Republic of Mozambique
Second Review Under the Policy Support Instrument and Request for Waiver of Nonobservance of Assessment Criteria; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Mozambique
Author: International Monetary Fund
Publication Date:
08 Jul 2008
eISBN:
9781451827347
Language:
English
Keywords:
ISCR; CR; request; nonobservance; weakening food price inflation; waiver; headline inflation; IMF mission; financial support; BM's balance sheet; IMF mission in April; International reserves
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This paper discusses key findings of the Second Review Under the Policy Support Instrument for Mozambique. Overall performance under the program was satisfactory but encountered unexpected challenges. Domestic revenues were stronger than envisaged, but the end-December 2007 assessment criterion (AC) on net credit to government (NCG) was missed largely because of aid shortfalls for onlending to public enterprises and deficiencies in cash-flow management that are being addressed. Monetary policy remained prudent, but the end-year AC on reserve money was missed.

Abstract

This paper discusses key findings of the Second Review Under the Policy Support Instrument for Mozambique. Overall performance under the program was satisfactory but encountered unexpected challenges. Domestic revenues were stronger than envisaged, but the end-December 2007 assessment criterion (AC) on net credit to government (NCG) was missed largely because of aid shortfalls for onlending to public enterprises and deficiencies in cash-flow management that are being addressed. Monetary policy remained prudent, but the end-year AC on reserve money was missed.

I. The Economy in2007 Remains Resilient

1. During the second half of 2007, Mozambique continued to meet its macroeconomic objectives under its medium-term development strategy Plano de Acção Para a Reduçao da Pobreza Absoluta II (PARPA II). The economy remained resilient to climatic and external price shocks, but social vulnerabilities have emerged.

A. Economy Resilient to Climatic and External Price Shocks

2. Overall macroeconomic performance in 2007 was satisfactory. Output growth exceeded expectations, despite extensive flooding late in the year and large international import price increases. Average inflation nevertheless declined and core inflation (excluding food and energy) was contained around 5 percent. Large foreign direct investments and an increased reliance on foreign exchange reserve sales to sterilize excess liquidity led to an appreciated REER. External reserves were higher than envisaged.

3. Recent increases in international food and oil prices have exposed potential social vulnerabilities. In the 12 months to March 2008, gasolene and food prices rose 27 and 15 percent respectively. Large domestic fuel price increases in February 2008 triggered riots and led to the introduction of a temporary and well-targeted transportation subsidy.

Mozambique-Selected Indicators, 2006-11

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

4. Fiscal policy implementation during the second semester was broadly as envisaged, but budget execution was constrained by project aid shortfalls. Domestic tax revenues exceeded expectations by 0.4 percent of GDP and current spending was in line with the program, despite emergency spending related to floods. However, project aid shortfalls, including from the health common fund, led to capital under-spending (4.6 percent of GDP). As a result, priority expenditures’ share of total spending fell below the 65 percent target. The end-year AC on NCG was missed by 0.8 percent of GDP, mainly because of aid shortfalls for on-lending to public enterprises (without a corresponding reduction in on-lending) and deficiencies in cash-flow management.1 These deficiencies are being addressed, particularly by strengthening the e-Sistafe and better coordination with the BM (see below).

Figure 1:
Figure 1:

Recent Economic Developments, 2005-07

Citation: IMF Staff Country Reports 2008, 220; 10.5089/9781451827347.002.A001

Sources: Mozambican authorities; and IMF staff estimates.

5.Monetary policy remained prudent, but encountered unexpected challenges. The deceleration of inflation allowed the BM to reduce the interest rates on its standing facilities in January 2008, but real interest rates nevertheless remain high. As intended, the BM increased its reliance on foreign exchange sales to sterilize excess liquidity during the second semester. However, this was not enough to compensate for the unusually strong seasonal demand for currency during the end-year festive season.2 As a result, the end-year reserve money target was breached, but was back in line with the program in early 2008.

Monetary Policy Mix

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Sources: Mozambican authorities; and Fund staff estimates.

B. Structural Reform Momentum Maintained

6. Efforts to strengthen fiscal operations have progressed faster than expected (MEFP ¶6-8). The government implemented extensive measures to improve tax administration and collections and Parliament approved new codes for income and value added taxes in December. Good progress has been made in implementing the first two phases of the e-Sistafe project.

7. The BM has continued to strengthen its operations (MEFP ¶9,12). It has expanded its range of instruments to control liquidity. An agreement in November to shift the costs of monetary policy to the Ministry of Finance (MF) will increase its financial independence and help ensure that monetary policy decisions are not constrained by financial considerations. These costs will be included in the 2009 budget. The BM also continued to strengthen its banking sector supervision to comply with Basel I principles.

8. The government has stepped up efforts to reduce the cost of doing business and strengthen its natural resource management (MEFP ¶13,18). It approved a new strategic plan in February 2008 to strengthen the business environment, simplified the licensing process and completed a study to facilitate cross border trade. It also issued regulations in February for the mining and petroleum fiscal regime laws approved by Parliament in June 2007. Several SADC countries, including Mozambique, concluded an interim-Economic Partnership Agreement with the EU in November, providing continued free access to EU markets, in exchange for reciprocal free access from July 2008.

II. Macroeconomic Policies in2008

9. Mozambique has progressed in cementing macroeconomic stability towards becoming a full mature stabilizer. Maintaining prudent macroeconomic policies will remain important for further sustaining growth, but will need to be buttressed by strengthening fiscal and monetary operations. Mozambique will need to continue relying more heavily on second-wave reforms for further impetus to growth. Strengthening the business environment for private sector development, especially small and medium-sized enterprises, is a priority to spread the benefits of Mozambique’s natural resources more widely and to avoid the emergence of a dual economy.

A. Maintaining Prudent Macroeconomic Policies

10. Macroeconomic prospects for 2008 remain positive. Real GDP growth is expected to remain robust despite localized floods (MEFP ¶3), while inflation is projected to decline, though less than previously envisaged because of higher international oil and food prices. The current account will likely widen mainly because of higher imports from the projected scaling-up of aid and high international oil prices. External reserves will remain at a comfortable level.

11. The fiscal objectives are in line with the revised medium-term fiscal framework. There will be no recourse to monetary financing to make room for credit to the private sector. The government aims to raise domestic revenues by 0.5 percent of GDP, while mitigating revenue losses from trade liberalization, by improving revenue administration, implementing tax measures, and from higher Cahora Bassa hydroelectricity concession fees. The fiscal framework accommodates a temporary transportation subsidy (0.15 percent of GDP) and costs related to the flooding and cyclone through the budget’s contingency line3. Donor’s firm commitments, on which aid projections are based, imply a substantial scaling-up of project aid—largely for capital spending—by over 5 percent of GDP.

12.The BM will maintain a prudent monetary policy stance in the context of a flexible exchange rate. The BM will continue to target base money with a view to achieving an average headline inflation of 7–8 percent in 2008. The adjuster on the outstanding stock of currency for end-December 2008 has been increased to take into account the seasonal increase in the demand for currency during the festive season in the fourth quarter of the year (TMU ¶19). Program adjustments also reflect technical revisions to the monetary survey.4

13. The government is considering how to mitigate the social impact of further increases in oil and food prices. A seminar to that effect is scheduled in May, organized by the IMF and the World Bank to identify best practices in this area.

14. The government is committed to program implementation. Despite the economy’s increased resilience, implementation will continue to face risks from natural calamities. Performance could be affected by adverse movements in international prices and further oil and food price increases could heighten social vulnerabilities. Approaching the elections, the government will need to resist pressures for additional spending that are not sustainable.

B. Strengthening Policy Operations

Fiscal operations

15. Measures to mobilize revenue collection play an important role in consolidating fiscal and macroeconomic stability (MEFP ¶26–27). The government will continue to implement its medium-term program to improve the efficiency of the tax system. This includes simplifying the tax system for small and medium sized enterprises, a new code on tax benefits, and the computerization of the entire chain of revenue collection (e-Tributação). A law updating excise taxes is expected to be submitted to Parliament by end-May 2008.

16. Strengthening PFM is also central to fiscal policy implementation (MEFP ¶29). The government is committed to completing the first two phases of the e-Sistafe project, relating to budget execution, control and evaluation. It will start using e-Sistafe to pay civil service salaries by end-April 2008 and will define a list of additional districts and municipalities for the rollout of e-Sistafe by end-June 2008 (both structural benchmarks). E-Sistafe will be expanded to allow for program budgeting for the 2009 budget and for selected pension payments starting in early 2009. The government will facilitate the transfer of project aid through the single treasury account (CUT), for which a pilot is currently underway. Timely donor support for the implementation of the third phrase of the e-Sistafe is important.

17. To realize the projected scaling-up of aid and ensure that priority spending targets are met, the government and donors are committed to address the causes of previous shortfalls in aid disbursement of projects and special programs (financed by the Common Fund for the health sector) and related spending. Measures will include routing externally financed projects through the CUT.

uA01fig01

There were large project aid shorfalls in 2007

Citation: IMF Staff Country Reports 2008, 220; 10.5089/9781451827347.002.A001

Source: Mozambican authorities; and IMF staff estimates.

18. To avoid further fiscal overruns, the MF, together with the BM, needs to improve its cash-flow management and be ready to take timely corrective measures. To that effect a study, with the support of technical assistance, will be undertaken by December 2008 (structural benchmark). This study will serve as a basis for drafting a public enterprise law requiring monthly financial report to the MF.

19. The government is working to conclude debt rescheduling agreements with bilateral creditors under the HIPC Initiative. It is currently negotiating with Bulgaria and Libya, has scheduled discussions with Iraq and Portugal and has invited Angola, Poland and Algeria to negotiate.

Fine-tuning central bank operations and safeguards

20.Over 2008, the BM will move progressively towards a monetary framework that better reflects the determinants of price stability (MEFP ¶25, 31). The BM will further strengthen its control of liquidity by introducing repo operations in June 2008 and by adapting the main interbank money market system (Meticalnet) to allow for outright operations of Treasury bills in the secondary market (end-June 2008 structural benchmark). To strengthen liquidity forecasting, especially with respect to fiscal transactions, the MF is committed to communicating its cash-flow projections to the BM on a weekly basis.

21.The BM will implement measures to strengthen its financial reporting and internal audit (MEFP ¶32). These measures include: publication of audited financial statements prepared in accordance with IFRS (starting with the financial year 2008), an external quality assurance review of the internal audit function, the adoption of an internal audit charter, and periodic reporting to the BM’s Executive Board on the implementation of the audit recommendations (end-July 2008 structural benchmark); following SADC’s approval of a model law, the submission to the Council of Ministers (CM) of a new central bank law in line with best international practices and including a revision to the composition of the audit committee. As an interim measure, the Audit Board will assume the role of the audit committee with a focused mandate (end-June 2008 structural AC).

22.The BM has continued to strengthen its supervision of the banking sector to comply with Basel I principles (MEFP ¶32-33). The BM will report its financial statement for 2008 in compliance with the IFRS and is working with the banking sector to facilitate the publication of IFRS-compliant accounts in 2008. The government will conclude a medium-term IFRS Strategic Implementation Plan by end-April 2008 to extend the standards to the corporate sector.

23.Mozambique has committed to introducing current account convertibility. A new foreign exchange law was submitted to Parliament in September 2007. Following its approval, the government intends to accept the obligations under Article VIII sections 2, 3, and 4 of the IMF’s Articles of Agreement (MEFP ¶35).

C. Implementing Second-Wave Reforms

24. With the help of the World Bank and other development partners, the government is implementing second-wave reforms to support private sector development, management of the country’s natural resources, and public sector governance.

25.The government aims to reduce the cost of doing business to make Mozambique’s business environment the most competitive in SADC by 2015 (MEFP ¶37-38). As part of its new strategic action plan, the government will facilitate cross-border trade during 2008, consolidate business inspections by April 2008, and submit an insolvency law to the CM by June 2008 for implementation during 2008.

Improving the Management and Boosting the domestic Economic Benefits of Megaprojects1

Improving the Management and Boosting the Economic Benefits of Megaprojects is a central government objective. The MF’s decision to implement a number of measures aiming at improving the overall fiscal risk management, accountability, and transparency of megaprojects is particularly welcome. In particular, to manage the budgetary and macroeconomic implications of megaprojects, the government intends in the short-term (2008–09) to:

  • strengthen the monitoring of megaprojects by developing data gathering and analytical and forecasting capabilities at the MF in close coordination with other interested ministries and the Bank of Mozambique;

  • enhance the oversight and control mechanism of the MF by ensuring that it formally agrees with the fiscal regime of new projects at the appropriate stages of the negotiations, and before its submission to the Council of Ministers. To this end, an appropriate legal instrument will be adopted before end-May 2008;

  • strictly implement the mining and petroleum fiscal regime and related regulations and model contracts to all new projects;

  • start to develop actions aimed to meet the steps necessary for the official declaration of Government to adhere to the Extractive Industry Transparency Initiative (EITI) in the course of 2008;

  • continue to adopt nonrecourse financing clauses in future megaprojects; and

  • draft a Public-Private Partnership law in 2009 which will also be applicable to megaprojects.

1

For a comprehensive overview, see ‘Post-Stabilization Economics in Sub-Saharan Africa– Lessons from Mozambique’, Jean A. P. Clément and Shanaka J. Peiris (eds.), IMF, 2008, recently published.

26. Measures are being implemented to improve the management and transparency of the country’s natural resources and increase the benefits flowing to the country (MEFP ¶39). The government initiated steps in March towards declaring its adherence to the EITI during 2008. A joint World Bank and IMF mission in April discussed ways to improve the management and boost the economic benefits of megaprojects, Public-Private Partnerships (PPPs) and concessions (Box 1).

27.Strengthening public governance remains a key focus of the reform agenda (MEFP ¶40-41). In months of imports of goods and nonfactor services, , paying due regard to fiscal sustainability. A decentralization strategy is being prepared, with the support of the World Bank and other development partners, for the CM’s approval by end-2008. A restructuring plan of PETROMOC will be submitted to the CM by May 2008. Progress on judicial reforms is slower than envisaged. As part of its anti-corruption efforts, the government will complete in April a strategy, with specific objectives and actions, to improve Mozambique’s governance indicators in 2008 and 2009.

III. Program Monitoring

28. The revised program incorporates modifications to the ACs for NCG, net international reserves (NIR), and reserve money for end-June 2008 for the third review (expected to be completed by end-December 2008). For end-June 2008, the NIR AC was modified to take into account technical revisions to the monetary survey, the AC on base money to take into account the reduced legal reserve requirement for banks, and the AC on NCG to take into account the revised schedule of disbursements of foreign program assistance (MEFP Table 1). ACs for end-December 2008 are proposed for the fourth review, expected to be completed by end-June 2009. The TMU has been updated. The adjuster on reserve money related to currency issued by the BM has been modified to take into account the seasonal increase in currency demand during the festive season in the fourth quarter of the year (TMU ¶19).

Table 1.

Mozambique: Selected Economic and Financial Indicators, 2006–2011 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.

2004 and 2005 data incorporate revisions in GDP. Projections exclude several megaprojects such as 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.

Data from 2008 onwards based on data following technical revisions to monetary survey finalized in January 2008.

IV. Staff Appraisal

29. Mozambique’s overall macroeconomic performance during the second half of 2007 was satisfactory. Economic growth was resilient to shocks and inflation continued to decline. However, the two end-December 2007 quantitative ACs on net credit to government and reserve money were missed mostly because of unforeseen challenges. The submission of the draft excise tax law to Parliament, a structural AC for end-February, has been temporarily delayed to May 2008.

30. Staff welcomes the authorities’ commitment to prudent fiscal and monetary policies in the context of a flexible exchange rate system and to avoid monetary financing of the budget. Staff urges the authorities to ensure that the civil service wage and pension reform does not compromise fiscal sustainability.

31. Strengthening fiscal and monetary operations will be important for policy implementation. In the fiscal area, staff commends the authorities for the progress made in tax administration and on PFM. Implementation of the e-Sistafe project has progressed well, but timely donor financial support will be important for its completion. It will also be important for the authorities and donors to promptly address the causes of the 2007 shortfalls in aid disbursement of projects and special programs and related spending to allow a scaling-up of aid in 2008. In the monetary area, the BM has made good progress in introducing new instruments. Staff welcomes BM’s efforts to move towards a monetary framework that better reflects determinants of price stability and to buttress its internal audit. Staff also welcomes the Treasury’s commitment to communicate its cash-flow projections to the BM on a weekly basis.

32. Reforms to strengthen private sector development and management of the country’s natural resources are a high priority. Implementation of the medium-term strategic plan to improve the business environment is important for private sector development. Staff particularly welcomes the implementation of the regulations on the mining and petroleum fiscal regime laws and stresses the importance of the MF having oversight of the fiscal terms for new megaproject agreements. Adherence to the EITI is an important step forward in making Mozambique’s business environment more transparent and spreading the benefits of Mozambique’s natural resources.

33. Staff welcomes the authorities’ continued focus on improving governance and urges the completion and timely implementation of its strategy to improve Mozambique’s overall governance performance.

34. A new foreign exchange law was submitted to the Assembly in September 2007. Following approval of the new law and implementing regulations, the authorities intend to accept their obligations under Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement. The staff recommends the approval of five exchange restrictions under Article VIII, Section 2(a) given the authorities’ stated intention to remove these exchange restrictions within one year.

35. Based on performance to date and their continued commitment to program implementation, staff supports the authorities’ request for waivers for the nonobservance of the two end-December 2007 quantitative assessment criteria on net credit to government and reserve money, and for the end-February 2008 structural assessment criterion on the excise tax law and recommends the completion of the second review under the PSI.

Table 2.

Mozambique: Government Finances, 2006-2011

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

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.

Residual discrepancy between identified sources and use of funds.

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

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

Excludes recapitilization bonds issued to the Bank of Mozambique.

Table 3.

Mozambique: Monetary Survey, 2006–2011/1

(Millions of MT, unless otherwise stated)

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Sources: Bank of Mozambique; and IMF staff estimates and projections.

Following the adoption of a Chart of Accounts in line with the IFRS, the monetary survey was revised back to January 1997 to incorporate more detailed information provided by banks regarding the residency and use of monetary instruments. As a result, deposit standing facilities previously included as part of base money are now excluded.

Based on data prior to the technical revisions to the monetary survey in January 2008.

Based on data after the technical revisions to the monetary survey in January 2008.

Includes MDRI assistance which was transferred to a government blocked deposit account at the BM. The balance is being drawn down by 0.5 percent of GDP per annum in line with an agreed increase in MDRI-financed government expenditures.

Table 4.

Mozambique: Balance of Payments, 2006–2011

(Millions of U.S. dollars, unless otherwise specified)

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

Since this presentation still follows the fourth balance of payments manual, MDRI and HIPC grants from the IMF are included in the current account.

Private borrowing, not guaranteed by the government or the Bank of Mozambique. Includes HCB borrowing in 2007.

The large amortization in 2006 reflects the repayment of IMF debt with MDRI resources.

Includes HCB amortization in 2007.

Projections are underestimated due to lack of information on new megaproject investments.

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

Based on the new monetary survey from 2008.