Republic of Mozambique: Staff Report for the 2015 Article IV Consultation, Fifth Review Under the Policy Support Instrument, Request for Modification of Assessment Criteria, and Request for an 18-Month Arrangement Under the Standby Credit Facility
Author: International Monetary Fund. African Dept.
Publication Date:
08 Jan 2016
eISBN:
9781484395950
Language:
English
Keywords:
ISCR; CR; monetary policy committee meeting; natural gas resource; committee meeting of the Banco de Mozambique; metical; real GDP; debt management; natural resource; capital gain; short term; FX market; Imports; Global
Download PDF (27.6 MB)

This 2015 Article IV Consultation highlights that despite lower commodity prices and a weaker global environment, Mozambique's economic prospects remain positive given planned massive investment in natural resources. Although GDP growth averaged 7 percent over the last five years, Mozambique's per-capita income and human development index remain low. There is a need to continue implementing policies that support fiscal sustainability, infrastructure investment, and inclusive growth. Mozambique's economic outlook remains robust. Growth of 6.3 percent is expected in 2015, and remains below potential at 6.5 percent in 2016, mainly owing to a stagnant mining sector and substantially tighter fiscal and monetary policies.

Abstract

This 2015 Article IV Consultation highlights that despite lower commodity prices and a weaker global environment, Mozambique's economic prospects remain positive given planned massive investment in natural resources. Although GDP growth averaged 7 percent over the last five years, Mozambique's per-capita income and human development index remain low. There is a need to continue implementing policies that support fiscal sustainability, infrastructure investment, and inclusive growth. Mozambique's economic outlook remains robust. Growth of 6.3 percent is expected in 2015, and remains below potential at 6.5 percent in 2016, mainly owing to a stagnant mining sector and substantially tighter fiscal and monetary policies.

Context

1. Despite lower commodity prices and a weaker global environment, Mozambique’s economic prospects remain positive given planned massive investment in natural resources. While GDP growth averaged 7 percent over the last five years, Mozambique’s per-capita income ($624 in 2014) and human development index (178 out of 187 countries) remain low. There is a need to continue implementing policies that support fiscal sustainability, infrastructure investment, and inclusive growth. Over the medium term, efforts to develop a sound framework to manage natural resource wealth should be stepped up.

2. Political tension remains a risk factor. Failure to find a permanent solution to the growing tension between the ruling Frelimo party and the main opposition party (Renamo), which is calling for greater political decentralization, could negatively affect the business environment. While the risk of a return to an outright civil war is low, the government’s attempt to disarm Renamo has resulted in violent clashes with the police. Peaceful negotiations are essential to preserve macroeconomic stability and investor confidence at a time when Mozambique is facing new economic challenges.

3. Following policy slippages in 2014, the economy has been significantly affected by lower commodity prices and a decline in foreign exchange inflows. This has resulted in slower export growth, lower net international reserves (NIR), and a marked depreciation of the metical vis-à-vis the dollar. While the authorities tightened the fiscal stance and monetary policy following the 4th review under the PSI, renewed market pressures since the summer have led to a further depreciation of the metical (see para 7) and lower NIR. As a result, the authorities have requested a standby credit facility (SCF) to supplement the PSI to address the present balance of payments (BOP) need and shore up reserves, which will also provide a strong signal to markets of their intent to stabilize the economic and financial situation.

Millenium Development Goals

article image
Source: World Bank, World Development Indicators.

Revised: national 1996/97 based basket National Poverty Line with 13 location price deflators and 2002/03 and 2008/09 data partially re-estimated. (source: World Bank, Poverty in Mozambique: New Evidence from Recent Household Surveys, October 2012)

Data in italics refer to 2013.

WEO, World Economic Outlook, October 2015.

Recent Economic Developments and Program Performance

4. Robust growth and low inflation continued in 2015, though at a somewhat lower pace than historical averages. Growth decelerated to 6.3 percent in the first half of the year, owing to floods in early 2015, a slowdown in the mining sector, reflecting lower international commodity prices, and the delay in the approval of the 2015 budget. Despite the sizable depreciation of the metical against the US dollar, 12-month inflation stood at 2.4 percent in September because of a more moderate depreciation against the South African rand, low food prices, and stable administered prices (fuels, public transportation, and utilities). The depreciation and increases in administered prices (bread and electricity) in October-November are likely to push end-2015 inflation to around 5 percent.

A01ufig1

Mozambique: GDP growth and CPI inflation projections

(percent)

Citation: IMF Staff Country Reports 2016, 009; 10.5089/9781484395950.002.A001

5. The new administration has been implementing the fiscal consolidation agreed under the PSI program. Following election-related fiscal slippages in 2014, the 2015 budget started to place public finances on a more sustainable path through a reduction of about 1½ percent of GDP (excluding one-off factors in 2014) in public spending. For the first nine months of the year, spending was broadly in line with program targets while revenues underperformed by a small margin. However, in June, the government made a lump sum payment of about $100 million (0.6 percent of GDP) to fuel distributors to compensate them for past losses generated by regulated fuel prices, which reflected under-budgeting for fuel subsidies. In addition, delays in donor flows, and the fact that the bulk of government securities received by companies as reimbursements for outstanding VAT credits (MT 8.2 billion) was discounted, pushed net credit to government (NCG) above target at end-June and September. Nonetheless, the government expressed a commitment to restrain spending in the last quarter to ensure that the program fiscal targets and NCG ceilings are met. This should be feasible if donor flows for the rest of the year proceed as planned.

6. While the overall current account is improving due to a decline in import-intensive megaproject investments (given the end of the gas exploration phase), the non-megaproject current account has continued to worsen, intensifying pressures in the foreign exchange market. Foreign exchange market pressures, first experienced in late 2014 and early 2015, subsided during April-July but have since re-emerged. The non-megaproject current account deficit largely drives these pressures in the domestic foreign exchange market.1 During July 2014-June 2015, this deficit worsened by $1.7 billion compared to the previous 12 months. This deterioration was caused by lower commodity prices and declining FDI and external aid, while imports remained dynamic owing to strong domestic demand fueled by expansionary fiscal and monetary policies. The depreciation of the metical has so far not had a noticeable impact on import demand.

A01ufig3

Nominal depreciation of selected currencies versus the US dollar

(Percent ; US dollar per national currency - November 14, 2014-November 16, 2015)

Citation: IMF Staff Country Reports 2016, 009; 10.5089/9781484395950.002.A001

7. The net international reserves (NIR) of the Bank of Mozambique (BM) continued to decline. In an attempt to stabilize the foreign exchange market, the BM intervened heavily during late 2014 to early 2015, resulting in a $700 million decline in NIR. The BM has virtually stopped discretionary intervention since April and allowed the exchange rate to adjust (with a 33 percent year-on-year depreciation against the US dollar by mid-November 2015, the second largest depreciation in sub-Saharan African countries during the same period), but its longstanding commitment to supply US dollars to cover fuel imports2 and the government’s payment of EMATUM debt service falling due in September drove NIR down to $2.1 billion by end-October.3 The BM kept reserve money growth in line with commitments in the 4th PSI review, resulting in a gradual deceleration of credit growth, to 23 percent in September compared to 28 percent in end-2014.

8. Performance under the PSI through September 2015 was less than satisfactory. The assessment criteria (AC)/indicative targets on NCG, NIR, external arrears, and government revenues for June and September were missed (see above), while those on reserve money, nonconcessional borrowing, and the stock of short-term external public debt were met. The structural reform agenda is being implemented broadly as scheduled: of the ten structural benchmarks falling due before January 2016, 3 have been met, 3 have been completed with slight delays, 2 are expected to be met in time, and the other 2 are experiencing some delays (see paragraph 42).

Program Performance

article image
met not met
Figure 1.
Figure 1.

Mozambique: Impact of Global Developments

Citation: IMF Staff Country Reports 2016, 009; 10.5089/9781484395950.002.A001

Sources: Mozambican authorities and IMF staff estimates and projections.
Figure 2.
Figure 2.

Mozambique: Inflation and Monetary Developments

Citation: IMF Staff Country Reports 2016, 009; 10.5089/9781484395950.002.A001

Sources: Mozambican authorities and IMF staff estimates and projections.
Figure 3.
Figure 3.

Mozambique: Selected External Sector Developments

Citation: IMF Staff Country Reports 2016, 009; 10.5089/9781484395950.002.A001

Sources: Mozambican authorities and IMF staff estimates and projections.
Figure 4.
Figure 4.

Mozambique: Fiscal Developments

Citation: IMF Staff Country Reports 2016, 009; 10.5089/9781484395950.002.A001

Sources: Mozambican authorities and IMF staff estimates and projections.

Economic Outlook and Policy Discussions

Discussions focused on a policy adjustment package underpinning an 18-month SCF arrangement in response to the temporary external shocks and BOP needs. The SCF would supplement but not replace the current PSI. As regards surveillance issues, the discussions focused on medium-term policies to achieve fiscal consolidation, maintain an adequate level of international reserves, strengthen the capacity for managing natural resource wealth, and reinvigorate the structural reform agenda to promote inclusive growth and financial sector development.

A. Outlook and Risks

9. Mozambique’s economic outlook remains robust. Growth of 6.3 percent is expected in 2015 (i.e., a 0.7 percent downward revision), and remains below potential at 6.5 percent in 2016, mainly due to a stagnant mining sector and substantially tighter fiscal and monetary policies. Over the medium term, growth is projected to recover to 7½–8 percent, supported by massive investment in natural gas projects and higher coal production if key agreements can be reached for coal and gas sector development.4 Inflation is expected to increase towards the BM’s medium target of 5–6 percent, due to the recent depreciation of the metical and adjustments in administered prices.5

MEFP ¶4

Mozambique: Mining Sector Indicators

article image
Sources: Mozambican authorities, and IMF staff estimates and projections.

10. Economic risks are substantial. In the short term, construction of liquefied natural gas (LNG) plants could be significantly delayed if the ongoing negotiations between the authorities and gas companies are not completed by the end of the year. Over the longer run, persistently weak international commodity prices and significant slowdowns in China and other key economies might delay the expansion of coal mining projects and dampen growth. If these risks materialize, the recovery of growth to 7–8 percent could be delayed by a few years, while the growth rate would remain above 6 percent owing to the expected growth of non-mining sectors. As a tail risk event, low international gas prices could cause significant delays in the gas projects for several years, although the oil and gas companies still remain confident in the feasibility of their projects.6 In addition, new concessions awarded in October 2015 could generate additional investment in the oil and gas sector.

11. The depreciation of the metical has heightened Mozambique’s debt vulnerability, implying a need for cautious future borrowing. With most public debt issued in foreign currency, the depreciation raised the present value of external debt to almost 40 percent of GDP at end-2015 (from 30 percent at end-2014). The updated DSA shows that Mozambique’s external debt rating remains moderate, but debt level indicators are now closer to a high risk rating, and the risk to overall public debt is now heightened.7 Maintaining debt sustainability will require vigorous fiscal discipline in line with the authorities’ program, a strong focus on contracting debt mostly on concessional terms, and increased prioritization among investment projects. Such prioritization is also important as debt service has started to increase sharply with the start of repayments on EMATUM debt, even if it remains manageable overall. The present value of debt is expected to decrease somewhat below 40 percent of GDP during 2016–19 before declining to less than 20 percent by the mid-2020s because of a higher GDP (LNG production).

Mozambique: Risk Assessment Matrix1

article image
1 The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding he baseline. The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with authorities.

B. Short-Term Challenge: Responding to Balance of Payments Shocks

12. The central bank’s NIR have declined markedly in 2015, mostly due to a series of external shocks. Cumulative losses in NIR amounted to $1.1 billion between September 2014 and October 2015 as foreign exchange inflows declined substantially due to: (i) Mozambique’s exports being hit by sharp declines in international commodity prices from late 2014, both for commodity and traditional exports; (ii) foreign direct investment in the natural gas sector coming to a halt, with the exploration phase concluded and investment in processing facilities awaiting finalization of key production agreements between the government and concessionaires; (iii) absence of revenues from capital gain taxes in 2015 (which had supported the budget and NIR levels in 2013–14) and (iv) declines in external aid flows. Unforeseen renewed pressures since June (Box 2) have rendered the end-2015 target agreed at the time of the fourth review unattainable (see paragraphs 6, 7).

13. While significant policy adjustment is now underway to ensure that reserves are safeguarded, a more timely policy reaction would have been preferable. The authorities implemented measures agreed in the fourth review; in particular, the fiscal deficit is projected to decline to 6.0 percent of GDP in 2015 from 10.4 percent in 2014. However, import demand has thus far remained high—partly due to a lingering impact of the major 2014 fiscal policy slippages—although the authorities let the exchange rate depreciate (see above) and the metical is now being broadly fairly valued (Annex 1). Given the adverse shocks to external inflows, import levels have become unsustainable and a more immediate policy reaction would have been preferable to redress the situation. Especially, a tighter monetary stance than agreed at the time of the fourth review would have been desirable to counteract NIR losses. Adherence to the initial reserve money targets meant that the central bank was reinjecting through open market operations part of the domestic currency liquidity that was being withdrawn through foreign exchange sales. This impaired the automatic adjustment mechanism to the balance of payment pressures.

Impact of External Shocks

This box illustrates how renewed external shocks can explain most of the reserve losses in 2015 by causing higher BOP pressures than anticipated at the time of the fourth review of the PSI-supported program:

  • Mozambique’s exports—having already fallen short of projections by $170 million during the first half of 2015—are performing worse on account of further declines in key commodity prices, especially for aluminum and natural gas but also affecting traditional exports. Coal companies have reacted to continued low coal prices by limiting export volume growth to contain their losses.

  • Foreign direct investment for megaprojects has come to a halt—halving during the first semester of 2015—with finalization of key production agreements between the government and concessionaires taking longer than expected previously, delaying investments in coal infrastructure in LNG processing facilities.1

  • Aid disbursements have continued their longer-term downward trend in 2015, in contrast to fourth review projections which proved too optimistic in projecting a slight rebound.

Mozambique: 2015 average commodity prices

(Pct change vs. 2014)

article image

Finally, the BM’s international reserves, when evaluated in US dollars, suffered from further valuation losses after June as a result of continued dollar strength.

Mozambique: Changes in external inflows during 2015 and potential NIR impact

(US$ millions)

article image

Includes coal, natural gas, aluminum, titanium, and electricity.

Does not include project aid, which is tied to specific projects, typically infrastructure.

Basis for calculation of NIR adjustor under PSI program. It excludes in kind flows and funds tied to specific government programs with limited fungibility in financing the government budget.

Valuation change of net international reserves in US dollars during 2015.

Impacts of exports and FDI on potential NIR accumulation are less than one-to-one: For exports, only 50 percent of revenues have to be repatriated with exceptions for some firms. For FDI, only a relatively small fraction is spent on domestic value added rather than imports.

1 Although only a relatively small proportion of this investment spent on procurement of domestic value added, the additional impact is notable, given the sheer size of such investment and its steep decline.

14. Further policy adjustments are required to stabilize the BOP and start rebuilding international reserves. Policy adjustment is most critical to stabilize the BOP, with Fund financing filling the remaining financing gap and ensuring that other donor support proceeds as planned. Policy adjustment is projected to reduce imports by about $1 billion per year and will make the BOP sustainable after its full impact has materialized by the end of the 18-month SCF program. Fund financing amounts to SDR 204.5 million (approximately $285 million) over the course of the program and is expected to serve a catalytic role. In the near term, the authorities’ ongoing engagement with the Fund ensures that planned World Bank disbursements, including for budget support, go ahead as planned. In 2016 and beyond, the engagement will continue to underpin confidence of the broader donor community.

15. Staff and the authorities agreed on a policy mix based on three interrelated pillars designed to allow rebuilding of reserves to commence in 2016. These three pillars are (1) further fiscal adjustment of two percent of GDP, which will generate a reduction in the overall fiscal deficit to 4 percent of GDP in 2016 (the projected 6.0 percent of GDP in 2015 is already significantly lower than programmed); (2) the monetary policy tightening cycle initiated in October and intensified in November; and (3) reforming the FX market and allow for continued exchange rate flexibility. These policies will be supported by a gradual phasing out of the guaranteed sales of US dollars for fuel imports8 and minimal discretionary intervention to smooth out exchange rate volatility, with the authorities standing ready to undertake further policy adjustment to safeguard reserves in case BOP pressures remain higher than expected. The front-loaded implementation of this corrective policy package, with the planned adoption of the 2016 budget by mid-December 2015 and the implementation of the monetary and foreign exchange market measures in November 2015, aim at providing support to the shoring up of reserves right from the start of the program. The policy mix will be supported by an ambitious structural reform agenda with an added emphasis on critical PFM reforms and managing fiscal risks on public enterprises (including EMATUM).

16. As a result of the policy adjustment under the SCF/PSI, NIR are expected to bottom out during the first half of 2016 before resuming a path of gradual recovery that would return import coverage ratios back to comfortable levels. Given the level of NIR in October 2015 and projected foreign disbursements for the remainder of the year, the end-2015 NIR level is projected to be just above $2 billion. The tightening of monetary and fiscal policies should restrain imports significantly in 2016, adding to the lagged impact of the substantial depreciation of the metical. Policy adjustment, together with an expected modest resumption of FDI, should result in sufficient dollar liquidity in the domestic foreign exchange market by mid-2016 to allow the BM to discontinue interventions for fuel imports and gradually start purchasing dollars to rebuild reserves. Import coverage of gross international reserves is projected to increase to 4.5 months of non-megaproject imports by end-2016 (from 4.2 months of imports at end-2015).9 The shallowness and current illiquidity of the interbank foreign exchange market impair the central bank’s ability to purchase significant amounts of foreign exchange in the market and to pursue significantly more ambitious NIR targets in 2016.

Fiscal Policy

17. The main objective of fiscal policy in 2016 is to ensure debt sustainability and contribute to the required external adjustment. In 2016, net domestic financing will be slightly negative (0.2 percent of GDP), which will contribute negatively to money creation and help prevent crowding out pressures. Beyond 2016, the main objective will be to put debt accumulation on a downward path. In that regard, the authorities concurred with staff’s recommendation on a more rapid fiscal consolidation in the medium term than envisaged in the 4th review. With regards to external borrowing, the program targets are set based on the authorities’ appropriately prudent 2016 borrowing plan Reflecting the Fund’s updated debt limits policy, targets are now present-value based and cover total external borrowing instead of nonconcessional borrowing only (see the authorities’ borrowing plan in Tables 8. 9). By eliminating a rigid concessionality threshold, they should afford the authorities more flexibility in loan negotiations.

Table 1.

Mozambique: Selected Economic and Financial Indicators, 2012–20

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

Net of verified VAT refund requests.

Estimate consistent with DSA definition, the nonconcessional Portuguese credit line is included under the external debt. Domestic debt projections include planned securitization

Includes disbursements of IMF resources under the ESF and August 2009 SDR allocation.

Table 2.

Mozambique: Government Finances, 2012-16

(Billions of Meticais)

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

VAT presented on a net basis (collection minus requested VAT refunds).

Residual discrepancy between identified sources and uses of funds.

Revenue minus noninterest current expenditure minus locally financed capital expenditure and locally financed net lending.

Table 3.

Mozambique: Government Finances, 2012-20

(Percent of GDP)

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

VAT presented on a net basis (collection minus requested VAT refunds).

Residual discrepancy between identified sources and uses of funds.

Revenue minus noninterest current expenditure minus locally financed capital expenditure and locally financed net lending.

Table 4.

Mozambique: Monetary Survey, 2012-16

(Billions of Meticais, unless otherwise specified)

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