Republic of Mozambique
2007 Article IV Consultation, Sixth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, Request for Waiver of Performance Criterion, Financing Assurance Review, and Request for a Three-Year Policy Support Instrument: Staff Report; Staff Supplement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Mozambique
Author: International Monetary Fund
Publication Date:
31 Jul 2007
eISBN:
9781451827316
Language:
English
Keywords:
ISCR; CR; debt; NPV; Mozambique; real GDP; central bank; trade balance; banking system; IMF staff estimate; current account; Exports; Global
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This paper discusses the Republic of Mozambique’s 2007 Article IV Consultation and Sixth Review Under the Poverty Reduction and Growth Facility (PRGF). The post-conflict rebound has largely run its course, and first-generation reforms are completed; a second wave of reforms is needed to sustain broad-based growth and further reduce poverty. Achieving the non-income-related Millennium Development Goals also requires scaling up basic services without undermining macroeconomic stability. The PRGF program helped maintain macroeconomic stability in the face of exogenous shocks and addressed the structural weaknesses identified in the Ex Post Assessment.

Abstract

This paper discusses the Republic of Mozambique’s 2007 Article IV Consultation and Sixth Review Under the Poverty Reduction and Growth Facility (PRGF). The post-conflict rebound has largely run its course, and first-generation reforms are completed; a second wave of reforms is needed to sustain broad-based growth and further reduce poverty. Achieving the non-income-related Millennium Development Goals also requires scaling up basic services without undermining macroeconomic stability. The PRGF program helped maintain macroeconomic stability in the face of exogenous shocks and addressed the structural weaknesses identified in the Ex Post Assessment.

I. Economic Resilience Supported by Prudent Macroeconomic Policies

1. Mozambique’s macroeconomic performance has been strong since the 2005 Article IV consultation. After some slippages, notably fiscal overruns as the December 2004 elections approached, President Guebuza’s new government has shown firm commitment to prudent macroeconomic policies in an uninterrupted PRGF-supported program. The stronger policy framework and reinvigorated structural reform agenda have helped make the economy more resilient to exogenous shocks; robust growth; moderate inflation; and a sustainable fiscal and external position have prevailed:

  • Real GDP growth accelerated to about 8 ½ percent in 2006, led by a rebound in agricultural production after the localized drought of 2005 and by continued activity in the construction sector (related to megaprojects and donor-financed projects).1

  • Prudent monetary policy helped lower core (nonfood) inflation to single digits in the second half of 2006, reversing a temporary rise after a spike in petroleum prices. Headline inflation declined to 4.9 percent in March 2007 after being above target at the end of year 2006 because of an unexpectedly large seasonal increase in food prices.

Mozambique: Selected Economic Indicators 2004-07

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Source: Mozambican authorities; and IMF staff estimates and projections.
Figure 1.
Figure 1.

Recent Economic Developments

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Sources: Mozambican authorities; and Fund staff estimates and projections.

  • The 2006 currency reform went smoothly. The BM introduced new meticais (MT) on July 1, 2006 (1,000 old MTs equal one new one); about 95 percent of MT in circulation by the end of March 2007 were new. Because of volatility in currency demand around the deadline for exchanging old currency for new, base money was above the end-year 2006 target (a performance criterion), though it fell below by January 2007 and was within the indicative target for March 2007.

  • The trade balance has gradually improved despite the oil price shock. With prices for commodities (particularly aluminum) booming, megaproject exports have surged over the past two years; nonmegaproject exports (cashews, sugar, and seafood) also rebounded after the 2005 drought and the MT appreciation of 2004 began reversing. Strong exports, along with sustained foreign aid inflows, helped keep net international reserves (NIR) at a comfortable level (about US$ 165 million higher than programmed at the end of 2006).

uA01fig01

Currency reform was successful

(Percent change)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Sources: Mozambican authorities; and IMF staff estimates.
uA01fig02

Trade balance is improving

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Sources: Mozambican authorities; IMF staff estimates; and IMF, Information Notice System.1/ Imports of gasoline, gasoil, and others subcategory.

  • The foreign exchange market has stabilized. Mozambique experienced bouts of rapid exchange rate depreciation after January 2005, when it moved to a more flexible exchange rate regime by introducing foreign exchange auctions. The volatility appears to have stemmed in part from correction of a somewhat overvalued exchange rate at the end of 2004, lumpy oil import transactions, and portfolio shifts in the shallow foreign exchange market. In response the BM introduced a temporary band in both the foreign exchange auctions and interbank market (MCI) in November 2005. Initially, the band in the auction market led to widening of the premium between the auction rate and the rate banks charged customers and foreign exchange bureaus. The band in the MCI market also discouraged transactions between banks at quoted rates, although such transactions continued outside the MCI market. However, as the BM gradually widened the bands in both the auction and MCI markets, the spread between the auction rate and rates for bank customers and bureaus fell to pre-band levels. Transactions in the MCI market also increased as onscreen quotations by banks were able to move closer to the rate outside the MCI market. The deepening of the MCI market was supported by a code of conduct among banks and measures to facilitate firm quotations.

uA01fig03

Exchange rate spreads are narrowing Premium on Auction Rate

(Percent; on a weekly basis)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: Mozambican authorities.
uA01fig04

The widening of the band in the MCI market has activated transactions and reduced the spread between the MCI rate and transaction rate outside the MCI

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

  • The financial system has deepened since the banking system was restructured. Sound financial policies and cleaned-up balance sheets, especially at the largest bank, have restored confidence in the banking sector, prompting broad money growth to outpace nominal GDP growth (Table 3) and credit to the private sector to almost double in just two years. These developments reflect structural factors associated with banks again taking on consumer credit (e.g., credit cards and loans to purchase durable goods) and lending for industrial activities, as well as borrowing by domestic petroleum distributors related to the syndication of larger oil import transactions. Lending to the agriculture and rural sector, however, remains minimal. According to a prudential measure introduced in July 2005, banks must provision 50 percent of foreign currency-denominated loans to nonexporters. This has led to a substitution from foreign currency to domestic currency lending partly because of an increase in interest rates on foreign-currency borrowing relative to domestic currency lending. Importantly, this measure has reduced banks’ exposure to unhedged borrowers and does not seem to have hampered financial intermediation as indicated by a steadily rising credit-to-deposit ratio.

uA01fig05

Financial intermediation is growing

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Sources: Mozambican authorities; and IMF staff estimates.

Credit to the Economy has nearly doubled in two years

Sectoral Contribution to Credit Growth 1/, 2005-6

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Source: Bank of Mozambique - Monthly Credit survey.

Total and sectoral growth on a 12-month basis and derived from BM’s Monthly Credit Survey. This survey covers only a sample of the universe of financial institutions covered in BM’s monetary survey.

Includes all loans to finance domestic and foreign trade activities such as oil and food imports.

Includes credit cards and consumer credit lines for vehicle and durable goods

Non-classified activities

  • The soundness of Mozambique financial system has continued to improve. Bank profitability was particularly good in 2006. Nonperforming loans (NPL) have also fallen to less than 5 percent of all loans according to Mozambican accounting standards (Table 6). Banks have also become more efficient. In particular, noninterest expenses to gross income, and to a lesser extent personal expenses to noninterest expenses, have been declining since 2004. Greater confidence in the banking system has also led to a significant decrease in liability dollarization and thus less financial vulnerability. On the other hand, while capital adequacy ratios are still above the minimum, they have continued to decline as a result of increased lending—the credit boom needs close monitoring. Recapitalization of the Bank of Mozambique is on schedule; the first and second tranche of government securities, each amounting to MT 1.5 million, were issued in June 2005 and June 2006. The last is expected to be issued in June 2007.

uA01fig06

Bank Soundness Evolution has improved

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: Bank of Mozambique.1/ Non- performing loans are defined according to Mozambican accounting standards (they include only part of the past due loans).
uA01fig07

Microfinance activities have blossomed

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: Mozambique Microfinance Facility, Survey of Microfinance Operators.

  • Microfinance institutions (MFI) have grown significantly in the last decade. Between 2000 and 2005 there was about a five-fold increase in the number of clients and a seven-fold increase in outstanding loans. Consolidation also seems to be underway: 3 institutions out of about 35 control more than 68 percent of the active loan portfolio. However, MFI outreach is very limited. Rural areas account for less than 12 percent of total borrowers. However, growth has 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.

  • The fiscal position is more sustainable because of higher revenues and current spending restraint (Table 2). Revenue collections in 2006—which were nearly 1½ percent of GDP higher than in 2004—were led by buoyant corporate tax collections (including arrears) and nontax revenues related to the boom in commodity prices. Domestic-related expenditures, which in 2005 were far lower than expected because of late budget approval after the December 2004 elections, also picked up in 2006. At the same time, the composition of spending improved, supported by donor-financed projects. The share of priority expenditures consistently exceeded the 65 percent PARPA target (Table 5). Thanks to these trends, and restraint on current spending, the domestic current primary balance has improved. The unexpectedly high external program aid in 2006 also meant that net credit to the government from the banking system (NCG) declined more than expected.

uA01fig08

Consolidation of the fiscal position continues

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Sources: Mozambican authorities; and IMF staff estimates and projections.

  • MDRI aid delivery has decreased external vulnerabilities, though megaproject- related transactions will require vigilance. As a result of MDRI, the net present value of public external debt was halved (from about 22 percent to about 12 percent of GDP), slightly more than previously estimated. An agreement signed in October 2006 will transfer majority ownership of the Cahora Bassa hydropower plant from Portugal to Mozambique. The authorities are committed to financing large infrastructure projects in the pipeline, including Cahora Bassa, through nonrecourse financing and private participation to unlock Mozambique’s growth potential while keeping debt sustainable (MEFP ¶35).

uA01fig09

External vulnerability has decreased

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: Mozambican authorities, and IMF staff projection.

II. Policy Challenges and Lessons from the PRGF-Supported Program

2. Sustaining Mozambique’s impressive growth takeoff is crucial to further reducing poverty. Since the end of its civil war in 1992, Mozambique has grown 8 percent a year, on average; it reduced its poverty headcount index from 69 percent in 1997 to 54 percent in 2003. Poverty levels declined more in rural areas than in urban ones, making Mozambique the second country in the world (other than Vietnam) to see such reductions. However, now that the post-stabilization rebound has largely run its course and first- generation reforms are completed, a lot more also needs to be done to address the large human capital and infrastructure gaps. The aim of achieving nonincome-related MDGs in areas like primary school completion, gender equality, and HIV/AIDS require a scaling up of basic services without undermining macroeconomic stability.

uA01fig10

Mozambique’s growth takeoff continues

(Growth Index, 0=100)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: World Economic Outlook.

Selected Human Capital and Infrastructure Indicators

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Source: Human Development Report 2006, UNDP; and World Development Indicators, World Bank.

2006 data.

2004 data.

2000 data except Mozambique (2002)

2005 data.

3. The current PRGF program helped maintain macroeconomic stability in the face of exogenous shocks and addressed structural weaknesses identified in the Ex Post Assessment (EPA). The request for the program targeted fiscal consolidation in the face of an expected decline in aid inflows after the aid surge and high inflation (2000-03) related to the flooding in 2000. Fiscal consolidation limited recourse to monetary financing and helped reduce inflation to single-digit levels, relieving pressure on domestic interest rates. The improved structural program performance since March 2005 has also helped the authorities complete outstanding first-generation reforms identified in the EPA—particularly in strengthening revenue mobilization by creating a central revenue authority (ATM), improving expenditure efficiency through the rollout of a government financial management information system (e-SISTAFE), and addressing vulnerabilities in the financial system.

4. Performance under the PRGF program was satisfactory in 2006. All quantitative and structural performance criteria from September 2006 through March 2007 were met except one: base money was above target at end-year 2006 (MEFP Table 1 and 2). A waiver for the missed performance criterion is justified as it was temporary and related to the currency reform. The indicative target on utilization of the Moatize coal mine deposit was also missed due to higher spending on the construction of a bridge over the Zambezi. Three out of four structural benchmarks were met for the final review; the benchmark related to the treasury single account (CUT) has been delayed to the end of September 2007 due to capacity constraints.

Table 1.

Mozambique: Selected Economic and Financial Indicators, 2004–10 1/

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Sources: Mozambican authorities; and Fund staff estimates and projections.Note: Takes into account IMF delivery of MDRI in January 2006 and reflects changes in quantitative targets in line with projected program adjustors.

Projections exclude the Moatize coal mine project, Cahora Bassa transfer, and Petroleum exploration.

Minus sign indicates depreciation.

Includes the issuance of government securities for the central bank recapitalization in years 2005-07.

Includes movement in the government account set abroad with the proceed of the Moatize coal mine concession.

Table 2.

Mozambique: Government Finances, 2004-10

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Sources: Mozambican authorities; and IMF staff estimates and projections.

The quasi-fiscal deficit of the Bank of Mozambique, amounting to MT 3,455 billion (or 2.5 percent of GDP) is not included.

Revenue minus noninterest current expenditure minus locally financed capital expenditure and locally financed net lending. Unallocated revenue and expenditure are included in the primary balance below the line.

Residual discrepancy between identified sources and use of funds.

Tracks the movements in the government account set up abroad with the proceeds of the Moatize coal mine concession.

Includes the US$123 million (2.0 percent of GDP) concession fee for the Moatize coal mine concession.

Includes the transfer of both MDRI and HIPC assistance from the central bank to the budget in 2006.

5. While reiterating the commitment to improving the quality of and access to public services, the government’s PARPA II (2006-09) recognizes that to sustain growth, more emphasis must be placed on productivity growth and a greater role for the private sector. This is to be achieved by:

  • consolidating macroeconomic stability and maintaining competitiveness through prudent monetary and fiscal policies in the context of a flexible exchange rate regime;

  • improving the investment climate and promoting employment generation by reducing the cost of doing business; and

  • improving governance and the management of natural resources.

6. These near- and medium-term challenges are addressed in a three-year PSI designed to consolidate macroeconomic stability and sustain rapid economic growth. Given its economic stability, comfortable level of international reserves, policy performance, and lack of need for balance of payments support, Mozambique is well-placed to graduate to a PSI when its current PRGF arrangement expires in July 2007. The government favors such an arrangement to monitor its ambitious reform program and send a signal to donors of its commitments. The authorities have asked that the PSI proposal be presented to the Executive Board before the current arrangement expires to avoid a vacuum between the two programs. This approach has been closely coordinated with the World Bank’s new Country Partnership Strategy (2007-11) and the joint Performance Assessment Framework (PAF) of the government and donor community.

7. Recent refinements to the design of the PRGF program should allow for a smooth transition to a PSI. The streamlining of quantitative performance criteria and adjusters at the completion of the fourth review seems to have helped focus the quantitative program, particularly in accommodating both spending and absorption of foreign aid as needed.2 The replacement of the domestic primary deficit by an asymmetric ceiling on NCG with regard to external financing and the removal of the indicative target on the wage bill were particularly useful in reinforcing the management of foreign aid once it became clear that the decline in aid in 2004-05 would be reversed. Further streamlining of structural conditionality and strengthening of the interministerial committee monitoring the program have helped build ownership and allow for regular updating of reform priorities. The likelihood of a further scaling up of foreign aid and strong program performance over the last three reviews points to a continuation of the present program design under the proposed PSI.

8. Close collaboration between the partners and targeted capacity building will need to continue to facilitate the realization of the reform agenda. The World Bank and the Fund have worked together very closely on, among other projects, the Poverty Reduction Support Credit and PRGF program content, the Cahora Bassa hydropower project, and reform of the fiscal code governing mineral resources. The practice of holding joint Bank-Fund missions has had synergistic benefits and has also reduced the burden on the government of preparing for multiple missions. The authorities have welcomed the close coordination between the Bank, the Fund, and the donor community in Maputo. Continuous Fund technical assistance, provided in close coordination with donors (for example, in the area of tax reform), has helped build administrative capacity to take the reform process forward. More recently, PFM reforms, an area where past performance was poor, are progressing well. These reforms were initiated with substantial Fund technical assistance on the ground; this has evolved to a more advisory role, and the medium-term PFM reform plan is being financed by a multidonor common fund. This highlights how intensive and well-coordinated technical assistance can catalyze progress in the early stages of a major reform that through time can help build ownership and sustain the reform momentum.

III. Article IV Policy Challenges

9. The main theme of the Article IV discussions was consolidating macroeconomic stability and accelerating the second wave of reforms in PARPA II to sustain broad-based growth and further reduce poverty. The mission discussed the results of a benchmarking exercise comparing the characteristics of fast-growing Asian and sub-Saharan African (SSA) countries with that of Mozambique to identify potential constraints on rapid growth. As the exercise shows, Mozambique is well placed to sustain its growth takeoff given its sound political institutions, geography (coastal and close to South Africa), and relative equality. On the other hand, regulatory quality and enforcement of the law are institutional weaknesses that may be detrimental to sustaining Mozambique’s growth takeoff.

uA01fig11

Political institutions are relatively sound

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: Kaufmann, Kraay, and Mastruzzi (2006).Note: Percentile rank indicates the percentage of countries worldwide that rate below selected country subject to a margin of error. The statistically likely range of the indicator is shown as a thin black line.
uA01fig12

Although a number of institutional weaknesses remain

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: Kaufmann, Kraay, and Mastruzzi (2006).Note: Percentile rank indicates the percentage of countries worldwide that rate below selected country subject to a margin of error. The statistically likely range of the indicator is shown as a thin black line.

10. The major challenges now are to:

  • Consolidate macroeconomic stability. Inflation is still higher in Mozambique than in ASEAN-4 countries and in South Africa, its main trading partner. To avoid stymieing growth it must also guard again real exchange rate misalignments. The authorities described the PARPA II three-pronged approach to macroeconomic stability:

    • Priority spending. Continue to monitor the additional priority spending, including MDRI resources, by strengthening PFM systems while embarking on a public sector reform program to improve efficiency and public service delivery.

    • Increased revenues. Given the low tax-to-GDP ratio and the need to guard against aid volatility and gradually reduce dependence on donors, target (through the medium-term fiscal framework CFMP), an annual average revenue increase of 0.5 percent of GDP, to be achieved by broadening the tax base and improving revenue administration.3

    • Monetary and exchange rate policy framework. Keep inflation in the single digits through monetary control and pursue greater exchange rate flexibility to cushion against exogenous shocks and maintain adequate reserves.

uA01fig13

Inflation needs to fall further

(Average period, percent)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: World Bank Development Indicators.
uA01fig14

Revenue mobilization is the key to fiscal sustainability

(% of GDP)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

1/ Data for China includes grants.Source: World Bank Development Indicators.

  • Reduce the costs of doing business. Export levels for Mozambique, as elsewhere in SSA, are comparable to the ASEAN-4 during their initial growth takeoff. Its share of world trade has been expanding but is attributable to only a few sectors (Box 1). Mozambique’s exports are dominated by capital-intensive megaprojects; 4 sustained growth tends to be associated with considerable manufacturing exports. The authorities agreed that the lack of manufacturing exports may partly reflect the wide gap in competitiveness between Mozambique and the ASEAN-4 and regional competitors, as measured by the World Bank’s Doing Business indicators. Therefore, lowering the costs of doing business must be at the core of the authorities’ strategy to promote export diversification. Priorities are to improve access to finance, build a manufacturing base, and generate jobs by fostering small- and medium-sized enterprises (SMEs).

    • Business surveys in 2002 and 2006 found the high cost of credit to be the most binding constraint to business; more than 70 percent of firms surveyed said they lacked access to bank loan or overdraft facilities. Access to credit is a particular problem in the agriculture sector, which is dominated by poor farmers who lack collateral.

    • Improving competitiveness is key to uncapping Mozambique’s export potential (Box 1). The limited number of skilled workers and labor market rigidities explain both relatively high labor costs and low productivity in manufacturing. High indirect costs and loss of output because of inadequate infrastructure and burdensome regulation also impede manufacturer and SME growth. Further trade reform would also reduce the cost of imported inputs because Mozambique’s export-tax equivalents of tariff barriers may still be relatively high.5

  • Better manage natural resources. Mozambique has proven resources of coal, hydropower potential, gas, titanium, and oil, but countries with abundant natural resources have seldom attained sustained growth.6 To avoid the “resource curse” that has plagued much of SSA, Mozambique needs (i) an efficient tax and regulatory regime to attract investment while maximizing benefits to the economy; and (ii) more transparent management of resource revenue.

uA01fig15

Export growth needs to be sustained…

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: World Bank Development Indicators.
uA01fig16

…Through greater diversification of non-megaprojects exports.

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: IMF staff estimates and projections.

Mozambique’s Competitiveness

Although Mozambique’s share of world exports has increased in the past decade, this is due to the increase in megaproject exports. Excluding megaprojects, its export-to-GDP ratio and its share of world trade have been relatively stable for the past decade and the contribution of non-megaproject exports to economic growth has been subdued. Because of the limited linkages between megaprojects and the economy as a whole, and their susceptibility to swings in commodity prices, there is a need to raise the contribution of non-megaproject exports. This is particularly true for manufacturing exports, which are often thought to be the engine of export-led productivity growth.

The real effective exchange rate (REER) has been relatively stable for a decade, although there are signs that it may currently be somewhat overvalued. Estimates of the fundamental equilibrium exchange rate (FEER) model for Mozambique suggest that the REER has appreciated in response to improved terms of trade and productivity and to increases in government consumption, investment, and foreign direct investment, and it has depreciated in response to increasing openness. Thus, although the evolution of the REER does not indicate that Mozambique is becoming less competitive, econometric results suggest that the REER may be overvalued by about 10 percent, though with some statistical uncertainty about the precise magnitude. As a result, export performance may be weaker than it could have been if the REER had been aligned with its underlying equilibrium rate.

Diversifying exports into products that are dynamic in the global market place should be part of Mozambique’s strategy to raise the contribution of the nonmegaproject export sector. Nonmegaproject exports tend to be concentrated in products that have had below average growth in world markets. This, together with relatively low price increases, suggests declining demand for these products. Megaproject exports are concentrated in products for which world demand is increasing, though commodity prices are volatile. Overall, to help sustain economic growth, there is a need to rebalance export growth toward non-megaproject exports by diversifying into labor-intensive sectors, in particular manufacturing exports.

uA01fig17

Mozambique: Export Performance by Product (2000-2005)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: IMF staff estimates and projections.
uA01fig18

Mozambique: Equilibrium Real Exchange Rate (1998-2006)

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Source: IMF staff estimates and projections.

Developments in Perceived Constraints

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Souces: Ministry of Planning and Development, Government of Mozambique (MPD), National Directorate of Studies and Policy AnalysisNote: Average across firms of judgements on how constraining listed factors are for the operation and growth of their business. Where 0 = no obstacle, 1 = slight, 2 = moderate, 3 = major and 4 = serious obstacle).
uA01fig19

Labor and indirect costs are high in Mozambique

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

Sources: Eifert, Benn, Alan Gelb, and Vijaya Ramachandran, 2005

IV. The PSI: Addressing Medium-Term Challenges 2007–10

A. Medium-Term Outlook

11. The baseline medium-term macroeconomic framework, which assumes that macroeconomic stability will be consolidated and the second-wave reforms in PARPA II accelerated, envisages real GDP growth of about 7-8 percent a year (Table 1).7 This means persevering with stabilization efforts with the CFMP largely unchanged, particularly a 0.5 percent of GDP annual increase in revenues and moderating current expenditures related to efficiency gains from the public sector reform program (MEFP ¶¶ 16 and 17). This would allow private sector credit to expand further while maintaining competitiveness through a flexible exchange rate regime. Monetary control will target inflation of 5-6 percent. The impact of recent floods and cyclone has been localized, and should not unduly affect the near-to-medium term outlook. The external current account deficit will continue to be largely financed by scaled-up concessional foreign aid; a comfortable level of international reserves will help cushion against exogenous shocks.

12. Managing scaled-up aid will be a challenge. Donors have indicated foreign aid may be scaled up by about US$200 million (2 percent of Mozambique’s 2008 GDP) over the medium term. The mission therefore discussed an alternative scenario to identify challenges in spending and absorbing additional external borrowing. The authorities agreed that unless all spending is on imports (as has not previously been the case), the higher demand for domestic goods will tend to appreciate the real exchange rate and thus discourage the expansion of exports to widen the trade deficit and absorb aid. Thus harm may be done to long-term growth. The mission emphasized that the additional spending must effectively reach the most economically and socially productive priority sectors (e.g., infrastructure, education, and health) to elicit a supply response and mitigate any Dutch disease effects.8 The fiscal framework will also need to rely more on revenue mobilization as an exit strategy from aid dependence in the long-run and to ensure that at least recurrent spending can be financed from own resources.

uA01fig20

Debt remains below the DSA threshold under the alternative scaling-up borrowing scenario, although the absorption of the additional foreign aid may require a real exchange rate appreciation

Citation: IMF Staff Country Reports 2007, 262; 10.5089/9781451827316.002.A001

13. Megaprojects are expected to make a growing contribution to poverty reduction and fiscal sustainability. Natural resource-based megaprojects can help reduce poverty indirectly by bringing in more revenue and linking to the economy.9 Beyond the PARPA II period, strong growth and increased fiscal revenues from megaprojects—such as the multibillion-dollar Moatize coal mine and the Pande-Temane gas project (still in its cost recovery phase)—would help Mozambique gradually decrease its dependence on donors.10

14. The medium-term structural reform agenda is designed to (i) reinforce fiscal policy to manage scaled-up foreign aid; (ii) refine monetary and exchange rate policy; (iii) enhance the business environment; and (iv) improve natural resource management (MEFP ¶17). The proposed PSI, drawn up in close collaboration with the World Bank and other donors, will support these priorities. The main risks to the medium-term program are inclement weather, too hasty decentralization, and poor fiscal performance in the run-up to elections.

B. Strengthening Fiscal Policy and Institutions

15. Total domestic revenue is envisaged to rise 0.5 percent of GDP by (i) increasing the number of taxpayers and audits to broaden the tax base; (ii) strengthening border control and limiting unwarranted customs exemptions; (iii) collecting tax arrears amounting to about 0.3 percent of GDP; (iv) again updating the specific fuel tax rate quarterly and recovering the real reduction resulting from not indexing in 2005;11 (iv) bringing in more nontax revenues based on buoyant commodity prices; and (v) continuing to improve tax administration in line with recent TA from the Fund (MEFP ¶22). Priority public investments will increase significantly (Table 6). Most of these expenditures will be financed by foreign grants and accompanied by sufficient counterpart funds and current spending for maintenance. The wage bill is unchanged relative to the CFMP; about 10,000 teachers and 3,000 health workers are to be hired. Transfer payments in 2007 are higher as spending is gradually decentralized, particularly through an increase in the investment budgets to each districts that began in 2006. If revenue falls short, the authorities have agreed to cut nonpriority expenditures to meet the NCG target. Overall, scaled up program aid will permit a higher domestic primary deficit with no recourse to domestic financing, which should bring a healthy increase in credit to the economy.

16. The emergency response to the floods along the Zambezi river and Cyclone Favio is expected to be accommodated within the 2007 budget ceilings, with the assistance of the international community.12 The government drew up a reconstruction plan estimated at US$71 million and the UN Office for the Coordination of Humanitarian Affairs launched an emergency appeal for a further US$29 million to meet short- to medium-term needs of those affected. The government has asked the donor community to cover most of the cost of the reconstruction plan. However, if donor financing is inadequate, the government may consider using the program adjustor to accommodate emergency outlays (TMU, paragraph 18).

17. Tax reforms are designed to improve tax system efficiency and achieve the medium-term revenue targets. A comprehensive review undertaken by Fund TA found the tax system to be generally sound and appropriate for a low-income country like Mozambique, but it also identified a few tax policy measures that might compensate for the further reduction in external tariffs scheduled for 2008 and thus help meet the authorities’ medium-term revenue targets. The government is thinking about including some of these measures in the 2008 budget (MEFP ¶21). An external audit of VAT refunds outstanding, including any arrears in payments to large infrastructure contractors, will also be completed in 2007 to address concerns of stakeholders about delayed payments while maintaining the integrity of the VAT system.13 The next phase of revenue administration reforms (2007-10) are designed to establish the ATM as a sustainable, semi-autonomous institution and improve its operations. The phased integration of the core functions of both tax and customs administration in 2007 will be supported by putting into operation the strategic plan of the ATM, drawing up an IT plan to support the ATM, and setting up the tax tribunals (MEFP ¶22).

Projected e-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.

Source: Authorities’ PFM APB (2006)

18. The implementation of the medium-term PFM plan (2007-09) will help maintain macroeconomic stability by supporting the monitoring of priority expenditures. A cornerstone of the PFM plan is the timely implementation of the e-SISTAFE Action Plan and Budget (APB) agreed with the donors and financed through a multi-donor common fund. Its main elements are rollout of the budget execution module to all central and provincial entities, and its customization for districts and municipalities; introduction of Phase II of the budget formulation module; and the design of new modules and functions. For 2007 (MEFP ¶23), the milestones are:

  • Development of an integrated and e-SISTAFE-compatible payroll database—registry of state employees (CAF)—so that the Ministry of Finance can pay salaries via e-SISTAFE by the end of June 2007 (structural benchmark).

  • Rollout of e-SISTAFE to all remaining ministries at the central and provincial levels listed in the TMU by end-December 2007 (structural benchmark).

  • Increase the level of effective direct budget execution (according to the sequence of commitment, verification, and payment) for goods and services to 30 percent by the end of September 2007 and 50 percent by the end of December 2007 (structural assessment criterion); and

  • Pilot test the multicurrency single treasury account (CUT) by the end of September 2007 (structural benchmark) with a goal of full production by January 2008 to facilitate inclusion of all donor-financed projects.14

19. Reinvigoration of Phase II of the public sector reform program under the auspices of the new public service authority (ANFP) must be carefully sequenced to retain accountability and fiscal control. The pillars of the program are (MEFP ¶40):

  • Civil service census. Completion of the census of all civil servants in the second quarter of 2007 will produce a unique number of total civil servants as the basis for an integrated payroll database. It should identify “ghost” workers and help control the wage bill as more frontline sectors recruit teachers, nurses, etc.

  • Wage reform. The government will identify reform options and set a timetable for improving incentive structures and performance by the end of June 2007; approval of a new wage policy is expected by the end of 2007, to be implemented in the 2009 budget (MEFP ¶40).

  • Decentralization. The government should be very cautious about devolving resources to subnational levels through June 2008 until e-SISTAFE is rolled out at the local level and a decentralization strategy is approved (MEFP ¶40). The strategy should include, among other things, a clear legal, regulatory, and institutional framework for the revenue and spending responsibilities of subnational units (provinces, districts, and municipalities) and monitoring of subnational fiscal operations. This would help address concerns about the accountability and transparency of district spending.15 The World Bank will take the lead on capacity-building assistance for local procurement reform and internal and external audit.

  • Anti-corruption strategy. In 2006 five ministries drew up operational plans; their implementation will be closely monitored by the National Anti-Corruption Forum with broad stakeholder participation and leadership from the highest levels (MEFP ¶41). The Central Office for the Fight Against Corruption is also expected to improve on its performance of 2006 where of 271 cases, 9 were shelved, 4 sent to other institutions, and only 18 were prosecuted.

C. Monetary and Exchange Rate Policy

20. The monetary program will continue to target base money aimed at keeping inflation at 5–6 percent (Table 3). Recent trends in monetary aggregates have helped anchor inflation expectations, keeping the monetary program largely unchanged for 2007. The impact of the recent flooding on food prices will need to be closely analyzed; no change in monetary targets is envisaged if core inflation remains subdued.16 The mission supported the reduction in required bank reserves from 11.5 percent to 10.15 percent of deposits beginning in April 2007 because it may help reduce the spread between deposit and lending rates, which is high by regional standards. The BM will need to keep a close watch on the liquidity impact, however, and mop up any excess liquidity to meet the base money targets. In general, the BM though it would continue to rely mostly on foreign exchange sales to mop up structural excess liquidity and absorb foreign aid-financed expenditures, and issue treasury bills to smooth seasonal liquidity fluctuations.

Table 3.

Mozambique: Monetary Survey, 2004–10

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Sources: Bank of Mozambique; and IMF staff estimates and projections.Note While the new family of meticais (MT) was introduced in July 2006, values in this tables have been converted to MT to reflect this change for ease of comparison.

Mozambique’s liability to the Fund rests with the Bank of Mozambique. MDRI assistance is immediately transferred to a government blocked deposit account at the Bank of Mozambique.

Balance declines from MDRI assistance by 0.5 percent of GDP corresponding to an agreed increase in government expenditures contingent on MDRI assistance.

On an annual average basis from December 2006 to December 2007, reserve money growth is 15.5 percent.