Front Matter

Author(s):
Shanaka Peiris, and Jean Clément
Published Date:
May 2008
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    © 2008 International Monetary Fund

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    Agency/Marco Moretti; primary school of Nhanpfuine, Eric Miller;

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    Cataloging-in-Publication Data

    Post-stabilization economics in Sub-Saharan Africa : lessons from Mozambique / edited by Jean A.P. Clément and Shanaka J. Peiris — [Washington, D.C.] : International Monetary Fund, 2007.

    • p. cm.

    • ISBN 978-1-58906-677-9

    • Includes bibliographical references.

    1. Mozambique — Economic conditions — 1975– 2. Mozambique — Economic policy. 3. Economic assistance - Mozambique. 4. Postwar reconstruction — Mozambique. 5. Poverty — Mozambique. I. Clément, Jean A. P. II. Peiris, Shanaka J. (Shanaka Jayanath), 1975– III. International Monetary Fund.

    HC890.P678 2007

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    Contents

    The following conventions are used in this publication:

    • In tables, a blank cell indicates “not applicable”; n.a. indicates “not available”; and 0 or 0.0 indicates “zero” or “negligible.” Minor discrepancies between sums of constituent figures and totals are due to rounding.

    • An en dash (–) between years or months (for example, 2005–06 or January–June) indicates the years or months covered, including the beginning and ending years or months; a slash or virgule (/) between years or months (for example, 2005/06) indicates a fiscal or financial year.

    As used in this publication, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.

    Foreword

    Mozambique, one of Africa’s most remarkable success stories, has benefited from sustained aid inflows, strong and broad-based growth, and deep poverty reduction. It has grown 8 percent annually, on average, since the early 1990s and sharply reduced its poverty headcount, thanks to prudent macroeconomic policies and the implementation of two successive and well-sequenced waves of reforms. Substantial progress has also been made in the country’s social sectors, including a doubling of the number of children in primary school, reduction in infant and maternal mortality, and the provision of antiretroviral treatment for HIV infection; these achievements have been financed, in part, by resources made available under the joint IMF and World Bank Highly Indebted Poor Countries (HIPC) Initiative. Endowed with abundant natural resources, Mozambique has been able to put itself on the global foreign direct investment map, attracting megaprojects worth several billion dollars. To sustain a high rate of growth and poverty reduction, it is implementing a second wave of reforms under its new Poverty Reduction Strategy (2006–09). It is also determined to avoid the natural resource curse that has plagued much of Africa in order to continue to reduce poverty.

    Mozambique is well placed to achieve the United Nations Millennium Development Goal (MDG) of halving poverty by 2015. Achieving the non-income-related MDGs, however, will require Mozambique to scale up basic services. In this context, Mozambique graduated from a reform program supported by concessional financing under the IMF’s Poverty Reduction and Growth Facility to one monitored, but not financed, by the IMF under a three-year Policy Support Instrument. The new program is flexibly designed to use scaled-up foreign aid to enable the country to sustain rapid, pro-poor growth and achieve the MDGs while maintaining macroeconomic stability. It is also better adapted to Mozambique’s status as a post-stabilization economy that has demonstrated ownership of its economic program.

    As the book notes, the collaboration between international partners and Mozambique’s government can serve as a model for other countries. In addition, the authorities are determined to focus on growth-critical reforms to strengthen fiscal and financial institutions, improve the business environment, and promote transparent management of natural resources. The continuation of a stable political environment through the buttressing of this young democracy is also key to Mozambique’s continued success.

    The book provides technical and policy analysis from which readers may obtain insights into some of the key macroeconomic issues facing low-income countries in a post-stabilization phase. These issues are at the center of the IMF staff’s work on low-income countries. They include, most notably, managing the scaling up of foreign aid, choosing the appropriate macroeconomic policy mix, undertaking financial and public finance reforms, collaborating with donors, getting on the path toward long-term sustainability and access to international capital markets, creating a virtuous cycle of natural resource use, reducing the cost of doing business, and improving competitiveness. In all these aspects, the chapters offer brief summaries of the most recent literature and draw lessons from Mozambique’s experience for sub-Saharan Africa that should make the book particularly valuable to policymakers, academicians, donors, and civil society.

    The book brings together material and analysis prepared by the IMF team working on Mozambique under the supervision of Jean A.P. Clément, Assistant Director in the IMF’s African Department, and includes insightful articles from colleagues in the World Bank on poverty reduction, and from Mozambique’s Ministry of Planning and Development on the sustainability of long-term growth. The team of authors was led by Jean A.P. Clément and included Rui Benfica (World Bank), Emmy Bosten, Felix Fischer, Louise Fox (World Bank), Julien Hartley, Sam Jones (formerly with the Ministry of Planning and Development of Mozambique), Victor Lledó, James Otto (Professor at the University of Denver Sturm College of Law), Shanaka J. Peiris (coeditor of the book), Magnus Saxegaard, and Melissa Sekkel (World Bank).

    Benedicte Vibe Christensen

    Acting Director

    IMF African Department

    Acknowledgments

    The authors acknowledge the valuable support, input, and comments provided by a number of colleagues at the International Monetary Fund (IMF) and, in particular, its African Department. The authors are grateful to Asimina Caminis, for her skillful editing of the book and coordination of its production, and to Paul Gleason of the IMF’s External Relations Department. They are also grateful to Messrs. Peter Gakunu and Jose Sulemane (IMF, Office of the Executive Director for Africa Constituency I) for their wise advice and to the staff of the IMF Resident Representative’s Office in Maputo, in particular Massiquina Calu. They would also like to thank Eteri Kvintradze and Nienke Oomes. Larissa Leony provided research assistance. The IMF team working on Mozambique has enjoyed the support and close collaboration of colleagues from the World Bank, including, in particular, Michael Baxter, Rui Benfica, Greg Binkert, Louise Fox, Peter Moll, Peter Nicholas, and António Nucifora. The team has also enjoyed close collaboration with the representatives of the international community, and an exchange of views with the representatives of civil society.

    This book would not have been possible without the fruitful and open discussions with the Mozambican authorities. In particular, we are indebted to Her Excellency, the Prime Minister of Mozambique, Ms. Luísa Dias Diogo; the Minister of Finance, Mr. Manuel Chang; the Minister of Planning and Development, Mr. Aiuba Cuereneia; the Minister of Education and Culture, Mr. Aires Bonifácio Aly; the Minister of Health, Mr. Paulo Ivo Garrido; the Minister of Industry and Commerce, Mr. António Fernando; the Minister of Labor, Ms. Helena Taipo; the Minister of Energy, Mr. Salvador Namburete, the Minister of Mineral Resources, Ms. Esperança Bias; the Minister of Public Administration, Ms. Vitoria Diogo; and the Governor of the Central Bank of Mozambique, Mr. Ernesto Gouveia Gove. We would also like to thank the staff of the Ministry of Finance, in particular the Director of the Treasury, Mr. António Laíce, and the staff of the Central Bank, in particular Mr. Waldemar de Sousa and Mr. António de Abreu. The Mozambican team would like to extend its warmest thanks to the Mozambican authorities for their hospitality and openness in discussing the many challenges facing their beautiful country.

    The opinions expressed herein, as well as any errors, are the sole responsibility of the authors and do not necessarily reflect the views of the Mozambican authorities, the Executive Directors of the IMF, or other members of the IMF staff.

    Introduction and Overview

    Jean A.P. Clément

    Mozambique, a post-conflict coastal country (see map) endowed with vast natural resources, is one of the few economic success stories in sub-Saharan Africa. It has staged a dramatic recovery from the ravages of civil war and, with the help of large and sustained aid inflows, achieved impressive and broad-based economic growth that is increasingly resilient to natural disasters, and deep and equitable poverty reduction. It now has one of the lowest levels of inequality in Africa, and the country’s poverty levels declined more in rural areas, where the majority of the population lives, than in urban areas, making it only the second country in the world (after Vietnam) to see such a reduction. Nonetheless, despite Mozambique’s admirable performance, absolute poverty is still more prevalent in rural areas than in urban ones, and its per capita income and human development indicators remain relatively low.

    Mozambique’s remarkable achievement was made possible by sound and sustained macroeconomic management, substantial official development assistance, and the launching of two successive waves of reforms tailored to the country’s particular circumstances. The role of donors, including the International Monetary Fund (IMF) and the World Bank, was instrumental in promoting aid effectiveness through well-coordinated efforts. Such coordination has evolved into an institutional setup that is often praised internationally as a best practice. On the political side, Mozambique was able to successfully bring about reconciliation, and it solidified its nascent democracy through elections that were seen as generally open and fair by the international community.

    Mozambique is one of the few sub-Saharan African countries that appears well placed to achieve the key United Nations Millennium Development Goal (MDG) of halving the poverty rate by 2015. Now that the post-stabilization rebound has largely run its course, however, the steady implementation of the second generation of reforms will be key to sustaining Mozambique’s growth takeoff by addressing the large gaps in human capital and infrastructure and enhancing total factor productivity, particularly in agriculture. The achievement of non-income-related MDGs such as universal primary education, gender equality, the reversal of the incidence of malaria and HIV/AIDS, and access to safe drinking water requires that Mozambique scale up basic services without undermining macroeconomic stability. Consolidating democracy by strengthening transparency and governance, and implementing a truly participatory process at all levels of government, political life, and society will be essential steps in consolidating the country’s gains.

    This book analyzes the lessons for sub-Saharan Africa from the experience of Mozambique. It focuses on post-stabilization economics, including the need to choose the appropriate macroeconomic policy mix in the face of scaled-up foreign aid and a surge in revenues from natural resources. The book also discusses possible ways to respond to the challenges ahead, including how to get on the path to long-term sustainability and access to international capital markets while further reducing poverty. The lessons and challenges described in the book are likely to be of interest to policymakers, academicians, civil society, and the general public in sub-Saharan Africa and low-income countries elsewhere. Most of the chapters offer summaries of the recent literature on their respective topics.

    Halving the Poverty Rate by 2015

    Chapter 1 presents a brief overview of Mozambique’s growth takeoff since the end of the civil war, which has been compared with the initial takeoffs of fast-growing Asian economies including Indonesia, Malaysia, the Philippines, and Thailand—the members of the Association of Southeast Asian Nations referred to in this book as the ASEAN-4—and China, India, and Vietnam. In addition to identifying the challenges ahead, which is likely to be relevant to many sub-Saharan African countries that are in the midst of growth acceleration, the chapter draws lessons from the experience of Mozambique for the rest of sub-Saharan Africa and the international community.

    Chapter 2 describes Mozambique’s remarkable success in reducing poverty over the past decade; the country’s poverty headcount declined 25 percent between 1996 and 2002. At the micro level, average earnings per worker on smallholder farms increased by about 4 percent per year, which accounted for three-fourths of the decline in the poverty headcount. Meanwhile, growth in the higher-productivity industry and service sectors attracted workers away from the low-productivity agriculture sector. These advances were achieved through a combination of crop diversification and more extensive land use, which increased crop incomes (including from crops grown for household subsistence), and diversification into nonfarm enterprises, such as manufacturing firms based on natural resources (for example, charcoal) or agricultural products, and services. Private investment in agriculture increased demand for wage labor, which supplemented smallholder incomes. Donor-financed government spending helped bring public services closer to the population, and school enrollment rates shot up. Rural households with better market access (thanks to new or better maintained roads and other infrastructure) had a higher rate of diversification and larger incomes from nonfarm enterprises. Chapter 2 offers key lessons for other sub-Saharan African countries. First, it is important to create an enabling investment climate for private investment in smallholder agriculture that includes building market infrastructure, improving access to land, and encouraging contract grower schemes that bring new technology. Second, the development of the commercial farm sector can create wage labor opportunities that provide rural households with a source of cash income. Third, it is important to support the growth of the microbusiness sector (very small family businesses) and the development of supporting institutions, such as microcredit institutions, cooperatives, and associations.

    Chapter 3, after a brief survey of the literature on sustained growth, considers the challenges and prospects for maintaining strong and sustainable rates of economic growth over the long term in Mozambique. The discussion is based on a detailed historical growth accounting analysis and a forward-looking macroeconomic projections model. In each case, it is found that high-quality growth relies on contributions from all major aggregate growth drivers—for physical investment to translate effectively into growth, it must be accompanied by continuous improvements in human capital and productivity. Thus, assuming continued access to concessionary external finance to support investment priorities, the key growth challenge identified for Mozambique will be to strengthen productivity via technological catch-up and the implementation of a second generation of reforms. The chapter concludes with a few important lessons. First, private sector investment must be stimulated via public investment in infrastructure and a strong government commitment to a stable macroeconomic environment. Second, countries with significant aid inflows need to manage them strategically to avoid unwanted macroeconomic side effects (such as Dutch disease) and to ensure that their application is aligned with domestic priorities. Third, investment in education is a vital component of a growth-conducive public policy stance. Simply expanding access to education is not enough, however; governments also need to focus on the quality of education and the development of technical skills oriented to business needs. Finally, institutional upgrading to confront the changing nature and deepening complexity of economic management challenges must remain at the forefront of development efforts.

    Post-Stabilization Economics, Scaling Up of Aid, and Donor Coordination

    Chapter 4 shows that the initial macroeconomic stabilization from periods of very high inflation and debt overhang, as occurred in Mozambique in the early 1990s, requires fiscal consolidation to anchor inflationary expectations and avoid recourse to unsustainable domestic financing (and public debt accumulation) to maintain a credible nominal anchor. A monetary targeting framework can be employed to maintain single-digit inflation in the face of numerous exogenous shocks. In addition, monetary and financial sector reforms, particularly those that address vulnerabilities in the banking system early on, can help consolidate macroeconomic and financial stability, set the stage for adopting a more formal inflation targeting regime, and sow the seeds for a sound expansion of the banking system that will make a growing contribution to private sector development.

    Chapter 5 argues that macroeconomic conditions in Mozambique have improved markedly in the past decade, providing greater scope for an activist monetary policy geared toward minimizing macroeconomic volatility and/or achieving an inflation target. The use of monetary policy for this purpose in sub-Saharan Africa poses a number of challenges that have not been fully analyzed in the literature, which focuses mainly on the conduct of monetary policy in industrial countries. These include (1) the need to coordinate monetary and exchange rate policy with fiscal policy in order to maintain macroeconomic stability and manage the potential adverse effect on competitiveness of large and volatile aid inflows (and revenues from natural resource exploitation), and (2) the need to incorporate a realistic description of the monetary policy environment in sub-Saharan African countries. This paper attempts to incorporate these elements in a dynamic stochastic general equilibrium (DSGE) model, estimated using recently developed Bayesian estimation techniques on data for Mozambique, and to use such a model to analyze the conduct of monetary policy in Mozambique in response to aid and numerous other exogenous shocks. To the authors’ knowledge, this is the first attempt to estimate a DSGE model for sub-Saharan Africa, except possibly for South Africa. Their results confirm that a “spend and absorb” response to aid shocks is probably best in normal circumstances, although they also provide insights into why many countries seem to have been reluctant to fully absorb aid shocks owing to a desire to smooth exchange rate fluctuations. In a more realistic setting in which the economy is prone to a wider set of shocks, however, the authors’ simulations suggest that a “lite” inflation targeting regime (or an exchange-rate-targeting regime if the authorities do not place a lot of weight on inflation stabilization) would perform best at minimizing macroeconomic volatility.

    The model and policy rules discussed in Chapter 5 are broadly applicable to other sub-Saharan African and low-income countries. First, although it was using data for Mozambique, the DSGE model can be adapted for the purpose of policy analysis in other sub-Saharan African countries. Second, the authors’ conclusions about how Mozambique should best respond to aid shocks are relevant to many countries in sub-Saharan Africa that benefit from substantial, but volatile, foreign aid. Third, the optimality of alternative monetary policy rules in terms of minimizing inflation, real exchange rate, and output volatility in a shock-prone economy is likely to be of interest to central bankers in non-CFA franc zone countries.1 Finally, the non-CFA countries in sub-Saharan Africa are rich in petroleum and mineral resources. The effect of variations in oil and mineral export prices on revenues can be treated in a manner that is directly analogous to the authors’ treatment of variations in aid. Many of the insights developed by the authors in the context of managing aid flows will therefore carry over to the monetary management of petroleum and mineral resource booms.

    Chapter 6 notes that Mozambique has fully spent and absorbed most of the scaled-up foreign aid, ranging between 10 and 20 percent of GDP, it has received over the past decade or so. The additional expenditures have allowed Mozambique to scale up basic services, including doubling the number of children in primary school, reducing infant and maternal mortality, and beginning to provide antiretroviral treatment for HIV infections while sustaining economic growth of 8 percent per year, on average, and reducing the poverty headcount index from 69 percent in 1997 to 54 percent in 2003. Looking forward, illustrative scaling-up scenarios highlight the need to carefully manage a further scaling up of foreign aid. Mozambique’s experience of managing foreign aid inflows and the illustrative scaling-up scenarios include a number of lessons: (1) Fully spending scaled-up foreign aid could help a country make major strides in human development and poverty reduction in a short period without encountering significant macroeconomic absorption problems and microeconomic capacity constraints, although the latter may appear with a lag and would call for a coordinated approach to capacity building, particularly training of frontline workers (for example, teachers, nurses, and agriculture extension workers). (2) Prudent macroeconomic policies and well-sequenced structural reforms are key to maintaining macroeconomic stability and sustaining rapid, broad-based growth. (3) The willingness of a central bank to sell foreign exchange associated with aid inflows to mop up excess liquidity, and thus mostly absorb foreign aid, could avoid an unsustainable buildup of domestic debt and crowding out of the private sector without a significant loss of competitiveness. (4) A prudent external borrowing strategy and encouragement of foreign direct investment, particularly in the natural resource and infrastructure sectors, can help consolidate long-term fiscal sustainability and gradually reduce dependence on donors. (5) Sustained large aid inflows in the range of 10–20 percent of GDP need not result in a weaker revenue effort and reform “fatigue,” including more difficult second-generation institutional reforms in, for example, public financial management, if the recipient country authorities take a longer-term perspective and the international community provides continued technical assistance.

    Chapter 7 notes that enhanced donor coordination can improve aid effectiveness, as has been observed in Mozambique. Mozambique receives about US$1.2 billion per year in donor aid, which raises a number of legitimate questions about whether these funds are used well or how they could be used better. The 19 donors that provide budget support through a common financing scheme are organized in a group to support the government’s poverty reduction strategy in an efficient, predictable, and less cumbersome way than other forms of donor assistance. This has helped reduce aid volatility and made donor disbursements to Mozambique among the least volatile in the region. In this chapter, Mozambique’s model of donor coordination is measured against the 12 indicators specified in the Paris Declaration, which are regrouped under “ownership,” “harmonization,” “alignment,” and “managing for results.” Mozambique scores in the top 25 percent on most of the indicators, despite a number of complicating factors vis-à-vis other countries, most notably the large amount of aid it receives and the large number of donor countries. Mozambique can be considered a model for other sub-Saharan African countries in terms of donor coordination and processes that lead to continued improvements in aid effectiveness. The country’s experience also confirms that budget support is superior to project aid, that increased reliance by donors on government systems increases the government’s responsibility to carry out the necessary reforms, and that the role played by the national authorities has helped donors comply with the Paris Declaration. Another important lesson is that the IMF can play a catalytic role in facilitating compliance with the Paris Declaration and improving aid effectiveness.

    Management of Mineral Resources

    Chapter 8 recalls that some resource-rich nations that derive a large part of their export earnings from their mineral (and oil and gas) sector have seen their economies lag those in resource-poor nations. This “resource curse” affects many, but not all, mineral-led economies and has been a favorite subject of economists for the past several decades. The curse is not inevitable, and examples of nations that have avoided it are as diverse as Botswana, Chile, and Malaysia. This chapter briefly reviews the literature on the resource curse and analyzes fiscal policy elements that can assist in deflecting it. It also traces the development of the mineral industry and related policies in Mozambique from a period of domination by state enterprises through a period of foreign investment promotion, including liberal tax incentives and confidential negotiated agreements, up to today, when transparent policies are designed to harvest curse-free benefits from the sector. Mozambique is quickly becoming a minerals-led economy, with several megaprojects now in place and others being developed or in the planning process. Whether Mozambique will avoid the resource curse in the long run will be known only in coming decades, but its policy approach provides a valuable example of a nation that has recognized the risks of the curse and sought to minimize them. The chapter concludes with a few key lessons for other sub-Saharan African and low-income countries on how to support a virtuous cycle of mineral resource use.

    Business Environment, Trade, and Competitiveness

    Chapter 9, which draws on the basic tools and best practices described in the private sector development literature, benchmarks Mozambique’s business environment relative to regional competitors and successful cases of sustained private sector–led growth with the aim of identifying reform priorities. Despite past efforts to improve the business environment, catching up with regional competitors still requires substantial improvements. The government of Mozambique is rightfully addressing this challenge by implementing a new strategy to make Mozambique’s business environment the most competitive in Africa by 2015. Mozambique is starting to emerge as a reform champion by regional standards and offers lessons on how to develop mechanisms that translate identified reform priorities into actionable, time-bound, and monitorable measures, as well on how to design implementation arrangements to promote coordination and ownership of the reform process.

    Chapter 10 reviews export performance and competitiveness. Mozambique has experienced impressive economic growth, driven to a large extent by improvements in its export performance. These developments, however, reflect mainly megaproject-related exports whose impact on the economy as a whole should not be overstated. This chapter analyzes the causes underlying the comparatively lackluster performance of Mozambique’s traditional export sector and makes some recommendations as to how to diversify the source of export growth to include non-megaproject exports. Although the real effective exchange rate (REER) does not suggest that Mozambique’s competitiveness has been deteriorating, the chapter suggests that the REER may recently have been slightly overvalued compared with its equilibrium and thus that there may have been scope for competitiveness to improve. The author argues that evidence of REER overvaluation may have been linked to exchange rate restrictions that were in place until June 2007. The recent removal of these restrictions should contribute to improving the competitiveness of the export sector in Mozambique. In addition, there is some evidence that many of the country’s traditional exports may be facing declining world demand. This, coupled with the concentration of exports, suggests that efforts should be made to diversify the export base. Doing so would require structural reforms to improve competitiveness, including improving the business climate in Mozambique and undertaking further trade liberalization.

    Chapter 10 contains a number of conclusions with policy implications for Mozambique and other sub-Saharan African countries, in particular with respect to measures that may contribute to expanding the export base beyond the capital-intensive natural resource sectors while diversifying into products for which demand in the world marketplace is growing. Mozambique’s experience also underlines the importance of careful monitoring of the REER to ensure that it does not become overvalued. This is particularly true in sub-Saharan Africa, where countries are prone to Dutch-disease effects and possible exchange rate overvaluation because of increased capital inflows. Finally, Mozambique’s experience suggests that misalignment of the REER is typically associated with an exchange rate that is tightly managed or restricted through administrative means. This provides some justification for greater exchange rate flexibility in the face of sharp increases in capital inflows.

    Notes

    The 14 mostly francophone countries in the CFA franc zone system share a fixed exchange rate regime, and their economic policy decisions are taken in the context of the regional monetary arrangements.

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