Download In the next section we describe recent economic developments

The Impact of East African Community Macroeconomic Convergence
Criteria on the Ugandan economy: A Dynamic General Equilibrium Analysis
Draft
Justine Nannyonjo1 and Wilson Asiimwe2
N.B This draft does not contain a detailed review of literature and reference list.
1. Introduction
The East African Community (EAC) member states of Kenya, Uganda, Tanzania. Rwanda and
Burundi have over the years, established closer economic links through a Free Trade Area
(2001), a Customs Union (2005), and a Common Market (2010). These efforts have led to a
deeper regional integration and trade within the EAC than in other African sub-regions, have
contributed to East Africa’s resilience during the global financial crisis 2009 and 2010 and to
overall fast growth (Brixiova and Ndikumana, 2011; and Guerguil et al., 2011).
Given the progress with intra-regional trade, the objective of the EAC countries is establishment
of the East African Monetary Union (EAMU), with the circulation of the single currency in
2021. The March 2010 Joint Meeting of the EAC Ministers adopted the road map for this goal,
which includes targets such the adoption of an Exchange Rate Mechanism, creation of the
regional central bank, and finally the establishment of the EAMU. The establishment of the
EAMU has gained momentum with the signing of the EAMU Protocol in November 2013.
Successful implementation of the proposed monetary union would yield several economic and
social benefits including promotion of trade through the enhancement of the payments system
for goods and services in the region; creation of a larger regional market and broadening of
business and trade-related income earning opportunities for the sub-region; labor mobility and
strengthening of social,
cultural, political and economic cooperation; and promotion of
1
Bank of Uganda. E-mail: [email protected]/ [email protected]
Ministry of Finance, Planning and Economic Development. E-mail: [email protected]/
[email protected]
2
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competitiveness and efficiency in production leading to increased Gross Domestic Product
(GDP). EAMU is also sought to facilitate the formation of a stable political state. However,
there are also costs linked to the unification, including loss of national autonomy in the monetary
policy, possibility of increased inflation and unemployment, loss of exchange policy and fiscal
independence (Schuberth and Wehinger, 1998; Bean, 1992; Calmfors, 2001). The magnitude of
this loss depends on how well individual countries were conducting monetary policy prior to
joining the currency union.
But in order to reap the maximum benefits and minimize costs, there ought to be a sufficient
degree of macro-economic convergence, and financial integration among the aspiring economies
preceding the union. Consistent with a number of Regional Economic Communities elsewhere,
EAC countries have put in place macro convergence criteria to be met by the each country prior
to entry into the monetary union. In 2007, the EAC Council adopted an indicative timetable for
the establishment of EAMU by 2015, which included a fiscal convergence road map to bring
countries’ fiscal deficits and total debt stocks within an acceptable range. In its first phase (20072010), this convergence road map targeted overall deficits of 6 percent of GDP when excluding
grants and 3 percent of GDP when including grants. In a second stage (2011-2014), overall
deficits would then fall to 5 and 2 percent of GDP, respectively. There was no explicit target on
debt apart from a sustained pursuit of debt sustainability. However, compliance with these
criteria has been low and decreasing since 2007, with no country meeting the criteria on fiscal
deficits by 2012/13. Among other developments, huge infrastructure spending has kept the fiscal
deficits high over the recent years. As such, meeting the more stringent fiscal deficit ceilings of
2 percent including grants has been elusive for most countries in the region. Furthermore,
increased levels of donor assistance to countries for example Uganda, Kenya, Tanzania and
Burundi which are already receiving huge grants, mainly to finance critical social programmes
has made it impossible for these recipient countries to achieve the target for fiscal deficit
excluding grants of 5 percent of GDP (Republic of Uganda, 2013). Susceptibility of inflation to
supply-side shocks (e.g. in Uganda, Kenya, Tanzania and Burundi), meant that countries would
not achieve the target criteria on inflation. Taking stock of these lessons, the partner states have
reformulated the convergence criteria to accommodate the developmental desires of EAC while
at the same time continuing to safeguard macroeconomic stability. These convergence criteria
focus on price stability, sustainable fiscal deficit, and maintaining desirable levels of foreign
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exchange reserves. These are to be achieved within period of eight years (2013-20). The
performance convergence criteria which each of the EAC countries must achieve are the
following macroeconomic status:
(a)
headline inflation of no more than 8%;
(b)
fiscal deficit, including grants of no more than 3% of GDP;
(c)
gross public debt of no more than 50% of GDP in Net Present Value terms; and
(d)
maintenance of official foreign reserves of at 4.5 months of imports.
But how far the nations will progress in aligning their economies to the set bench marks remains
a question given the discrepancies in institutional mechanisms, social and economic structures.
The prospective impact of (i.e. macroeconomic, sectoral and welfare effects) of the
macroeconomic convergence criteria on the economies have also not been ascertained. For
example, what would be the impact of adjustment of fiscal policy to meet the thresholds in the
convergence criteria on GDP, sectoral performance and house welfare? Which mixture of fiscal
policy adjustment (i.e. what percentage change in capital and/or recurrent expenditure) would
maximize benefits for the economies? Therefore, the above issues call for a careful assessment
of the prospective macroeconomic, sectoral and welfare effects impacts of the macroeconomic
convergence criteria on the economies.
1.1. Objectives of the study
The study aims to assess the prospective impact of the macroeconomic convergence criteria on
the Ugandan economy. The specific objectives are the following:
i. To critically examine the prospects of Uganda achieving the macroeconomic
convergence criteria.
ii. To assess the prospective macroeconomic, sectoral and welfare effects of the
macroeconomic convergence criteria on the Ugandan economy.
iii. To draws policy implications for achieving the convergence criteria.
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In the next section we describe recent economic developments, outlook and prospects for
performance against the current convergence criteria. Section 3 describes the data and
methodology. Section 4 presents the results while section 5 concludes and draws policy
recommendations.
2. Recent economic developments, outlook and prospects for performance against the
current convergence criteria
This section assesses the recent economic performance of Uganda and track record in achieving
the existing convergence criteria. This together with a review of the medium term
macroeconomic frameworks and targets of Uganda provide an indication of the prospects for
Uganda achieving the convergence criteria.
Convergence criteria
The primary criteria as currently formulated constitute Stage I (2007-2010), Stage II (2011-2014)
and Stage III (2013-2019) are summarized in Table 2.1 below:
Table 2.1 EAC primary convergence criteria
Stage I (2007-2010)
Stage II (2011-2014)
Stage III(2013-2019)1
1. Overall budget deficit
excluding grants of not
more than 6 percent of
GDP, and including grants
not more than 3 percent of
GDP
1. Overall budget deficit excluding
grants of not more than 5 percent of
GDP, and including grants not more
than 2 percent of GDP
1. Overall budget deficit including
grants of not more than 3 percent
of GDP.
2. Annual average
inflation not exceeding 5
percent.
2. Annual average inflation not
exceeding 5 percent.
2. Annual average headline
inflation not exceeding 8 percent.
3. External reserves of
more than 4 months of
imports of goods and nonfactor services
3. External reserves of at least 6
months of imports of goods and nonfactor services
3. External reserves of at least 4.5
months of imports of goods and
non-factor services.
4. Gross public debt of no more
than 50% of GDP in Net Present
Value terms.
Source: EAC Monetary Affairs Committee, May 2009 and EAC 2012.
1/ The convergence criteria was revised in November 2013.
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Performance under the Criteria for Stage I and II (2007-2013) and prospects for achieving
Stage III criteria
With respect to the fiscal deficit ceiling, (i.e., both including and excluding grants) Uganda
exceeded the target particularly in the second stage of the performance criteria. Like for other
countries in the region, huge infrastructure spending has kept the fiscal deficits for Uganda high
over the recent years, thus making it difficult for it to achieve the more stringent fiscal deficit
ceiling of 2 percent including grants, during stage 2 ((Table 2.2a). Furthermore, increased levels
of donor assistance have made it impossible for the country to achieve the target for fiscal deficit
excluding grants of 5 percent of GDP. Looking ahead the fiscal deficit (including grants) is
projected to remain above the current target of 3 percent of GDP in 2013/14 and 2014/15 but fall
to 1.5 percent by 2017/18, below the criteria target of 3 percent (Table 2.2b) . This would give
the country fiscal space to increase spending on its priority areas of infrastructure, human
resource and private sector development, employment generation and poverty reduction.
On inflation target, Uganda’s headline inflation averaged 11 percent well above the 5 percent
target. Inflation rose to double-digits level during 2008-09, due to high global food and fuel
prices but eased back towards target in 2010 when these shocks started dissipating. After easing
in 2010, the headline inflation rose to 23.5 in 2011/12 owing to the increased oil and food prices
as well as the weakening of the exchange rates vis-à-vis major international currencies. Droughtinduced food shortages also took a toll on inflation.
More recently in 2012, inflationary
pressures has eased remarkably to target levels on account of easing world oil prices, improved
weather conditions, and firming of the exchange rates against the major international currencies.
Despite continued susceptibility of inflation to supply-side shocks, inflation is expected to be
contained by cautious macroeconomic policies. Thus, the revised inflation target of 8 percent as
measured by the average headline inflation is likely not to be to be exceeded in stage III of the
performance criteria.
Like the other countries in the region Uganda achieved the reserve target of over 4 months of
imports cover specified for Stage I, but missed the reserve target of 6 months of imports cover
for Stage II in 2011, mainly due to an increase in the import bill with rising oil prices, and large
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infrastructure spending. Uganda’s level official reserves is projected to remain below the criteria
target of 4.5 months of imports.
Public Debt
The evolution of Uganda’s total public debt (external and domestic debt) indicates that Uganda
would achieve the criteria target of 50 of GDP in net present value terms over the projection
period. The public debt-to-GDP ratio is projected to peak at about 30.8 percent of GDP in 2016,
well below the benchmark level of 50 of GDP (Table 2.2b). However, the relatively short
average maturity of domestic debt(less than three years) combined with a low revenue base leads
to a debt service-to-revenue ratio of about 35 percent, among the highest in LICs (IMF, 2013).
This significantly increases the rollover and interest rate risks, and needs to be addressed in the
medium term by a combination of stronger revenue mobilization and deeper financial markets to
extend average maturities. Stress tests also indicate that the path of public debt would become
unsustainable in the absence of fiscal consolidation.
Table 2.2a: Uganda: Selected economic indicators 2007/8 - 2012/13
2007/08 2008/09 2009/10 2010/11 2011/12 2012/13
Real GDP growth (%)
8.7
7.3
5.9
6.6
3.4
5.1
Budget deficit (including grants)/GDP (%)
-1.85
-1.67
-4.72
-4.3
-3
-3.9
Budget deficit (excluding grants)/GDP(%)
-4.87
-4.61
-7.19
-6.58
5.3
5.7
7.3
14.1
9.4
6.5
23.5
5.6
Headline Inflation (average, %)
NPV of gross public debt/GDP (%)
22.2
22.7
5.97
5.09
4.37
3.21
4.26
4.06
Official foreign reserves (months of Imports)
Source: Republic of Uganda (2013, 2012) and IMF (2013).
Table 2.2b: Uganda: Selected economic indicators 2013/14 - 2017/18
2013/14 2014/15 2015/16 2016/17 2017/18
Real GDP growth (%)
6
6.9
7
7
7
-5.4
-3.3
-1.7
-0.1
-1.5
Budget deficit (including grants)/GDP (%)
-6.8
-4.4
-2.4
-0.6
-2.0
Budget deficit (excluding grants)/GDP (%)
Headline Inflation (average, %)
6.2
5
5.1
5.1
4.9
NPV of gross public debt/GDP (%)
26.6
28.2
30.8
30.6
30
Official foreign reserves (months of Imports)
4.1
4.1
4.1
4
4
Source: Republic of Uganda (2013, 2012) and IMF (2013).
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3.0 Methodology and data
The methodology is premised on a Dynamic Computable General Equilibrium (CGE) model to
analyze the prospective macroeconomic, sectoral and welfare effects of the macroeconomic
convergence criteria, on the Ugandan economy over time. The data is obtained from 2002 SAM
uprated to 2009/10.
3.1 The CGE model
This paper addresses the above objectives using the Dynamic CGE Model. The model is
composed of the behavior of households, investors, industries, government and exporters that are
based on the theoretical structure of the ORANI-G model (Dixon et al., 1982). Dynamic
equations are extracted from ORANIGRD model to produce a Recursive Dynamic (forecasting)
model. The dynamic equations are used to derive the capital accumulation and investment
allocation as well as real wage and employment adjustment mechanisms. Households are
assumed to maximize utility whereas firms minimize costs subject to input prices. Domestic and
imported commodities are assumed to be imperfect substitutes and are combined using a
constant elasticity of substitution (CES). Production for domestic market and export is captured
using the Constant Elasticity of Transformation (CET). Additional variables and behavioral
and/or identity equations are included in this model to capture the additional data from the Social
Accounting Matrix (SAM).
3.1.1 Recursive Dynamic Mechanisms in the CGE
This section describes the additional equations and variables added to the model to implement an
annual recursive dynamic model. The rate of growth of capital stock is linked to investment; and
investment is guided by the rates of return.
Capital accumulation
Capital in each period grows by an amount equal to the rate of investment at the beginning of the
period, less of depreciation as expressed in the Equations 1 below.
(1)
K = Y0 - DK0, or …………………………………………………….……………………………..(1)
(2)
K0 = Y00 - DK00 ………………………………………………………………………….…(2)
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Here: Y
investment.
K
amount of capital.
D
depreciation rate.

price of a unit of new capital.
The subscript '0' denotes the initial (start-of-period) value. Thus, a change in investment in the
current period affects the growth rate of capital not in the current period but in the next. We say
that investment has a 'gestation' period of one year. Both sides have been multiplied by 0 in
order to relate Y0 and K0 to the values which appear in the initial database.
The investment allocation mechanism has two components. The first component is that
investment/capital ratios are positively related to expected rates of return. From variables; unit
rental price of capital (Pk), unit asset price of capital (investment (Y) and amount of capital
(K); we can postulate that;
R
G
E
= Pk/
= Y/K
actual gross rate of return ……………………………..(3)
gross rate of capital growth next period ………………...(4)
expected gross rate of return for next period
The theory that the rates of growth of capital stock depend on expected rates of return may be
expressed as:
G = F(E) where FE > 0 ………………………………………………………………….….….(5)
Notice that both G and R (and by extension E) must be > 0. In the case of R, this is guaranteed
by other model equations — capital always earns a positive rent. For convenience, we have
expressed (6) in terms of gross rather than net rates of growth and return.
We also hypothesize that each industry has a long-run or normal rate of return (Rnormal) and
that when E, the expected rate is equal to Rnormal , then G = Gtrend where Gtrend is a normal
or secular gross growth rate. That is,
Gtrend = F(Rnormal) ……………………………………………………………………….………..(6)
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We choose a type of logistic curve for the function F:
G = Q.GtrendM/(Q-1+M) where M = E/Rnormal . …………………………………………………(7)
if M = 1 then G = Gtrend ; if M is large then G = QGtrend = Gmax and if M is 0 then G = 0.
Real wage adjustment
These allow wages to adjust to employment levels that is; If end-of-period employment exceeds
some trend level by x% then real wages will rise, during the period, by x%. Since employment is
negatively related to real wages, this mechanism causes employment to adjust towards the trend
level in the dynamic model.
3.2 SAM Extension
The above theoretical description of the CGE model does not capture the Social Accounting
Matrix (SAM) variables. The coefficients and variables names in the SAM are based on the row
and column in which they are located. Here we capture SAM accounts including; a) Gross
operating surplus, b) Enterprise account, c) Labour income of households, d) Household income,
consumption, savings and transfers,
e)
Government income and expenditure, f) Private
investment expenditure and g) rest of the world (ROW).
Enterprises: Enterprises generate their income from factors (Gross Operating Surplus, GOS),
transfers from households and the ROW. Transfers from the rest of the World to enterprises are
assumed to follow national income developments. Receipts from households to enterprises
follow household income from the GOS; enterprise receipts from other enterprises follows their
respective shares in the total GOS; transfers from the ROW to enterprises follow the movements
in the national income (GDP); government payments to enterprises follow developments in
government income. Payments made by enterprises are depicted by the Equation 8 below.
VENTEXP = VHOUENT + VGOVENT + VTAXENT + VENTENT + VROWENT .....(8)
Where;
VENTEXP is the total payments of enterprises.
VHOUENT is the enterprises payments to households.
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VGOVENT is the non-tax transfers to the government from enterprises.
VTAXENT is the direct tax payment from enterprises.
VENTENT is the enterprise payments to other enterprises.
VROWENT is payments to the ROW of the world from enterprises.
The percentage change in VGOVENT, VHOUENT and VROWENT follows the percentage
change in the post-tax income of enterprises. Whereas corporation tax paid by enterprises is
proportion to movements in enterprise income. Enterprise savings is the difference between
enterprise income and payments.
Household accounts: Households derive their incomes from factors earnings (labor), transfers
from economic agents like government, ROW, GOS and intra-household transfers. Transfers
from government and ROW to households follow the developments in GDP. Intra-household
transfers follow the post-tax income of the donor households.
Households spend on consumption, transfers to other households, non-tax transfers to
government, taxes, payments to households and the ROW. The level of the household disposable
income determines their consumption, transfers to other households and the ROW. However,
payments to enterprises are linked to the rate of return from GOS.
Government accounts: Government derived its income from taxes, receipts from GOS, ROW,
dividends from enterprises and non-tax transfers from households. Government budget is spent
on both development and recurrent items. Development budget include items like infrastructure
whereas recurrent expenditures include government consumption, payments to the enterprises,
transfers to households and the ROW. We assume that, government receipts and payments to the
rest of the world follow the developments in GDP.
Rest of the World (ROW): Income to the ROW is a summation of import payments, transfers
from enterprises, government and household. In the model we link transfer from government on
GDP whereas remaining transfers are linked to the disposable income of the respective donor.
The ROW spend on Ugandan exports, payments to Ugandan households, enterprises and
households. Rest of the world savings is derive difference between receipts and payments.
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3.3 Data
The CGE model is using the uprated 2009/10 Social Accounting Matrix. This 2002 SUT/SAM
was uprated to 2009/10 by Oxford Policy Management. (OPM) but the structure of the economy
was maintained to that of 2002. This is the database that was used in this simulation. The data is
made up of 34 commodities and 34 industries that is each industry produces one unique
commodity. Its only captures two types of margins, that is transport and trade margins. Factors of
production are of three forms; capital, land and labor.
3.4 Simulation design
3.4.1 EAC Macroeconomic Convergence Simulation:
The simulation hinges on the adjustment of the fiscal policy to meet the thresholds in the EAC
Macroeconomic convergence criteria. Given that the debt sustainability analysis (DSA) for FY
2013/14 reveals that Uganda external debt is highly sustainable, the simulation mainly focuses
on meeting the thresholds on inflation (8 %) and fiscal deficit as a percentage to GDP (3 %). The
simulation is developed in such a way that, fiscal policy is expanded until the EAC thresholds
are met. Two simulations are developed including a) Simulation in which both government
development and recurrent expenditures are equally shocked with the same percentage
expansion, b) In simulation 2 we shock fiscal policy in proportions of 60:40, for development
and recurrent expenditure.
Simulation 1
In this simulation both development and recurrent budgets are shocked with the same percentage
expansion. The first four fiscal years of this simulation show that, the upper limit of the inflation
threshold is reached before attaining the sealing of the fiscal deficit to GDP. Thus between FY
2014/15 and FY 2017/18, inflation averages about 8% and fiscal deficit as percentage to GDP
stays below 3 %. However, in the FY 2018/19, the upper limit of fiscal deficit percentage to
GDP is met with inflation at 3.7 % and fiscal policy expansion of 1 %. In FY 2019/20, at the
inflation level of 3.58 %, fiscal policy cannot be expanded beyond 1 % without violating the
EAC fiscal deficit to GDP of 3% as shown in Figure 1 below.
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Figure 1: Simulation 1 design
Figure 1 above shows that upper limit for both of the EAC convergence thresholds may not be
easily met in the same financial year. That is the fiscal space is exhausted upon reaching the
upper limit of one of the thresholds as explained above. The results from the simulation are
generated upon exhausting the fiscal space arising from meeting the upper limit of at-least one of
the EAC Macroeconomic convergence criteria thresholds.
Simulation 2
Here fiscal policy is shocked in proportions of 60:40, for development and recurrent expenditure,
respectively. This simulation indicates that in the initial years of the simulation, development
budget expands faster than recurrent in real terms. However, in the medium term real difference
between recurrent and development budget expansion becomes narrow as shown in Figure 2
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Figure 2: Simulation 2 design
Figure 2 shows that in the first 3 years the upper limit of the inflation threshold is hit and that for
the fiscal deficit threshold remains highly sustainable. In FY 2017/18 both the upper limits of the
fiscal deficit and inflation are attained simultaneously at -3.02 % and 8.03 respectively.
However, with the accumulation of debt with domination of debt service, in FY 2019/20 fiscal
policy has to refrain from violating the fiscal deficit threshold. This results in the inflation of
3.47 percent for that year.
4.0 Preliminary results and interpretation
The results are presented into two parts; the first part captures the detailed results from simulation 1
and the second part entails the comparison of simulation 1 and simulation 2. Results from simulation
1 capture the following areas; a) macroeconomic impacts, b) sectoral impacts and c) impact on
household welfare as discussed below.
4.1 Macroeconomic implications (Simulation 1)
Adjustments of the fiscal policy towards fulfilling the macroeconomic convergence criteria over
the medium term would result into changes in domestic consumer prices, investment price, and
export prices. For instance, increases in the above prices would lead to deterioration of the real
imports, loss of export competitiveness and a fall in real household consumption.
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Reducing export volumes accompanied with their increasing prices, would lead to an increase in
the terms of trade in the year FY2014/15 through FY2017/18 and a slight deterioration in FY
2019/20. Given that the deviation in imports volume is positive say 1.5% for FY 2014/15
whereas the deviation for exports is negative say -4.6% for FY 2014/15; then balance of trade
would have a reducing effect on real growth.
4.1.1 Impact on economic growth
In the short-run real wages are sticky, capital is fixed; thus any changes in output arise through
changes in employment. The deterioration of the balance of trade and reduction of investment
demand are outweighed by the improvements in government and household consumption, thus
having a positive net effect on the aggregate demand throughout the simulation period. Real
GDP deviates by 0.53% and 0.37% more than it would be without the adjustments in the fiscal
policy in FY 2014/15 and 2015/16, respectively. In the short run capital is fixed and real wages
are sticky, output can only improve through an increase in employment which results into
increases in rental price of capital and nominal wage. For instance in FY 2014/15 fiscal
adjustments to the EAC macroeconomic convergence criteria, results into a 0.56 % more of labor
contribution to GDP, whereas capital contributes 0.01 % more in the same financial year.
Economic performance is shown in Figure 3 below.
Figure 3: GDP performance
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Beyond the FY 2015/16 capital is less sticky whereas labor employment is stickier; thus we see a
continuous fall in employment deviations, increases in real wage and capital stock to maintain an
increasing output. In the long-run firms can increase output by using more capital and varying
real wages.
Sources of economic growth performance (2013 to 2016): Aggregate demand improves in FY
2014/15 mainly due to strong performance in government and private consumption. The increase
in government investment is offset by a bigger reduction in the private investment; thus
aggregate investment has a negative net contribution to the aggregate demand. The sectoral and
factor contributions to economic performance in the medium term are summarized in Table 3
below.
Table 3: Disaggregated GDP performance
GDP (Percentage deviations)
2014/15
2015/16
2016/7
2017/18
Consumption
1.17
1.14
1.12
1.12
Investment
-0.14
-0.25
-0.34
Government
1.42
1.55
1.68
FY
2014/15
2015/16
20116/17
2017/18
Land
0.00
0.00
0.00
0.00
-0.42
Labor
0.56
0.43
0.32
0.25
1.8
Capital
0.01
-0.02
-0.05
-0.09
0.01
0.01
0
0
Stocks
Technical
-0.04
-0.05
-0.05
-0.05
Exports
-1.38
-1.62
-1.83
-2.03
Imports
-0.45
-0.39
-0.33
-0.29
GDP
expenditure
change
GDP
0.53
0.37
0.22
0.11
at
factor cost
0.59
0.42
0.27
0.16
Table 3 above shows that in the FY 2014/15, aggregate demand will be 0.53 percent more than it
would have been without the fiscal adjustments to meet the EAC criteria. Of this increase,
exports accounts for -1.38 percentage points, consumption (1.17 percent), investment (-0.14
percent) and imports accounts for -0.45 percent; this trend continues in the medium term.
On the other hand, the change in GDP at factor cost is mainly driven by employment of more
labor throughout the simulation period. This is because in the short run capital and real wages are
sticky; thus the increased aggregate demand can only be satisfied through raising output by
employing more labor as depicted in Table 3.
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4.1.2 Impact on consumer prices
The consumer basket is comprised of 34 commodities to which in FY 2014/15 the consumer
prices would increase by 2.84 percent higher than it would be without the EAC convergence
criteria. This positive deviation would break in FY 2018/19 to -1.23% less than it would be
without the EAC convergence. The key drivers for the consumer prices are shown in Figure 4
below:
Figure 4: Consumers prices performances by commodity
Figure 4 above shows that, the key movers of Consumer Price Index (CPI) are sectors whose
investment follows government expenditure like health, education, utilities, real estate, forestry,
construction, recreation, financial services and reciprocally animal farm. The behavior of these
CPI movers is summarized below.
The above CPI drivers are for sectors whose investment follows government investment and
have government as the biggest consumer of their products. Given that Uganda’s CPI has on
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average been lower than EAC 8%, this gives the government more fiscal space which increases
government demand thus increasing prices of products demanded by government.
However, in some sectors like animal farm, prices reduced throughout the simulation period. For
instance in FY 2014/15, prices of animal farm are 3.3 percent less than they would be without
fiscal adjustment. Prices fall because this sector is non-tradable and government is not a main
user of its products. Only 5% of animal farm products are exported and 86% are used as
intermediate products of which 65% is consumed by food producing sector and 31.5% within
animal sectors. During the simulation period, activity for these sectors reduced thus curtailing the
demand of intermediate products like animal farm. In the same period household and export
demand for animal farm products reduced, thus making a fall in the sector’s production
inevitable. The fall in demand for animal farm products resulted into reduction in investment in
the sector as well as fall in the respective prices.
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4.1.3 Impact on Competiveness and real exchange rate
Fiscal policy expansion raises aggregate demand which outstrips the supply capacity for non –
traded goods thus raising domestic prices and construction boom, hence, leading to deterioration
of the quality of output. With stable import prices, relative increase in export prices result into an
improvement in the terms of trade. However, the real exchange rate continues to appreciate
mainly due to the foreign exchange inflows to finance the budget in form of external debt. This
offsets the real depreciation arising from deterioration of the balance of trade as shown in Figure
5 below.
Figure 5: Competitiveness and real exchange rate
Real exchange rate appreciation and the improvement in terms of trade deteriorates the
competiveness of the Ugandan exports. This is because exports become relatively expensive in
the international market which leads to a reduction in export volumes. However, in the long run
say FY 2018/19, as fiscal policy subsides and external debt forex inflows reduce, real exchange
rate depreciates (1.24 %), export prices fall (-0.05 %) and terms of trade deteriorate by -0.05 %.
The relative reduction in export prices improves competivieness of Uganda’s exports thus
accounting for a less fall in real exports (-0.4 %) in FY 2018/19 compared to -6.7 % fall in FY
2017/18.
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4.1.4 Fiscal performance
4.1.4.1 Impact on tax
A zero tax on exports, indicates that there would be no direct impact of a reduction in exports on
taxes. An improvement in real imports would increase aggregate tax revenues. In the FY
2014/15, some taxes will improve following the expansion of the fiscal space. These include;
tariff revenue (9.1 billion Shs), production (2.4 billion shs), taxes on intermediate consumption
(22.84 billion shs), indirect taxes on investment (4.58 billion shs) and indirect taxes on
household consumption (131.73 billion shillings) as shown in Table 4 below.
Table 4: Performance of tax revenues
Tax Item
Nominal Change in Tax (Billion Shillings) due
to the fiscal policy shock
2014/15
2015/16
2016/17
2017/18
Aggregate tariff
9.1
11.06
13.47
16.75
Production tax
2.4
-5.72
-17.04
-31.11
22.84
28.26
34.67
42.78
4.58
4.4
4.04
3.77
Indirect taxes on household consumption
131.73
165.27
204.94
255.1
Total indirect taxes
170.65
203.27
240.07
287.3
Indirect
taxes
on
intermediate
consumption
Indirect taxes on investment
In the medium term aggregate indirect taxes increase mainly due to rising aggregate demand in
the economy. However, production taxes fall due to quick expansion of fiscal spance which
mainly raises prices and has less impact on production in the shortrun. Despite this, total nominal
indirect taxes continue to grow in the medium term as depicted in Table 2 above.
4.1.4.2 Government expenditure
Despite the exponential increase in aggregate indirect tax revenue, the fiscal deficit continues to
grow as the fiscal policy is expanded to meet the EAC macroeconomic convergence criteria. For
instance in FY 2014/15 the fiscal deficit grows by 1.38 trillion shs and 1.88 trillion shs in FY
19
2015/16 to exhaust the fiscal space created by the EAC macroeconomic convergence criteria.
This deficit continues to grow throughout the simulation period.
Despite the perpetual deterioration of the fiscal balance, government revenue continues to grow
though offset by the growth in government expenditure. For instance in FY 2014/15 government
revenue improves by 1.71 percent more than it would be without the fiscal policy shock. This
improvement is attributed to indirect taxes due to increased aggregate demand and direct taxes
resulting from increase in labor demand (employment). Performance of government expenditure
is shown in Table 5 below.
Table 5: Performance of government expenditure
Ordinary changes (Billion shillings)
ITEM
2014/15
2015/16
2016/17
2017/18
Change in government Deficit/Saving
-1,383.61bn -1,876.85bn -2,476.67bn -3,219.22bn
Percentage changes in fiscal operations
Current government expenditure
15.92 %
15.42 %
14.74 %
14.12 %
Government Investment
1.39 %
1.01 %
0.67 %
0.44 %
Government revenue
1.71 %
1.63 %
1.55 %
1.52 %
13.75 %
13.48 %
13.04 %
12.65 %
Total government expenditure
In FY 2014/15 the increase in government expenditure (13.75 percent) supersedes the
improvement in Government income (1.71 percent). This worsens the fiscal deficit by a tune of 1,383.61billion shillings more than it would be without the EAC convergence criteria. This trend
continues in the medium term as shown in Table 5 above.
20
4.2 Sectoral impacts (Simulation 1)
4.2.1 General sectoral performance
A number of sectors respond differently as fiscal policy adjusts to the Macroeconomic
convergence criteria as shown in the fan-decomposition3 (Figure 6) below.
Figure 6: Fan-decomposition for the FY 2014/15
1 LocalMarket
Market contribution to sectoral perform ance
2 DomShare
4 Total
45
42.5
40
37.5
35
32.5
30
27.5
% change
25
22.5
20
17.5
15
1 LocalMarket
4 Total
12.5
10
17.5
LocalMarket
1 LocalMarket
1 LocalMarket
5
1 LocalMarket
LocalMarket
1
1
LocalMarket
12.5
LocalMarket
1
LocalMarket
1
1 LocalMarket
LocalMarket
0
4 Total
2
2
2
2
2
DomShare
DomShare
DomShare
DomShare
DomShare
-2.5
3
3
3
3
3
3
3
3
Export
Export
Export
Export
Export
Export
Export
Export
4
4
4
4
4
4
4
4
4
4
4
Total
Total
Total
Total
Total
Total
Total
Total
Total
Total
Total
1 GrainSeeds
2 Cof TeaOth
3 AnimalFarm
4 Forestry
5 Fishing
6 Mining
7 RawOil
8 FoodProds
9 DrinksSmokes
10 TexLeatFoot
11 WoodProds
12 PaperPrint
13 Petroleum
14 Chemicals
15 RubberPlastc
16 NonMetlMinrl
17 BasicMetals
18 FabMetalPrd
19 ElecGasWater
20 Construction
21 Trade
22 Repairs
23 HotelRest
24 Transport
25 CommunicServ
26 FinServ ices
27 RealEstDwl
28 BussineServ
29 Gov ernment
30 Education
31 Health
32 ComSocWork
33 Recreational
34 OthActiv ity
4 Total
3 Export
2 DomShare
1 LocalMarket
-5
Figure 6 above shows that sectors that produce tradable products are the most affected in the
economy, mainly because of the loss of competitiveness in the export market. The performance
by non tradable sectors undermines quality thus may affect competiveness in the long run. For
instance, when government spending rises quickly to exhaust the fiscal space created, this
Fande-composition disintegrates the change in production of a given sector by its source from changes in
demand from the local market, export market and changes in the domestic/import share of the composite
commodity.
3
21
outstrips the supply capacity for non traded goods. There will be a construction boom, but
construction prices will rise and quality will fall.
Winner (Benefiting sectors): Sectors whose investment is not mainly driven by profit but
follow aggregate investment are those that perform much better compared to the rest of the
sectors. These sectors include petroleum, raw oil, government parastatals, health, education,
community social work, recreational and extraterritorial activity. The good performance of these
sectors is mainly driven by increased local market demand for instance performance by raw oil
(46.28 %), health (5.6 %), education (5.3 %) and community social work (2.8 %) is wholesomely
attributed to the local market effect. All tradable sectors faced a reduction in export demand due
to loss of competitiveness in the international market as depicted in Figure 6 above.
Losers sectors (poorly performing): In FY 2014/15, sectors producing traded goods are the
most affected including; Hotels and restaurants (-4.24 %), fabricated metal products (-2.98 %),
wood products (-2.91 %), basic metals (-2.48 %) and textiles leather foot products (-2.32 %).
Most of these sectors gained from the increase in domestic demand, but this gain is offset by a
larger loss of the export market. For instance in the FY 2014/15, the 0.56% improvement in the
output for hotels and restaurant is attributed to local market effect. However, this performance is
offset but the export demand effect of -4.8 % emanating from loss of competitiveness, thus
causing a net loss in production of -4.24 % in the hotel and restaurant sector as shown in Table 6
below.
Table 6: Losing sectors
Local
Industry
Market
Domestic Share in
Export
Total production
effect
composite demand
demand effect
( % changes)
Hotel & Restaurants
0.56
0
-4.8
-4.24
Fabricated metals
0.21
-1.02
-2.18
-2.98
Wood products
-0.2
-2.45
-0.26
-2.91
Basic metals
-0.42
-0.27
-1.8
-2.48
Textiles, Leather foot
0.94
-0.8
-2.46
-2.32
22
Table 6 above, also shows that the poor performance of wood products sector is mainly
attributed to the domestic substitution effect; that is domestic demand is switched in favor of
imported wood that has become relatively cheaper. Thus, this loss in demand of domestic wood
products accounts for the 2.45 % reduction in domestic production of wood products. Despite of
this loss, the sector also loses competiveness in the export market mainly due to the rising local
prices. These effects simultaneously results into a 2.91 % reduction in output for the wood
products sector in FY 2014/15.
4.3 Impact on household welfare (Simulation 1)
Adjustments of the fiscal policy to meet the EAC macroeconomic convergence criteria create
ripple effects on the product market, factor market and balance of payment accounts. Reequilibration in these markets generates economic waves that affect household welfare. The
effects are discussed below.
4.3.1 Household income:
Fiscal policy adjustments post a positive effect on household income throughout the simulation
period. For instance in FY 2014/15 household disposable improved by 4.02 % mainly due to a
1.14 % increase in employment and 5.31 % increase in nominal wage. Dividends from
enterprises grew by 3.39%, rest of the world transfers to households by 4.03 %, government
transfers to household by 4.03 % and income from gross operating surplus by 3.42%. The
performance of household revenue categories is shown in Figure 7 below.
23
Labor employ ment
Disposable income
Primary f actor pay ments
Div idend to households
Gov 't transf er to households
2019
2018
2017
2016
2015
2014
2013
2012
4.25
4
3.75
3.5
3.25
3
2.75
2.5
2.25
2
1.75
1.5
1.25
1
0.75
0.5
0.25
0
-0.25
-0.5
-0.75
-1
-1.25
-1.5
-1.75
-2
-2.25
-2.5
-2.75
2011
% change
Figure 7: Performance of household income and employment
Figure 7 above shows that in the short-run firms reduce cost of production employ more labor
given a fixed capital stock; a rise in employment as well as nominal payment to labor. As more
output is produced to satisfy the increasing aggregate demand, the domestic prices are forced to
increase to chock the excess demand. Since capital is fixed in the short run, perpetual increases
in aggregate demand outstrip the supply capacity. This translates into increasing nominal wage to
maintain real wages fixed as well as to attract more labor for employment, since in the short run
output can only be increased through increase in employment of labor. The increased economic
activity also results into improvements in the operating surplus and dividends to households.
However, this improvement can only be sustained in the medium term but collapses in the long
run as the EAC macroeconomic thresholds are reached. In the long-run debt accumulates and
fiscal deficit percentage to GDP hits the threshold of 3%, fiscal policy is forced to contract to
keep within the EAC Macroeconomic criteria. In FY 2018/19, fiscal deficit hits -2.99 % of GDP,
thus necessitating a 1 % expansion of the fiscal policy. Employment falls by -1.51 % and
24
disposable income by -2.05 %. This accounts for the drastic fall in household income by FY
2018/19.
4.3.2 Household consumption
Despite the 4.25 % increase in household nominal consumption in FY 2014/15, the
corresponding real consumption improved by 1.43 % and the relative consumer prices increase
by 2.84 %. Thus the high improvement in consumption is mainly attributed to inflation resulting
from fiscal policy expansion. The performance of household consumption is shown in Figure 8
below.
Real hh consumption (x3tot)
Consumer prices (p3tot)
2019
2018
2017
2016
2015
2014
2013
2012
4.25
4
3.75
3.5
3.25
3
2.75
2.5
2.25
2
1.75
1.5
1.25
1
0.75
0.5
0.25
0
-0.25
-0.5
-0.75
-1
-1.25
-1.5
-1.75
-2
2011
% change
Figure 8: Household consumption and consumer prices
Nominal hh consumption (w3tot)
Figure 8 above shows that nominal household consumption is mainly driven by inflation
throughout the simulation period. The improvement in real consumption is deduced from an
increase in employment in the short run. In the medium term, part of the additional income from
additional employment serves as a compensating variation of the price increase whereas the
remaining additional income is used to raise real consumption and saving.
25
In the long run, say FY 2018/19, as fiscal policy contracts, inflation subsides by -1.23 % forcing
nominal consumption (-2.06 %) to subside more than real consumption (-0.85 %). Thus
exhausting the fiscal space generated by EAC Macroeconomic convergence thresholds, is good
news to the households in the short run and bad news to the same households in the long run.
This is because it raises household consumption in the medium term that cannot be sustained in
the long run.
4.3.3 Household savings
Household savings would improve by 350.32 billion shillings, 436.3 billion shillings and 537.52
billion shillings in FY 2014/15, FY 2015/16 and FY 2016/17, respectively. The performance of
household savings is shown in the Figure 9 below.
Figure 9: Household income and savings
Figure 9 above shows that household savings follow movements in employment and
consumption levels. Over the medium term real consumption performance is stable which allows
household savings grow. However, this creates an unsustainable high household consumption
pattern in the long run. This results into negative savings as households struggle to maintain the
high levels of consumption.
26
This simulation indicates that to improve national savings, there is a need to enhance factor
payments and employment as well as creating a good macroeconomic environment to enable
profitable international transactions. Factor payments may be enhanced through enacting
minimum wage, generation of employment through industrialization and sensitization to
encourage savings for productive investments. Transactions with the rest of the world could be
improved through increased export oriented production, improvement of quality of local
products as well as focusing fiscal policy on improving production efficiency.
4.4 Macroeconomic comparison of Simulation 1 and 2
In the simulation fiscal policy is expanded in proportions of 60:40 for development and recurrent
expenditure. We compare macroeconomic and sectoral impacts of the shock to examine the
dynamic impacts when more funds are put in infrastructure development. A comparison of the
impact of simulation 1 and 2 is summarized in Table 7 below.
Table 7: Macroeconomic comparison of Simulation 1 and 2
2014/15 2015/16
2016/17
2017/18 2018/19
Economic Performance
GDP factor cost (Sim 1)
7.51
7.33
7.18
7.07
6.04
GDP factor cost (Sim 2)
7.52
7.33
7.21
7.09
5.97
Real exchange rate
Real devaluation (Sim 1)
-3.39
-3.47
-3.53
-3.63
1.24
Real devaluation (Sim 2)
-3.47
-3.48
-3.65
-3.74
1.66
Terms of trade
Terms of trade (Sim 1)
1.27
1.41
1.55
1.71
-0.05
Terms of trade (Sim 2)
1.31
1.42
1.61
1.77
-0.19
Indirect taxes
Total indirect taxes (Sim 1)
170.65
203.27
240.07
287.3
-87.19
Total indirect taxes (Sim 2)
176.21
205.95
251.78
301.36
-118.17
Fiscal Deficit
Change in fiscal Deficit/Saving (Sim 1)
-1383.61 -1876.85
-2476.67 -3219.22 -1124.66
Change in fiscal Deficit/Saving (Sim 2)
-1406.99 -1879.17
-2534.53 -3289.68
-936.08
Household Savings
Household savings ( Sim 1)
350.32
436.3
537.52
665.61
-17.55
Household savings ( Sim 2)
359.82
439.85
557.72
689.71
-77.11
Employment
Employment ( Sim 1)
1.14
0.81
0.54
0.34
-1.51
Employment ( Sim 2)
1.15
0.79
0.57
0.36
-1.66
27
Table 7 above depicts that the performance of real GDP is higher in Simulation 2 as compared to
simulation 1. This performance is mainly born from the domestic economy through improvement
of productivity triggered by prioritizing the national budget towards infrastructure development.
Despite the negligible difference in GDP for the two scenarios, real exchange rate appreciation
and increasing terms of trade are more pronounced in simulation 2. Therefore in simulation 2 the
economy’s competitiveness deteriorates more than it does in simulation 1. This is mainly
because simulation 2 generates more fiscal space in the medium term due to minimal impact of
the fiscal policy on inflation.
In the medium term, employment grows faster in simulation 2 mainly because of the investment
in the economy’s productivity through the national budget. This raises household income as well
as resulting into higher household savings as shown in Table 5 above.
5.0 Conclusion
The paper analyzes the prospective macroeconomic, sectoral and welfare effects of the East
African Community macroeconomic convergence criteria, on the Ugandan economy using a
Dynamic CGE model. The results indicate that the impact of the convergence criteria is positive
on the aggregate demand throughout the simulation period, mainly attributed to strong
performance in government and private consumption. FY 2014/15 the consumer prices would
increase by 2.84 percent higher than it would be without the EAC convergence criteria. This
positive deviation would break in FY 2018/19 to -1.23% less than it would be without the EAC
convergence. The key drivers for the consumer prices are for sectors whose investment follows
government investment and have government as the biggest consumer of their products including
social sectors.
Achieving the convergence criteria would lead to a deterioration of the competiveness of the
Ugandan exports in the medium term, but lead to improvement of Uganda’s competiveness in
the export market in long run, as fiscal policy subsides and external debt forex inflows reduce.
While achieving the convergence criteria targets, the growth in government revenue (mainly
28
indirect taxes) would be outstripped by fiscal expansion and this leads to an increase in the fiscal
deficit thus having negative implications for debt sustainability.
As regards to sectoral performance, sectors whose investment is not mainly driven by profit but
follow aggregate investment are those that would perform much better compared to the rest of
the sectors. Sectors producing traded goods would be the most negatively affected, mainly due to
their loss of competitiveness in the external market.
Fiscal policy adjustments post a positive effect on household income throughout the simulation
period, mainly due to an increase in increase in nominal wage and transfers to households.
However, this improvement can only be sustained in the medium term but collapses in the long
run as the EAC macroeconomic thresholds are reached. In the long-run debt accumulates and
fiscal deficit percentage to GDP hits the threshold of 3%, fiscal policy is forced to contract to
keep within the EAC Macroeconomic criteria. Similarly, household savings would improve in
the medium term but deteriorate in the long term, due to the unsustainable household
consumption patterns. This simulation reveals that to improve national savings, there is a need
to enhance factor payments and employment as well as creating a good macroeconomic
environment to enable profitable international transactions.
The results justify the existence of the impossible macroeconomic trinity. That is, it’s not
possible to have low fiscal deficit, low inflation and a sustainable high growth at the same time.
For the economy to clear, one of these aggregates must be compromised to attain the two. For
instance, if the high economic growth is to be attained, inflation and deficit need to be allowed to
adjust upwards by expanding the fiscal space.
However, GDP would grow faster if the fiscal space is focused on the government investment.
This would improve technical and production efficiency in the economy as well as sustaining a
low inflation as shown in Table 5 above. Since government investment has a mild impact on
inflation, this would generate more fiscal space than when the fiscal policy in geared towards
recurrent expenditure.
In addition, the speed of expansion of the fiscal policy determines the nature of the sectoral
impacts. If government spending rises quickly to exhaust the fiscal space created as seen above,
aggregate demand outstrips the supply capacity for non traded goods. This generates a
29
construction boom with increasing construction and falling quality. The results also postulate
that faster fiscal policy expansion would have a negative impact on Uganda’s competiveness
through appreciating the real exchange rate and speedy improvements in the terms of trade. The
best economic results would be attained by a gradual fiscal policy expansion mainly focusing
infrastructure (investment).
References (to be completed)
Dixon, P.B., Parmenter, B.R., Sutton, J. & Vincent, D.P. (1982). ORANI: A Multisectoral Model
of the Australian Economy. North-Holland, Amsterdam.
30