Republic of Mozambique: Staff Report for the 2013 Article IV Consultation, Sixth Review Under the Policy Support Instrument, Request for a Three-Year Policy Support Instrument and Cancellation of Current Policy Support Instrument—Debt Sustainability Analysis (DSA)

The staff report for the 2013 Article IV Consultation for the Republic of Mozambique focuses on the development agenda and appropriate policy priorities to successfully transition to a resource-rich era. These priorities include skillful medium-term management of the impact of developing coal and gas resources, high public investment spending on growth, external competitiveness, and through increased commercial borrowing, on debt sustainability and investment planning. Mozambique has a high rate of public investment of which more than half is financed domestically. The authorities are working to strengthen their project selection and economic profitability analysis capacity, and to assess the impact of related borrowing on public debt.

Abstract

The staff report for the 2013 Article IV Consultation for the Republic of Mozambique focuses on the development agenda and appropriate policy priorities to successfully transition to a resource-rich era. These priorities include skillful medium-term management of the impact of developing coal and gas resources, high public investment spending on growth, external competitiveness, and through increased commercial borrowing, on debt sustainability and investment planning. Mozambique has a high rate of public investment of which more than half is financed domestically. The authorities are working to strengthen their project selection and economic profitability analysis capacity, and to assess the impact of related borrowing on public debt.

Underlying DSA Assumptions

1. This DSA is consistent with the macroeconomic framework outlined in the Staff Report for the Sixth Review under the PSI (Box 1). Compared to the previous DSA,1 the main changes in this DSA are as follows:

a. The medium-term macroeconomic framework has been revised (Text Table 1). In particular, economic growth slows in 2013 as a result of widespread flooding early in the year that damaged agricultural output and transport infrastructure. Growth is projected to bounce back quickly and accelerate over the medium term as agriculture recovers, extractive industries boom, and infrastructure investments materialize. The fiscal deficit was lower in 2012, among other factors because of windfall capital gain tax revenues received. Significant revisions have been made to the balance of payments that result in larger current account deficits and larger FDI inflows—both historically and in the projections. The bulk of the revision is related to megaprojects, particularly the inclusion of imports of goods and services related to exploration in the natural gas sector; the counterpart of these imports is a large increase in recorded inward FDI.

Text Table 1:

Evolution of Selected Macroeconomic Indicators between DSA Updates

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The disbursement pace is not faster as in the previous DSA, because implementation of some projects has been slower than previously expected and the large prospective new loan for the Moamba Major Dam is currently expected to start disbursing only in 2015.

Portuguese credit line.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new disbursements).

Macroeconomic Assumptions 2013–33

The medium-term assumptions in the baseline scenario for 2013-33 are consistent with the medium-term macroeconomic framework underlying the Staff Report for the Sixth Review under the Policy Support Instrument.

Non-LNG Real GDP growth is projected to be around 8 percent on average in the next few years and 7½ percent in the longer term. Growth will slow down in 2013 due to the impact of floods, but is expected to accelerate over the medium term, supported by recovery in agricultural production, expansion in coal mining, and infrastructure investments in the pipeline, including to support coal exports and LNG manufacturing. Growth is sustained in the long term by strong population/labor force growth, continued infrastructure investment, and related productivity gains. Risks to growth include public investment not achieving expected payoffs and thus limiting productivity gains, and the possibility of Dutch disease effects. The government is aware of the risks, and is taking steps to strengthen project evaluation and selection, and is considering options such as fiscal rules and sovereign wealth funds to mitigate the risk of excessive real exchange rate appreciation.

LNG sector. LNG plants are assumed to be under construction during 2014–22. The projection assumes a moderate-sized plant consisting of four LNG manufacturing units (“trains”). One train is assumed to start production in 2020, followed by a second train in 2021, and the third and the fourth train will start production in 2023. Total investment is projected at $40 billion. The sector’s contribution to GDP is expected to be small during the construction period due to a high import content. Annual LNG output will reach 20 million tons in 2023, contributing more than 20 percent of nominal GDP by then.

Consumer price inflation is projected to rise to 5–6 percent in 2013, owing to rising food prices and an increase in public transport fares in late 2012 and also reduced domestic food supply as a result of the floods. As per the Central Bank medium term target, inflation is assumed to stabilize at around 5½ percent over the forecast period beginning from 2014.

Growth of exports is projected to stabilize at around 5 percent a year in the longer term as coal and LNG exports stabilize. In the shorter term export growth rates show sharp changes as a result of coal and LNG operations. In particular the growth rate of exports would almost double in 2020-23 due to LNG exports coming on line.

Imports are projected to increase sharply in 2014 during the LNG plant construction phase and their growth would stabilize at around 9 percent a year in the long term.

The non-interest external current account deficit is projected to rise to over 40 percent of GDP in the medium term largely driven by LNG-related imports. The deficit will be primarily financed through FDI and private external borrowing. It would then stabilize at around 8 percent of GDP in the long term as coal exports increase with transport capacity and as LNG exports start.

The non-interest primary fiscal deficit is projected to widen in 2013 and 2014, reflecting high public investment in the pipeline to mitigate the infrastructure gap. The fiscal balance would improve in the medium to long term as public investment tapers off to more sustainable levels and non-interest spending falls in percent of GDP terms. The fiscal balance is expected to improve further from 2020 onwards once LNG revenue commences.

b. The natural gas sector. The baseline scenario in this DSA has incorporated the emerging gas sector in Mozambique. The basis for the development of the sector is one of the largest worldwide discoveries of gas. These developments result in: (i) higher foreign direct investment and private external borrowing for exploration (since 2010) and the construction of a 4-train gas liquefaction (LNG) plant (2014-2022); (ii) increased imports of goods and services related to LNG; and (iii) increased GDP and exports from 2020 onwards when the LNG plant becomes operational. Under baseline assumptions, the LNG sector will contribute 20 percent of GDP and half of exports by 2023. LNG-related fiscal revenue will be small in the beginning owing to cost recovery provisions. Revenue will gradually increase over the medium to long term.

c. The coal mining sector. Coal production is expected to expand rapidly over the medium term to 20 million tons (6 percent of GDP) in 2017 from about 5 million tons (2 percent of GDP) in 2012. Most of the coal produced will be for exports—high quality coking coal—while the abundant lower-value thermal coal is not currently marketed due to transport capacity constraints. Coal-related investments in mines, railways, ports, and a coal-fired power plant are conservatively expected to amount to $5 billion during 2013–17, financed by FDI inflows. Adverse world coal price movements constitute a risk to these expansion plans, which could result in delayed implementation or scaling back.

d. The related substantial BOP revisions show much larger changes in variables, especially FDI, and thus larger volatility than assumed in the last DSA. The related standard shocks in the DSA template produce larger deviations from the baseline scenario, and thus make breaches of the sustainability thresholds more likely and more prolonged than in the last DSA.

e. A revised public investment and external borrowing profile. Thus far, disbursements, particularly of nonconcessional loans, have been lower than expected in the previous DSA, mainly because of a somewhat slower start of projects. Disbursement are projected to increase in 2013–16, in line with the recent increase in the non-concessional borrowing ceiling to $1.6 billion under the current IMF-supported program and the proposed non-concessional borrowing ceiling under the successor program, but also through a notable increase in bilateral concessional loans (Text Table 2). Following the acceleration of external borrowing through end-2013, the authorities plan to moderate the pace of new borrowing over the medium term (Text Figure 1). Starting at the end of this decade, new public sector borrowing is expected to decline gradually relative to GDP in light of the coming on stream of natural resource-related revenue from the coal and natural gas sectors. Nominal disbursements, however, are projected to continue increasing throughout the projection period. Other large potential future investment projects, e.g. in railroads, the LNG and power sectors, are deemed commercially viable by the authorities and would be expected to be undertaken largely by the private sector, without substantial need for government financing or guarantees. However, these projects could constitute a risk for the public debt trajectory if significant government financing became necessary. Another risk is that pressures may emerge and make it difficult to slow the future pace of public loan contracting, particularly in light of the country’s vast infrastructure needs. Finally, project costs could be underestimated, as was the case for the Nacala airport.

Text Table 2.

Non-concessional Loans Contracted and in the Pipeline

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34 percent grant element.

Text Figure 1.
Text Figure 1.

Public Sector External Debt Disbursement Path

Citation: IMF Staff Country Reports 2013, 200; 10.5089/9781475573855.002.A002

f. A revised grant element in financing terms for future borrowing. This DSA assumes that the grant element for new borrowing will experience a pronounced decline during the next two decades, contrary to the previous DSA that assumed a roughly constant 30-percent grant element. This reflects revised assumptions on the long-run availability of donor financing with government relying increasingly on commercial borrowing.

g. The reduction of the DSA discount rate from 4 percent a year ago to 3 percent in this DSA yields a higher present value of debt/borrowing in this DSA compared to the previous one.

External Debt Sustainability Analysis

2. External debt is projected to rise rapidly during this decade, reflecting mainly private sector investment in the natural gas sector. External debt (both public and private) is expected to peak at about 128 percent of GDP in 2019, at which time private sector debt will constitute about two thirds of total external debt. With investment in the coal sector projected to be financed through foreign direct investment, this increase in private external debt is mostly driven by investments in the natural gas sector. Public sector debt is also expected to peak in 2018 at 45 percent of GDP (in PV terms) on the back of infrastructure investment. The significant buildup of private sector external debt needs to be monitored by the authorities to contain vulnerabilities. However, with renowned global companies leading investments in the natural resource sector, the risk for government contingent liabilities or other vulnerabilities beyond those specific to the natural resource operations is currently considered to be low.3

3. All baseline public external debt indicators remain below their respective thresholds but now come closer to the thresholds than previously (Figure 1).4 While the indicators remain contained throughout the projection period, they are significantly higher than at the time of the last DSA, especially the PV of debt relative to GDP. It now peaks around 39 percent (in 2018), relative to a 28½ percent peak in the previous DSA. The beginning of LNG production, however, and the ensuing surge in GDP would drop the ratio safely back down to below 33 percent in the next decade (Table 1). The increase of debt ratios is partly due to the lowering of the discount rate from 4 to 3 percent, which contributed to about one third (3 percentage points) of the increase in the PV of debt to GDP ratio. PV of debt to GDP ratio would be about 6 percentage points lower throughout the DSA period if the discount rate were at the longer-term historical average benchmark rate of about 5 percent instead of the 3 percent assumed in this DSA (Figure 1 and Table 2).

Figure 1.
Figure 1.

Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2013-2033 1/

Citation: IMF Staff Country Reports 2013, 200; 10.5089/9781475573855.002.A002

Sources: Country authorities and IMF staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2023. In each case it corresponds to a Combination shock.
Table 1.

Mozambique: External Debt Sustainability Framework, Baseline Scenario, 2010-2033 1/

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 2.

Mozambique: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2013-2033

(In percent)

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Sources: Country authorities; and staff estimates and projections.

A discount rate of 5 percent is applied to the calcualtions of NPV of debt (discount rate is 3 percent in the baseline.)

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

4. External debt ratios remain vulnerable to FDI and exchange rate shocks. The threshold for the PV of debt to GDP ratio is breached under stress tests for a sustained period.5 A sharp reduction in non-debt creating FDI in 2014-2015 would push the PV Debt/GDP ratio well above the 40 percent threshold during the second half of this decade, with a peak at more than 80 percent (Figure 1). Apart from the FDI shock, a sharp depreciation of the metical in 2014 also leads to breaches of this threshold (Table 2). Both shocks lead to a significant overshooting of the threshold for a sustained period: 13 years for the FDI shock and 19 years for the depreciation shock.6 The impact of these two shocks is now much larger than in the previous DSA given revisions to historical BOP data to account for FDI-financed natural gas exploration.7 The PV of debt will also breach two other thresholds: 150 percent of exports, and 250 percent of revenue under the FDI shock scenario.8 The thresholds for the PV of debt to export ratio is breached by a number of indicators, particularly a shock to non-debt creating flows. In many countries with large natural resource sectors, price volatility adds another source of risks to external debt sustainability. Given the long-term nature of the contracts that usually govern LNG development – including buying prices – the risk of significant volatility for external debt sustainability seems relatively small.

5. Ensuring that LNG production materilizes is crucial for Mozambique’s debt sustainability. The LNG sector will contribute significantly to GDP, exports and government revenue. A gradual public investment scaling-up under the baseline scenario anticipating some LNG revenue would be appropriate given Mozambique’s infrastructure investment needs. If, however, LNG production or revenue is much lower than expected, the debt ratios would be higher over the medium to long term.9

Public Sector Debt Sustainability

6. The evolution of public debt indicators (including domestic debt) mirrors that of the external indicators because of the predominance of external debt (Table 3 and Figure 2). The medium-term increase in public debt reflects the temporary surge in public investment financed in part by external borrowing on non-concessional terms. Under the baseline scenario, the PV of public debt remains below 50 percent of GDP throughout, therefore remaining well contained below indicative benchmarks that research has linked to increased probability of debt distress.10

Table 3.

Mozambique: Public Sector Debt Sustainability Framework, Baseline Scenario, 2010-2033

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Covers nonfinancial public sector. Gross debt is used.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.