month.  nogov et al. 2014) discusses how donors should respond to Consequently, Uganda needs to pursue ongoing efforts to potential windfalls in their client countries. It argues that improve tax collection. These efforts should be accompa- Many resource-rich countries have grappled with the while complementing other available self-insurance mech- nied by fiscal rules that incentivize improvements in tax complex issue of revenue sharing with local govern- anisms (for example, Sovereign Wealth Funds and facili- administration and collection. In fact, one of the advan- ments. No clear, effective and field tested formula seems ties from International Monetary Fund), the International tages of a NONG fiscal deficit rule is that the incentive to to be available at this stage. In addition the distribution of Development Association (IDA) could be structured to pro- mobilize non-oil domestic revenue remains high even when oil revenue to local governments should take into account vide a larger degree of insurance against major declines in oil revenues start to flow. Using a NONG fiscal deficit as macroeconomic and financial stabilization issues influenc- resource prices. a fiscal anchor implies that a drop in non-oil tax revenue ing the management of both central and local governments. would need to be accompanied by an equivalent reduction Economic and financial stabilization policies will always D. Policies to promote private sector in expenditure. With a credible limit based on an enforced remain one of the principal functions of central authorities. development NONG fiscal deficit rule, the government would be encour- The study of the Nigerian experience may provide useful aged to continue ongoing efforts, widen the tax base, and examples of what should be done and what should be avoid- The private sector is the most powerful instrument improve the administrative efficiency of tax collection. ed. Most of these issues will be addressed as the govern- of economic development. It creates economic growth, ment develops a more detailed strategy aimed at optimizing generates government revenue, provides employment, c. Public spending pressures (including subsidies) and modernizes technology, trains staff, develops skills and the benefits to be derived from oil and other extractives. Revenue sharing with local governments reduces the costs associated with hiring expatriates. Oil and d. Oil revenue and aid mineral development brings new opportunities for private In many oil-producing countries, domestic produc- sector development. Together with growing urbanization tion of oil and gas created pressures to lower domestic Recent research argues that the growing number of and overall economic growth, it expands demand for food petroleum prices below international levels. Several hydrocarbon discoveries in low-income countries could and other services. Increasingly international oil companies factors could help the Ugandan government manage these reduce the need for foreign aid (Arezki and Banerjee, outsource a number of specific tasks, ranging from pressures. First, at this stage Uganda does not have sub- 2014). However, empirical evidence shows that there is no construction to food provision. This is a good opportunity stantial fuel subsidies (except for kerosene) and domestic significant statistical relationship between oil discoveries for domestic suppliers to obtain contracts and participate in prices generally follow international prices. Second, Ugan- and the level of foreign aid. Many analysts argue that while the supply chain of oil production. Cheaper oil could also da repeatedly suffered from prolonged fuel shortages and the often sizable stream of new income from the exploita- stimulate the emergence of energy intensive industries, price spikes due to: (i) limited fuel storage capacity (equiv- tion of natural resources will relax budget constraints in including fertilizers, chemicals, metal products and cement. alent to 20 days, one of the lowest in the region) and (ii) developing countries, donors have many strategic reasons the country’s dependency on fuel imports from the Mom- to continue providing aid (Alesina and Dollar 2000). These Several factors, however, affect the capacity of the Ugan- basa refinery. Third, as Uganda is a landlocked country, the include: (i) ensuring access to oil and energy produced by dan private sector to take advantage of these opportu- cost of transporting petroleum products is very high (it is the recipient nation (to address the energy needs of the donor nities. First, the current business environment is not very true that as the country invests in infrastructure, the cost of countries); and (ii) facilitating access for major Western oil favorable. According to the most recent Global Compet- transportation will decrease, leading to lower prices at the companies to oil extraction contracts. In addition, foreign itiveness Index, Uganda ranks 129th out of 148 countries. 22 are expected to spend approximately US$10.8 billion (39 The revenue mobilisation percent of 2014’s GDP) in the next 4-5 years and to create perfomance will need to be improved prior to the first flow of almost 13,000 direct jobs during that phase. This is a unique oil revenues opportunity that should not be missed by Uganda. Achieving the short and long-term objectives of the pro- posed strategy will require a series of actions, includ- ing (a) improving public sector management (PFM, PIM, public sector incentives), (b) improving the role of the pri- vate sector and the civil society, (c) leveraging the possible impact of regional integration while mitigating associated risks (for example, in the context of the monetary union), and (d) managing expectations of the population. A. Improving public sector institutions and management Corruption, inadequate access to finance and deficient infra- Perhaps the most effective instrument of the public a. Institutions structure are viewed as the main constraints. The number sector in that area is likely to be the introduction of of registered firms is growing but more than 90 percent effective local content policies in order to promote new Managing oil resources involves many different aspects of of these firms are microenterprises. As a result, Uganda’s linkages between the oil industry and the domestic private economic management, including energy, finance, labor, potential suppliers may lack the capacity to meet the quality sector. Uganda’s petroleum law already provides for pref- industrial policy, land, infrastructure and social services. standards of international oil companies. Finally low back- erential treatment for goods produced in the country. This Seven key institutions - the Ministry of Finance, Planning and ward and forward linkages with other sectors may limit the applies not only to oil companies but also to contractors and Economic Development, the Ministry of Justice, the Bank positive impact of the oil industry on the country’s private sub-contractors that constitute the supply chain. The gov- of Uganda, the Uganda Revenue Authority, Energy (PEPD), sector. ernment should also include in future oil contracts provi- National Evironment Management Authority (NEMA) and sions aimed at promoting socioeconomic development (use Office of the Auditor General (OAG) - will play a major role In this context, government policies should address a of local suppliers, support for training and local skills devel- in formulating and implementing the government’s oil sec- wide variety of private sector development issues. The opment programs, priority for Ugandan citizens). tor strategy. Two other institutions - the Petroleum Authority first priority should be to pursue ongoing efforts to improve and the National Oil Company are in the process of being the business climate, address the most critical infrastruc- The final success of local content policies will largely created.  The creation of NOC is critical to shield the state ture deficiencies, including electricity, communications and depend on the capacity of local suppliers to deliver prod- from direct liability. Other institutions in the social and infra- transport, and support public and private initiatives aimed at ucts and services on time at a competitive cost. The role structure sectors (the Ministry of Education, the Ministry in improving access to long-term capital. Strengthening exist- of the government and private enterprises should, therefore, charge of labor and gender, the Ministry of Health, and the ing enterprises and encouraging small and medium - size be to select sectors and sub-sectors in which local capac- Ministry of Works and Transport) also play a significant role, firms to grow and join the formal sector should be an essen- ity is available or can be developed through appropriate notably with respect to the formulation and implementation tial component of that policy. training and financial support. A high priority should first of policies and strategies concerning infrastructure and skills be given to the construction phase. International investors development in the O&G sector. 23 Part III: Government Actions Necessary to Address Specific Implementation Issues The government should clarify the roles and responsi- to the government. The Ministry should use experienced joint briefings on oil sector revenue involving the gov- bilities of its institutions. The lack of clear definition of consultants and develop local capacity through staff train- ernment and the oil companies. The government should the respective roles of the Petroleum Authority, the Minis- ing abroad and in the country. The URA will also need addi- also strengthen its PFM systems and, in particular, improve try of Energy, the National Oil Company and other agen- tional technical staff specialized in reporting, auditing and its public investment management capacity, with special cies involved in oil management is particularly important taxation of the oil and gas sector for its recently established emphasis on more effective implementation. Uganda’s per- for the development of a promising oil sector. Creating all Natural Resource Management unit. NEMA should review formance is good with respect to budget transparency (rank- the necessary oil management institutions and clarifying the its guidelines taking into account the special characteristics ing 18th out of 100 countries), but its PFM systems are weak roles of the existing ones must be done before production of complex oil-related environmental issues. OAG itself is in terms of budget credibility, budget execution controls begins. For instance, the absence of a National Oil Compa- concerned with its lack of technical knowledge with respect (particularly payroll), procurement compliance and legisla- ny could obscure the division of labor between the Ministry to the auditing of oil and gas institutions. In effect, the gov- tive scrutiny of external audit reports. of Energy and the Ministry of Finance and could strengthen ernment should address weaknesses in the accountability the influence of other institutions. Such problems would be chain, including staffing and specialized technical skills, as The recently approved PFM law introduced a Con- difficult to correct at a later stage in an environment which well as legal, case management, and political interference tingencies Fund to finance unforeseen, but urgent and may be dominated by rent-seeking behavior. issues. unavoidable expenditures without destabilizing other components of the budget. This is already a positive step The strengths and weaknesses of each institution should In summary, while close coordination between MFPED, toward improving budget credibility. However, additional be assessed and addressed through hiring the most Energy, URA, the Bank of Uganda and other institu- measures are necessary to enhance the effectiveness of the appropriate expertise (domestic or foreign) and com- tions is vital for effective management of oil revenue, PFM system. These measures include: (i) accelerating the prehensive local capacity building programs. Most of the development of a comprehensive capacity building complete roll out of IFMS to all entities, interfacing IFMS these institutions need specialized expertise to perform new program for the O&G sector also is of high priority. In with IPPS and extending it to funds with specific conditions tasks in the oil sector. Highly skilled technical personnel this context, the recent preparation of a skills development (for example, donor projects), as 77 percent of expenditures is also needed to help the Ministry of Finance design and strategy and actions plan (SDSP) for the O&G sector is a going through the IFMS leave a substantial gap that can use effective oil revenue spending and saving mechanisms. positive initiative. be exploited; (ii) introducing the Treasury Single Account Each year, MFPED sends two public sector agents abroad (TSA) to promote greater transparency and accounts recon- to study oil and gas management issues. This is not suffi- b. Management ciliation; (iii) improving on unpredictable and late release cient to remedy the lack of specialized MFPED staff in that of funds which often lead to under-spending or to rushed The government should design an oil revenue manage- area. The Ministry of Justice also needs skillful negotiators spending at year-end, making procurement less competi- ment strategy dominated by transparency and account- to negotiate the best possible deals with international oil tive and more costly (70 percent of public expenditures go ability, including information of the public through companies and maximize the share of oil revenue accruing through procurement systems); (iv) reviewing parliamenta- 24 ry processes for a more efficient handling of audit reports and strengthening inter-institutional linkages between OAG and its partners (investigation bodies and other regulators/ auditors including PPDA) to improve coordination and focus reporting on risks and impact; and (v) developing the Value addition to agricultural produce at capacity of public servants in PFM functions, and introduc- Flona Commodities , a ing incentives and performance management frameworks pineapple farm in Bugerere (pay reform and performance appraisal). Incidentally, pub- lic sector wages stagnated and are now low compared to private sector equivalents. Public Investment Management (PIM) systems also need to improve, in terms of strategic guidance for public projects (alignment on NDP priorities and adoption of min- imum technical and financial standards), project selection, budgeting and implementation (integration into the budget cycle and medium-term expenditure frameworks), project audit and evaluation. The most urgent measure to strength- en PIM systems is the development of a Public Investment Methodology for Project Appraisal which is forthcoming with support of a Bank technical assistance project financed by the DfID trust fund. donors and the civil society in support of common objec- itive impact of oil development on other sectors. Neverthe- tives. In fact, close collaboration between the public and the less, the agricultural sector should benefit from the higher B. Participation of the private sector and private sectors and also with the civil society is a win-win demand for food. Uganda should also be able to develop involvement of civil society for Uganda as it creates substantial benefits, including train- agro-processing and light manufacturing and the country ing, import of technology (through MNCs), joint infrastruc- has the resources necessary for the development of a com- Governments and corporations have different goals. The ture (through PPP),  and accountability (through improved petitive tourism industry. main goal of good governments is to promote the long-term demand for good governance). economic and social development of their citizens. The In this context, the main priorities for public sector goal of multinational corporations (MNCs) and other pri- Despite a mediocre business environment, the number interventions are: (i) improving the business environment vate enterprises is to generate profits for their shareholders of registered enterprises tripled during the 2000s, but and helping small enterprises manage crises; (ii) promoting and maximize returns on investments. However, to achieve the business landscape is dominated by micro-enterprises. regional integration and open trade policies; (iii) increasing their objectives, governments need to create an environment Oil production will stimulate private sector development, the competitiveness of strategic sectors; (iv) supporting the favorable to private sector investment. At the same time, but the lack of linkages between the oil industry and other growth of larger formal sector enterprises; and (v) encour- private enterprises recognize that the sustainability of their sectors, and the incapacity of smaller firms to meet the high aging the densification of the industrial landscape to enable activity depends on effective cooperation with governments, standards of international oil companies may limit the pos- firms to benefit from economies of agglomeration. An effec- 25 tive collaboration between the public sector, the private sec- barriers, including non-tariff constraints and logistical In this context, the CEM recommends that: (i) EAC tor, and the civil society will be particularly critical. Such a services. It should also be noted that the resource endowment countries should adopt sound fiscal policy (including clear collaboration should take place at three levels: (a) during the of many EAC countries gives an opportunity to a country fiscal rules) to minimize changes in the price levels in East design of the strategy: the private sector should be involved like Uganda to invest in the provision of specialized skills Africa’s new commodity exporters, relative to their neigh- in the development of the legal and institutional framework which could then be utilized in other countries. bors and, (ii) the process of integration should be slow and and should also participate in negotiations. In this context, reversible, as Uganda builds on its experience on infla- the government should be able to capitalize on the influ- On the macroeconomic front, regional cooperation, tion targeting monetary policy management. Meanwhile, ence of pressure groups such as the Uganda Chamber of including the move towards monetary union will be the other members of the East African Community should Mines and Petroleum; (b) during implementation of the complicated by the emergence of oil and gas resources establish a network of stable, pegged exchange rates - ideal- strategy: through various interventions such as PPPs, joint among regional economies. Abandoning independent ly through harmonizing interest rates rather than accumulat- infrastructure projects, training, transfer of technology, and monetary policy at the national level and transferring ing foreign reserves at least until the resource expenditure community help; and (c) for the monitoring of the strategy: that function to a regional entity comes with a number stabilizes. joint mechanisms (for example. EITI) will be crucial for an of advantages. First, it may be the best way to create an effective monitoring of this trilateral collaboration.   independent and credible central bank which no national D. Managing expectations government can dominate. Second, a regional monetary authority is less likely to import recessions since monetary Given the numerous uncertainties associated with the C. A sound approach to regional integration   policies do not need to be linked to countries outside the oil sector, the eventual development of the sector and The report discusses the consequences of oil development area. Third, creating a single currency can significantly the possible emergence of additional government reve- on the ongoing regional integration effort and on the reduce trade costs if the members of the union are also nue should not significantly change the overall goals of future creation of a monetary union. Oil production will major trade partners. the government strategy. Efficiency gains and economic provide an opportunity to expand regional infrastructure diversification must continue to dominate Uganda’s strate- and promote regional integration but it will also complicate EAC countries will face four major challenges as they gic objectives. Efficiency can provide fiscal space virtually the coordination of macroeconomic and fiscal policies move towards a single monetary policy. First, the addi- at the regional level. Regional integration is crucial for a tional oil-financed demand will trigger an increase in rel- landlocked country like Uganda. As an example, Uganda ative prices in commodity-rich countries which will make needs a pipeline through Kenya or Tanzania to export them more vulnerable to commodity-price shocks. Second, most of the expected oil production. Subsequently, priority there will be a big difference between resource-endowed should be given to using oil revenue to enhance connectivity countries (Uganda, Tanzania, and Kenya) which will grow across countries, notably (but not only) with Kenya which faster than the other countries (Burundi and Rwanda). is Uganda’s natural gateway to global markets. Efforts Third, the value of independent monetary policies may be should also focus on the central corridor linking Uganda to limited in developing countries, where there is little finan- Tanzania in order to diversify trade routes.  Oil revenues will cial intermediation and limited scope for changes in interest provide an opportunity to remove some of the infrastructure rates to affect the behavior of households and firms. Fourth, bottlenecks since the cost of upgrading or building new the timing of the oil and gas production in the region is still connectivity infrastructure (such as ports on Lake Victoria, uncertain and production will not start at the same time. It railways, and regional roads) is very prohibitive. The is probable that Uganda will export oil before Tanzania pro- effectiveness of regional infrastructure developments will duces gas on a large scale. also depend on the removal/reduction of soft infrastructure 26 equal to the expected levels of oil revenue. More impor- tantly, despite the role oil production and revenue can play in Uganda’s future, the country should not abandon other available development and economic diversification oppor- tunities. In fact, future oil revenue will be best used if inte- grated into Uganda’s current development objectives and Oil-rich countries are tempted to subsidize partnerships. fuel prices at their own peril In this context, the development of an effective commu- nication strategy is a high priority. This strategy should define clear responsibilities for nation-wide communi- cations on the oil and gas sector. The ultimate goal of the strategy will be to empower citizens by educating them on pertinent issues concerning the prospects and the possible impact of oil, gas and other mining activities, and to encour- age them to participate in the ongoing dialogue on the future use of oil and gas revenue. This will also encourage trans- parency and accountability. Ultimately, the success of Uganda in optimizing the ben- efits from oil will be largely determined by the country’s capacity to set up the stage for a non-oil economy in the longer term. Successful countries have been those that have used non-renewable resources to diversify their economies by a combination of policies and actions aimed at building the stock of physical and human capital and implementing an effective social policy to protect vulnerable groups. Sim- ply put, Uganda’s success will be measured by its capacity to go up the ranking in the human capital index, the doing business indicators, and access to basic infrastructure over time. 27 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 building, good Short to medium term institutions 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 revenue, involving both the government Short to medium term 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 assessing progress Short to medium term 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 Authority, Short to medium term 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, gas, and other Immediate to short term mining activities Improving performance Additional efforts to promote economic diversification through communicating the virtues of diversification Immediate of existing institutions Address weaknesses in the chain of accountability, including staffing, resources, specialized technical skills, legal and case management issues, Short to medium term 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 abuse by businesses and other Short to medium term 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 Immediate, short-medi- Improve product complexity through training, skill development, FDI and/or joint venture with foreign firm um term Adopting the right set of Maintain macroeconomic stability through inflation targeting monetary policy and prudent fiscal policy involving spending constraints/limits Short to medium term policies Design and implement a set of business friendly policies in the areas in which Uganda may have a comparative advantage (food processing, Short to medium term construction materials and other labor intensive industries) Invest in infrastructure, with special attention to horizontal and vertical inequality, and invest in human capital to promote a larger long-term Short to medium 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 prices and oil Short to medium term revenue Strengthen domestic revenue mobilization to ensure that increased oil revenue is not offset by declining tax collection in other sectors (large or Short to medium term 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. 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