MANAGEMENT OF PUBLIC DEBT BY MINISTRY OF FINANCE, PLANNING AND ECONOMIC DEVELOPMENT

T H E R E P U B L I C O F U G A N D A OFFICE OF THE AUDITOR GENERAL MANAGEMENT OF PUBLIC DEBT BY MINISTRY OF FINANCE, PLANNING AND ECONOMIC DEVELOPMENT

OFFICE OF THE AUDITOR GENERAL

T H E R E P U B L I C O F U G A N D A OFFICE OF THE AUDITOR GENERAL MANAGEMENT OF PUBLIC DEBT BY MINISTRY OF FINANCE, PLANNING AND ECONOMIC DEVELOPMENT

AUDITOR GENERAL S MESSAGE

AUDITOR GENERAL S MESSAGE 31st March 2015 The Rt. Hon. Speaker of Parliament Parliament of Uganda Kampala REPORT OF THE AUDITOR GENERAL ON THE MANAGEMENT OF PUBLIC DEBT BY THE MINISTRY OF FINANCE, PLANNING In accordance with Article 163 (3) of the Constitution, I hereby submit my report on the audit undertaken on the acquisition process of public debt by Ministry of Finance Planning and Economic Development (MoFPED). My office intends to carry out a follow up at an appropriate time regarding actions taken in relation to the recommendations in this report. I would like to thank my staff who undertook this audit, the consultants from the National Audit Office of the United Kingdom (NAO-UK) for the technical support provided, the staff of the Ministry of Finance, Planning and Economic Development and Bank of Uganda (BoU) for the assistance offered to my staff during the period of the audit. John F. S. Muwanga AUDITOR GENERAL

TABLE OF CONTENTS LIST OF TABLES AND FIGURES... i LIST OF ABBREVIATIONS AND ACRONYMS... ii EXECUTIVE SUMMARY... iii CHAPTER ONE... 1 INTRODUCTION... 2 1.1 BACKGROUND... 2 1.2 MOTIVATION... 2 1.3 DESCRIPTION OF THE AUDIT AREA... 3 1.4 AUDIT OBJECTIVE... 5 1.5 AUDIT SCOPE... 6 CHAPTER TWO... 7 AUDIT METHODOLOGY... 8 2.1 SAMPLING... 8 2.2 DATA COLLECTION... 8 2.3 DATA ANALYSIS... 9 CHAPTER THREE... 10 SYSTEMS AND PROCESS DESCRIPTION... 11 3.1 Roles and Responsibilities of Key Players... 11 3.2 Public debt acquistion PROCESS... 13 3.2.1 External debt acquisition process... 13 3.2.2 Domestic Debt acquisition process... 14 CHAPTER FOUR... 15 FINDINGS, CONCLUSIONS AND RECOMMENDATIONS... 16 4.1 SUSTAINABILITY OF THE PUBLIC DEBT PORTFOLIO... 16 4.1.1 Status of Uganda s Public Debt Portfolio... 16 4.2 ADEQUACY OF THE PUBLIC DEBT MANAGEMENT FRAMEWORK... 28 4.2.1 CONFORMITY OF THE UGANDAN DEBT MANAGEMENT FRAMEWORK TO RPINCIPLES OF BEST PRACTICE...28 4.2.2 Medium Term Debt Management Strategy and Borrowing plan... 32 4.3 INSTITUTIONAL/ORGANISATIONAL ARRANGEMENTS... 33 4.4 BORROWING ACTIVITIES... 35

4.4.1Cost Of Domestic Borrowing... 35 4.4.2 The Issuance of Debt for Short-Term Cash flow Needs... 39 4.4.3 Technical Evaluation of Terms of Borrowing... 41 4.4.4 Assessing the Economic Rate of Return (ERR)... 42 4.4.5 Feasibility Studies... 44 4.4.6 Timelines within the Debt Acquisition process... 46 APPENDICES... 48 APPENDIX I: SAMPLED LOANS... 48 APPENDIX II: DOCUMENTS REVIEW... 50 APPENDIX III: INTERVIEWS CONDUCTED... 52 APPENDIX IV: LOW ABSORPTION PROJECTS... 53 APPENDIX V: TIME FRAME FOR LOAN APPROVALS... 59 LIST OF TABLES Table 1: Public debt stock: FY2011/12-2013/14 (in USD Bn)... 5 Table 2: IMF and Ugandan Debt Sustainability Thresholds... 17 Table 3: Ugandan metrics of debt sustainability... 18 Table 4: Risk management metrics for the Ugandan debt portfolio... 21 Table 5: Domestic Arrears for 2010/11-13/14... 22 Table 6: Showing Active Government Guarantees as at 30 June 2014... 27 Table 7: Assessment of Uganda s Arrangements for Debt management against IMF guidance... 29 Table 8: Selected Treasury Bond Issues in B-Rated Sovereign, 2014... 37 Table 9: Showing Comparisons between loan terms... 41 Table 10: List of Non-Concessional Loans committed since June 2013... 42 Table 11: Showing a Summary of Low absorption by Sectors as at December 2014... 45 LIST OF FIGURES Figure 1 Public Debt Acquisition Process... 13 Figure 2: Composition of Uganda s externally Owed debt (USD, bn)... 20 Figure 3 Maturity of Domestic Debt Portfolio... 21 Figure 4 IMF and MoFPED Projections of Overall debt sustainability... 24 Figure 5 IMF and MoFPED projections of External debt Sustainability... 25 Figure 6: Composition of Domestic Debt Investors... 31 Figure 7 Domestic and External Financing as a % of GDP... 35 Figure 8 Yield to Maturity in Uganda s Treasury Bond Auctions, 2011-2015, (%)... 36 Figure 9: End-of Year Cash balances for Districts & Municipal Councils, 2009/10-2013/14 UGX, Mn)... 40 i

LIST OF ABBREVIATIONS AND ACRONYMSY AfDB ADF ADFD AFD ALD BADEA Bn BOU CPIA DeMPA IDA IFAD IMF INTOSAI JICA KfW LIBOR MEPD MEFMI MoFPED MTDS OFID PDMF SFD USD UGX African Development Bank African Development Fund Abu Dhabi Fund for Development Agence Francaise du Development Aid Liaison Department of MoFPED Arab Bank for Economic Development Billion Bank of Uganda Country Policy and Institutional Assessment Debt Management Performance Assessment International Development Association International Fund for Agriculture Development International Monetary Fund International Organisation of Supreme Audit Institutions Japan International Cooperation Agency Kreditanstalt für Wiederaufbau (Germany Development Bank) London Interbank Offered Rate Macroeconomic Policy Department Macroeconomic and Financial Management Institute of East and Southern Africa Ministry of Finance, Planning and Economic Development Medium Term Debt Strategy OPEC Fund for International Development Public Debt Management Framework Saudi Fund for Development United States Dollars Uganda shilling ii

Executive Summary Public debt is incurred primarily for financing budget deficits, development of domestic financial markets, supporting the country s Balance of Payment (BOP) position/foreign reserves and monetary policy objectives. In Uganda, public debt is managed by the Ministry of Finance, Planning and Economic Development (MoFPED) in liaison with Bank of Uganda (BoU). Government borrows internally from domestic markets through issuance of Treasury bills and Bonds by BoU and externally through Bilateral and multilateral borrowings. Currently, over 60% of the public debt is external debt and 40% is domestic debt. GoU borrowing has been rising over the years from United States Dollar (USD) 5.7 billion in Financial Year (FY) 2011/12 to USD 7 billion in FY 2013/14. The growing National debt, if not properly managed, could revert to unsustainable levels as was the case in the past. The major objective of the audit was to assess the efforts being undertaken by Ministry of Finance to ensure that the public debt is acquired in a sustainable manner. KEY AUDIT FINDINGS There have been concerted efforts by the Ministry of Finance, Planning and Economic Development to address gaps in the Legal framework for management of public debt through the crafting and eventual approval of the Public Finance Management Act, 2015. The Ministry is also undertaking organizational re-structuring and Public Financial management reforms in a bid to improve efficiency in budget management as well as plug gaps in the institutional/organizational arrangements for public debt management. Measures to introduce a Treasury Single Account (TSA) for central government accounts were launched in October 2013. The Directorate of Cash and Debt Management was also created in 2014 to better coordinate the forecasting of debt needs with its issuance. The ministry is also commended for its efforts to undertake annual Debt Sustainability Analyses (DSA) in order to check and ensure that the country s debt levels remain sustainable. Inspite of these achievements, there are still areas of concern discussed as follows. For the latest review in 2014, Uganda s three-year average Country Policy and Institutional Assessment (CPIA) score moved below the threshold for strong performer status from 3.75 to 3.73. Despite this, the IMF ruled that its classification would remain as a strong performer, due to remaining within 0.05 of the threshold. It stated however, that another year with a score below the threshold could see the country downgraded. The uncertainty around Uganda s borderline status as a Strong performer because of a drop in its CPIA score is a cause for concern. A downgrade to Medium performer could increase external perceptions that the country is at risk of debt distress, thus increasing the government s cost of borrowing. The most recently published data on Ugandan debt sustainability metrics for domestic and external debt levels indicates that the external indebtedness of Uganda does not present any immediate cause for concern, with large amounts of headroom relative iii

to the sustainability thresholds set out in the Public Debt Management Framework (PDMF). Nonetheless, for domestic indebtedness, there was limited headroom between the debt stocks recorded in 2013 and the recommended thresholds, as set out in the PDMF. Furthermore, the ratio of domestic debt to private sector credit (a key indicator of the risk of government competing with private sector credit) was very close to the maximum recommended level Interest rates on domestic debt have overall stabilised in recent years relative to their peak in 2011/12. However, they remain a cause for concern due to their high contribution to overall debt service costs and the relatively high yields which they attract stand in stark contrast to those achieved by comparator nations with similar credit ratings. Taking into consideration the relative inflationary levels however, the difference in Yield-to-Maturity when considering Uganda and Cameroon which had issued a similar bond around the same time is larger than would be expected from the inflation differential. Overall, there was clear articulation of the high-level aims of debt management strategy, albeit with some gaps in the reporting framework of the Debt Management Strategy. For instance, the government does not publish the semi-annual statistical information (Statistical bulletin) on the composition of the public debt, despite there being provision to do so within the Public Debt Management Framework (2013). There was evidence of lack of coordination between the different institutions for instance the maintenance of two separate databases of outstanding debt maintained, by the Bank of Uganda and the Ministry of Finance. These databases did not always record additions to debt in a similar way. Audit noted that they occasionally needed to be subjected to time-consuming reconciliation processes for any discrepancies identified. It is expected that the harmonization of debt and cash management operations under the new Directorate of Debt and Cash management will result in an opportunity to consolidate reporting into one system. By the time of audit, MoFPED had not prepared a Medium Term Debt management Strategy (MTDS) and borrowing plan which provide a framework within which authorities make informed choices on how government s financing requirement should be met. The MTDS helps to prioritise sectors and areas in which loans will be acquired and the proposed funders in the medium term. The advantage is that donors don t just dictate to government which areas to fund which may be outside the country s priorities. MoFPED still operates a fragmented Debt management unit (DMU) despite its attempts to create an independent Directorate of Debt and cash management. There was also no clarity and division of roles and responsibilities among the different DMUs. However, efforts to come up with regulations which clearly spell out the roles and responsibilities of key players are commendable. MoFPED did not carry out technical and economic assessments of all new loan proposals and projects which therefore compromised the National public Debt risk portfolio and sustainability. With the current trend of acquisition of non-concessional loans (short and medium term to the tune of 4.7billion USD), it is imperative that such technical and economic evaluations are done for all new borrowing proposals to ensure competitive/favourable terms are offered by lenders so that the National Debt remains sustainable in the medium and long term thus mitigating adverse effects of accumulated debt levels on the future generation. iv

KEY RECOMMENDATIONS MoFPED should continue to come up with mechanisms to improve on those indicators such as public sector management, which currently impact on the CPIA scores in order to sustain the strong performer status. To address the high cost of domestic borrowing, MOFPED should broaden investor participation in domestic bond market by lowering barriers to participation and promoting bonds to potential investor groups and involving more external participation Furthermore the ministry should continue promoting an environment of low and stable inflation, to lower the inflation risk premium element which may be increasing bid values in domestic auctions. MOFPED should continue with its efforts of issuing longer term dated securities to even out the maturity profile and reduce the risk for refinancing The ministry should expedite the consolidation of the debt management functions as well as finalization and approval of the regulations spelling out the roles and responsibilities of the different units within the DMU clearly stating the different functions of the front, middle and back Debt Management Unit. MoFPED should expedite the preparation of the Medium term debt management strategy and the borrowing plan. This will help explore appropriate strategies to achieve a composition of the debt portfolio which encapsulates the cost/risk tradeoffs desired by the government. To enhance openness, transparency and predictability, MOFPED should prepare and publish a semi-annual statistical bulletin as required by the Public debt management framework so as to avail the general public with debt statistics. MoFPED should ensure that technical and economic assessments are carried out for all new borrowing proposals and feasibility studies undertaken by the implementing agencies. This will necessitate building the capacity of the DMU and the implementing agencies Overall AUDIT Conclusion The MoFPED has conducted a prudent policy of acquiring new debt since 2007 which minimises risks. It has, for instance, chosen not to issue non-concessional debt in a foreign currency, and is continuing to extend the average maturity of domestic debt by issuing 15 year debt. It also continues to prioritise the acquisition of cheaper concessional loans in preference to the more expensive domestic borrowing. These policy measures have contributed to sustainability projections which indicate that the country faces a low probability of debt distress in the short to medium term, even under challenging external macroeconomic and financing environments. v

Nonetheless with the current economic conditions characterised by reduced exports and a depreciating Ugandan Shilling against the dollar (30% for the last 4 months) there is a risk of stress which can affect future sustainability. Interest rates on domestic debt remain a cause for concern due to their high contribution to overall debt service costs (78%), and the relatively high yields which they attract stand in stark contrast to those achieved by comparator nations. The full implementation of the plan to consolidate the debt management functions and the roll out of the TSA should lead to improvement in management of the public debt. vi

1 CHAPTER ONE V A L UE F O R M O N E Y A U DIT REPORT 1

CHAPTER ONE INTRODUCTION 1.1 BACKGROUND Public debt refers to the outstanding liabilities of government requiring future payment of principal and/or interest. Liabilities represent the total outstanding borrowings or obligations of government and comprise of internal (owing to national creditors) and external (owing to foreign creditors). Government borrows internally from domestic markets through issuance of Treasury bills and Bonds by the BoU and externally through Bilateral and multilateral borrowings. Currently over 60% of the public debt is external debt and 40% is domestic debt. 1 The use of government securities as a mode of financing for fiscal purpose commenced in FY 2012/13, with funds raised specifically to provide for roads sector financing gap. 2 Public debt is incurred primarily for financing budget deficits, development of domestic financial markets, supporting the country s Balance of Payment (BOP) position/foreign reserves and monetary policy objectives. In Uganda, public debt is managed by the Ministry of Finance, Planning and Economic Development (MoFPED) in liaison with Bank of Uganda (BoU). In the past, Uganda s debt peaked to unsustainable levels such that the economy did not have the capacity to meet its debt repayment obligations. Fortunately, Uganda benefited from the various Debt relief initiatives like the Heavily Indebted Poor Country (HIPC) Initiative in 1998, the Enhanced HIPC in 2000 and the Multilateral Debt Relief Initiative (MDRI) in 2006. Despite these initiatives, GoU borrowing has been rising over the years from USD 5.7 billion in Financial Year (FY) 2011/12 to USD 7 billion in FY 2013/14. The growing National debt, if not properly managed, could revert to unsustainable levels as was the case in the past. 1.2 MOTIVATION Public debt is becoming an increasingly important source of deficit financing as the domestic revenues continue to perform below the required expenditure, for instance, in F/Y 2013/14 domestic revenues averaged at 12.6% of Gross Domestic Product (GDP) while total expenditure to GDP remained higher at 18.8% a shortfall of 6.2%. In order to bridge this gap and therefore provide critical financing for Government interventions, MoFPED has opted to secure financing through External and Domestic borrowing. In the FY 2013/14 Public debt increased to USD 7 billion up from USD 6.4 billion in F/Y 2012/13, reflecting a 9.38% increment in one year alone, the increment was way above the GDP growth of 6.2% in the FY 2013/14 3. Domestic debt accounted for 9.55% (UGX 1,437 billion) of the National budget, 2014/15 an increase of 1.65% (UGX 397 billion) from 1 Report on Public debt Grants and Guarantees 2011/12-2013/14 2 Report on Public debt Grants and Guarantees 2013/14 pg. 3 3 Budget speech FY 2014/15 2

7.9% (UGX 1,040 billion) in financial year 2013/14. External financing on the other hand increased from UGX 2,660 billion in F/Y 2013/14 to UGX 2,733 billion of the National budget, 2014/15 an increase of UGX 73 billion. As non-concessional borrowing increases, the need for proper debt management becomes even much greater. Given the above trend, it is imperative that public debt management activities are performed in accordance with sound principles of public financial management and best management practice, which entail transparency, accountability and predictability. It is also important to ensure that government financing needs are met (by raising the required amount of funding), national wealth is created while mitigating risks, borrowing costs are minimized, the domestic market is developed and debt levels remain sustainable and do not compromise economic stability. It was therefore against this background that the Office of the Auditor General deemed it necessary to undertake an independent study to assess whether MoFPED acquires public debt in a sustainable manner. 1.3 DescriptIon of the audit area 1.3.1 General Description Government finances the budget using internally generated resources, grants and borrowings. Government borrows internally from domestic markets through issuance of Treasury bills and Bonds by the BoU and externally through Bilateral and multilateral borrowings. In Uganda, public debt is managed by the Ministry of Finance, Planning and Economic Development (MoFPED) in liaison with Bank of Uganda (BoU). The Aid Liaison department (ALD) of MoFPED is the focal point for Aid policy implementation and management while coordinating policy implementation, management and accounting for the resources. 1.3.2 Legal Framework for Management of Public debt The legal framework for management of public debt in Uganda is enshrined in the Constitution of the Republic of Uganda, 1995 (as amended), and several Acts of Parliament which include: the Treasury Bills Act, 1969, the Bank of Uganda Act, 1993 (as amended), the Budget Act, 2001, and in the Public Finance and Accountability Act (PFAA), 2003. Article 159 of the Constitution of the Republic of Uganda, 1995 (as amended), authorizes the Government of Uganda to borrow from any source provided such borrowing is expressly approved by Parliament. Section 1 of the Treasury Bills Act, 1969 gives the Minister in charge of Finance the authority to borrow by issue of Government treasury bills. Section 4 (2) (e) of the Bank of Uganda Act, 1993 (as amended) authorizes Bank of Uganda to Manage Public Debt. The Public Finance and Accountability Act, 2003 (PFAA) on the other hand outlines the control and management of public finance. Part III in particular provides for the regulation of Government borrowing. Section 20 of the PFAA vests the authority to raise money by loan and market securities (treasury bills and bonds) in the MoFPED. 3

1.3.3 Vision and Mission Vision The vision of MoFPED is to be A most effective and efficient Ministry of Finance, Planning and Economic Development that is capable of achieving the fastest rate of economic transformation among the emerging economies. Mission The mission of MoFPED is To formulate sound economic policies, maximize revenue mobilization, and ensure efficient allocation and accountability for public resources so as to achieve the most rapid and sustainable economic growth and development. 1.3.4 Objectives of the public debt management Government s primary debt policy objectives are: i. To meet Government s financing requirements at the minimum cost, subject to a prudent degree of risk; ii. To ensure that the level of public debt remains sustainable, over the medium- and long-term horizon while being mindful of the future generations; and iii. To promote the development of the domestic financial market 1.3.5 Organization Structure The management of public debt takes place at three levels: the Front office, the Middle office and the Back office, as illustrated below. The front office is managed by the Aid Liaison Department, in MoFPED, which is responsible for planning, negotiation, external relations, reporting and communication, and monitoring and evaluation of loan effectiveness of External loans. Bank of Uganda (BoU), on the other hand, performs the front office roles for domestic issuance on behalf of MoFPED. The middle office functions are handled by the Macroeconomic Policy Department (MoFPED) which is responsible for conducting research and providing input to debt sustainability analyses as well as carrying out debt sustainability, risks analysis simulations, formulating debt management strategies. The middle office also develops operational procedures to reduce operational risks and to ensure that debt management operations are conducted within stipulated parameters to manage risk exposures. In addition, as adviser to Government, BoU also plays a middle office role with regard to both external and domestic public debt. The bank participates in the national debt sustainability analyses. The functions of the back office are handled by the Treasury Services Department (TSD) and these include: processing and disbursement of funds, capturing and validation of debt data, accounting and managing the Debt Management Financial Analysis System (DMFAS). The Bank of Uganda also forms part of the back office as it keeps custody of the loans disbursed by the development partners and runs a parallel DMFAS tool. The bank also maintains the Central Systems Depository (CSD) which is used for recording domestic debt. 4

1.3.6 Stock of Public Debt On average, 60% of public debt is external loans of which Multilateral loans constitute over 80%. The domestic debt is largely derived from the sale of bonds which constituted an average of about 60% over the period FY2011/12-2013/14. For the past 2 years (2012/13 and 2013/14), there has been an increase in the share of domestic debt, which is less concessional and this share is projected to increase with the adoption of the Public Private Partnership model of financing public infrastructural investments. As non-concessional borrowing increases, the need for proper debt management becomes even much greater. Table 1: Public debt stock: FY2011/12-2013/14 (in USD Bn) FY 2011/12 (Mar 2012) % Share FY 2012/13 (Mar 2013) % Share 2013/14 (Mar 2014) % Share External Debt Outstanding and 3.053 59.44 3.53 61.71 4.18 59.71 Disbursed * o/w Bilateral 0.279 0.47 1.15 o/w Multilateral 2.774 3.05 5.50 Domestic Debt * 2.083 40.56 2.20 38.46 2.82 40.29 o/w Treasury Bills 0.864 0.93 1.07 o/w Treasury Bonds 1.219 1.27 1.75 Total Public Debt 5.136 100.00 5.72 100.00 7.00 100.00 Arrears (UGX Bn) 427.26 605.70 840.28 *Source: Report on Public debt Grants and Guarantees 1.4 AUDIT OBJECTIVE The overall objective of the study was to assess the extent to which MoFPED ensures that Public debt is acquired in a sustainable manner. The specific objectives of the Audit were:- 1. To evaluate the measures undertaken by MoFPED to ensure sustainability of public debt; 2. To evaluate the adequacy of the Public Debt Management Framework (PDMF) in enhancing debt sustainability; 3. To assess the extent to which public debt is acquired in a timely manner 5

1.5 AUDIT SCOPE The Audit covered the roles played by the MoFPED in ensuring that public debt is sustainable with specific reference to composition, costs and maturity periods of debt acquired. The audit also assessed how the institutional arrangements i.e regulatory framework, structures and strategies enhance efficiency in the acquisition process. In evaluating whether the debt, acquisition process facilitates debt sustainability, the audit mainly focused on the acquisition of external debt since it constitutes over 60% of the National debt portfolio. The Audit covered a period of three financial years from 2011/12 to 2013/14. 6

2 CHAPTER TWO V A L UE F O R M O N E Y A U DIT REPORT 7

CHAPTER TWO AUDIT METHODOLOGY The audit was conducted in accordance with the International Organization of Supreme Audit Institutions (INTOSAI) Performance Auditing Standards and the Performance Auditing guidelines prescribed in the Office of the Auditor General (OAG) VFM audit manual. The standards require that the audit be planned in a manner which ensures that an audit of high quality is carried out in an economic, efficient and effective way and in a timely manner. To achieve this, the audit followed the practical guide on Auditing Public Debt Management developed by the INTOSAI Development Initiative (IDI) in collaboration with INTOSAI Working Group on Public Debt (WGPD), International Monetary Fund (IMF) Revised Guidelines for Public Debt Management 1 st April 2014, World bank Debt Performance Assessment tool (DeMPA), Macroeconomic and Financial Management Institute of Eastern and Southern Africa (MEFMI) guidelines on Public debt Management and the Uganda Public Debt Management Framework (PDMF) 2013. 2.1 SAMPLING The study was conducted at the Ministry of Finance Planning and Economic Development headquarters and Bank of Uganda. In addition, thirty five out of 70 active loans were purposively selected based on the borrowing terms of the loans. The less concessional loans were selected first as they are apparently more costly to the economy then followed by a random selection of concessional loans. The loan files were reviewed to ascertain whether the approved loan acquisition process was followed and whether they were acquired at the least cost possible with a prudent degree of risk. Appendix I provides details of the sampled loans. 2.2 DATA COLLECTION The following data collection methods were used to gather evidence for the audit:- 2.2.1 Document review Various documents were reviewed to obtain an in-depth understanding of the legal and institutional framework for public debt acquisition as well as the current National Debt Portfolio. The documents reviewed included: The Constitution of the Republic of Uganda, 1995 as amended; the Treasury bills Act, 1969; the Bank of Uganda Act, 1993; the Budget Act 2001; the Public Finance and Accountability Act, 2003; the Public Debt Management Framework 2013; Uganda Debt Sustainability Report (FY 2011 2013); and Budget speeches. Other documents reviewed are shown in Appendix II. 8

2.2.2 Interviews The team conducted 13 interviews with officials of MoFPED, officers in Bank of Uganda, World bank, European Union and the African Development bank which are the key agencies involved in the Public debt acquisition process. Details of the interviews conducted are indicated in Appendix III. The information obtained from the interviews was used to triangulate/corroborate that obtained through document review. 2.3 DATA ANALYSIS Data collected was analysed to establish performance trends in public debt management over the period under review as well as to determine variations between standards set and actual implementations. The analysis was also intended to check compliance with the established Public debt management procedures, laws and regulations. The models used to carry out debt to GDP analysis; sustainability and appraisal of development projects were also assessed. 9

3 CHAPTER THREE V A L UE F O R M O N E Y AUDI T REPORT 10

CHAPTER THREE SYSTEMS AND PROCESS DESCRIPTION 3.1 ROLES AND RESPONSIBILITIES OF KEY PLAYERS MoFPED At the executive level, the public debt management function is constitutionally delegated to the Minister for Finance. The Minister is responsible for directing and organizing the entire public debt management system, including policy formulation, regulation and mobilization of resources as well as establishment of a legal framework to govern public debt functions. The MoFPED identifies the overall budget financing needs consistent with the fiscal and debt sustainability framework. A Debt Sustainability Analysis (DSA) is carried out annually by MoFPED as the lead institution, and the ministry advises on the overall debt management policy. The Ministry presents borrowing requirements to cabinet and to parliament for authorization or approval as may be necessary in accordance with the laws, regulations and policies in force. MoFPED also spearheads negotiation and re-negotiations of terms and conditions of public debt and, signing debt agreements. Bank of Uganda The Central Bank of Uganda provides advice on debt management in accordance with the Bank of Uganda Act, 1993. Within the debt acquisition process, the bank is charged with the responsibility of determining the type of domestic debt to issue, the asset mix, the calendar, the volumes to be issued and issuing of domestic debt in a given year. BoU also maintains an up-to-date database (DMFAS and CSD) of the country s indebtedness and assesses how Uganda s current level of debt and prospective new borrowing would affect the country s ability to service its debt. The Parliament The parliament is responsible for approving new loans that the government intends to acquire and approving the amount to be borrowed domestically in a given year, as provided for in Article 159 (2) of the constitutions of Uganda 1995 (as amended) 11

The Accountant General s Office The Debt Management Unit (DMU) in the Accountant General s Office, operates a Debt Management and Financial Analysis System (DMFAS) for recording and reporting domestic and external public debt. It maintains a debt amortization schedule that shows the opening balance, additions in the year, repayments and closing balance for each loan or credit. The Accountant General processes debt service payments, monitors and reports on loan disbursements and obtains details of all financial assets of government for the purpose of computing the country s net debt position. The Accountant General is also responsible for loan drawdown (signing of loan withdraw applications). Other Ministries, Departments and spending Agencies (MDAs) Ministries Departments and Agencies (MDAs), through their Sector Working Groups, identify projects to be funded and prepare project proposals which are submitted for consideration to MoFPED. The MDAs also participate in all consultations and negotiations of all loan agreements for projects and programmes under their jurisdiction, in close collaboration with the National Planning Authority. Solicitor General The Solicitor General provides legal support and advice throughout the loan acquisition process, including comments on the legality of a project, and provides support during Cabinet and Parliamentary approval in order to provide clarification on any matters. The Solicitor General also forms part of the negotiation team. Attorney General The Attorney General gives a legal opinion on the loan agreements after parliamentary approval and signing of the agreement. The legal opinion is a no objection on behalf of GoU to the terms of the signed agreement and it is against this opinion that the loan becomes effective. 12

CHAPTER THREE 3.2 PUBLIC DEBT ACQUISTION PROCESS 3.2.1 External debt acquisition process Figure 1a: External debt acquisition process The external debt acquisition process involves project identification where line ministries identify the project, discusses it in the sector working group and forwards it to the development committee for approval. After approval by the development committee the Aid Liaison department under the directorate of economic affairs prepares and solicits for funding. Project appraisal is done and negotiations between MoFPED and potentiation financers proceed, loan documentation is agreed upon and initiated, sent to cabinet and parliament for approval before eventual loan signing is done. 13

3.2.2 Domestic debt acquisition process Figure 1b: Domestic debt acquisition process The key players in the domestic debt acquisition process are MoFPED and BoU. The process starts with determination of the borrowing needs by MoFPED followed by discussions between the players, that is, MoFPED/BoU to agree on the timing and amounts to be borrowed domestically. 14

4 CHAPTER FOUR V A L UE F O R M O N E Y A U DIT REPORT 15

CHAPTER FOUR FINDINGS, CONCLUSIONS AND RECOMMENDATIONS The audit noted that there have been concerted efforts by the Ministry of Finance, Planning and Economic Development to address gaps in the Legal framework for management of public debt. This has been achieved through the crafting and eventual approval of the Public Finance Management Act, 2015. The Ministry is also undertaking organizational re-structuring and Public Financial management reforms in a bid to improve efficiency in budget management as well as plug gaps in the institutional/organizational arrangements for public debt management. Measures to introduce a Treasury Single Account (TSA) for central government accounts were launched in October 2013. This involved the closure of over 400 government accounts and an automatic arrangement whereby end-of-day balances of unspent cash are swept back into the Consolidated Fund. The Directorate of Cash and Debt Management was also created in 2014 to better coordinate the forecasting of debt needs with its issuance, with a recruitment exercise announced in November 2014 for a Debt Issuance Expert and a Cash Management Expert. The creation of the new Directorate of Debt and Cash management should help to improve financial management further by allowing the issuance of securities for cash management to be more responsive to short-term cash flow needs. The ministry is also commended for its efforts to undertake annual Debt Sustainability Analyses (DSA) in order to check and ensure that the country s debt levels remain sustainable. Despite these achievements, audit noted some areas that need improvement and these are presented as follows: 4.1 SUSTAINABILITY OF THE PUBLIC DEBT PORTFOLIO 4.1.1 Status of Uganda s Public Debt Portfolio A core objective of the Ugandan public debt policy is to ensure that the level of public debt remains sustainable, both in the medium and long term. To ensure this outcome, the Public Debt Management Framework (2013) prescribes limits for the ratio of Uganda s debt stock and debt service to various macroeconomic country indicators (e.g. domestic budget revenue). The intention is that these limits guide the contracting and management of government debt while maintaining a high degree of debt sustainability. These limits are largely guided by IMF and World Bank Country Policy and Institutional Assessment (CPIA) country scores, which use empirical analysis to relate country-specific factors (e.g. debt burden, quality of institutions) to the probability of debt distress. 4 Table 2 sets out the relationship between CPIA score and the recommended policy thresholds. 4 IMF, IDA, Debt- Sustainability in Low-Income Countries Proposal for an Operational Framework and Policy Implications,2004 16

a) IMF and World Bank sustainability thresholds For the latest review in 2014, Uganda s three-year average CPIA score moved below the threshold for strong performer status 3.75 to 3.73. Despite this, the IMF ruled that its classification would remain as a strong performer, due to remaining within 0.05 of the threshold. It stated, however, that another year with a score below the threshold could see the country downgraded 5 Despite its current designation as a strong performer, MoFPED has chosen to adhere to thresholds that are in some respects stricter than the IMF-World Bank guidance (e.g. the debt/exports threshold), but in other respects more lax (debt service to revenues). Table 2: IMF and Ugandan Debt Sustainability Thresholds 6 7 Strong performer (CPIA >3.75) Medium Performer (3.25<CPIA<3.75) PDMF (2013) Thresholds Exports 200 150 150 PV of debt in per cent of Debt service in per cent of GDP 50 40 50 Revenue 300 250 300 Exports 25 20 25 Revenues 22 20 35 Management Response Country Policy and Institution Assessment (CPIA) frame work ratings of Uganda are buoyed by the good Economic Management rating of 4.2(including debt policy of 4.5) while hampered by the fair rating of Public Sector Management and Institutions (3.0). As a country, we note that improvements in other indicators will enable keep us in the strong performers status. Audit Comment The uncertainty around Uganda s borderline status as a Strong performer because of a drop in its CPIA score is a cause for concern. A downgrade to Medium performer could increase external perceptions that the country is at risk of debt distress, increasing the government s cost of borrowing. 5 MF, Uganda: Third Review Under the Policy Support Instrument, Country Report no. 14/344, December 2014 6 Factsheet: The Joint World Bank IMF Debt Sustainability Framework for Low-Income Countries, http://www.imf.org/ external/np/exr/facts/jdsf.htm, Accessed 28.02.15 7 Republic of Uganda, Public Debt Management Framework, 2013 17

Recommendation The Ministry should come up with mechanisms to improve the CPIA scores and therefore sustain a Strong performer status by improving overall performance of the indicators. Noted areas such as Public Sector Management and Institutions criteria in which performance is still low need improvement. b) Uganda Debt sustainability metrics The most recently published data on Ugandan debt sustainability metrics for domestic and external debt levels indicates that the external indebtedness of Uganda does not present any immediate cause for concern, with large amounts of headroom relative to the sustainability thresholds set out in the PDFMF (Table 3). Nonetheless, for domestic indebtedness, there was limited headroom between the debt stocks recorded in 2013 and the recommended thresholds, as set out in the PDMF. Furthermore, the ratio of domestic debt to private sector credit (a key indicator of the risk of government competing with private sector credit) was very close to the maximum recommended level. MoFPED have not published more recent data on domestic credit metrics than June 2013, making it difficult to assess to what extent progress has been made against these indicators. Table 3: Ugandan metrics of debt sustainability Metric PDMF Criterion Status 8 9 Domestic External Present value of domestic debt stock / GDP <20% Domestic interest cost / Domestic revenue <15% Domestic interest cost / Total Government Expenditure <10% Domestic debt stock / Private Sector Credit <75% Sovereign credit rating B+ (S&P) B (Fitch) 10 Present value of external debt to GDP <30% Present value of external debt to exports of goods and services Present Value of External Debt to Domestic Budget Revenue (PV/DBR) Total External Debt Service to Export of Goods and Service (TDS/XGS) Total External Debt Service to Domestic Budget Revenue (TDS/XGS) <150% <300% <25% <35% 12.2% (June 2013) 12.1% (June 2013) 8.5% (June 2013) 74.6% (June 2013) B+ (Fitch) (Feb 2015) 9.4% (Dec 2014) 43.4% (Dec 2014) 72.1% (Dec 2014) 2.7% (Dec 2014) 4.5% (Dec 2014) 8 June 2013 figures are from the Public Debt Management Framework, MoFPED 2013, 9 Dec 2014 figures are from IMF, Uganda: Third Review Under the Policy Support Instrument, Country Report no 14/344, December 2014 10 Credit ratings to be maintained or exceeded 18

Management Response Domestic debt ratios are just within the Public Debt Management Framework 2013 (PDM2013) criteria. It is important to note that the ratios were far beyond the set criteria over 10 years ago. A case in point, prior to the PDM2013, the ratio of Domestic debt/private sector credit had reached 130% by 2005 necessitating setting the ratio to less than 100% under the 2007-Debt Strategy. 2001 2002 2003 2004 2005 2006 Domestic Debt/PSC 86% 110% 117% 118% 130% 130% The current set criteria of 75% under the PDM2013 came as a result of aiming to reduce the ratio further. Audit Comment Audit appreciates government s efforts to create more ambitious thresholds of 75% (compared to the previous targets of 100%) especially with the current high YTM for domestic debt, where lenders may be more inclined to lend to government than the private sector. It is thus important that the Ministry sets realistic targets, which they can enforce, in line with comparable countries and prevailing economic conditions. Reporting of the full spectrum of debt metrics is not sufficiently frequent to be able to provide sufficient assurance on the level, and evolution of, the domestic debt. In particular, recent evidence is not available on whether domestic debt is within levels which risk driving up private sector debt costs, which could hamper GDP growth. c) Risk Management Further analysis shows that the composition as well as the absolute quantity of publicly guaranteed debt can present risks which can threaten sustainability. There are two particular risks which are relevant and affect the Ugandan debt portfolio: Exchange rate risk: Debt denominated in foreign currencies can give rise to large and an unanticipated liability where the home currency depreciates. Over the course of 2010, for instance, the Ugandan Shilling depreciated 20 per cent against the US Dollar, implying a similar increase in the government s dollar-denominated liabilities, when measured in Shillings. Refinancing risk: Too much debt falling due for refinancing within a short period of time risks the bond market charging a premium due to the higher demand for debt, thereby increasing average debt service costs. Exchange rate risk is entirely confined to the external part of the Ugandan debt portfolio, as there is no foreign-currency domestic debt. Outstanding external debt (including arrears) stood at USD 4.3bn on December 2014, or around 20 per cent of Ugandan GDP. This accounts for around 58% of the total of publicly guaranteed debt (32.5 per cent of GDP). Figure 2 sets out a breakdown of this debt into its different currency denominations: 19

Figure 2: Composition of Uganda s externally Owed debt (USD, bn) *SDR= Special Drawing Rights (Claims on IMF member country reserve assets) Source: World Bank Data The external debt is almost entirely fixed rate, and characterised by loans which have long maturity and grace periods (an average time to maturity 12.6 years). This limits the impact of adverse exchange rate movements in the near future, and means that inflation will play a part in eroding the real value of the principal of these loans offsetting some of the eventual impact of adverse exchange rate movements. 20

In the discussions on the issuance of dollar-denominated domestic debt in the near future, the BOU advised against such borrowing especially where absorptive capacity was still low as this would un-necessarily increase the cost of external debt. Similar difficulties were cited for Ghana, and it was highlighted that the debt-service costs on the dollardenominated debt rose sharply after the Cedi fell 35 per cent against the dollar in a year. 11 The PDMF 2013 assesses refinancing risks against its own set of control thresholds. In June 2013, performance against these thresholds indicated material refinancing risks due to the high proportion of debt maturing within 1 year (Table 4). Table 4: Risk management metrics for the Ugandan debt portfolio 12 Risk management benchmarks Criterion Status (2013) Percent of debt maturing in 1 year <40% 57.2% Percent maturing after 1 year <20% 17% Ratio of bonds to bills 70:30 62:38 Average time to refinancing >3 years 1.8 years Average time to maturity >3 years 1.8 years Risk management The government has since made progress in reducing its exposure to refinancing risk however notably by introducing longer maturity (15 year) bonds in 2013. In December 2014, about 47 per cent of the total 9,267bn UGX of domestic debt was due for refinancing within 1 year 13 (by December 2015). Details as in Figure 3 below Figure 3: Maturity of Domestic Debt Portfolio Source: BOU as at Feb 2015 Figure 3 shows the highly front-loaded maturity profile of the domestic debt portfolio. The average number of years to maturity of domestic loans is relatively low at 2.5 years (below the recommended 3 yrs), which increases the risk that unfavourable financing conditions may result in an inability to satisfy the government s requirement for refinancing and raising the new finance it needs. 11 H. Abdalla, Uganda rules out use of risky Eurobonds, The East African, 30/08/2014 12 MoFPED, Public Debt Management Framework, June 2013, 13 OAG analysis of BOU Data 31/12/2014 21

Management Response MoFPED intends to take further actions, such as: start budgeting for Principal maturities in order to reduce rollover risk, take greater involvement with primary dealers and other stakeholders in the financial market such as NSSF as well as facilitating counter trading of securities in Uganda Securities Exchange with a target of reducing the Yield to Maturity (YTM). Audit Comment The involvement with the primary dealers and other stakeholders in the financial market is welcome strategy albeit the specific activities and extent of involvement need to be articulated. Recommendation In addition to stakeholder engagement, MoFPED should also consider issuing longer term dated securities to even out the maturity profile and reduce the risk for refinancing. d) Domestic Arrears Domestic Arrears are payables to Government suppliers, employees and service providers which have remained outstanding at the end of every financial year. These arrears imply that government departments delay payments for goods supplied, services rendered and pension liabilities. These are implicit claims on government (borrowings) which have to be honoured at some unspecified future date. From a review of government (Treasury) financial statements it was noted that government had accumulated arrears worth UGX 583,585,553,455 as at 30th June 2014. Details in Table 5 below: Table 5: Domestic Arrears for 2010/11-13/14 Details 2010/11 2011/12 2012/13 2013/14 Domestic arrears (UGX Bn) 473.65 763.19 1,127.24 583.59 *Source: Treasury Statements of Financial position (2010/11-2013/14) Although these arrears are not normally included in the Public debt stock figures, they represent a future liability to government. Further analysis shows that the composition of these arrears includes a big proportion of these debts arising from court awards which attract interest until fully paid. This increases both the refinancing and interest rate riskiness of the debt. 22

Management Response Domestic arrears are normally excluded from public debt but only disclosed as memorandum item as the process for contracting arrears is unique and outside the legal framework for acquiring debt. The scope of public debt also tends to exclude arrears as a best practice especially as it is an area that is prone to abuse. The Debt strategy stipulates measures for reduction and eventual elimination of arrears that is, 1 st call on next FY Resources, IFMS implementation, and prepayment of utilities etcetera. In addition, the PDMF 2013 has provided guidelines to reduce the incurring of domestic arrears that include publishing a shame list for accounting officers who commit government without authority and punitive measures. Audit Comment Although Domestic arrears are normally excluded from public debt, they are legally binding and still have to be paid off, with likely consequences if not paid. Their constant variations year by year is also a cause of concern which if not contained can cause significant challenges to government budgets. Moreover, this is an area that still contributes to the Country s low performance under the CPIA assessments. Although government has undertaken reforms, including introduction of Commitment control system, this area is still a challenge. Recommendation There is need for the MOFPED, in liaison with MDA Accounting Officers, to come up with a strategy or framework within which liabilities such as domestic arrears can be verified, authenticated, reported and paid off to avoid accumulation and future strain on government budgets. e) Debt sustainability projections and stress-testing The IMF s December 2014 sustainability assessment of Ugandan debt used the joint World Bank IMF Debt Sustainability Framework for Low Income Countries 14. The exercise used a model calibrated with macroeconomic assumptions to project debt sustainability ratios 20 years ahead. The base case broadly assumes a continuation of the existing debt issuance environment (deepening of domestic debt markets, continued availability of non-concessional loans with a grant element of 15-20 per cent), average medium-term real GDP growth of 6.5% per annum, and a long-term average fiscal deficit of 2.75 per cent of GDP. The analysis features sensitivity analysis of key input variables meant to represent unpredictable adverse shocks which the economy may experience. These include (assuming a base year of 2015): A1. Real GDP growth and primary balance restricted to historical averages A2. Primary balance remains unchanged from 2015 A3. Permanently lower GDP growth B1. New public sector loans on less favorable terms in 2015-35 14 IMF, Uganda: Third Review Under the Policy Support Instrument, Country Report no 14/344, December 2014 23