1. Introduction

The Mozambican authorities are appreciative of the Fund’s continued engagement and support in advancing their economic reform agenda aimed at safeguarding macroeconomic stability, gradually removing binding constraints to economic competitiveness, and strengthening policy institutions. Economic performance has remained broadly in line with the targets envisaged under the Policy Support Instrument (PSI), amidst heightened downside risks related to protracted low commodity prices, the slowdown in FDI inflows, restrained donor support, and the weakened global demand. However, in spite of timely actions to contain increased depreciation pressures that have emerged since completion of the Fourth PSI Review, BOP pressures have remained significant. This has led to a draw down in reserve buffers and a robust adjustment of the macroeconomic policy stance to address short term vulnerabilities while accelerating the pace of external adjustment. In view of this, the authorities seek the Executive Board’s approval for completion of the fifth review under the PSI and modification of assessment criteria, as well as the request for an 18-month arrangement under the Standby Credit Facility.

2. Recent Economic Developments and Outlook

The challenging environment, primarily related to the protracted commodity price slump coupled with the adverse impact of floods earlier in 2015, prompted a slight downward revision of the macroeconomic policy objectives set for 2015–2017. GDP growth receded to 6.3 percent in the first half of 2015, compared to an average of 8 percent over the past two years. This slowdown is primarily attributed to a significant decline of mining sector growth from 29 percent in the first half of 2014 to 17 percent during the same period of 2015. There was also weak performance in the commerce, transportation and agriculture sectors, the latter mostly reflecting the impact of the floods. Recent developments indicate that in the first three quarters of the year, real GDP grew by 6.2 percent, broadly in line with the projected growth of 6.3 percent in 2015. Real GDP growth is forecast to reach on average 7–8 percent over the medium term, in consonance with the goal set forth in the Five-Year Government Plan. This performance improvement will be driven by projected increases in infrastructure investments to boost competitiveness in labor intensive sectors including agriculture and manufacturing, and by massive logistic investments in preparation of the exploration phase in the hydrocarbon sector.

Consumer price inflation is forecast to average 2.4 percent in 2015, and is expected to remain at the Bank of Mozambique’s (BM) target of 5–6 percent, in the short and medium term. To lessen the impact of heightened depreciation pressures on the economy, the Monetary Policy Committee increased its reserve requirements by 100 basis points in October and by 150 basis points in November 2015. The BM also raised both its standing lending facility rate and its standing deposit facility rate by 225 basis points, cumulatively in October, November and December, 2015, in an effort to further tighten the monetary policy stance. This should help achieve a rapid adjustment of the external position, while preserving net international reserves, consistent with the goal of maintaining comfortable levels of 4.5–5 month of import cover over the near term.

The current account deficit excluding megaprojects deteriorated slightly in the first half of 2015, on account of weaker performance of traditional exports, lower commodity prices and declining FDI and external aid. In the medium term, the current account deficit including mega projects is expected to increase significantly, from around 42 percent of GDP in 2015, to 55.5 and 81 percent of GDP, in 2017 and 2019, respectively, due to large projected imports to support logistic investment in extractive sector. In the longer-term, however, once the gas production begins, the current account balance could steadily improve and reach a surplus of around 10 percent of GDP, in 2025.

3. Program Performance

The authorities have stepped up efforts to mitigate the adverse impact of short term vulnerabilities arising from the lingering low commodity prices and terms of trade shocks, coupled with weather related shocks, with mixed program performance under the PSI through September 2015. Performance on three AC related to net credit to the government (NCG), net international reserves (NIR), and external payment of arrears was mixed, while government revenue fell short of the indicative target. Deviation in the NCG reflected transitory factors, particularly the need to clear payment arrears (0.6 percent of GDP) of subsidies to fuel distributors to compensate for the past losses, which have been under-estimated in the budget, coupled with accelerated pace of discounting of bulk of government securities issued to clear outstanding VAT arrears. The NIR was missed by a small margin mostly reflecting significant BOP pressures and continued valuation losses due to a stronger US Dollar. Coordination constraints in reconciling information with donors led to small amount of arrears, which has since been resolved. On the structural front, significant progress has been achieved; all measures have been implemented broadly as planned.

4. Fiscal Policy

The implementation of the authorities’ fiscal strategy in the short and medium term aims to foster fiscal consolidation, support the needed external adjustment, and rebalance expenditure towards growth-enhancing sectors, while safeguarding debt sustainability. Total revenue for 2015 is projected to reach 25.2 percent of GDP, the total expenditure including net lending to amount to 35.3 percent of GDP, with the implied overall fiscal deficit projected around 6.0 percent of GDP. The targeted 2015 fiscal adjustment is expected to lead to a reduction of around 1.5 percent of GDP, through containment of current expenditure, mostly the wage bill, and subsidies, while scaling back public investment based on implementation capacity.

The authorities will continue to step up fiscal structural reforms to broaden the tax base, enhancing the efficiency of tax administration, and set a robust legal framework to enable an optimal intergenerational redistribution of the revenues from natural resource taxes. In addition, strengthening of institutional capacity to monitor implementation of investment programs, and upgrading the selection criteria to ensure adequate value for money of capital expenditures will continue.

While cognizant of the risks posed by heightened depreciation pressures to debt sustainability, the authorities remain committed to invigorate the implementation of policy measures to improve debt management, and upgrade the institutional capacity on financial oversight of public enterprises. This set of policy priorities will contribute to prevent escalation of fiscal risks, and safeguard debt sustainability, over the medium and long term. At the same time, an elevation of the debt vulnerability rating should not result purely from external factors, such as exchange rate depreciation. Changes in the risk of debt distress rating should also take into account exogenous factors which are beyond the authorities’ control.

5. Monetary and Exchange Rate Policies

The monetary and exchange rate policies continues to be geared towards achieving price stability and smoothening exchange rate volatility in the short and medium term. The BM will gradually fine tune its policy instruments to contain the current depreciation pressures, while curbing the second round effects exerted on inflation expectations prompted by adjustment in administered electricity, bread and water prices in October 2015. More specifically, measures directed to enhance the monetary policy framework, particularly through improved analytical capacity on inflation forecasting and liquidity management will be given a priority. Swift implementation of policy measures aimed at strengthening crisis management tools to contain risks for financial stability, stemming from significant concentration of loans in the banking system, will also be critical.

Restoring reserve buffers is paramount to improve the ability of the economy to absorb future external shocks. In this regard, the BM will continue to pursue actions directed at rebuilding international reserves while allowing exchange rate flexibility.

6. Financial Sector Development Policies

Enhancing financial deepening and inclusion remain a critical challenge to address the limited access to financial services in the economy. The authorities remain committed to foster the implementation of ongoing reforms aimed at achieving the main objectives of the Financial Sector Development Strategy (FSDS 2013–2022): (i) maintain financial stability; (ii) increase access to financial services and products, and eliminating structural constraints to the economy; and (iii) increase the supply of private capital to support private development. To this end, a set of measures have been deployed, including the establishment of credit registry bureaus, promotion of mobile banking and implementation of a moveable collateral registry.

7. Structural Reforms

Fostering broad based-growth and achieving productivity gains in traditional sectors of the economy such as agriculture and manufacturing, remain a challenge for Mozambique in the next decade. The weak growth elasticity of poverty reduction, estimated at 0.1 percent, side by side with still sub-optimal patterns of income distribution, call for accelerating structural reforms to reinforce the growth-poverty- nexus, while addressing the outstanding bottlenecks to economic competitiveness and productivity. The implementation of the authorities’ reform agenda going forward, as stated in their Five Year Government Plan (2014–2019), seek to foster economic transformation and diversification and swiftly deploy a set of policy measures to tackle binding constraints to growth, through continued investment in infrastructure projects to unlock the country’s growth potential and augment job creation.

Further, to improve the business climate, the authorities will revamp steps underway to expedite the process of starting up a new business, particularly through improved online provision of integrated services for facilitating “start ups”, in addition to expanding the geographical coverage of one-stop shops.

8. Conclusion

Going forward the authorities stand ready to advance the implementation of policy reforms aimed at restoring market confidence and safeguarding macroeconomic stability. They will continue to implement measures which mitigate the adverse impact of short term vulnerabilities. In line with these commitments, the authorities look forward to continued constructive engagement with the Fund in order to support enhanced institutional capacity on policy design and implementation.