The UK government has cancelled £5m ($10m) of funding to Uganda, because it feels not enough has been done to establish fair multi-party politics.
Museveni has been seen as part of the new generation of democratic leaders in Africa
About half of Uganda's entire budget comes from donor funding.
Political parties have for years been severely restricted and some opposition groups have urged donors to cut aid.
Multi-party elections are expected to return next year, but some say the government is not doing enough to ensure a smooth transition.
Although the British have handed over almost 90% of the proposed funding for the year, the BBC's Will Ross in Kampala says this action is intended to send out a message: "The British government will work with you and support you but only if the political process is fair."
Since President Yoweri Museveni came to power 18 years ago, Uganda has operated a unique political system which severely restricted political parties but the political landscape is set to change.
The political temperature has been rising in recent months
The Ugandan government and opposition parties have said they all support a return to multi-party politics ahead of elections in a year's time.
The political temperature in Uganda has been increasing in recent months - partly because of attempts to amend the constitution and allow President Museveni to run for office again.
As the British-led Commission for Africa is calling for more aid to the continent, other donor countries share the British concern over the current political transition in Uganda.
At the launch of the commission, rock star turned anti-poverty campaigner Sir Bob Geldof said that his admiration for Mr Museveni's fight against poverty and Aids had now been lost due to the moves to let Uganda's leader remain in office.
"Get a grip Museveni. Your time is up, go away," he said.
This cut in funding is a reminder that Uganda stands to lose a great deal more if donor countries are not seeing good governance and a level playing field ahead of next year's elections, our correspondent says.