Summary: KEY ISSUES Growth has continued to recover from the 2011/12 low. In an environment of declining inflation—recently halted by a drought-driven food price shock—the fiscal stimulus has been successful in driving economic activity, and a planned program of infrastructure investment is expected to boost growth further. Monetary policy was appropriately tightened to abate the impact of the price shock on core inflation. Consolidating its credibility as an inflation-targeting central bank, the Bank of Uganda (BoU) raised the policy rate in reaction to the shock, and subsequently signaled a neutral monetary stance until the updated inflation forecast adjusts to the 5 percent medium-term target. Exchange rate flexibility continued to support the regime. Construction of two large hydropower projects is expected to address Uganda’s electricity deficit. The economy would absorb these investments with limited impact on inflation and the exchange rate. Nonetheless, efficiency and transparency in managing the projects are crucial to mitigating potential fiscal risks. The external accounts remain sustainable. The current account deficit declined mainly owing to a temporary slowdown of foreign direct investment (FDI)-related imports. International reserves would remain at a comfortable level despite the high import component of the hydropower projects. External debt will remain at low risk of distress notwithstanding the non-concessional borrowing (NCB) requirements to finance the projects. The fiscal stance has remained broadly consistent with the program, but spending pressures need to be resisted. With output closer to potential and the recent inflation pickup, expenditure needs to adhere to the budget. Although there is space for raising the domestic debt-to-GDP ratio somewhat this year, it needs to start declining thereafter because domestic debt service accounts for a large share of government revenue. With satisfactory program performance, staff supports completing the first PSI review and increasing the ceiling on NCB. Quantitative assessment criteria (QAC) were met and structural benchmarks partially observed. Operation of a treasury single account started, public accounting systems were improved, and the central bank was recapitalized. Progress on increasing tax revenues and reducing arrears, however, are key remaining challenges.

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