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October 08, 2020

Balancing Uganda’s Fiscal Rules during the COVID-19 Pandemic

Covid
Posted by Enock Bulime and Ezra F. Munyambonera[1]

A previous PFM blog suggested that Uganda’s existing fiscal rules might need modification to make them better guides to fiscal policy. In the present article, we explain how the government might better balance the flexibility and credibility of the fiscal rules during the COVID-19 pandemic.

Globally, the pandemic and the associated containment measures are increasing fiscal pressures. Many governments are activating escape clauses in their Fiscal Responsibility Laws and Charters to deviate from pre-announced fiscal rules. These rules comprise numerical limits on budgetary aggregates that aim to reduce the tendency for governments to run perpetual budget deficits.

In Uganda, the Ministry of Finance, Planning and Economic Development (MoFPED) has indicated that the government will deviate from its fiscal deficit rule. In response to the economic downturn and health challenges posed by the pandemic, the objective of reducing the fiscal deficit (including grants) to 3 percent of GDP has been postponed from 2020/21 to 2024/25.

During this period, fiscal rules are expected to support flexibility and safeguard credibility. Balancing the flexibility and credibility of the rules enables the government to respond effectively to economic shocks while ensuring that necessary steps are taken to comply with the rules. It is also crucial because greater flexibility may make it difficult to enforce rules and to anchor expectations about fiscal and debt sustainability.

Uganda’s fiscal deficit rule is flexible because the government can temporarily deviate from it to respond to economic shocks such as COVID-19. Postponing enforcement of the rule influences private sector and market perceptions about the government’s credibility in honouring its commitment. However, the current deviation from the deficit rule should not be interpreted as a signal of weak fiscal credibility.

The government is credible if the markets and the public at large believe that it will undertake its announced economic and fiscal policies. Therefore, fiscal rules are credible if they are viewed as enforceable and binding. Credibility is crucial because it determines the government’s ability to influence expectations about fiscal and public debt sustainability and its ability to borrow.  However, credibility is not intrinsic to Uganda’s fiscal system – it is an outcome of a long track record of successfully enforcing past policy pronouncements.

Whereas the fiscal deficit rule was postponed because of COVID-19, risks to Uganda’s fiscal stability and credibility are increasing because of the fiscal costs associated with the political winds of change, corruption, declining social norms and the creation of more political positions within government. These developments could make it harder for the government to implement its announced policies for economic development and growth. The government’s credibility in managing the rapidly growing fiscal deficit and its commitment to fiscal rules could also be strained.

Looking ahead, safeguarding the credibility of Uganda’s fiscal rules will be more contingent on internal factors than on external shocks. Therefore, the government must ensure that the recently announced deviation from the deficit rule is temporary and that the public is continually updated on the size of the deviation and planned measures to bring the deficit back on track. Policies directed toward mitigating the health crisis and promoting economic recovery should be closely linked to measures for reducing the deficit. These policies may require hard decisions to cut spending where the government will need the support of the public. Lastly, efforts to improve budget planning, execution, accounting and reporting practices will help ensure enforcement and compliance with the fiscal rules.

In conclusion, the markets, the public and policymakers need to be confident that the government’s announced fiscal policy will be sustained during the next four years and that the fiscal deficit will eventually return to its target or announced path. The fiscal actions, accommodated by rule flexibility, to address short-run economic fluctuations should not jeopardise the commitment to sound fiscal and debt policies. They should support fiscal and debt sustainability. As Uganda makes the fiscal adjustments that are required to prevent deficits increasing further, by increasing revenues and cutting some expenditures, the credibility of the fiscal rules will be tested.

This article is part of a series related to the Coronavirus Crisis. All of our articles covering the topic can be found on our PFM Blog Coronavirus Articles page.

 

[1] Economic Policy Research Centre, Makerere University, Uganda.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

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