Republic of Mozambique: Selected Issues
Author: International Monetary Fund
Publication Date:
05 Aug 1998
eISBN:
9781451827040
Language:
English
Keywords:
ISCR; CR; Mozambique; investment-to-GDP ratio; productivity of investment; ratio; wage compression ratio; inflation equation; inflation-transmission mechanism; metical-rand exchange rate; inflation determination; error-correction term; Inflation; Exchange rates; Consumer price indexes; Natural disasters; Agricultural production; Africa
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This Selected Issues paper on the Republic of Mozambique highlights that in the period 1987–97, the economy of Mozambique made impressive gains. Real GDP and exports grew on average by 6.8 percent and 15.6 percent, respectively, and the ratio of investment to GDP rose from 36.1 percent in 1987 to 45.2 percent in 1997. In the two years ended December 1996, the 12-month inflation rate fell dramatically from 70.1 percent to 16.6 percent.

Abstract

This Selected Issues paper on the Republic of Mozambique highlights that in the period 1987–97, the economy of Mozambique made impressive gains. Real GDP and exports grew on average by 6.8 percent and 15.6 percent, respectively, and the ratio of investment to GDP rose from 36.1 percent in 1987 to 45.2 percent in 1997. In the two years ended December 1996, the 12-month inflation rate fell dramatically from 70.1 percent to 16.6 percent.

II. The Determinants of Inflation3

A. Introduction

16. The rate of inflation in Mozambique was consistently high from 1987 to 1995, averaging 47 percent, but it plunged in 1996 to 17 percent from a peak of 70 percent in 1994. This chapter analyzes the behavior of inflation in Mozambique though three different approaches. The first one decomposes inflation into three components: a trend that represents underlying inflation, a seasonal component that follows closely the agricultural season, and an irregular component. The second approach derives a theoretical model of inflation determination and estimates an inflation equation. The third analyzes the transmission mechanism embedded in the system by estimating a multivariate dynamic system.

17. The combined analysis of the three empirical exercises suggests that the rate of inflation in Mozambique is a combination of a “fundamental” trend set by economic polices, a seasonal behavior that follows closely that of agriculture, and a collection of irregular events that corresponds mainly to agroclimatic conditions. The results show that the marked tightening of monetary policy in 1996 was the ultimate reason for the decline of inflation in that year. The control of monetary expansion had the added effect of helping to stabilize the metical, thus contributing twice to the containment of inflation. This turnaround was achieved despite the serious floods in the first quarter of 1996, which pushed up accumulated inflation to 10 percent in February. Thus, it seems that Mozambique has experienced a change in the “fundamental” inflation trend that may have long-lasting effects.

B. Composition and Structure of the CPI

18. The consumer price index (CPI) for Maputo compiled by the National Planning Directorate (DNP) was the official price index in Mozambique until December 1996. In 1995, the National Statistics Institute started the compilation of an alternative index, with an updated and improved basket of goods that is deemed to better represent the evolution of purchasing power for the average Mozambican consumer, and this new index became the official price index starting in January 1997. However, for reasons of data availability, our analysis was performed with the DNP index.4

19. Mozambique’s CPI was introduced in 1989 as a first attempt to estimate inflation based on a survey of family expenditure in the Maputo area. It covers 1,060 products, and the weights are those derived from an August 1984 expenditure survey of randomly selected households.5 For this reason, the index covers only goods and services offered in Maputo and is highly dependent on the price of a few staples that are subject to strong seasonally, especiality tomatoes and cabbage, which together account for 10 percent of the CPI.

20. The components and weights of the DNP CPI basket appear in Table 1. Foodstuffs dominate the CPI, representing almost 75 percent of the consumption basket; fruits and vegetables alone represent 22 percent. Consequently, factors affecting food prices dominate movements in the CPI. These factors include mainly agroclimatic conditions, domestic inputs, and import prices, with rainfall playing a crucial role. Given the importance of imports from South Africa for the supply of foodstuffs, the evolution of the exchange rate, especially the metical-rand exchange rate, may also play an important role in the behavior of the CPI.

Table 1.

Mozambique: DNP Consumer Price Index Basket

(In percent of total)

article image
Source: National Directorate of Planning.

C. The Evolution of Inflation During 1990–96

21. Inflation, as measured by changes in the CPI for Maputo, increased sharply between 1989 and 1994, but this trend was reversed in 1995. Table 2 presents data on some of the factors likely to have influenced the inflationary process in Mozambique. Inflation fell from 163 percent in 1987 to 35 percent in 1991, but accelerated again in 1992. A large budget deficit and slow GDP growth were behind the 47 percent inflation rate in 1990. The reduction of this deficit and the containment of money growth reduced inflation by 12 points in 1991. However, the important depreciation of the metical in 1991, the excessive monetary expansion in 1992, and the 153 percent rise in fresh produce prices in 1992—owing to the severe drought that affected the country and contributed 22 percentage points to the inflation rate—raised inflation again to 54 percent. In 1993, the inflation rate declined, helped by the strong growth in GDP and tighter fiscal policy. However, inflation peaked again in 1994 at 70 percent, reflecting difficulties in monetary control, the significant depreciation of the exchange rate during the preceding year, and expansionary fiscal policies during 1994. In 1995, GDP grew by only 1.4 percent (down from 4.5 percent in 1994), the budget deficit was reduced, and inflation fell somewhat to 54 percent. Of this increase, 42 percentage points were due to the rise in prices of foodstuffs. In 1996, a turnaround took place: a significantly tighter economic policy and a metical that was much more stable than in previous years, led to an inflation rate of 17 percent, despite floods in the first quarter of the year. Figure 1 shows that in mid-1995 both the exchange rate and broad money growth started a declining trend, whose effect on inflation was seen in 1996. These developments suggest an important, although lagged, effect of these two variables on inflation.

Table 2.

Mozambique: Factors Influencing Inflation

(Annual percentage change, unless otherwise indicated)

article image
Source: Mozambican authorities.
Figure 1.
Figure 1.

Mozambique: Monthly Growth Rates, 1991–96

Citation: IMF Staff Country Reports 1998, 059; 10.5089/9781451827040.002.A002

D. An Unobserved-Components Interpretation: Trend, Seasonal, and Irregular

22. The previous analysis of the possible causes of inflation during 1990–96 shows that the evolution of prices in Mozambique is likely to be a combination of the effect of food prices, with their marked seasonality, economic policies, and external factors affecting these two. A tentative interpretation of these factors could be that economic policies determine the evolution of “underlying inflation,” which would be represented by the statistical trend of the series. Along this trend, the seasonal behavior would be determined by factors affecting agriculture, while exogenous events influence the series on an irregular basis. A way of exploring this interpretation is to perform an ARIMA-model-based univariate decomposition of the series into these three components: trend, seasonal, and irregular (see Ubide (1997) for a detailed description of the procedure and model specifications).

23. Figure 2 presents the original series and the performed decomposition. The upper-right panel of Figure 2 shows an increasing trend component up to late 1994, a turnaround during 1994, and an acceleration of the decreasing trend in early 1996. Inflation in Mozambique shows a very stable and sizable seasonal pattern, peaking in November-February and with a trough in May-June. This seasonal pattern resembles somehow the pattern, although inverted, of agricultural production observed in Mozambique. Agricultural production in Mozambique has a very marked seasonal pattern, with a peak in August and a trough about February. This finding confirms the intuition that the marked seasonality of prices in Mozambique could to a great extent be the result of agricultural seasonality. We can see that the irregular component of inflation is important over the whole sample and captures remarkably well the periods of drought (early 1992), cyclone Nadia (late 1993 and early 1994), elections (late 1994), and floods (early 1996).

Figure 2.
Figure 2.

Mozambique: Decomposition of Monthly Changes, February 1990-December 1996

(In percent)

Citation: IMF Staff Country Reports 1998, 059; 10.5089/9781451827040.002.A002

E. Estimation of the Inflation Equation

24. Ubide (1997) presents a simple model of inflation determination in a developing country, in which inflation is a function of money supply, real income, inflation expectations, exchange rates, and foreign prices. In this model, increases in money supply, expected inflation, the exchange rate, and foreign prices are expected to push up inflation, while an increase in real income will lead to a fall in the growth of prices. The effect of sluggish adjustment because of rigidities can be incorporated by adding the effect of lagged prices to the equation.

25. The choice of the relevant variables is not straightforward. Given the lack of data on real income at a suitable frequency and for an adequate sample size, a monthly index of agricultural production is used, constructed from information on agricultural prices, as a proxy for income. Because of the importance of agriculture, especially smallholder agriculture, a rainfall variable, measured in terms of millimeters of rainfall per month in Maputo, is used in the estimation. The choice of the relevant partner country is also an important consideration. South Africa, which accounts for almost 30 percent of Mozambican trade, seems the best choice, particularly when examining price developments in southern Mozambique. Likewise, the exchange rate variable is the metical-rand exchange rate. Agricultural and political events (such as floods or droughts and elections) are modeled by including relevant dummies. Because integrated variables are involved, the first step in the estimation is testing for cointegration. Weak evidence of cointegration is found, with a cointegrating vector that indicates that, in the long run, inflation in Mozambique is positively related to South African prices, money supply, and the metical-rand exchange rate (the cointegrating vector is [1.64 0.72 0.18]). On the basis of the previous analysis, a general-to-specific modeling approach is followed to estimate a general dynamic error-correction autoregressive distributed-lag model. Different parameterizations and lag lengths were considered during the process, and the guideline used to reach the final specification was model reduction with the final objective of a parsimonious and congruent model.

26. An inflation equation is estimated by ordinary least squares (OLS) with monthly data for the period 1989:1-1996:12. The general specification included all the variables in first differences with up to 12 lags, and its final specification appears in Table 3, Equation I. Two dummy variables are found to be significant, one in late 1994 accounting for the national elections (parameter estimate: 0.09 (0.021)) and another in early 1996 (parameter estimate: 0.19 (0.033)) accounting for the serious floods that affected southern Mozambique. Figure 2 shows that the irregular component during these periods was very large, and, hence, the introduction of the dummy variables seems warranted. The agricultural index variable is a six-month moving average of the original series. Likewise, the rainfall variable is a three-month moving average of the original series. Several normality and heteroskedasticity tests were performed to ensure that the residuals were well behaved.

Table 3.

Mozambique: Estimation Results

article image
Notes: Standard errors in parentheses. Seasonal dummies and two impulse dummies, for 1994:8 and 1996:2, were included in the estimation. ECM is the error-correction term; Erate is the metical-rand exchange rate; Agr is a six-month moving average of the index of agricultural production; and Rain is a three-month moving average of monthly rainfall (in millimeters).

27. The results indicate that the metical-rand exchange rate has a significant short-run effect on inflation, both contemporaneous and lagged. The coefficient is positive as expected, reflecting the effect on inflation of trade in goods, mainly through imports in the informal sector. As expected, money, represented by M2, has no contemporaneous effect on inflation, but it has an important effect with four lags. The short-run elasticity of money is 0.5. Interestingly, lagged inflation is not significant. These two facts would indicate that the adjustment process in Mozambique is very fast, and that changes in monetary policy are translated quickly into price changes. Finally, the coefficient of the error-correction (ECM) term indicates that the adjustment of inflation towards its equilibrium value is 6 percent per month.

28. The variable proxying for income, the monthly agricultural index, was found to be weakly significant and with a negative sign, as was expected. The variable rainfall is also significant with a negative sign, owing to the positive effect of the rains on agricultural production and therefore on the evolution of prices in Mozambique.

29. Simulations not reported here show that, had the stance of monetary policy in 1996 been, ceteris paribus, that of 1995 (in terms of money growth), inflation in 1996 would have been 26 percent instead of the 17 percent actually recorded.6 By the same token, had the exchange rate depreciated in 1996 as it did in 1995, inflation in 1996 would have been 36 percent. Finally, had agricultural output in 1996 equated that of 1995, inflation in 1996 would have been 18 percent.

30. The model satisfies all the basic diagnostic tests, and it can be seen in Figure 3 that it is able to track all the main turning points of the inflation cycle, especially since mid-1995. The forecasting performance of the equation is also satisfactory. It seems from the evidence that the relationship has been more stable in the last two years, probably reflecting the improvement in the conduct of monetary policy in Mozambique.7

Figure 3.
Figure 3.

Mozambique: Actual, Fitted and Forecast Changes in the CPI, 1991–96 Actual (-) and Fitted (..)

Citation: IMF Staff Country Reports 1998, 059; 10.5089/9781451827040.002.A002

F. A Causality Analysis

31. The results from the inflation equation suggest the dynamic nature of the inflation-transmission mechanism and the presence of feedback effects among prices, exchange rates, and money. Hence, a dynamic multivariate analysis that encompasses the single equation methodology can give robustness to the analysis and shed some light on these dynamic transmission mechanisms by allowing the causality links among the variables to be disentangled.

32. A vector autoregression (VAR) has been fitted to Mozambican prices, the metical-rand exchange rate, money, and South African prices. The lag length of the VAR has been selected so as to minimize a multivariate version of the Hannan and Quinn criterion. Evidence of cointegration is found among the variables, and the system is estimated by maximum likelihood. The selected specification on the basis of this criterion is a VAR(6), and the residuals do not display any problem of serial correlation. Table 4 presents the Granger causality test.

Table 4.

Mozambique: Granger Causality Test

article image
Notes: Critical value is 9.48. Cell (i,j) is the test for variable; j causing variable I. CPI and CPISAF are the consumer price indices for Mozambique and South Africa, respectively. Erate is the metical-rand exchange rate.

33. Ubide (1997) reports the graphs of the accumulated orthogonal impulse responses. The results can be summarized as follows: Granger causality tests indicate that both money and the exchange rate Granger-cause inflation, in line with our previous analysis. Interestingly, the accumulated orthogonal impulse response of prices when money is shocked by 1 percent shows a peak after four to five months, stabilizing thereafter to a long-run effect of 0.4 percent. A 1 percent depreciation of the metical induces a 0.2 percent increase in inflation that lasts about 10 months and dies out after 20 months.

34. The metical-rand exchange rate is Granger-caused by all the variables. The impulse responses show that a 1 percent positive shock to Mozambican prices induces a depreciation of the exchange rate that lasts three months, followed by an appreciation of approximately the same amount as the shock, A shock to South African prices creates an opposite and more intense effect—an initial appreciation followed by a return to the steady state. Hence, it seems that the exchange rate moves in the long run toward an equilibrium value that is not necessarily the purchasing power parity.

35. Finally, money seems to be caused only by South African prices. The impulse responses show that an inflationary shock in Mozambique drives down money in the long run, and the same happens after an appreciation of the exchange rate; the opposite happens after an inflationary shock in South Africa. These results point to the importance of capital flows moving between Mozambique and South Africa in accordance with the economic conditions of each country, especially the inflation differential.

G. Conclusions

36. The rate of inflation in Mozambique was consistently high over the 1989–94 period; after dropping from 70 percent in 1994 to 54 percent in 1995, it plunged in 1996 to 17 percent. This study uses three alternative approaches to the empirical analysis of inflation and argues that monetary expansion, together with the depreciation of the exchange rate and unpredictable events in the agricultural sector, is responsible to a large extent for the inflationary process in Mozambique. The combined analysis of the three approaches suggests that the marked tightening of monetary policy in 1996 was the ultimate reason for the deceleration of the inflation rate in that year. The control of monetary expansion had the multiplier effect of helping to stabilize the metical (recall that money Granger-causes the exchange rate), thus contributing twice to the containment of inflation. There are several reasons to believe that this success can be long lasting. First, this turnaround was obtained in a year in which a major agricultural shock resulting from serious floods pushed accumulated inflation up to 10 percent in February. Second, the unobserved-components analysis shows a break in the trend in 1996, probably reflecting the changes in monetary control policies. This hypothesis is corroborated by the analysis of the seasonality of money supply, which shows a stabilization of the seasonal fluctuations in the last two years. Finally, the stability of the metical should also benefit from any improvement in the economic situation in South Africa and from the rand being more stable; this should help in turn to keep inflation in Mozambique under control. Money is Granger-caused by South African prices, reflecting the mounting inflows of capital from South Africa into Mozambique during the last year as a result of the decrease in the inflation differential between the countries. These inflows should be kept under control to avoid inflationary pressures and excessive exchange rate fluctuations.

References

  • Comissão Nacional do Piano, 1985, Preços ao Consumidor e Nivel de Consumo, DNE/DD/SER, B/11 (Maputo: Direcção Nacional de Estatística).

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  • IMF, 1996, Republic of Mozambique: Recent Economic Developments, Staff Country Report 96/142 (Washington, DC: International Monetary Fund).

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  • Ubide, Angel, 1997, “The Determinants of Inflation in Mozambique”, IMF Working Paper 97/145 (Washington: International Monetary Fund).

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3

This chapter was prepared by Angel Ubide.

4

The two indices showed some divergences in earlier years, but they converged significantly during 1996. Hence, the policy implications of this paper can be extrapolated to explain the behavior of the new index.

6

Clearly, the ceteris paribus assumption is not consistent with the fact that money Granger-causes the exchange rate (see Table 4 below), but it is made for illustration only.

7

Since 1995, the use of indirect instruments has increased, the real rediscount rate has been kept positive, and the sale of the Banco Comercial de Mozambique allowed the Bank of Mozambique to exert a stricter control over the money supply; see IMF (1996).

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Cover IMF Staff Country Reports
Republic of Mozambique: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 1998: Issue 059
Publisher:
International Monetary Fund
ISBN:
9781451827040
ISSN:
1934-7685
Pages:
122
DOI:
https://doi.org/10.5089/9781451827040.002
  • View in gallery

    Mozambique: Monthly Growth Rates, 1991–96

  • View in gallery

    Mozambique: Decomposition of Monthly Changes, February 1990-December 1996

    (In percent)

  • View in gallery

    Mozambique: Actual, Fitted and Forecast Changes in the CPI, 1991–96 Actual (-) and Fitted (..)

Mozambique: Monthly Growth Rates, 1991–96

Mozambique: Decomposition of Monthly Changes, February 1990-December 1996

(In percent)

Mozambique: Actual, Fitted and Forecast Changes in the CPI, 1991–96 Actual (-) and Fitted (..)