Decentralization Strategy

Local Government Organization and Finance: Uganda 117

Conditional recurrent grants The expansion ofthe conditional grant system should be seen in connection with the Heavily Indebted PoorCountries (HIPC) Initiative and the establishment ofthe Poverty Action Fund (PAF) (box 3.1)

The large number ofconditional grants has ensured funding for crucial service and infrastructure but has also created a number ofchallenges.Each grant has its own budget lines (restrictions on use),transfer modalities,and guidelines and reporting system,creating limited autonomy,flexibility,and efficiency in use—coupled with significant transaction costs for local governments in adhering to the complex modalities.This situation undermines the decentralization objectives and compromises the efficiency gains.12

BOX 3.1 The Poverty Action Fund, the Heavily Indebted Poor Countries Initiative, and the Fiscal Decentralization Strategy

One ofthe vehicles for the large increase in transfers was the Poverty Action Fund (PAF), which was established in 1998. This fund was a mechanism to demonstrate and ensure that resources from debt relieffrom the Heavily Indebted Poor Countries Initiative (Uganda was granted debt reliefin 1998) and additional donor funds were channeled to the key priority sector areas in the Medium-Term Expenditure Framework. Already in FY 2000/01, the PAF accounted for 30 percent ofthe total government budget, ofwhich 73 percent was transferred to the districts (Donor Sub-Group on Decentralisation 2001)— a share that has been fairly stable in recent years. The PAF system has had a very important effect on the entire system oflocal government finance. Through a detailed system ofconditional grants, it has earmarked the transfers to specific sectors and subsectors, aiming at providing the government and donors with confidence in local government adherence to the overall Poverty Eradication Action Plan. PAF funds have increased significantly, from U Sh 98 billion in 1998/99 to U Sh 692 billion in 2002/03 (Donor Sub-Group onDecentralisation 2001; MoFPED 2003a).

The large increase in transfers was not without problems, especially when coupled with numerous modalities for transferring funds, depending on the sector area and the donor agency. In the late 1990s, there was an increasing awareness ofthe problems these strictly earmarked funds created for local government efficiency in managing service provision—in terms oflack ofautonomy to address local priorities; large administrative transaction costs (multiple budgeting, accounting, and reporting systems); the tendency to focus on upward instead ofdownward accountability; and so forth. The fiscal decentralization strategy (FDS), developed by the government and approved by the cabinet in June 2002, was designed to address these challenges (box 3.2).

Source: Steffensen and Tidemand 2004.