Republic of Mozambique: Selected Issues
Author: International Monetary Fund
Publication Date:
31 Jul 2007
eISBN:
9781451931129
Language:
English
Keywords:
ISCR; CR; Mozambique; firm; Ilha de Moçambique; spend; BM loss; support bank soundness; supervisory capacity; Financial sector reform; Financial sector development; Government debt management; Bank supervision; Sub-Saharan Africa; Africa
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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.

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.

II. Evaluating Mozambique’s Financial Sector Reform Strategy32

A. Introduction

23. Financial sector development is an important objective of Mozambique’s poverty reduction strategy. Empirical evidence has consistently confirmed financial sector development as an essential enabler of sustainable economic growth periods. 33 Mozambique’s new PRSP (PARPA II in Portuguese) has taken that into consideration by selecting financial sector development as one of the main objectives of its economic development pillar. 34

24. Mozambique’s financial sector strategy provides some important lessons on how to manage financial sector reforms in low-income countries. While institutional obstacles continue to constrain financial intermediation, Mozambique has made substantial progress in promoting financial liberalization, and restructuring its banking sector over the past ten years. Mozambique is now deepening those reforms by strengthening the institutional regulatory architecture for financial sector development within the framework of a financial sector development strategy developed after the 2003 financial sector assessment of its financial sector. This chapter will take a closer look at the ongoing reforms with a view to assess the extent to which they address the most critical financing constraints, and are implemented with the appropriate ownership and coordination, so as to ensure the sustainability of the reform process. Section B summarizes the main weaknesses of the financial sector in 2002 and reform priorities resulting from the 2003 Financial Sector Assessment Program (FSAP). Section C outlines Mozambique’s current financial sector strategy. Section D takes stock of the reform progress to date. Section E concludes with some policy lessons and implementation challenges that lie ahead.

B. Diagnosing Mozambique’s Financial Sector

25. Though still small, and fairly underdeveloped in 2002, Mozambique’s financial system had come a long way since the end of the civil war—evolving from a government-owned system to a full-blown, market-based financial system. 35 Then, the financial system was dominated by foreign banks and highly concentrated with the five largest banks accounting for 96 percent of total deposits at end 2002 (Table 1). 36 The system had also become increasingly dollarized: foreign currency deposits, and loans accounting for 51 percent and 70 percent of their respective totals in 2002. The system’s role in financial intermediation was also underdeveloped even by regional standards, as reflected in its small credit to GDP ratio, and loan to deposit ratio. While Mozambican banks were deemed generally profitable, and well capitalized, they were exposed to significant credit risk as reflected in the high ratio of nonperforming loans (NPL) to total loans (21 percent at end-2002).

Table II.1.

Mozambique and Comparators: Financial Intermediation, 2002

article image
Sources: IFS, and Barth, Caprio and Levine (2004).

26. Mozambique’s high lending rates and poor financial intermediation were considered to be partly the result of high credit risk with deeper structural implications. Real lending rates in Meticais in the period 1999-2002 averaged 17.5 percent. Such high rates mostly reflected very large intermediation spreads, which according to a decomposition exercise conducted in the FSAP (Figure 1), were partly caused by high levels of NPLs made to state-owned enterprises and other non-compliant borrowers in the aftermath of the bank privatization process in the mid-nineties. This problem reflected the lack of a mandate and capacity to effectively supervise banks and was compounded by the lack of adequate reporting standards for effectively monitoring the soundness of bank lending. Other factors included (i) high overhead costs, partly reflecting the small size of the Mozambican financial system, (ii) high reserve requirements, and (iii) generally substantial profit margins, reflecting high bank concentration and limited competition.

Figure II.1.
Figure II.1.

Mozambique: Decomposition of Interest Rate Spreads in Meticais

Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A002

Source: FSAP (2003).Note: 2002 data from Bank of Mozambique.

27. Financial intermediation was also constrained by legal and institutional impediments. Mozambican’s high credit risk and poor financial intermediation were partly attributed to the lack of institutional capacity to (i) enable lenders to collect debt upon default including efficient debt enforcement for unsecured loans through the courts, comprehensive laws for taking and enforcing security through collateral systems, and efficient bankruptcy laws, and (ii) assist lenders in their credit selection decisions by disseminating information on borrower’s creditworthiness (Box 1). In the absence of institutions that facilitate loan recovery and contract enforcement, banks were led to adopt a conservative stance toward smaller borrowers in their lending policies by restricting access and pushing up lending rates. Lack of information on borrowers’ creditworthiness further aggravated this problem; indeed, it increased uncertainty regarding nonperforming loans forcing banks to increase loan loss provisions (with direct implications to the cost of credit), impose stringent collateral requirements, or simply refuse credit to applicants with no previous credit history. Business surveys at the time also corroborated this view by showing that, given the high cost of finance, and high level of collateral required, Mozambican enterprises were severely capital-constrained with an overwhelming majority using retained earnings to finance capital accumulation (World Bank 2003).

28. High and volatile real treasury bill rates were also partly affected by weaknesses in monetary and public debt management stemming from the unstable macroeconomic environment. 37 Mozambique has long been subject to significant supply shocks (e.g., related to weather and terms of trade) and to large fiscally-induced, demand shocks (i.e., unanticipated influx of external grants and loans). Weaknesses in the monetary framework and liquidity management operations have prevented monetary authorities from cushioning those shocks in a systematic, credible, and transparent way, causing, at times, substantial volatility in both prices and nominal interest rates (Box 2). Real interest volatility was further exacerbated by the shallow foreign exchange and public debt markets.

Institutional Roots of Poor Financial Intermediation in Mozambique

Mozambique’s lending environment was hampered by poor enforcement and securitization of lending contracts. As a result of inefficient courts, Mozambique ranked very poorly both regionally and internationally on contract enforcement, as measured by the high number of procedures, the long delays, and the high cost to enforce commercial contracts. Pledging real property as a collateral was also very difficult because of weak property rights; and complex and costly procedures to register and transfer property.

uA02bx01fig01

Mozambique: Days to Resolve Business Dispute, 2002

Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A002

Source: World Bank (2003).

The coverage and scope of credit registries in Mozambique was limited. Mozambique had no private credit bureau and its public credit registry run by the central bank, while generally a well-functioning institution had a narrow scope and lacked reliability. The public credit registry covered only about 11,500 borrowers (firms and individuals), did not include credit information compiled by nonfinancial institutions such as utility payments and retail credit, and has limited resources (only three full-time staff). Though the situation has since improved—borrowers increased to about 99,000 in 2006—its overall quality still falls short of regional best practices, and a number of ASEAN 4 countries.

uA02bx02fig02

Mozambique and Comparators: Credit Information Index 1/

Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A002

Source: World Bank (2007).1/ Index ranges from 0 to 6, w ith higher values indicating the availability of more credit information, from either a public registry or a private bureau, to facilitate lending decisions.

Weaknesses in Monetary Policy Management

Effective monetary policy and public debt management in Mozambique are compromised by weaknesses in the (i) monetary framework, and (ii) Bank of Mozambique’s (BM) net financial position.

The monetary framework lacked transparency. Market participants did not fully understand the goals or operational framework of the monetary policy. This partly reflected insufficient efforts of the BM in communicating with market participants, as well as inconsistencies in the use of instruments that send conflicting signals on the BM monetary policy stance.

BM’s fragile financial position risked its operational independence. While BM reported positive capital and declared operating profits in recent years, its net worth and profits become negative once valuation adjustments are properly accounted for. BM losses originated mainly from (i) accumulated foreign exchange valuation losses on BM external liabilities to foreign lenders, and (ii) operating losses stemming from the purpose of sterilization (costs of monetary policy) not transferred to the budget.

29. According to the 2003 FSAP, access to affordable finance was hampered by the poor outreach among financial institutions and its impact on savings mobilization. Financial savings mobilization was deemed constrained not only by Mozambique’s low-income levels but also by a thin branch network of banks, particularly in rural areas (Table 2). The situation was further aggravated by the relatively small size, and outreach of the microfinance industry. Constraints to providing financial services in rural and remote areas were widely noted to include very low population densities, weak or nonexistent markets, poor physical and communication infrastructure, and the local unavailability of skilled staff.

Table II.2.

Mozambique and Comparators: Savings Mobilization, Branch Density, 2002

article image
Sources: World Bank, World Development Indicators.

30. Nonbank financial institutions (NBFI) were small, nontransparent and subject to limited institutional and regulatory oversight. As such, they could mask sizeable contingent fiscal liabilities. The situation was particularly critical in the insurance and pension sectors, where supervisory capacity was weak and diluted between the Ministry of Finance (insurance) and the state pension scheme, INSS (pensions), which, in turn, had both an administrative and a prudential mandate.

31. Tackling the identified weaknesses in the financial sector required measures to (i) strengthen banking supervision and reporting standards, (ii) refine the management of monetary policy and public debt, and (iii) improve the institutional lending environment (Box 3). Measures to support the soundness of banks included addressing potential shortfalls in banking supervision and reporting standards. To limit the volatility in prices and interest rates, refinements in monetary policy formulation would need to be prioritized. Further, the reform efforts were to be directed toward improving the legal and institutional environment for lending followed by a more gradual process of reforms to promote the sound development of nonbank financial institutions initially by enhancing its regulatory and supervisory framework. Underlying FSAP recommendations, there was a clear sense that financial sector development should have been initially pursued through measures to ensure financial sector stability given the recent (and at the time not yet resolved) banking restructuring episode, and continued volatility in prices and interest rates.

C. Mozambique’s Financial Sector Reform Strategy

32. To address the above challenges, the government developed in collaboration with donors a comprehensive financial sector reform strategy. Financing for the capacity building and implementation of the strategy was provided as a multiple donor program under one umbrella referred as the Financial Sector Technical Assistance Project (FSTAP). Mozambique’s FSTAP is a comprehensive financial sector reform program focused on (i) strengthening the banking sector and enhancing the capacity of the BM in terms of banking supervision, managing the banking system, and financial infrastructure, including real time gross settlement system; (ii) improving financial accountability and transparency by the introduction of international financial reporting standards (IFRS) to commercial banks (first phase) and corporate entities (second phase); (iii) strengthening public debt management capacity, including the development of a debt management strategy and reorganization and strengthening of the public debt department of the Ministry of Finance; and (iv) improving money and government bond market efficiency and depth, including the introduction of a central securities depository. The IMF plays an important role in the FSTAP by providing technical assistance in a number of areas in close coordination with the government and other donors. The remainder of this section outlines the elements of this strategy by describing the main features of the FSTAP, including the prioritization and sequencing; financing, implementation and coordination arrangements, and monitoring.

Summary of Key FSAP Recommendations

Banking Supervision and Reporting Standards

  • Establish closer links with foreign shareholders and their supervisors;

  • Bring the loan classification system and loan loss provisioning system in line with international practices;

  • Strengthen and modernize supervisory functions through capacity building and reorganization;

  • Define a program towards full adoption of IFRS; and

  • Review the legal and regulatory framework for bank resolution.

Monetary Policy and Public Debt Management

  • Make monetary policy more effective by:

i. Ensuring consistency between the use of instruments and the policy framework to support the monetary targeting framework;

ii. Introducing new instruments (repos/reverse repos) for short-term liquidity management and direct foreign exchange interventions to smooth volatility in the foreign exchange market;

iii. Enhancing the central bank’s capacity to provide accurate and timely forecasts of short-term liquidity flows in coordination with Ministry of Finance; and

iv. Improving the central bank’s communication strategy by establishing a monetary policy strategy document and selecting ways to better disseminate monetary policy decisions.

  • Ensure BM’s operational independence by:

i. Transfering medium- and long-term foreign (HIPC) debts to treasury; and

ii. Reviewing accounting and profit transfer practices to shift monetary policy costs to the Ministry of Finance.

  • Strengthen public debt management operations by:

i. Improving information analysis and reporting and formulating a debt management strategy; and

ii. Restructuring the Public Debt Unit of the Ministry of Finance;

Institutional Lending Environment

i. Enact proposed amendments to BM law and the Banking Law;

ii. Review Commercial Code;

iii. Modernize the Notary Office, the Public Commercial Registry, and Code of Civil Procedure;

iv. Establish a special division of the Maputo City Court to execute judgments;

v. Update the legal framework for secured transactions; and

vi. Consider establishing a specialized commercial court.

Capital Market, Pensions, Insurance

i. Review regulation on capital controls and build up supervisory capacity;

ii. Improve accounting and disclosure standards for insurance and pensions; and

iii. Separate supervisory and administrative functions of state pension scheme (INSS).

Microfinance

i. Review draft legislation on microfinance.

Reform priorities

33. The government’s reform priorities were in line with the 2003 FSAP recommendations. Given the dominant role of banks in Mozambique’s financial system and in particular its fragile state at the time the reform was conceived the government reform strategy prioritized measures to (i) support bank soundness by promoting transparency and disclosure, and by strengthening of BM’s supervisory capacity; and (ii) deepen financial markets denominated in local currency through a concerted effort to strengthen monetary, foreign exchange, and public debt management. The strategy also included measures to reform the institutional lending environment with a view to improving access to credit. Given its small size, more fundamental reforms to support the development of markets for longer term financial obligations (e.g., pensions, insurance, and housing) were left to a later stage with immediate priority given to strengthen supervisory capacity in line with those envisaged for the banking sector so as to avoid regulatory arbitrage.

Reform areas and donor involvement

34. The reform strategy has been operationalized into one project with ten components supported by multiple donors (Box 4, Table 3). The reform priorities to improve banking soundness and deepen money and debt markets have four components and are being financed by the World Bank (IDA) with the IMF, the United Kingdom’s Department of International Development (DFID), and Sweden International Development Association (SIDA) providing complementary technical assistance. The African Development Bank (AfDB) supports four components in the areas of institutional lending environment, development of pension and insurance markets, and anti-money laundering. The German Technical Cooperation (GTZ), and the German Fund for Reconstruction (KfW) jointly managed and finances a component looking at measures to improve access to financial services by supporting microfinance and rural finance institutions. 38 Besides the nine technical components referred above, a tenth administrative component financed and managed by the World Bank established a project implementation unit responsible for all fiduciary activities (accounting, reporting, and auditing).

Table II.3.

Mozambique: FSTAP Support by Components and Agencies

article image
Source: World Bank (2005).Note: 1/ Provided in collaboration with the International Fund for Agriculture Development outside FSTAP under the Rural Finance Support Program.

Implementation and coordination arrangements

35. Mozambique’s financial sector reform strategy incorporates novel implementation arrangements. As discussed above, while funding for each project is provided separately by multiple donors, ultimate responsibility for implementation lies in the project implementation unit (PIU). The PIU is headed by a project coordinator who reports to the Ministry of Finance and is responsible for providing guidance on procurement of goods and services, monitoring and evaluation, and the overall thrust of financial sector reforms. In line with the guidelines for harmonization and alignment established under the Paris Declaration for Aid Effectiveness, this arrangement seeks to reduce transaction costs and promote donor coordination by avoiding the duplication of parallel implementation units, while fostering country ownership and coordination as the ultimate responsibility for implementation lies in one government agency.

Monitoring and evaluation

36. The reform strategy is monitored by measurable performance indicators and systematically evaluated by government and development partners. An action plan (i.e., a results framework matrix specifying objectives and corresponding performance indicators) for each of the FSTAP components spans the program’s five years. 39 On the basis of these results frameworks, quarterly monitoring tables, and progress reports are prepared by the PIU and discussed by a technical working group (TWG) jointly chaired by the PIU coordinator, its procurement officer and representatives of the beneficiaries government agencies involved. Actions identified as high priority by the government and donors within the results framework are also included in the Performance Assessment Framework (PAF) Matrix, which is the common monitoring mechanism used by the government and donors to evaluate progress on the overall poverty reduction strategy on an annual basis. A medium-term review of the strategy is expected to take place at the end-2008, which will include an assessment of the effectiveness of the reform program and will be preceded by a reappraisal of the identified obstacles to the soundness and depth of Mozambique’s financial system (the latter in the context of an FSAP update).

Key Elements of the Reform Strategy: FSTAP Components

Technical and financial support for Mozambique’s financial sector reform strategy is provided through the FSTAP under its nine components; a list of some of their corresponding key measures is described below.

Component1: StrengtheningBM’sInstitutionalCapacity

(i) Support BM’s Banking Supervision Department (BSD) towards full implementation of Basel I principles including preparation of new inspections manuals, drafting of prudential regulations (focus on loan classification and consolidated supervision), and on-the-job training;

(ii) Consultancy services to assist BM draft a bankruptcy law applicable to financial institutions;

(iii) Prepare a supervisory framework and training for NBFIs on new risks (anti-money laundering; new instruments (electronic banking, leasing, and factoring);

(iv) Improve information technology and transition of central bank accounting into IFRS including revision of the Chart of Accounts;

(v) Strengthen analytical capacity at BM’s research department; and

(vi) Divest the government of its remaining shareholdings of financial institutions.

Component2: ImprovingFinancialAccountabilityandTransparency

(i) Adopt and implement IFRS applicable to commercial banks;

(ii) Transition of corporate sector to IFRS;

(iii) Establish a central securities depository for government debt instruments; and

(iv) Implement effective procedures for the registration of private debt in the BM.

Component3: StrengtheningPublicDebtManagement

(i) Formulate a public debt management strategy;

(ii) Improve liquidity management policies and procedures;

(iii) Restructure the public debt unit of the Ministry of Finance and strengthen procedures and controls, and staff capacity building including information analysis and reporting; and

(iv) Consolidate and reconcile the debt database for all public debt.

Component4: ImprovingMoneyandDebtMarketsandFinancialInfrastructure

(i) Improve primary and secondary government debt market; and

(ii) Improve the monetary policy framework and develop the repurchase (repo) market.

Component5: MicroandRuralFinance

(i) Support strengthening of micro and rural finance institutions; and

(ii) Promote rural expansion and the integration of microfinance institutions (MFIs) in the financial system.

Component6: StrengtheningtheInsuranceandSupplementaryPensionSystem

(i) Fine-tune insurance law to (a) adopt international best practices in the regulation of insurance contracts, (b) provide guidelines on investments by insurance companies to ensure risk diversification; and (c) empower Mozambique’s insurance regulator (IGS);

(ii) Establish a supervisory framework and prudential regulations to guide the conduct of the insurance sector;

(iii) Develop pension funds legislation; and

(iv) Improve capacity at IGS.

Component7: StrengtheningtheSocialSecuritySystem

(i) Conduct a study on affordable options for improving social security coverage;

(ii) Address INSS organizational, transparency, and accountability deficiencies; and

(iii) Perform an actuarial analysis of the compulsory social protection system.

Component8: Improvingthelegalandjudicialenvironmentforfinancialtransactions

(i) Develop a new Bankruptcy Law;

(ii) Establish commercial sections in the Judicial Tribunals of the City of Maputo and the Provinces of Beira and Nampula;

(iii) Modernize and link the property registries electronically; and

(iv) Enhance the scope and reliability of the credit registry. Component9: SupportforAnti-MoneyLaunderingEfforts (i) Establish the Financial Intelligence Unit.

Component10: SupportforProjectImplementation

(i) Finance implementation costs with consultancies, financial advisor, personnel, training, and office equipment.

Source: World Bank (2005).

Capacity building

37. Capacity building is a central element in Mozambique’s financial sector reform strategy. The success and sustainability of reform programs depends to a large extent on local capacity to analyze issues and to redesign and implement strategies in the face of changing circumstances. The FSTAP accordingly includes capacity building measures in most of its components. The IMF plays an important role in this regard providing technical assistance in close coordination with other FSTAP agents to improve BM’s liquidity management, monetary and exchange rate policy operations, and financial sector supervisory capacities. In consultation with government authorities and donors, a technical assistance strategy specifying priority areas and modes of delivery has been prepared (Box 5).

IMF Technical Assistance Strategy

IMF technical assistance priorities are: (i) making monetary policy more effective; (ii) further strengthening the supervisory and regulatory framework to foster the sound expansion of the financial sector and achieve full compliance with international standards in accounting, anti-money laundering, and banking supervision; and (iii) developing interbank foreign exchange market and government debt management capacity to support financial deepening and smooth monetary policy transmission. These priorities are supported by

  • Annual multi-topic TA missions to follow up on financial sector reforms with targeted peripatetic expert visits in priority areas including bank supervision, liquidity forecasting and monetary operations.

  • An FSAP update in 2008 to take stock of reforms to date and map out future reform priorities with regard to access, cost of finance, and financial stability.

D. Taking Stock of the Reform Progress

Reform effort to date

38. Efforts since the 2003 FSAP have focused on restructuring and strengthening the supervision of Mozambique’s banking system. Mozambique’s bank privatization process has been plagued by lack of due diligence resulting in costly recapitalizations from the government during 2000-02. 40 However, over the last four years, the government has demonstrated its commitment to return banks to private ownership and remains a minority shareholder of only one bank for which intentions to withdraw have already been publicly announced. Reform efforts have also been more pronounced in the area of banking supervision and reporting standards (Box 6). To dispel uncertainties about the overall condition of the banking system following the restructuring, the government allowed the comprehensive diagnostic reviews of the major banks in Mozambique by international firms according to IFRS. These reviews, which were concluded in 2005, endorsed the overall soundness of the banking system. A new law strengthening the BM’s supervisory and enforcement mandates has also been implemented with capacity building being provided by the IMF, World Bank, and other donors.

Strengthening Banking Supervision and Regulatory Environment in Mozambique

Measures adopted after the FSAP included:

  1. Comprehensive diagnostic reviews of the major banks by international firms according to IFRS (completed in 2005).

  2. The implementation in 2004 of a new Financial Institutions Law strengthening the central bank’s supervisory powers and introducing more strict penalties for noncompliance violations.

  3. Continued progress to strengthen banking supervision practices in line with Basel Core Principles (BCP) by (i) building on- and off-site supervisory capacity; (ii) requiring the preparation of financial statements of Mozambique’s financial institutions and corporate sector in compliance with international, and (iii) adopting prudential regulations in line with international best practices.

  4. Adoption of IFRS by the BM in 2006 and by commercial banks in 2007.

39. While there has been some recent progress in improving the monetary framework, important measures to enhance monetary policy operations and public debt management have yet to be implemented. The BM has taken important steps to strengthen its monetary policy operations by increasing the use of foreign exchange sales to sterilize excessive liquidity and allowing the issuance of treasury-bills for monetary policy purposes. Monetary authorities are currently working to implement several measures to improve its liquidity management practices and forecast, to ensure its operational independency, and to deepen its foreign exchange, money, and debt markets (Box 7).

40. Reform in the institutional lending environment has been more recent. Among the few achievements on the legal front have been the implementation of the new Commercial Code, and the establishment of the commercial sections of the judicial tribunals in the cities of Maputo, Beira, and Nampula. The former will help relieve the overburdened judicial system by avoiding commercial disputes. The latter, which will become operational in 2007, is expected to accelerate debt recovery of unsecured lending once appropriate equipment; facilities and capacity building are provided. Debt recovery is expected to be accelerated even further once a revised Civil Procedure Code with streamlined judicial procedures is enacted. However, despite these encouraging steps, significant measures to improve the lending environment are still required (Box 8).

41. The government has taken initial steps to support a sound expansion of NBFIs. The BM has started to license and supervise deposit-taking MFIs. A new law on social protection recently submitted to the Assembly will help strengthen the social security and supplementary pension system. As part of the restructuring of the INSS, an actuarial study to determine whether the current level of contributions is capable of sustaining the scheme of benefits covered will be completed before the end of 2007. The government is also enhancing the regulatory and supervisory framework for the pension and insurance sector. The Insurance Law is being reviewed in line with international best practices, and revised prudential and solvency requirements for Mozambican insurers are being developed, while new IFRS-compliant Chart of Accounts for insurers will also be designed. New supplementary pension funds regulations are also being prepared. Looking ahead, the focus would need to shift to strengthening the capacity of industry regulators.

42. Increasing attention is being devoted to rural financing issues. As part of the overall reform effort to increase access to financial services in rural areas, the government has recently launched a package of initiatives to enhance the physical presence of banks in rural districts. Proposed measures are mostly targeted to reduce the operational costs of providing banking services in rural areas through the provision of fiscal incentives, infrastructure improvements, and by relaxing legal reserve requirements in rural branches so as to include cash in vault. 41 Transport costs related to the constitution of legal reserves, and cash in vault for immediate withdrawal have been further minimized with the opening of BM branches in selected districts.

Strengthening Monetary and Public Debt Management in Mozambique

Monetarypolicyframework. The BM has adopted a money targeting framework using base money as the operational target. In order to improve BM’s transparency and communication vis-à-vis market participants, the BM has approved a long-term monetary policy strategy document clarifying the money targeting framework, defining a new format for the monetary policy committee, and specifying its communication policies. The central bank has also made good progress in increasing its analytical capacity through the development of databases and the use of standard monetary models to assess the appropriateness of the monetary policy stance. Work is ongoing to translate the annual and quarterly monetary targets into a liquidity management plan that separates the management of short-term “temporary” and long-term “structural” liquidity resulting from government domestic expenditures mainly financed through foreign donor inflows. The BM will introduce repos in 2007 to fine-tuning “temporary” liquidity variations, and is working to ensure an “appropriate” mix of foreign exchange sales and net treasury bill issuance to sterilize structural liquidity to facilitate absorption of foreign aid, with clear signaling of sterilization and intervention actions in the foreign exchange market. The deepening of debt and foreign exchange markets will also be needed to avoid undue movement in interest rates and exchange rates.

CentralBankoperationalindependence. Despite the recent recapitalization agreements reached between the BM and the Ministry of Finance, central bank operational independence in conducting monetary policy has yet to be ensured through a more comprehensive agreement to shift the corresponding costs to the Ministry of Finance. In this regard, the two institutions are currently discussing the operational details of specific modalities to be included in a memorandum of understanding expected to be signed by both parties in 2007.

Centralbankliquiditymanagement. The BM is in the process of refining its liquidity monitoring and forecasting with technical assistance from the Fund. Further technical assistance is needed to enhance the BM’s capacity to accurately forecast short-term liquidity flows in the financial system and manage “temporary” fluctuations liquidity using appropriate instruments. Of critical importance are improvements in the information provided by the treasury on its daily cash flows and introduction of repos to fine-tune temporary liquidity variations (see above).

Publicdebtmanagement. Reform is still in its early stages. The government needs to develop a strategy for the management of domestic debt, and the public debt department at the Ministry of Finance will need to be restructured and its staff trained.

Treasurybillandmoneymarkets. While recent progress was achieved with the removal of interest caps on T-bill auctions, more needs to be done to promote an active and liquid market for government securities. At the top of the list would be improving the enforcement of the legal framework governing the transfer of securities and the implementation of a real time gross settlement (RTGS) system to foster the development of a secondary market. On the latter, the government has just submitted a draft law on a new national payment system. An analysis of the main obstacles to the development of money and secondary debt markets is expected to be concluded by end-2007. In addition, the BM is also starting to look for alternative secondary debt market models so as to deepen Mozambique’s secondary T-bill and T-bond markets.

Foreignexchangemarkets. Important steps have recently been taken regarding the interbank foreign exchange market (MCI) with the gradual removal of price caps (foreign exchange auctions and MCI), and measures to promote the practice of firm quotations among market participants. MCI reforms needs to be pursued further by ensuring the complete removal of any remaining price caps, and the adoption of an appropriate collateral system.

Strengthening Mozambique’s Lending Environment

Framework for secured transactions. Additional measures include the updating of the legal framework for secured transactions. The recent enactment of a decree on urban land use and corresponding regulations was an initial step in this direction; it is expected to facilitate the use of urban land as a collateral by reducing the time and costs involved in transactions. Next steps in this area would need to tackle the modernization and linking of property registries and the implementation of a new Insolvency and Bankruptcy Law.

Enhancement of the scope and reliability of the credit registry. Reform effort is just starting in this area with assistance from the World Bank- International Finance Organization (IFC) and the Millennium Challenge Corporation (MCC). The BM with assistance from IFC will conduct a feasibility study to examine options to increase the scope and reliability of its credit registry.

Gauging the reform impact

43. Financial sector reforms to restructure and strengthen the supervision of Mozambique’s banking system are starting to enhance financial intermediation. While still incomplete, these reforms appear to have contributed to improvements in the soundness of the banking system: nonperforming loans have declined markedly, and bank profitability has recuperated (Figure 2). Greater confidence in the banking system combined with the adoption of prudential measures has led to a significant decrease in financial dollarization and thus lower financial vulnerability. 42 Such improvements seem to have presented positive spillovers to financial intermediation (Figure 3). Real lending rates and spreads have been on a declining trend since 2002 with private credit growth starting to pick up more recently, particularly in domestic currency.

Figure II.2.
Figure II.2.

Mozambique: Bank Soundness Evolution, 2000-06

Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A002

Source: Bank of Mozambique.1/ Non- performing loans are defined according to Mozambican accounting standards (they include only part of the past due loans).
Figure II.3.
Figure II.3.

Mozambique: Financial Intermediation Evolution, 2000-06

Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A002

Source: Bank of Mozambique.

44. Despite some recent improvements, access to affordable credit remains a top constraint. Recent business surveys continue to identify the high cost of finance as the top constraint to private sector growth: access to financial services is among the top three constraints (Table 4). Access to finance is also a major constraint to firm growth in Mozambique: more than 70 percent of firms do not have access to a bank loan or to overdraft facilities (the number even higher for small and medium-sized enterprises (SMEs), according to the 2003 ICA and 2006 CTA-MPD survey (World Bank 2003, Ministry of Planning and Development 2006)). Access to credit in the agriculture sector is also an issue, as indicated by its shrinking contribution to total credit (Figure 3) and poor microfinance outreach in rural areas (Box 9). This seems to suggest that some of the most binding constraints to financial intermediation have yet to be tackled.

Table II.4.

Mozambique: Developments in Perceived Constraints

article image
Souce: MPD (2006).Note: 1/ Average across firms of judgements on how much listed factors constrain the operation and growth of their business; where 0 = no obstacle, 1 = slight, 2 = moderate, 3 = major; and 4 = serious obstacle.

Microfinance in Mozambique

The microfinance sector has grown markedly in the past decade. Growth both in the number of clients and, especially in the outstanding loan portfolio was considerable (about a five and seven-fold increase from 2000 to 2005). Consolidation also seems to be underway: three institutions out of about thirty-five control more than 68 percent of the active loan portfolio. There are also some indications of institutional growth, meaning that the number of MFIs with higher client numbers has grown. In 1998 there were only two operators with more than 1,000 clients. By 2005 half the MFIs had more than 1,000 clients. Growth has also been accompanied by a substantial improvement in performance. The percentage of MFI with recovery rates considered acceptable (90 percent or above) increased from 16 percent in 1997 to about 30 percent in 2005.

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Mozambique: Growth in Microfinance Activities

Citation: IMF Staff Country Reports 2007, 258; 10.5089/9781451931129.002.A002

Source: Mozambique Microfinance Facility, Survey of Microfinance Operators.

However, MFIs’ outreach, particularly in rural areas remains very limited. About 62 percent of MFIs and 50 percent of microborrowers are concentrated in the Maputo-Matola urban corridor: rural areas account for less than 12 percent of borrowers and only 5 percent of the total active portfolio. To some extent, this disparity in microfinance provision seems to reflect the large concentration of nonagricultural informal activities in the province of Maputo or Maputo City. Preliminary data for 2005 on informal sector activities published by Mozambique’s national statistical agency show that of the nonagricultural informal sector activities, 42 percent of those involved in trading and 48 percent of those involved in services (excluding transport) are located in those areas.

45. While broadly in line with identified priorities, reform implementation in some areas needs to be intensified. Emphasis has been rightly placed on finalizing the banking restructuring process and improving banking supervision. However, the prevalence of the high cost of, and limited access to, credit among SMEs, and limited credit growth in the agriculture sector seems to indicate the need to step up reform efforts to improve the institutional lending environment, as well as measures to improve banks and MFI outreach in rural areas. The pace of reforms in monetary and public debt management, while satisfactory overall, have been slower than envisaged, in the areas of liquidity and public debt management. As a result, interbank and secondary markets remain shallow, limiting the effectiveness of monetary policy and the pace of capital market development. The next section flags the positive aspects of the reform strategy that could usefully be preserved and disseminated as lessons, as well as challenges that need to be confronted to further strengthen the strategy’s effectiveness.

E. Strengthening the Strategy: Lessons and Challenges

46. There is scope to further strengthening Mozambique’s reform strategy. This section identifies lessons learned and some near term challenges. It will serve mostly as groundwork for a more comprehensive assessment envisaged for 2008, which will encompass a planned FSAP update along with the FSTAP midterm review. Mozambique’s financial sector strategy will be revised on the basis of these assessments with a particular focus on accelerating financial sector development.

Lessons learned

47. Mozambique’s financial sector reform strategy by rightly addressing the key weaknesses in the design and implementation of reforms in low-income countries has some important lessons to offer.

  • Gettingdiagnosticsandprioritiesrightisanimportantstartingpoint. Obstacles to financial sector development abound in low-income countries. As such, countries would benefit by making full use of recent diagnostics exercises in the design of the reform strategies, paying particular attention to the proposed prioritization. This strategy has paid off in Mozambique, where the proposed financial sector reform strategy has taken full advantage of the diagnostics, and recommendations of a preceding FSAP. In particular, FSAP- proposed prioritization has allowed for targeted and more effective interventions, thus building the political capital of reformers and thus reform momentum.

  • Closeattentionneedstobepaidtoinstitutionalarrangementsthatensuregovernmentownershipandcoordinationofthereformprocess. Mozambique’s financial sector reform strategy has taken into account the transaction and accountability costs of implementing reforms in an environment with multiple financiers on one side, and government beneficiaries, on the other. While the FSTAP stops short of being financed by a common fund, there is a clear division of labor, and financing responsibilities among donors regarding reform areas. Moreover, the adoption of a common implementation unit to deal with aspects related to procurement, monitoring, and evaluation of all projects further contribute to donor coordination and reduced transaction costs. In addition, making the unit directly accountable to a single government ministry but responsive to a committee of all beneficiaries strengthened government ownership while promoting intragovernmental coordination.

  • Capacitybuildingisanessentialelementtosustainthereformprocess. The success and sustainability of reform programs depend to a large extent on local capacity to analyze issues and to redesign and implement strategies in the face of changing circumstances. The FSTAP takes that into consideration by including capacity building measures in each of its components.

  • Measuringperformanceisalsokey. The availability of easily measurable outcomes is essential to gauge the reform progress, identify reform bottlenecks, and ensure accountability. Mozambique’s results framework has been particularly useful in this regard.

Challenges ahead

48. Improving access to affordable finance remains a key challenge. With the soundness of the banking system restored, reforms to improve financial sector intermediation and access to financial services are assuming center stage. Policies and reforms in this area will need to continue to strengthen the lending environment and facilitate the outreach of banks and MFIs and other privately provided financial services to SMEs and rural areas. In this regard, the recently announced rural financing strategy is particularly welcomed. Reflecting a satisfactory consultative process with banks, it tackles some of the main impediments to bank branch development, including less stringent reserve requirements. Looking ahead, it would be important to identify new quick wins. In this regard, special attention could be given to credit registries, particularly by expanding their scope and making sure that their coverage increases in line with outreach growth. 43 The alternative of using leasing and factoring agreements could also be explored.

49. Capacity building and human resource mobilization would need to keep pace with reforms to strengthen monetary policy formulation and deepen monetary and public debt markets. Reforms to improve the efficiency of primary debt markets, and reduce segmentation in the interbank market with the introduction of repo operations could be accelerated. Along with the implementation of a RTGS system, such pacing would help deepen the market for government securities, thus establishing a benchmark for future capital market development. Capacity building and resource mobilization at the BM and Ministry of Finance will remain a main priority in the near term so that participants can tap deepening monetary and debt markets. At the BM this will require the permanent mobilization of resources towards policy and operations so as to (i) systematically assess the monetary stance and select the appropriate mix of instruments, (ii) conduct repo transactions, and (iii) communicate and justify BM’s actions to market participants in a transparent way. Capacity building could also be enhanced at the Ministry of Finance, where the public debt department needs to be reorganized, and its staff trained with a view to strengthen information and analysis reporting.

50. Supervision and accounting standards need to be strengthened beyond the banking sector to ensure the soundness of an expanding financial system. In the near term, introduction of risk-based supervision and international reporting standards in the banking sector will facilitate monitoring of capital adequacy during a period of strong credit growth. Rolling out IFRS standards to the corporate sector will further reduce credit risk by improving the ability of the financial system to evaluate the quality of their loan portfolios. Looking ahead, the sustainability of the national pension fund needs to be secured through a restructuring based on an actuarial study. A strengthening of the supervisory framework for the growing nonbank financial sector is becoming more important. In this area, special attention could be given to microfinance and other institutions catering to the poor and unbanked. The regulatory and supervisory framework will need to continue to strike a balance between ensuring soundness and sustainability without compromising growth and outreach.

51. Preserving the positive institutional features of the reform strategy will also be key to keep the reform momentum. In this regard, it will be important to ensure that the FSTAP remains the umbrella under which financial sector reforms are conducted in Mozambique. In the same vein, government and donors would benefit by fully relying on the FSTAP implementation arrangements when pursuing new initiatives. In particular, rather than transferring the Micro and Rural Finance component from the FSTAP to the IFAD project, the government could usefully consider increasing the coordination and sharing of information among these two projects. Equally beneficial would be the integration of the IFC-MCC project on credit registry to the FSTAP so as to avoid a duplication of implementation and monitoring arrangements and the increasing transactions costs they entail.

Appendix. FSTAP Action Plan

Table II.A.

Mozambique: FSTAP Results Framework Matrix - Selected Key Actions 1/

article image
Source: World Bank (2005).

Please refer to source for a complete description of the results framework matrix.

Large (medium) enterprise is defined as a company with greater than 1,000 (250-1,000) employees.

Sequencing and targets on Component Five were not determined.

References

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32

Prepared by Victor Lledó. This chapter has benefited from valuable comments from the Bank of Mozambique and the World Bank.

33

See Levine (2005) for a survey of the empirical literature and IMF (2006) for an analysis of the Asian experience.

34

PARPA II has three pillars (i) governance, (ii) human capital, and (iii) economic development. The economic development pillar, in turn, focuses on promoting private sector development, including through measures to increase the soundness and depth of the financial system.

35

2002 was the latest year for which data were available at the time of the FSAP diagnostics.

36

This high level of concentration was mostly due to the merger of the parents of the two largest banks in their home market of Portugal.

37

Boyd, Levine, and Smith (2001) have shown that low levels of financial intermediation are partially explained by high volatility in interest rates and monetary aggregates, a result that was robust to reverse causation and simultaneity bias.

38

Access to financial services in rural areas is also being addressed by a joint AfDB/ International Fund for Agriculture Development (IFAD) under the Rural Finance Support Program (RFSP). This projects aims to support policy, legal, regulatory, and institutional aspects of rural finance.

39

The results framework matrix is summarized in the appendix.

40

The privatization process started in the mid-1990s. Subsequent crises at both Banco Austral and Banco Comercial de Mozambique required recapitalizations, amounting to 6 percent of GDP.

41

Fiscal incentives in the form of grant and loan resources are partially provided under the Rural Finance Support Program (RFSP) financed by the AfDB and IFAD.

42

The strong decline in credit in foreign currency was particularly driven by the implementation of a prudential measure to provision 50 percent of foreign-currency denominated loans to nonexporters introduced in July 2005 (Notice 5/2005). This decrease was, however, accompanied by an increase in applications for private external financing.

43

Expanding the scope and coverage of credit registries have usually been regarded as less controversial than reforms to bankruptcy or property laws. It has also emerged as a partial substitute for institutions ensuring creditor rights (Djankov et al 2006).

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Republic of Mozambique: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2007: Issue 258
Publisher:
International Monetary Fund
ISBN:
9781451931129
ISSN:
1934-7685
Pages:
70
DOI:
https://doi.org/10.5089/9781451931129.002

Mozambique: Decomposition of Interest Rate Spreads in Meticais

Mozambique: Days to Resolve Business Dispute, 2002

Mozambique and Comparators: Credit Information Index 1/

Mozambique: Bank Soundness Evolution, 2000-06

Mozambique: Financial Intermediation Evolution, 2000-06

Mozambique: Growth in Microfinance Activities