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The Fiscal Effects of Aid in Uganda

Working papers

 This paper, one of a set of three country case studies, examines the effect of aid and other external financing on Uganda's public expenditure, revenue and domestic borrowing. The underlying purpose is to throw light on how Uganda has been able, since the late 1980s, to absorb considerable inflows of aid productively, and to use it to achieve economic recovery, sustain growth and reduce poverty. The paper uses formal econometric techniques to identify the broad patterns of fiscal response associated with aid, and deploys non-formal descriptive analysis to provide historical context and to offer detail on the use of public expenditures at the sectoral and sub-sectoral levels and on the accompanying economic policies.

The general conclusions, as expected, are that aid has been used to increase public expenditure, and in particular (though not exclusively) through the development budget, and that it has effectively contributed to growth and poverty reduction. This is because it has been associated with effective policies and institutional reforms and has financed the provision of services relevant to the immediate post-conflict needs of the economy and, later, to sustaining longer-term growth.

The period of high and sustained inflow of aid, starting in the late 1980s, has been a time of high development budget expenditure. It was also a time when the government achieved macroeconomic stability through fiscal control, and when it implemented a progressive programme of profound economic reforms to the support of which aid was explicitly devoted. During these years aid has been successfully deployed through the development budget for the rehabilitation and development of the economic infrastructure, the reform of public administration and of the financial sector and, since the mid-1990s, for the accelerated implementation of pro-poor programmes, notably in the social sectors.

High levels of aid disbursement, in both the 1980s and 1990s, have occurred at times when domestic revenues were rising, suggesting that aid has not been allowed to substitute for revenue mobilisation. In the 1990s aid receipts helped the government to stabilise the macroeconomy by putting an end to its (monetised) domestic borrowing, to overcome its (previously fraught) balance-of-payments problems by providing resources with which to cushion the liberalisation of its exchange regime, and to take action to reduce its non-concessional external debt.

The paper distinguishes a succession of phases in the development history of independent Uganda. In the first phase, up to the late 1960s, the management of public finance was prudent: Uganda had a semi-convertible currency within the East Africa Currency Board area, its receipts of aid were low, and it made little use of external borrowing. In the second phase, starting in the years immediately prior to the seizure of power by Idi Amin in 1971, this prudence was cast aside. Fiscal deficits emerged, financed domestically by monetisation and externally by limited non-concessional borrowing, and persisted, though on a diminishing scale until the overthrow of the dictatorship in 1979. The Amin regime caused the contraction of an economy which had previously been in slow expansion, and inflicted serious damage on its export earning capacity and thus on domestic revenues. Public expenditure declined in real terms and as a share of GDP.

The fall of Amin heralded the start of a third phase of nearly a decade of acute economic (as well as political) instability, featuring an episode in the mid-1980s of hyperinflation. This followed the collapse of domestic revenue mobilisation after the overthrow of Amin, the demonetisation of the economy, a steep, post-1981, rise in public expenditure and the printing of money by successive governments. The economic decline persisted until the later 1980s, with a temporary remission under the Obote II regime (1981-6), which, encouraged by agreements with the IMF and the Paris Club and significant commitments of aid, engaged in an imprudent expansion of public expenditure, but achieved no lasting development benefit. The incoming Museveni regime in 1986 inherited a weakening revenue base and an economy deserted by donors. Its first task was to stabilise the economy by reducing expenditure.

The fourth and final phase began with the implementation of the Museveni government's Economic Recovery Programme in the late 1980s. This consisted of commitment to the initial steps in what was to become a comprehensive structural adjustment and liberalisation of the economy, and of an ambitious programme of infrastructural rehabilitation. It attracted donor support - in programme and project form - on a scale from which Uganda had never previously benefited. ODA receipts, which previously had only exceptionally been as high as 10% of GDP, peaked at 28% of GDP in 1990/91 before settling at 10-15% of GDP in the remainder of the decade.

The paper notes a number of reforms in the 1990s in public expenditure planning and management which have enhanced the effectiveness of public expenditure and set the real economy on a path of recovery and sustained expansion. Revenue buoyancy was restored through reforms of the tax administration and the introduction of VAT in substitution for taxes on exports. On the expenditure side, Uganda, in common with many other countries, introduced cash budgeting to help overcome the destabilising effects of inadequate resource estimating and expenditure control. However, it managed to implement cash budgeting without loss of a sense of allocative priority, and without relapsing into hand-to-mouth allocative practices. This was done by defining a budget-within-a-budget - the Poverty Action Fund - which exempted programmes and sub-programmes deemed important for poverty reduction from ad hoc allocation reductions. Medium-term budgeting was also introduced together with consultative, transparent, budget preparation processes to which donors were invited to contribute. The government thus obtained a clearer forward view of resource availability and was better placed to implement its expenditure strategies than would otherwise have been possible.

The analysis of public expenditure shows that the recurrent and development budgets have responded to somewhat different laws of motion. The recurrent budget has tended to rise and fall with the availability of domestic revenue - supplemented by domestic borrowing and on occasion by aid. Shares of recurrent expenditure have been relatively constant, though the shares of defence and general administration have risen when revenues were low, and fallen when revenues have increased, indicating that these services have been treated as having priority claims. Interest charges paid have never been overwhelming as a share of the recurrent budget, and have fallen from a peak of 25% reached in the early 1990s. The recurrent budget's sectoral allocations have not reflected the pro-poor changes in development expenditure priorities that occurred after the mid-1990s.

The development budget, on the other hand, has undergone significant inter-sectoral reprioritisation since the late 1980s. The shares of administration and defence have been steadily reduced to the benefit of education and economic infrastructure within a resource envelope which grew from 3-4% of GDP prior to 1986 to 8-10% of GDP in the 1990s. At the same time, the share of fixed capital formation, formerly close to 80%, fell to less than half as the development budget was increasingly used as a source of intra-governmental transfer payments to sustain recurrent services.

The paper notes that the large and sustained increase in aid inflows that occurred in the late 1990s was predominantly in the form of grants and highly concessional loans, and that in the late 1980s and early 1990s net disbursements were well in excess of receipts recorded in the budget. The difference is only partly explicable by the inclusion in ODA of technical cooperation, debt relief, food aid and emergency flows. It is evident that part of donor activity - probably associated with infrastructure projects with direct payments made by donors to contractors - was not captured in the fiscal records. The purposes of donor assistance have been multifarious: aid has comprised programme, project and sector-wide support, the first of which was devoted to balance-of-payments support and budget support linked to the implementation of reforms, and the second and third to the rehabilitation and expansion of public services. Evaluation studies show more satisfaction with the performance of policy-related programmes than with that of aid for projects, many of which have experienced delays for administrative reasons, especially in the late 1980s and early 1990s.

The paper uses time series data and a vector error correction model as the econometric technique to test the main observations derived from the development narrative and non-formal interpretation of the statistical evidence. The technique is suitable for the analysis of relationships existing between variables which are endogenous to an economic system and co-determined - such as in a budget - and allows the examination of lagged effects and feedback mechanisms. However, like other time series regression-based tools, it yields results which represent average responses to stimuli over the period examined. These averages are not necessarily representative of the response mechanisms at work at particular moments in time. In the case of Uganda there have been a series of break points - in terms of political order, policy and relationships with external financiers. It has not been possible, with the available data, to test statistically whether these have occasioned changes in the underlying fiscal response model.

The econometric evidence confirms the hypothesis that external financing has increased public expenditure. Grant aid (and arguably also multilateral concessional lending) seems to have exerted a stronger impact over time on the development budget than on the recurrent. Aid - in the form of both grants received and ODA disbursed - may have had a positive long-term effect on revenues, but the evidence is not conclusive. Some of the effect on revenue has doubtless come indirectly through income growth. As expected, given the contrasting levels of fiscal responsibility of successive governments, the average effect of external financing on domestic borrowing has been ambiguous.

Sonja Fagernas and John Roberts