Abstract
This Selected Issues paper on the Republic of Mozambique reports key policy and institutional issues in the macroeconomic management of scaled-up aid and in promoting sustainable private-sector led growth. A further moderate scaling-up of foreign aid could continue to be fully spent and focus on productive priority sectors. This would help achieve the Millennium Development Goals while at the same time eliciting a supply response to mitigate potential Dutch-disease effects brought on by an appreciating real exchange rate.
I. Macroeconomic Management of Scaled-up Foreign Aid in Mozambique1
A. Introduction
1. While large aid inflows can play an important role in achieving the Millennium Development Goals (MDGs), they also pose a number of macroeconomic challenges. The Commission for Africa (2005) and the U.N. Millennium Project identifies the need for a scaling-up of aid flows to meet the MDGs in well-governed low-income countries, including Mozambique. Scaling-up scenarios are intended to illustrate a potential medium-to-long-term macroeconomic outcome, and identify some of the key measures and policies that would help countries absorb a higher level of aid and ensure that it is used efficiently. In practice, donors might be less likely to offer higher aid and recipient governments might be less likely to accept it on a sustained basis if one party or the other started to observe significant macroeconomic absorption problems—such as rising inflation, crowding-out the private sector and/or a serious loss of international competitiveness, and microeconomic capacity constraints—severe skill shortages, deteriorating quality of services or other bottlenecks. Such scaling-up scenarios are developed in the context of a country’s efforts to achieve the MDGs with the support of the international donor community. 2
2. There are three basic approaches to preparing scaling-up scenarios (IMF 2006). The first approach assesses the macroeconomic implications of a fiscal scenario that is based on an explicit costing of achieving those MDGs that do not focus on income levels (e.g., those related to education, health, and water access). The costing exercise, which is typically carried out with the assistance from development partners such as the World Bank and the U.N., provides a judgment about the resources required in each sector. It also may illustrate trade-offs among policies, resources, macroeconomic outcomes, and identify bottlenecks that need to be addressed. A second approach is to assess the macroeconomic impact of a significant but arbitrary increase of external finance (e.g., 1-2 percent of GDP or a doubling of aid). This approach is probably more suited for Mozambique as an explicit MDG costing is not yet available and aid inflows continue to be large and rising (about 15 percent of GDP). A third approach is to target a specific growth rate if achieving the income poverty MDG is unrealistic with present resources and policies, which is not the case in Mozambique. 3
3. The objective of this paper is to assess the macroeconomic challenges of managing scaled-up foreign aid in Mozambique. The paper is organized as follows: section B analyses the past impact of aid in Mozambique; section C presents illustrative scaling-up scenarios geared to identifying macroeconomic policy tradeoffs and improving potential outcomes; and section D concludes by identifying the challenges for Mozambique.
B. Foreign Aid and Macroeconomic Management in Mozambique
4. Identifying the fiscal effects of aid is a prerequisite to understanding the macroeconomic impact of aid (McGillivray and Morrissey 2001). However, there has been limited analysis of the fiscal effects of aid in Mozambique. 4 Therefore, we will start by estimating the fiscal impact of aid in Mozambique.
5. There is a growing literature on how aid affects the fiscal behavior of governments (see McGillivray and Morrissey 2001). The most common approach is through fiscal response models (FRMs). These studies tend to find that aid ultimately leads to increased spending, and total spending often increases by more than the value of aid (McGillivray and Morrissey 2001). There is evidence that aid has had a beneficial impact on investment and recurrent spending in sub-Saharan African countries (Commission for Africa 2005). IMF (2005a) suggests that aid was mostly spent in Mozambique where the degree of spending was calculated by the widening in the government fiscal deficit net of aid that accompanies an increase in aid. 5 IMF (2005a) shows that public expenditures actually increased, on average, more than the increment in net aid inflows, leading to a substantial widening of the fiscal deficit net of aid during the aid surge of 2000-02. The aid surge was roughly equally distributed between current and capital expenditures. However, IMF (2005a) focus on short time periods of surges in aid and relatively simplistic approach compared to the fiscal response literature of aid may miss more complicated dynamic effects (Mavrotas 2002).
6. The fiscal effects of aid in Mozambique are assessed by estimating a FRM within a vector autoregression (VAR) modeling framework as in Osei, Morrissey, and Lloyd (2005). The variables of the fiscal response VAR model are ordered as follows: foreign aid (AID), government expenditure (Expenditures), tax revenue (Tax), and the change in net credit to the government from the banking system (NCG). Note that as nontax components of revenue and nonbank borrowing are omitted, we are not estimating an identity. We also estimate a model in which foreign aid is divided by grants and loans as well as and project aid and budget support (BUDSUP). Total government expenditure is disaggregated into capital and current components. We use quarterly data over the period 1996Q1 to 2006Q3 with all the variables measured in constant 2004 prices expressed in millions of new meticais (MT). Data on domestic fiscal variables and external financing are obtained from IMF country desk data.
7. The dynamic effects of aid shocks can be evaluated using impulse response functions. An analysis of the time-series properties of the variables revealed that the variables are integrated of order one or I(1), except for aid and NCG which are stationary I(0). However, cointegration tests did not identify a significant cointegrating vector between the variables. Therefore, the series are first differenced for estimation purposes to avoid the spurious and inconsistent regression problem (Hendry 1995). 6 Results of Granger causality tests are somewhat mixed, but clearly point to aid Granger-causing fiscal variables but not vice versa. This suggests that aid disbursements have not been influenced by the budget balance over the period. In addition, this tends to suggest that shocks to foreign aid are exogenous to the system rather than determined by it and offers statistical support for the legitimacy of the impulse response analysis of aid shocks in Mozambique below. The structural shocks are recovered from the VAR residuals using the Cholesky decomposition of the variance-covariance matrix. 7
8. Aid has been mostly spent in Mozambique. Plots of the impulse response functions for a one standard deviation shock in aid on a quarterly time interval are shown in Figures 1-2. A one standard deviation shock corresponds to about MT 1500 million (this would represent about 1 percent of GDP in 2004). Figure 1 with total aid and expenditures shows that the cumulative impulse response to an aid shock of one standard deviation gives a full pass-through (change in spending t periods after the shock over an initial percent change in aid) within four quarters. In fact, as observed in IMF (2005a), public expenditures actually have a tendency to increase more than the original shock to aid in Mozambique. However, unlike IMF (2005a), the aid shock seems to result in more capital expenditures with only about one-third of the aid financing current spending within a year (Figure 2). 8 Not only does aid result in an increase in capital spending, but it leads to an increase in domestic taxation. Moreover, these results are largely unaltered whether one considers loans or grants,9 although the picture is somewhat less clear regarding the impact of aid on NCG possibly reflecting smoothing of expenditures and/or issuance of domestic debt. However, as expected, budget support seems to initially reduce NCG and start picking up with a slight lag of a quarter or two but still leading to a full spending within 5-6 quarters.
Fiscal Effects of Foreign Aid
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Effects of Foreign Aid
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Effects of Foreign Aid
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Effects of Foreign Aid (cont.)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Effects of Foreign Aid (cont.)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Effects of Foreign Aid (cont.)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
9. The spending of foreign aid could undermine competitiveness, although such effects can be ameliorated depending on the nature of the supply side response over the long-term. Given that aid inflows have been spent by the government in Mozambique, the next issue is whether these expenditures have induced a significant appreciation of the real exchange rate and thus discouraged the expansion of exports, thereby hurting long-term growth. The results presented in the staff report show that government spending (both current and total expenditures) has tended to appreciate the fundamental equilibrium real exchange rate but some of those effects have been mitigated by trade liberalization and negative terms of trade movements. 10 In addition, even though Mozambique’s total export shares in world trade have increased this is mainly as a result of the strong growth in megaproject exports. Nonmegaproject exports share of world trade and ratio to GDP has remained roughly constant. As such, concerns remain regarding the impact of scaled-up aid on Mozambique’s competitiveness. These results are somewhat different from those presented in Benito-Spinetto and Moll (2005) who simulate a simple 1-2-3 model in the spirit of Devarajan et al. (1994) and indicate that Dutch disease appears not to be an important factor in Mozambique. They argue that supply-side effects of aid coming through health and infrastructure investments could help mitigate a real exchange rate appreciation. The lack of visible evidence that supply-side effects are strong enough to dampen pressures on the real exchange rate to appreciate due to the demand side impact of spending the aid inflow may, however, be explained by well-known lagged (and possibly nonlinear) effects as well as the rudimentary state of PFM systems in Mozambique, that, at least until recently, were relatively weak compared to most other SSA countries. 11
10. Even the short-run response to aid is dependent on a number of factors, including the degree of aid absorption. 12 As discussed in Peiris and Saxegaard (2007), the impulse responses of the estimated DSGE model for Mozambique shows that the degree of absorption of aid-financed spending can have very different effects on the short-term dynamics of the exchange rate, output and inflation. In order to investigate how those effects may have played out in Mozambique, we estimate an identified six-variable VAR from Q1 1996 to Q3 2006. 13 The ordering of the variables embodies two key identifying assumptions, that is, that aid shocks contemporaneously effects all variables in the system and that economic variables do not respond contemporaneously to the policy variables, except for the exchange rate. The exchange rate is an asset price, and is expected to response faster to policy shocks than real economy variables. The following ordering is chosen: foreign aid, real GDP14 (or real nonmegaproject exports), inflation, reserves, domestic debt, and the nominal exchange rate. The structural shocks are recovered from the VAR residuals using the Cholesky decomposition of the variance-covariance matrix. While the ordering is certainly debatable and a nonrecursive structural VAR could have been used for identification, the estimation provides a generalized view of the impact of aid shocks in Mozambique. In addition, it is fairly well accepted that many macroeconomic variables do not respond instantaneously to policy shocks, particularly when we consider quarterly time intervals (see Christiano et al., 2005 for the general approach).
11. Aid-financed expenditures have been mostly absorbed in Mozambique, with only hints of Dutch-disease effects affecting the export sector (Figures 3 and 4). The impulse responses on a quarterly time interval suggests that aid shocks (that have been mostly spent) have, at least initially, resulted in a nominal exchange rate appreciation, and possibly lower output. Inflation declines initially but picks up gradually. A similar picture emerges when one considers real nonmegaproject exports instead of our proxy for real GDP, suggesting only modest contractions of the export sector in response to aid shocks in Mozambique. Interesting, most of the foreign exchange associated with aid inflows appears to have been sold by the central bank within five quarters of the initial aid shock facilitating a textbook spend and absorb response to aid in Mozambique. The results do indicate, however, that the central bank may have somewhat smoothed sales of foreign exchange sales in the very short term through temporary net domestic debt issuance (i.e., sterilization) possibly to avoid “excessive” exchange rate volatility in a thin market. The temporary mopping-up of excess liquidity through sterilization while ultimately selling the foreign exchange may have helped keep prices at bay and minimized the likelihood of crowding-out private sector credit at the same time. This contrasts with the response to aid shocks of most other non-CFA SSA countries that seem to have relied more heavily on sterilization (IMF 2005a), contributing to unfavorable debt dynamics and probably greater crowding-out of the private sector. Overall, the macroeconomic impact of aid shocks seems to go roughly in the same direction as the model simulations for Mozambique in Peiris and Saxegaard (2007), in the case where aid has been absorbed through sales of foreign exchange by the central bank.
Macroeconomic Impact of Foreign Aid
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Macroeconomic Impact of Foreign Aid
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Macroeconomic Impact of Foreign Aid
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Macroeconomic Impact of Foreign Aid (cont.)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Macroeconomic Impact of Foreign Aid (cont.)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Macroeconomic Impact of Foreign Aid (cont.)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
C. Illustrative Scaling-up Scenarios
12. The purpose of illustrative scaling-up scenarios for Mozambique are to identify the potential macroeconomic implications, and key measures and policies that would help absorb a higher level of aid and ensure that it is used efficiently. A full costing of the MDGs has not been undertaken for Mozambique and it appears to be well-placed to achieve the income poverty MDG by 2015 with present resources and policies. 15 Therefore, we consider the macroeconomic consequences of arbitrary but sustained increases of external finance for illustrative purposes. This contrasts with scaling-up scenarios presented for a few other countries (e.g., Mattina 2006) based a costing of MDGs and targeting a specific growth rate to meet the income poverty MDG. The focus of this paper is more to discuss the macroeconomic implications and policy trade-offs involved in spending and absorbing a further scaling-up of foreign aid amounting to more than 15 percent of GDP at present.
Macroeconomic implications and policy trade-offs
13. The impact on medium-to-long-term growth of a further scaling-up of aid is difficult to gauge but research points to areas for further analysis and prioritization of reform strategies. A number of research papers that have undertaken growth accounting exercises for Mozambique (e.g., Jones 2007, IMF 2005c, and World Bank 2005) suggest that physical capital accumulation and total factor productivity have played a fundamental role in explaining the post-conflict growth acceleration supported by first-generation structural reforms. 16 They also confirm the possibility of achieving about 7 percent growth in the medium term (baseline in staff report) and 5-6 percent in the long-term, a level sufficient to halve the poverty rate by 2015, assuming a continuation of strong productivity growth given the relatively low productivity levels in agriculture and manufacturing (Fox et al., 2007, and Eifert, Gelb and Ramachandran 2005). On the specific issue regarding the impact of scaling-up, Jones (2007) highlights the upside potential from higher public investment (depending on the ratio of current-to-capital spending), and crowding-in private investment and spillovers from infrastructure and human capital accumulation. Whilst formal modeling of absorptive capacity is in its infancy (for a discussion see Bourguignon and Sundberg, 2006), a preliminary estimation in Jones (2007) also shows possible negative consequences from a further scaling-up in Mozambique operating through private investment and human capital quality growth. The former is intended to reflect diminishing returns while the latter reflects labor market effects including the challenge for Mozambique of maintaining education quality in the face of rapid aid-financed expansion of the school network (see Arndt et al., 2007). Recent evidence suggest that primary education completion rates and the quality of education are relatively low, probably reflecting high pupil-to-teacher ratios and a growing number of untrained teachers, although innovate steps have been taken lately to address the shortage of trained teachers. 17
14. The literature and evidence presented in section B calls for paying particular attention to potential Dutch-disease effects related to aid-financed scaling-up of expenditures and thus ways to mitigate such effects. While it is fairly well accepted that to spend and absorb is likely to be the best response to an aid shock in normal circumstances (see Buffie et al 2007, IMF 2005a, and Peiris and Saxegaard 2007), such a response could still entail a significant loss of competitiveness, and thus lower exports and real GDP growth. Therefore, we analyze this issue further by simulating the estimated DSGE model for Mozambique in Peiris and Saxegaard (2007) in response to a persistent aid shock (autocorrelation coefficient of 0.7) which raises aid by 2 percent of steady-state GDP. 18 For illustrative purposes, we consider three scenarios (Figure 5). In the first scenario, we assume there are no productivity spillovers from public investment. The second scenario assumes a modest level of spillovers (the baseline in Peiris and Saxegaard 2007). In the third scenario, we consider a high level of productivity spillovers from public investment. All scenarios assume a full spending and absorption of foreign aid; the usual assumption in scaling-up scenarios. Note that the function form as in Pratti and Tressel (2006) assumes that productivity is an increasing function of the size of public investment expenditure; so the higher levels of productivity could come from greater spillovers (e.g., related to infrastructure investments) or a decrease in the ratio of current-to-capital spending. 19 The unbroken line describes a scenario where there are no productivity spillovers; the thick broken line assumes a modest level of spillovers; and the light broken line depicts a higher level of productivity spillovers from public investment in response to aid shocks (Figure 5).
Scaling-up Scenarios
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Scaling-up Scenarios
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Scaling-up Scenarios
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
15. Greater productivity-enhancing public investment expenditure could ameliorate or even reverse Dutch-disease effects of additional government spending in Mozambique (Figure 5). The impulse responses in Figure 5 on a quarterly time interval clearly shows the role productive government investment expenditures can play to mitigate Dutch-disease effects of aid-financed government spending by reducing real exchange rate appreciation pressures and thus eliciting a stronger export performance. Moreover, consumption and output are unambiguously higher with greater productivity spillovers as expected while the pick-up in inflation following an initial decline (as in section B) would be milder. At this point, it is important to note that analysis of this kind come with a number of caveats. For example, we assumed that productive government spending affects the transitional dynamics of the economy but not the steady-state for simplicity and tractability. While this makes sense when considering fairly persistent but stationary aid shocks as observed in the past in Mozambique (see section B), one could have also considered the impact of permanent increase in aid that could affect steady-state variables, which is a area for future research. 20 Finally, it is important to note that none of the outcomes of productivity spillovers from public investment are assured and will depend critically on the composition of government expenditure and efficiency of public service delivery. However, the discussion emphasizes the importance of prioritizing productive government investments and accelerating the implementation of second-generation reforms in PARPA II to increase returns to investment:
Infrastructure and human capital accumulation. Since 2000, about 65 percent of scaled-up spending has been allocated to priority sectors (e.g., education, health and infrastructure) identified in Plano de Acção para Redução da Pobreza Absoluta I (PARPA I), helping double of the number of children in primary school, reduce in infant and maternal mortality, and begin the provision of Anti-Retro-Viral (ARV) treatment for HIV infection, partly financed by resources made available by the Highly Indebted Poor County (HIPC) initiative. While substantial progress has been made, large human capital and infrastructure gaps remain. Comparisons with fast growth Asian economies during the initial phases of their growth takeoff indicate the importance of expanding secondary education and addressing the acute infrastructure gap, particularly communication and transportation networks (Table 1).
Improving agricultural productivity lies at the heart of growth prospects and poverty reduction (Fox et al 2007). A great deal of the increase in crop income has been achieved through extensive agricultural practices, that is area expansion and use of available labor, both family and hired. As a result, basic food crops, widely grown by smallholder farmers, predominantly for subsistence, have exhibited relatively stagnant yields (output per hectare). Security of land-tenure and use of new technologies associated with cash crops mostly grown under contract by agro-industrial firms could help improve productivity. Smallholders can also increase land productivity and crop income through diversification into profitable cash crops many of which are tied to contract farming schemes. The use of productivity enhancing inputs (particularly fertilizers, seeds and irrigation), and developing rural credit and input markets can facilitate diversification to such crops. Further development of the agriculture sector would require the development of a good road infrastructure, storage facilities and extension services. Mozambique also has the potential to further cultivate high value vegetable crops and floriculture for export to Europe through better quality standards and marketing infrastructure. 21
Strengthening the business environment is key to building a manufacturing base and generating employment. While sustained growth accelerations tend to be associated with considerable manufacturing exports, Mozambique’s manufacturing base remains nascent due to poor competitiveness. Low “factory-floor” productivity levels in manufacturing firms are explained by considerably high indirect costs and output losses including those from burdensome regulations as they squeeze firms value-added and reduce TFP, as well as the use of obsolete and ill-maintained equipment and the absence of modern management techniques. The wide gap in business competitiveness between Mozambique and fast-growing Asian economies and regional competitors, as measured by the World Bank’s Doing Business indicators, suggest that lowering the costs of doing business must be at the core of the authorities’ reform strategy by: (i) streamlining burdensome regulatory practices; (ii) reducing the costs of hiring and firing workers; (iii) removing infrastructure bottlenecks; (iv) a financial sector reform agenda centered on further reducing the cost of and expanding access to financial services; and (v) a governance agenda to minimize expropriation risks.
Strengthening public financial management systems and wider public sector reforms will be vital to ensure that resources efficiently reach the most economically and socially productive priority sectors, including at the subnational level where some of the scaled-up resources will ultimately be spent (Box 1). Enhancing administrative capacity is also essential to effectively absorb scaled-up donor assistance. To improve the link between policy objectives, appropriations and performance indicators, the government is embarking on a transition towards program-based budgeting. The government could proceed on a pilot basis with a few line ministries in 2008 budget. In support of this initiative, the CFMP will also require strengthening through a better costing of policies and more comprehensive sector strategies. In addition, the significant role played by state-owned or public-participating enterprises22 in the provision of public services, and their impact on macroeconomic developments—including domestic and external borrowing levels—argues for their consolidation into the budgetary accounts, or, at a minimum, enhanced monitoring of their activities. Finally, the international community has a role to play by including donor-financed projects in the single treasury account and e-SISTAFE to improve timely fiscal reporting on all development expenditures and thus gauge their impact better.
Increasing Returns to Public Investment: Lessons from Asia
1/ Data are for the most recent period available.
Data refer to year closet to growth take-off.
Gross enrollment ratio.
Increasing Returns to Public Investment: Lessons from Asia
| Human | Infrastructure | |||
| Primary Education 3 | Secondary Education 3 | Telephone Mainlines (per | Total Roads Surface Area | |
| 1,000 people) | (in km) | |||
| sub-Saharan Africa | ||||
| Mozambique | 8 | 8. | 4 | 3 |
| SADC | 10 | 42. | 6 | 227. |
| SSA | 91. | 31. | 35. | 166. |
| Selected Asian Countries that have sustained growth accelerations2 | ||||
| Chin | 112. | 45. | 2 | 12 |
| ASEAN 4 | 83. | 22. | 6. | 184. |
| Indonesia | 8 | 16. | 1. | 151. |
| Malaysi | 88. | 34. | 13. | 261. |
| Thailan | 81. | 17. | 5. | 140. |
1/ Data are for the most recent period available.
Data refer to year closet to growth take-off.
Gross enrollment ratio.
Increasing Returns to Public Investment: Lessons from Asia
| Human | Infrastructure | |||
| Primary Education 3 | Secondary Education 3 | Telephone Mainlines (per | Total Roads Surface Area | |
| 1,000 people) | (in km) | |||
| sub-Saharan Africa | ||||
| Mozambique | 8 | 8. | 4 | 3 |
| SADC | 10 | 42. | 6 | 227. |
| SSA | 91. | 31. | 35. | 166. |
| Selected Asian Countries that have sustained growth accelerations2 | ||||
| Chin | 112. | 45. | 2 | 12 |
| ASEAN 4 | 83. | 22. | 6. | 184. |
| Indonesia | 8 | 16. | 1. | 151. |
| Malaysi | 88. | 34. | 13. | 261. |
| Thailan | 81. | 17. | 5. | 140. |
1/ Data are for the most recent period available.
Data refer to year closet to growth take-off.
Gross enrollment ratio.
Mozambique and Comparators: Total TFP Decomposition (China =1)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Source: Eifert, Gelb and Ramachandran (2005).Mozambique and Comparators: Total TFP Decomposition (China =1)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Source: Eifert, Gelb and Ramachandran (2005).Mozambique and Comparators: Total TFP Decomposition (China =1)
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Source: Eifert, Gelb and Ramachandran (2005).PFM Reforms in Mozambique
PFM systems in Mozambique have shown major improvements. The public expenditure and financial accountability (PEFA) assessment of 2006 highlights that PFM systems in Mozambique have shown major improvements in recent years. The government has been implementing a nationwide PFM reform called SISTAFE, initially with substantial IMF technical assistance and more recently financed by a multidonor common fund, focusing on rolling out a government financial management information system (e-SISTAFE). e-SISTAFE has been rolled out to most line ministries at the central and provincial level by end-year 2006. The medium-term fiscal framework (CFMP) is also closely aligned with the PARPA II priorities. It was for the first time, approved by the Council of Ministers in 2006, making it a credible tool to guide the preparation of subsequent budgets. It is also possible to identify programs through Phase I of the budget formulation module of e-SISTAFE, and to track priority expenditures defined in PARPA II on a real time basis.
The authorities’ medium-term PFM action plan and budget (APB) covers the key areas of PFM weaknesses identified by the 2006 PEFA assessment. According to the APB, e-SISTAFE will be extended to the remaining ministries at the central and provincial levels, and state organs by end-December 2007, and progressively rolled out to districts and municipalities (initially to 27 districts by end-October 2007). New e-SISTAFE functionalities will also be implemented, particularly Phase II of budget formulation, payroll and pension, and revenue collections modules in 2007. Notably, following the completion of the census of the civil service, an integrated and e-SISTAFE compatible payroll database will be developed to carry out salary payments via direct budget execution in e-SISTAFE by end-June 2007 as it was identified by the PEFA assessment to be a major remaining fiduciary risk. 1 A limited number of separate foreign currency accounts will be opened within the single treasury account in 2007 to facilitate the inclusion of donor-financed projects. As part of the decentralization efforts, a National Decentralization Strategy, including a review of intergovernmental fiscal relations, will be prepared by June 2008. Work will also continue to implement the new procurement system up to the district level. Finally, work is on-going to increase capacity of internal and external audit bodies, with specific milestones set for end-2007.
Overview of 2004 PEFA scores and identified ‘potentinl scores’ for 2006
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Source: PEFA (2006)Overview of 2004 PEFA scores and identified ‘potentinl scores’ for 2006
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Source: PEFA (2006)Overview of 2004 PEFA scores and identified ‘potentinl scores’ for 2006
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Source: PEFA (2006)Projected SISTAFE Outputs, 2006-2009
Projected SISTAFE Outputs, 2006-2009
| 1. | Financial and budget execution in operation in all ministries at the |
| central, provincial and district levels, and in the municipalities and | |
| public enterprises. | |
| 2. | The module of payment of salaries and pensions implemented. |
| 3. | The budget formulation module implemented (Phase II). |
| 4. | The asset management module and procurement interface implemented. |
| 5. | The ATM revenue management module implemented. |
| 6. | Program budgets under preparation by ministries. |
| 7. | The debt management module implemented. |
| 8. | The internal audit module implemented. |
| 9. | The Data Processing Centre (CPD) operating as an effective and |
| sustainable unit. | |
| 10. | Project Implementation Unit for SISTAFE operating as an effective and |
| sustainable unit. |
Projected SISTAFE Outputs, 2006-2009
| 1. | Financial and budget execution in operation in all ministries at the |
| central, provincial and district levels, and in the municipalities and | |
| public enterprises. | |
| 2. | The module of payment of salaries and pensions implemented. |
| 3. | The budget formulation module implemented (Phase II). |
| 4. | The asset management module and procurement interface implemented. |
| 5. | The ATM revenue management module implemented. |
| 6. | Program budgets under preparation by ministries. |
| 7. | The debt management module implemented. |
| 8. | The internal audit module implemented. |
| 9. | The Data Processing Centre (CPD) operating as an effective and |
| sustainable unit. | |
| 10. | Project Implementation Unit for SISTAFE operating as an effective and |
| sustainable unit. |
An “exit” strategy and fiscal sustainability
16. Domestic revenue needs to gradually increase to enable an orderly exit from donor dependence. Following the 2015 target to achieve the MDGs, donors could revert to or decrease foreign aid from present levels. As a result, the exit strategy from aid dependence should aim to raise domestic revenue during the next eight years so that at least recurrent spending can be financed from own resources. In this way, the government can avoid recourse to unsustainable domestic borrowing (or a disruptive expenditure contraction) to offset declining external assistance. To evaluate whether the authorities long-term revenue target, as described in the accompanying Joint World Bank/IMF Debt Sustainability Analysis (DSA) is sufficient to maintain a scaling-up of aid-financed expenditures in a sustainable manner, we illustrative a fiscal framework assuming a spending of an additional US$200 million from 2008-15 compared to the baseline presented in the staff report. 23 Given the absence of a costing of policies and sectoral interventions to achieve the MDGs, the increased expenditures is assumed to be divided between current and capital spending in a 1:2 ratio based on the historical distribution of aid shocks estimated in section B. 24 This is a simplifying assumption and would no doubt vary with the type of programs envisaged, but at least fulfills the requirement of planning for maintenance and hiring of additional personnel involved with most investments in priority sectors targeted towards achieving the MDGs.
17. The authorities’ ambitious revenue targets are adequate to gradually reduce donor-dependence and maintain debt sustainability in the event of a moderate scaling-up of expenditures. The projected revenue ratio of about 19½ percent of GDP in 2015 (increasing from14 percent of GDP in 2006) would cover both the scaled-up level of recurrent spending and a portion of the public investment program in the event of a US$200 million annual scaling-up of expenditures. 25 In addition, even if one assumed that all of the scaled-up spending was financed through concessional external borrowing, the external debt-to-export ratio would still remain below the indicative performance-based debt burden thresholds (e.g., NPV of debt-to-exports ratio of 150 percent for Mozambique), which take into account the empirical finding that the debt levels that a low-income country can sustain increase with the quality of its policies and institutions. This highlights the fiscal space available to scale-up concessional external borrowing focused on achieving the MDGs, partly as a result of MDRI aid delivery. A prudent external debt management strategy of avoiding recourse to non-concessional external borrowing has also helped and is assumed to continue. In addition, the low level of domestic public debt in Mozambique (about 8 ½ percent of GDP), due partly to the willingness of the central bank to mop-up excess liquidity through foreign exchange sales and thus absorb foreign aid, has also contributed to a low level of debt distress It should be noted, however, that exports, revenues, and real GDP growth will play an important role in defining the scope for expanded real government spending in the context of fiscal sustainability and an acceptable level of aid dependency. 26 Given this, and to safeguard the exit strategy, spending plans would need to be carefully reassessed regularly in light of the growth and Dutch-disease effects of the initial expansion in spending as well as realized revenue outcomes. As discussed in the Joint World Bank/IMF DSA any nonconcessional financing of large infrastructure projects would need to be considered case by case based on economic return, impact on debt sustainability, and potential effects on the financing decisions of donors and concessional lenders.
Fiscal Framework under an annual US$ 200 million Scaling-Up of Externally Borrowed Expenditures
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Framework under an annual US$ 200 million Scaling-Up of Externally Borrowed Expenditures
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
Fiscal Framework under an annual US$ 200 million Scaling-Up of Externally Borrowed Expenditures
Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A001
18. The ambitious revenue increase would need to be supported by continuing to implement revenue administration reforms and strengthening tax policies particularly the fiscal regime for exploitation of mineral and petroleum resources. Varsano et al., (2007) estimated the tax gap for Mozambique where actual tax collection is considered to be a function of the taxing capability, that is the maximum collection that would be possible to extract from it (which depends on the economic, social, institutional, demographic, and other characteristics of the country) and of the effort exerted in mobilizing funds for public use (determined by the tax laws and strictness with which the tax administration enforces them). The study concluded that Mozambique’s tax effort (ratio between actual collection and taxing capability) was one of lowest in SSA at about 50 percent, suggesting significant scope for raising revenues, up to a level of nearly 22 percent of GDP. Schenone (2004) also estimated the difference between potential collection and actual collection due to tax laws (exemptions and nonassessments) and to noncompliance (evasion). The study found that the latter portion is much larger than the former. The implication is that although there is room for achieving an expansion of the revenues through tax policy measures, the prospects are much greater for measures that increase the efficiency of the tax administration. 27 Importantly, this highlights the possibility of achieving medium-term revenue targets by widening the tax base without resorting to tax rate increases. The next phase of the revenue administration reforms (2007-10), to be supported by a multi-donor common fund, which will focus on implementing the central revenue authority (ATM) strategic plan, will be important in this regard. The ATM will be established through three stages: a transition period to end-2007, a gradual integration of the tax and customs agencies that will take place during 2008, and further strengthening and consolidation in 2009 and 2010.
19. Mozambique’s vast natural resources and present boom in commodity prices also provide a tremendous opportunity to attract greater foreign direct investment (FDI) in the mining and petroleum sectors aimed at maximizing fiscal returns and economic linkages, while minimizing environmental damage and social dislocation. Megaprojects in the mining and petroleum sectors have put Mozambique on the global FDI map, though fiscal revenues to date have been low due to generous fiscal incentives put in place to attract private investment during the recovery from the civil war. 28 Now that investor confidence in Mozambique is stronger, the authorities recognize that the fiscal contribution of new projects in these sectors could be substantially increased by reducing generous tax exemptions. As discussed in Hartley and Otto (2007), Mozambique is making important strides in this regard by putting in place a new fiscal regime for the mining sector and capacity building of personnel to negotiate effectively with multinationals through the use of financial models and model contracts. A significant amount of FDI has also flowed to the country’s petroleum sector. 29 Following agreements negotiated in 2000, the Pande-Temane gas field installations, processing facilities, and gas export pipeline to South Africa were commissioned in 2004 amounting to some US$1 billion FDI in all. The government has also secured more than US$300 million in petroleum exploration work commitments from the recent Rovuma Basin round, adding to perhaps US$200 million in planned drilling and evaluation activities on contract areas awarded earlier. Mozambique has the potential to become a significant regional gas producer. Companies are exploring both for oil, and for significant gas deposits that might supply liquefied natural gas export (LNG) facilities. The Pande-Temane project (including the pipeline) is currently in a period of cost recovery and high debt service, therefore government revenues have been modest, comprising mainly petroleum production tax and a small amount of corporate income tax, but these are set to increase significantly as production ramps up and joint venture investors have recovered their initial development costs. 30 Further exploration is continuing and sufficient additional reserves have been identified that the joint venture partners31 are considering a possible 50 percent expansion of the annual gas sales volume to around 180mmGj. Even though fiscal incentives were granted for petroleum exploration, and the investors benefit from stability assurances, the current combination of economic terms for exploration and production concession contracts (EPCCs), if properly administered, should yield a share of revenues for the government that is competitive (both for government and companies) by international standards. In addition, the authorities are presenting reviewing the petroleum fiscal regime and intend to put in place a comprehensive fiscal regime that would be embodied in the general tax law to avoid case by case negotiation of petroleum tax and production sharing terms. The present mining and petroleum projects in the pipeline including the multibillion dollar Moatize coal-mine project now under negotiation could yield revenues in the range of 2-4 percent of GDP beyond 2010. Further gas and oil discoveries would result in significant revenue contributions over the long term.
D. Conclusions
20. Mozambique has fully spent and mostly absorbed scaled-up foreign aid (ranging between 10-20 percent of GDP) over the last decade or so. The additional expenditures have allowed Mozambique to scale-up basic services including a doubling of the number of children in primary school, reduce infant and maternal mortality, and begin the provision of ARV treatment for HIV infections while at the same time sustaining economic growth of eight percent per year on average and reducing the poverty headcount index from 69 percent in 1997 to 54 percent in 2003. The pursuit of prudent macroeconomic policies and a first wave of structural reforms helped sustain the growth momentum by maintaining macroeconomic stability, and a sustainable fiscal and external position. Looking forward, illustrative scaling-up scenarios highlight the need to carefully manage a further scaling-up of foreign aid.
21. A modest scaling-up of foreign aid inflows (about 2 percent of 2008 GDP) could continue to be spent and absorbed aimed at achieving the MDGs. A scaling-up of spending, whether financed from donors or not, will tend to appreciate the real exchange rate and thus potentially hurt the export sector and long-run growth. Therefore, there is a need to effectively reach the most productive priority sectors (e.g., agriculture, education, health, infrastructure as defined in PARPA II) to illicit a supply response and mitigate potential Dutch-disease effects, by strengthening PFM systems while embarking on a public sector reform program to improve efficiency and public service delivery. Enhancing productivity growth not only requires greater productive public investments but also complementary second-generation reforms aimed at strengthening the business environment and buttressing agricultural production. It could, however, be the case that policymakers view the level of macroeconomic variables (e.g., inflation, real exchange) as well as macroeconomic volatility, even in a spend and absorb aid scenario, to be too large from a consumer welfare and/or long-term growth point of view depending on developments on the ground. This could be particularly relevant if the scaling-up is significantly larger or less persistent than the aid shock considered here or microeconomic capacity constraints start binding in some sectors. In such a case, the authorities may consider smoothing the expenditure pattern and saving part of the aid in international reserves to be spent and absorbed at a later date.
22. Debt relief and prudent macroeconomic management has provided fiscal space to sustain scaled-up spending, albeit with a continued need to consolidate long-term fiscal sustainability. The HIPC initiative and MDRI has reduced Mozambique’s debt levels and provided fiscal space to maintain a relatively high level of expenditures (about 25-30 percent of GDP) financed through concessional external borrowing and foreign grants. The authorities strategy of absorbing foreign aid through sales of foreign exchange and avoiding recourse to nonconcessional external borrowing has also helped create a conducive environment for scaled-up expenditures. However, given the low tax-to-GDP ratio and the need to guard against aid volatility and gradually reduce donor dependence, an annual average revenue increase of 0.5 percent of GDP should continue to be targeted through the CFMP, achieved by widening the tax base and improving revenue administration. Beyond the PARPA II period, strong growth and increased fiscal revenues from megaprojects—including the development of the multibillion dollar Moatize coal-mine project and Pande-Temane Gas Project—would help Mozambique maintain long-term fiscal sustainability and possibly allow it to start tapping international capital markets. This approach will provide an exit strategy from aid dependence in the long-run and ensure that at least recurrent spending can be financed from own resources.
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Prepared by Shanaka J. Peiris.
Mozambique’s new PRSP or Plano de Acção para Redução da Pobreza Absoluta II(PARPA II) for 2006-09 considers a modest increase in external financing including the MDRI and could be complemented with more detailed scaling-up scenarios in annual progress reports.
See Arndt et al., (2007) and World Bank (2005).
The deficit net of aid is equal to total expenditures (G) less domestic revenue (T) and is financed by a combination of net aid and domestic financing: G-T=Nonaid fiscal deficit = Net aid + Domestic financing.
The VARs were also estimated using detrended data. The results were largely unchanged from that of first-differencing the data, and thus are not reported here.
The Cholesky decomposition imposes the correct number of restrictions for just identification and imposes a recursive structure on the system; so that the most endogenous variable is ordered last, that is it is affected by all contemporaneous “structural” shocks.
It should be noted, however, that all donor-financed projects are classified as capital spending in the fiscal accounts although a significant share of such spending is likely on wages and goods and services. In addition, the unavailability of expenditures on a quarterly basis according to a functional classification also limits an analysis of the impact of foreign aid on the composition of spending.
The increase in government taxation allays concerns identified in Gupta et al. 2004 that grants can substitute for domestic revenues, and, hence, are more likely to dampen domestic efforts to collect more revenue.
Another issue frequently discussed in the literature is the degree of REER misalignment. Econometric results presented in the staff report, suggest that the REER may have potentially been overvalued at times of tight exchange rate management. As a result, export performance may be weaker than it could have been if the REER had been aligned with its underlying equilibrium rate. However, it is difficult to infer whether such deviations from equilibrium could be attributed to the response to aid in Mozambique.
See IMF (2005b) for a comparison of PFM systems undertaken for highly indebted poor countries.
IMF (2005a) defines aid absorption as the extent to which a country’s nonaid current account deficit (in foreign currency terms) widens in response to an increase in aid inflows. If one assumes that the capital account is closed as in Peiris and Saxegaard (2007), full aid absorption is equivalent to an unchanged level of international reserves in response to an aid shock. This latter definition is used in this chapter.
An analysis of the time-series properties of the variables revealed that the variables are integrated of order one or I(1), except for aid which is stationary I(0). Therefore, the series are detrended for estimation purposes to avoid the spurious and inconsistent regression problem (Hendry 1995). Results of Granger causality tests are somewhat inconclusive, showing little evidence of Granger causality in either direction, but lend support for a transmission of aid shocks to the domestic economy.
Quarterly GDP series are yet unavailable in Mozambique, therefore a quarterly GDP proxy was constructed statistically by estimating the correlates of real GDP annually and using predictions based on the quarterly explanatory variables.
Jones (2007) also shows that advances in education have contributed significantly to Mozambique’s growth.
A similar situation prevails in the health sector, particularly with regard to human resource constraints.
See Peiris and Saxegaard (2007) for the structure of the DSGE model, estimation, and steady-state calibration.
The calibration of the DSGE model uses the ratio of current-to-capital spending estimated for Mozambique.
Further analyses could also consider the impact of absorptive capacity, for example, through the World Bank’s Marquette for MDG simulations as piloted on Ethiopia (see Mattina 2006). This is particularly true for Mozambique, as it is one of the few countries in the range of saturation points for aid identified in the literature.
See World Bank (2006) for an agricultural strategy that would build on the present approach.
Public-participating institutions are enterprises with some private equity participation.
Note that the assumption of an additional US$200 million in foreign aid is based on an indication by donors of a likely scaling-up in 2008 compared to the baseline scenario presented in the accompanying staff report.
Note, however, that a concrete scaling-up scenario would preferably distinguish between the sectoral composition of spending, type of aid (e.g., project or program), and allocate adequate current expenditures to support the projected increases in investment including increasing demands on recurrent expenditures due to the cumulative impact of (aid-financed) public investments, which is not captured here.
However, one must take this result with caution given the uncertainties regarding the propensity of current spending in aid-financed expenditures and present classification of most donor-financed spending as capital expenditure.
Mozambique’s sovereign Standard & Poor’s credit rating (B) is expected to improve, especially by buttressing institutional capacity and maintaining debt levels closer to emerging market thresholds established by Bank-Fund debt sustainability analyses. This could allow Mozambique to access international capital markets to smooth any shortfalls in donor disbursement after 2015 and/or finance large infrastructure projects to realize its full growth potential.
For example, IMF (2005c) estimated that nearly 8 percent of GDP of the total 12 percent of GDP of the revenue gap in 2003 was attributed to noncompliance, especially VAT.
The mining sector is broadly interpreted to include Mozal, a megaproject, which produces aluminum billets from imported alumina using electricity generated by the Cahora Bassa hydroelectric plant.
Under the Petroleum Production Agreement the joint venture partners are allowed 25 percent depreciation, resulting in reduced income tax revenues in the early years of the project in addition to numerous other tax exemptions.
The joint venture partners are South Africa’s gas giant, Sasol (70 percent), a Mozambican state-owned enterprise, CMH (25 percent) and the international finance corporation (5 percent).
