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.
The Mozambican authorities wish to acknowledge the Fund’s engagement, support, and constructive dialogue and thank staff for the well written reports which clearly identify the challenges for its development process, as well as the various policy options facing the country in the medium to long term. They are in broad agreement with the thrust of the analyses, conclusions, and recommendations in the report.
Recent Macroeconomic Developments and Performance
Since the end of the civil war in 1992, growth has been strong in Mozambique, and has contributed to the reduction of the poverty. It was in line with this trend that real GDP growth accelerated from 6.2 percent in 2005 to an estimated 8.5 percent in 2006, propelled by a rebound in agricultural production and the continued strength of the construction sector. Implementation of prudent fiscal and monetary policies helped maintain inflation at a single digit at the end of 2006. Annual inflation declined from 11.2 percent at the end of 2005 to 9.4 percent at the end-December 2006, and reduced further to 8.3 percent in May 2007, despite the effects of high oil prices. Increased exports as well as sustained inflow of foreign aid kept net international reserves at over four months of imports cover, resulting in the foreign exchange market remaining stable during the year.
The authorities’ fiscal policy stance was better than programmed as revenue collection was above target, with expenditure directed to priority areas, especially for poverty reduction, in line with the 65 percent target in the Poverty Reduction Strategy Paper (PARPA). Progress has been made in reforming the revenue administration and widening the tax base, while the new Central Revenue Authority (ATM) is now fully operational. In addition, during 2006, the number of taxpayers increased by more than 30 percent; while other measures undertaken contributed increased revenue collection.
In the area of tax policy, the Cabinet approved and submitted to the Parliament three laws on specific taxes and fiscal incentives in the mineral resources and petroleum sectors in December 2006. A new fiscal code for succession and donations, and a draft municipal finance and asset law were also submitted to the Parliament. The latter aligns the finance and asset management of the municipalities with the new financial and fiscal systems implemented over the last six years. Progress continues in Public Financial Management (PFM) reforms to improve budget preparation and monitoring at the central level, and on strengthening the planning capacity at sub-national institutions. At the end of April 2007, the Census of the civil service was completed that would help improve the planning of the wage bill. In order to improve coverage in the execution of the budget, guidelines were also issued to facilitate the inclusion of donor-financed projects on the Single Treasury Account (CUT). The reforms in this area have contributed to increased confidence on domestic mechanisms for aid delivery, and as at end April 2007, 19 donors are committed to giving general budget support to Mozambique under a specific memorandum of understanding.
The authorities pursued a prudent monetary policy stance in 2006, resulting in a smooth introduction of the new family of meticais (MTn). The financial system has continued to improve. In this regard, prudential ratios of the banking system remained sound and the ratio of non-performing loans to total loans was below 4 percent; commercial banks are highly profitable with their levels of capital adequacy being closely monitored in light of the overall strong growth in credit to the economy; and foreign currency loans in total loans have decreased from almost 64 percent in 2005 to 45 percent in 2006. In the process of increasing transparency and modernization, the Central Bank (BM) has adjusted its Chart of Accounts to allow for the valuation of foreign exchange gains/losses consistent with International Financial Reporting Standards (IFRS), and its financial statements for 2006 have been issued in compliance with IFRS and in parallel with the financial statement prepared under the current accounting standard.
Progress on implementation of structural reforms accelerated, particularly in the areas of the public sector, cost of doing business, and governance reforms. First, the second phase of the public sector reform strategic action plan (2006-2010) was approved by the Council of Ministers in October 2006. Second, the draft strategy for reducing the cost of doing business was finalized in March 2007, while in the Justice sector, the Supreme Court concluded 66 percent more cases in 2006 than in the previous year, with activities in the provincial courts increasing by 48 percent. This resulted in a reduction of the backlog of outstanding cases. Third, to accelerate the enactment of approved laws, the authorities have assigned the production of the Government Gazette to the Ministry of Justice. Finally, the Parliament has recently approved the Labor law, which is an important component of the cost of doing business.
Performance Under the PRGF
The authorities’ commitment to implementation of the reforms has resulted in meeting all end-December 2006 quantitative performance criteria, except for base money for year-end target due to the temporary volatility in currency demand around the deadline to exchange the old currency for the new. In January 2007 the trend in this indicator was within the indicative target for March 2007. The structural performance criteria and benchmarks through end-March 2007 were also achieved, except for the benchmark related to the treasury single account which has been delayed to end-September 2007.
Outlook and Policies for 2007 and Under the Three-Year PSI
The authorities’ medium term policy framework continues to focus on the consolidation of macroeconomic stability. The medium term challenges facing the economy relate to the timely implementation of the second wave of reforms, especially in facilitating improvements in service delivery in the public sector and the creation of an enabling environment for private sector development. Equally important is the need to improve governance through the enhancement of coordination mechanisms within the public sector and the generation of more domestic revenues from both the traditional tax system and also from the use of natural resources.
Given the focus on growth, the authorities will take advantage of the current and medium term favorable economic conditions to sustain growth at 7 percent and their effects to substantially reduce poverty. A key medium term challenge is the scaling up of aid and managing its macroeconomic implications. In this regard, the authorities will strike a balance between the development and benefits from mega-projects and the imperative to improve other sectors of the economy in order to expand exports in the traditional and in new sectors, as well as on the growth of the non-traded sector of the economy.
Fiscal Policy
The Government is committed to continuing with implementation of measures to enhance and strengthen domestic revenue mobilization and ensure raising revenues each year as part of the exit strategy to reduce aid dependency. In this context, there will be no recourse to domestic financing of the budget in 2007 and subsequent years. To reach the goals on domestic revenue mobilization, the authorities’ revenue enhancing measures include increasing the number of taxpayers, elimination of unwarranted tax exemptions, collection of tax arrears, updating the specific fuel tax, and ensuring efficiency in the customs area.
The authorities are aware of the importance of maintaining prudent public financial management (PFM) and have agreed on a detailed action plan and budget (APB) with donors for the period 2007-2009. The APB will include, among other things, rollout of the budget execution module to all central and provincial entities, customization for districts and municipalities; introduction of Phase II of the budget formulation module; and developing new modules functionalities.
Monetary Policy
Monetary policy will continue to target base money to achieve single digit inflation in the medium term. In this regard, the BM will improve liquidity management to control base money, in particular, in the context of foreign aid financed expenditures. To this end, the Ministry of Finance will improve the preparation of cash-flow projections and ensure prompt communication to the Central Bank. The BM will continue to strengthen its supervisory functions and implement the organizational changes with a view to strengthening on-site and off-site monitoring. The process of adopting IFRS in the banking system will continue and will be extended to the corporate sector, in order to improve the ability to evaluate the quality of the loan portfolio. In addition, new regulations on the assessment, classification and provisioning of credit as well as a regulation of integral risk management for credit institutions and finance companies will become effective in 2007. The BM will support the expansion of the non-bank financial sector, and it will also continue to license and supervise the microfinance deposit-taking institutions to facilitate access to finance by SMEs and rural households.
Regarding the reforms in the foreign exchange system, a new foreign exchange law that includes comments from all stakeholders will be submitted to the Parliament in July 2007 as harmonization of various views took some time. Upon approval of the law and its related regulations, the authorities intend to accept obligations under Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement.
Structural Reforms
The reforms’ agenda to tackle the structural constraints of the economy are still daunting, action-oriented, and well phased. Strong leadership in pursuing them is important, and the authorities are aware of these and are committed. In the next three years, the focus of the reforms will be centered on governance, improving the business environment and the effective management of the natural resources. The main pillars of the public sector reform are: (i) civil service reform, which includes the census and the wage bill reforms; (ii) decentralization and use of the momentum in PFM reforms to sub-national units (provinces, districts, and municipalities); (iii) the anti-corruption strategy which encompasses the development of operational plans in five sectors, and the development of oversight and monitoring mechanisms with ample participation of different stakeholders within the society.
The second wave of reforms puts emphasis on the business environment and the reduction of the cost of doing business in order to sustain high growth in the medium term and support the development of SMEs and transform Mozambique into a competitive economy as well as serving as a location for FDI. In this regard, the authorities plan to embark on developing the financial sector in order to increase access to credit and lower financing costs. The authorities are implementing an action plan designed to reduce the cost of doing business and accelerate business registration, reduce employment costs, simplify trade regulations, among other measures. At the same time, the authorities will play an important role in supplying public infrastructure and delivery of public services that will complement and enhance private sector investment and productivity.
The Mozambican authorities are conscious of the importance of FDI in enhancing the development of mining and other natural resources. In this regard, the government intends to commence application of international best practices in tax structure and transparency for these types of projects. A new legislation has recently been approved in the area of mining and petroleum products. The government is considering following the Extractive Industries Transparency Initiative (EITI), and is already participating in seminars and workshops on the subject to get more insights and information on the way forward.
Conclusion
Mozambique’s experience with the PRGF arrangements in recent years was very positive and created the basis for macroeconomic stability and advancement with the first wave of reforms in the period after the end of the civil war. The prospects for the Mozambican economy remain favorable in the medium term and the authorities have expressed strong commitments to implementing the reform agenda as spelt out in PARPA II. The authorities request the completion of the sixth review and the financing assurances, and the waiver on the Performance Criterion. In addition, and based on the accumulated experience, the authorities also request for a Three-Year Policy Support Instrument. They strongly commit themselves to ensuring that the objectives and policies set forth under the PSI are achieved.