Uganda: Balancing Flexibility and Credibility of Fiscal Rules during the COVID-19 Pandemic

This article was originally published by EPRC. 

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 % 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 enable 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.

A fiscal rule is flexible if the government can deviate from it during large economic shocks. Uganda’s fiscal deficit rule is flexible because the government can temporarily deviate from it to respond to economic shocks such as COVID-19. This deviation is also supported by the Protocol on the Establishment of the East African Monetary Union requiring the East African Community countries to temporarily deviate from one of the fiscal rules, but not both, in case they experience large economic shocks. Deviating from the rule will involve running deficits that exceed the pre-announced limit to contain the pandemic, stabilise the economy and ensure economic recovery. 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 (such as meeting the fiscal deficit target by 2024/25). 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. To illustrate this, if the public or the market or lenders believe that the government will comply with the fiscal rule by undertaking fiscal adjustments as planned, they will not hesitate to invest in the economy and to continue lending to the government during any domestic revenue shortfalls.

However, credibility is not intrinsic in Uganda’s fiscal system – it is an outcome of a track record of successfully enforcing past policy pronouncements. The current pandemic has freed the government from the test of fiscal credibility, in principle, because meeting the fiscal deficit rule has been postponed from 2020/21 to 2024/25. Nonetheless, fiscal projections in the Budget for 2019/20 indicated that this rule would be violated with or without COVID-19.

Whereas the fiscal deficit rule was postponed because of COVID-19, severe risks to Uganda’s fragile but important 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 new administrative units and political positions. These developments could make it hard to implement the pronounced policy by the MoFPED. This contradiction of purposes could strain credibility in managing the rapidly growing fiscal deficit and the commitments to fiscal rules. Therefore, today and in the years ahead, safeguarding fiscal rules credibility will be more contingent on internal factors than external shocks.

To balance between flexibility and credibility of the fiscal rules, the following measures should be undertaken. First, the government must ensure that the recently announced deviation from the deficit rule is temporary. Second, strengthen transparency by continually updating the public on the size of the deviation and planned adjustment measures to bring the deficit back on track. Third, policies directed toward mitigating the health crisis and promoting economic recovery should be closely linked to measures for reducing the deficit. Fourth, the public and political authorities should support increasingly hard decisions like cuts in expenditures to reduce the deficit. Fifth, forecasts on the anticipated economic recovery/growth should be more realistic and should recognise the increasing fiscal risks. Lastly, efforts to improve budget planning, execution, accounting and reporting practices will help ensure enforcement and compliance with the fiscal rules.

In conclusion, the market, 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 current fiscal actions, accommodated by the flexibility of the deficit rule, to address short-run economic fluctuations should not jeopardise the government’s commitment to sound fiscal and debt policies. Therefore, these actions should support fiscal and debt sustainability. Fiscal rule credibility will be tested as Uganda plans to carry out reforms (fiscal adjustments) in its fiscal system and steps back from increasing deficits further.