Republic of Mozambique: Fourth Review Under the Policy Support Instrument—Debt Sustainability Analysis

The economic outlook remains positive. Growth is expected to reach 7 percent in 2015 and inflation to remain low. Substantial policy adjustment is underway to respond to slippages around the elections and new balance of payment pressures from low commodity prices. Fiscal adjustment, greater exchange rate flexibility and stronger liquidity management are essential to preserve macroeconomic stability and continue to attract foreign investment to support growth, including in the oil and gas sector where projected investments could reach $100 billion over the next decade.

Abstract

The economic outlook remains positive. Growth is expected to reach 7 percent in 2015 and inflation to remain low. Substantial policy adjustment is underway to respond to slippages around the elections and new balance of payment pressures from low commodity prices. Fiscal adjustment, greater exchange rate flexibility and stronger liquidity management are essential to preserve macroeconomic stability and continue to attract foreign investment to support growth, including in the oil and gas sector where projected investments could reach $100 billion over the next decade.

Underlying DSA Assumptions

1. This DSA is consistent with the macroeconomic framework outlined in the Staff Report for the Fourth Review under the PSI (Box 1). Compared to the previous DSA,2 the main changes in this DSA are as follows:

  • a. The medium-term macroeconomic framework has been updated but is similar to the last DSA (Text Table 1). The economic outlook remains positive, although somewhat less buoyant than projected during last DSA, with economic growth at 7.4 percent in 2014 and projected at 7 percent in 2015 (compared to 8.3 and 8.2 percent respectively). The main reasons being slower-than-expected increases in coal production, political uncertainties before the presidential election in 2014, and the effects of the floods in early 2015. Nevertheless, growth is expected to accelerate over the medium term on the back of extractive industries and infrastructure investments. The overall fiscal deficit was higher in 2014, with expenditure loosening influenced by the electoral cycle and one-off spending on maritime security (2.8 percent of GDP). To ensure debt sustainability, substantial fiscal consolidation is expected in 2015, mainly through a reduction in public spending and continued improvement in domestic revenue mobilization.3 The current account deficit is projected to remain in the range of 38-45 percent of GDP over the medium term reflecting significant imports of goods and services related to the development of the gas and coal sectors. These imports are financed primarily by non-debt creating FDI.

    Text Table 1:

    Evolution of Selected Macroeconomic Indicators between DSA Updates

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    Macroeconomic Assumptions 2015–35

    The medium-term assumptions in the baseline scenario for 2015-35 are consistent with the medium-term macroeconomic framework underlying the Staff Report for the Second Review under the Policy Support Instrument.

    Real GDP growth is projected to be in the 7-8 percent range on average in the longer term. Growth is expected to accelerate over the medium term, supported by the expansion in coal mining and infrastructure investments, including support for coal exports and LNG manufacturing. A sharp increase in growth in 2020 reflects the assumed coming on line of the first natural gas production plant (“train”) and related exports in that year. 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 and private investment not achieving expected payoffs and thus limiting productivity gains, and the possibility of Dutch disease.

    LNG sector. LNG plants are assumed to be under construction during 2016–22. 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 high import content. Annual LNG output will reach 20 million tons in 2023, contributing more than 20 percent of nominal GDP by then. These assumptions are conservative given the potential size of the project, but remain adequate before a final investment decision is made by the investors.

    Consumer price inflation is projected to remain in the authorities’ target range of 5–6 percent over the medium term.

    Export Growth is projected to remain around 7 percent a year in the longer term as coal and LNG exports stabilize. In the short term, export growth rates show sharp changes as a result of large coal and LNG development project cycles. In particular the growth rate of exports would almost double in 2020-23 due to LNG exports coming on line.

    Imports are projected to show abrupt jumps in 2016-2023 during the LNG plant construction phase but their growth would stabilize at around 8 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.4 The deficit will be primarily financed through FDI and private external borrowing. It would then average 14 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 2014, reflecting an expansionary budget in an election year, including one-off expenditure on maritime security (2.8 percent of GDP). The fiscal balance would improve in the medium to long term as revenue efforts continue, the wage bill and public investment taper off to more sustainable levels and other non-interest current expenditure falls in percent of a fast-growing GDP. The fiscal balance is expected to improve further beyond 2020 once LNG revenue commences.

  • b. External borrowing profile. New borrowing has generally been contained since the last DSA, but the amount of pending applications for large bilateral loans has increased and now surpasses US$ 2.2 billion (Text Table 2), although it does not include all priority projects of the government’s five-year investment plan.5 This pipeline is expected to lead to an increase in external borrowing compared to the previous DSA, with more costly domestic financing being scaled back to achieve the envisaged fiscal consolidation.6 While about two-thirds of this external loan pipeline is envisaged to be contracted on concessional terms, the total borrowing approaches the pipeline of 2012-13 (US$ 3 billion), which ultimately elevated the risk of debt vulnerability rating from low to moderate (Country Report 13/200).

    Text Table 2.

    Large Bilateral Loans in the Pipeline, as of June 2015

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    Text Figure 1.
    Text Figure 1.

    Public Sector External Debt Disbursement Path

    Citation: IMF Staff Country Reports 2015, 223; 10.5089/9781513533568.002.A002

    Note: Excludes US$ 850 million EMATUM guarantee in 2013, but includes government assumption of US$500 million of this debt issue in 2014.1/ Large bilateral loans are those with amounts exceeding US$60 million.2/ Also includes disbursements on small bilateral loans.

  • c. Private sector debt stocks and medium-term borrowing have been revised further upwards. The International Investment Position data now puts private external debt at 31 percent of GDP in 2014. It is projected to rise to some 85 percent by 2020, i.e. somewhat less steeply than in the previous DSA in response to the financing of gas liquefaction capacity, because more of this financing is now expected to be through equity financing. The ratio is expected to fall back to 49 percent by 2025 when LNG is exported and private borrowing is being amortized. This debt is mobilized and repaid entirely through offshore SPVs, which limits risk to the domestic financial system.

External Debt Sustainability Analysis

2. Total 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 137 percent of GDP in 2020. By then time private sector debt will represent 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. The significant build-up of private sector external debt needs to be monitored by the authorities to contain vulnerabilities, though risks (as noted above) are limited due to the financing structures through SPVs offshore. With renowned global companies leading investments in the natural resource sector, however, the risk for government contingent liabilities or other vulnerabilities beyond those specific to the natural resource operations is deemed modest.7

3. All public external debt indicators remain below their respective thresholds in the baseline (Figure 1).8 The PV of debt in terms of GDP now peaks around 35.6 percent (in 2019), compared to a peak of 33 percent in the previous DSA. The beginning of LNG production and the ensuing surge in GDP would reduce the ratio down to a 30-32 percent range in the next decade (Table 1).

4. External debt ratios are sensitive to FDI, terms-of-trade and exchange rate shocks.9 The threshold for the PV of debt to GDP ratio is breached under the most extreme stress tests for a sustained period.10 A combination shock consisting of reductions in non-debt creating FDI, export prices and growth in 2016-2017 would push the PV of debt/GDP ratio well above the 40 percent threshold during the next 15 years, with a peak of about 70 percent (Figure 1). Apart from this combination shock, a sharp depreciation of the metical in 2016, or a shock to FDI lead to significant overshooting of the threshold for a sustained period.11 The pattern of these impacts is broadly consistent with the previous DSA. In these three shock scenarios the PV of debt will also breach the debt/exports threshold of 150 percent of exports.12

5. Ensuring that LNG production materializes is crucial for Mozambique’s debt sustainability. The authorities have made significant progress in establishing legal frameworks for the sector, but further time-sensitive steps need to be taken this year to ensure that LNG investment can move forward. The LNG sector is expected to contribute significantly to GDP, exports and government revenue. A gradual public investment scaling-up, as under the baseline scenario, anticipating some LNG revenue would be appropriate given Mozambique’s infrastructure investment needs. If, however, there are delays in project take-off or LNG production or revenue is much lower than expected, the debt ratios would be higher over the medium to long term.

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 gradual contraction of loans currently in the pipeline leading to a temporary buildup in externally-financed public investment toward the end of this decade. The DSA assumes that about 10 years after the start of LNG exports the public sector will dedicate an increasing share of resources to pay back debt. Under the baseline scenario, the PV of public debt remains below 45 percent of GDP throughout, therefore remaining well contained and below the indicative benchmarks that research has linked to increased probability of debt distress.13

7. The public DSA illustrates that it is essential for debt sustainability to prioritize appropriately the investment projects currently in the pipeline. This is particularly important as funding may also be needed for other important investment projects, including in the energy sector, which are currently not yet in the pipeline. This borrowing plan will need to be consistent with the envisaged gradual reduction in the fiscal primary deficit over the medium run to place public debt on a downward trajectory.

Conclusion

8. While the standard DSA shocks indicate that Mozambique would be in the moderate risk of external public debt distress category, public investment should continue to move forward. However, in light of a large loan pipeline, projects need to be appropriately prioritized to maintain debt sustainable. Even against the background of a temporarily accelerated pace of disbursements toward the end of this decade, the baseline debt trajectories remain below their respective thresholds throughout. Importantly, debt service indicators remain substantially below their thresholds, including under stress tests, and reflect conservative assumptions regarding the grant element for future borrowing.14 The breaches under the stress tests would be reversed by the coming on stream of LNG production, and seem manageable against the backdrop of the authorities’ strong track record of prudent economic management. Moreover, the impact of shocks is heightened by the fact that the standard stress tests revert to historical values, which are significantly different from current and expected values because of the structural change in the Mozambican economy resulting from the large-scale exploitation of coal and natural gas.

9. This analysis highlights three important points for debt sustainability. First, it will be important to continue to improve debt management and investment planning capacity to ensure that the most deserving public investment projects are selected and yield their desired payoff. This is becoming even more important, because of the full loan pipeline. Second, it will be important for the authorities to commence the gradual fiscal consolidation envisaged in their program to place public debt on a gradual downward trajectory over the medium term while addressing key public investment priorities. Third, it continues to be important—including from a debt sustainability perspective—to take the essential time-sensitive steps to ensure that LNG production materializes in order to lock in the beneficial effects on GDP and fiscal revenue.

Figure 1.
Figure 1.

Mozambique: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2015-2035 1/

Citation: IMF Staff Country Reports 2015, 223; 10.5089/9781513533568.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025. In figure b. it corresponds to a Combination shock; in c. to a Combination shock; in d. to a Combination shock; in e. to a Exports shock and in figure f. to a Combination shock
Table 1.

Mozambique: External Debt Sustainability Framework, Baseline Scenario, 2012-2035 1/

(In 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, 2015-2035

(In Percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

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 b

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 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.

Figure 2.
Figure 2.

Mozambique: Indicators of Public Debt Under Alternative Scenarios, 2015-2035 1/

Citation: IMF Staff Country Reports 2015, 223; 10.5089/9781513533568.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2025.2/ Revenues are defined inclusive of grants.
Table 3.

Mozambique: Public Sector Debt Sustainability Framework, Baseline Scenario, 2012-2035

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

[Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or 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.

Table 4.

Mozambique: Sensitivity Analysis for Key Indicators of Public Debt 2015-2035

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

1

The DSA presented in this document is based on the standard low-income countries (LIC) DSA framework. See “Staff Guidance Note on the Application of the Joint Bank-Fund Debt Sustainability Framework for Low-Income Countries” (http://www.imf.org/external/pp/longres.aspx?id=4827) and World Bank Report No. ACS6956, 10/23/13). Under the World Bank Country Policy and Institutional Assessment (CPIA); updated on July 25, 2014 with the 2013 CPIA rating, Mozambique maintains the medium policy performer rating, albeit close to the threshold of 3.75 for strong performers, with an average rating of 3.67 during 2011–13; the DSA uses the indicative threshold for medium performers for 2014-15.

2

See IMF Country Report No. 14/148.

3

From 2020 onwards staff adopts a relatively conservative approach with public debt stocks falling by less than implied by projected growth (and the fiscal deficit path) due to the uncertainty surrounding the LNG development, which constitutes a major growth driver in this period. This results in modestly positive residuals in the analysis of public debt.

4

Meanwhile, the non-megaproject current account is expected to remain on the order of 11-12 percent during the next years.

5

Non-concessional borrowing had been high in 2013 because of the government guarantee for Loan Participation Notes (LNP) of $850 million (6 percent of GDP) issued on behalf of the newly created enterprise EMATUM (tuna fishing). Of this amount, the government incorporated $500 million as government debt in the 2014 budget, which were related to maritime security (under the budget of the Department of Defense). This change does not have an impact on the DSA, which already included publicly-guaranteed debt..

6

The authorities only envisage to sign most of the loans of Text Table 2 (and all its non-concessional ones) only after their ongoing work on the medium term fiscal framework has been completed.

7

Likewise, the risk of BOP pressures emerging as a direct result of megaproject-related investment activity is considered to be low. Care will have to be taken in the long term, however, once revenues from these ventures materialize, as these may be volatile reflecting world commodity prices and in relation to imports. Moreover, large natural resource exports then also hold competitiveness risks emerging from a possible exchange rate appreciation, which will have to be carefully managed.

8

Following the previous DSA, the historical scenario has been excluded from Figure 1. The reason for the exclusion is that such a scenario shows unrealistically fast declines of public debt ratios over the medium term, because it fixes the current account deficit at an historical average of 19.2 percent of GDP. This is much lower than the 38-45 percent of GDP deficits. With private debt accumulation assumed to remain unchanged compared to the baseline, this assumption then results in unrealistically fast declines of public debt ratios.

9

The impact the of the standard shocks in the DSA template is heightened by the fact that the standard stress tests revert to historical values, which are significantly different from current and expected values because of the structural change in the Mozambican economy resulting from the large-scale exploitation of coal and natural gas since 2011.

10

The scenario in which variables are at their historical levels has been omitted given that it generates negative debt as a result of the large changes in variables in the baseline arising from LNG activities.

11

The charts in Figure 1 display the stress test with the most adverse outcome in 2025.

12

This breach, however, should not be overemphasized as a fall in FDI would likely be linked to lower imports rather than higher borrowing as implicitly assumed in the standard shock scenario.

13

At Mozambique’s CPIA rating, the indicative public debt benchmark signaling higher risk of debt distress lies between 56 and 74 percent for the PV of debt-to-GDP ratio. See IMF, 2012, “Revisiting the Debt Sustainability Framework for Low-Income Countries.”

14

Moreover, these indicators do not account for other buffers, such as comfortable levels of international reserves relative to non-megaproject imports.