Jean A.P. Clément and Shanaka J. Peiris

Mozambique, a post-conflict coastal country endowed with vast natural resources, is one of the few economic success stories in sub-Saharan Africa. Since its civil war ended in 1992, Mozambique has achieved impressive broad-based GDP growth (8 percent a year, on average) and lowered poverty (the poverty headcount index went from 69 percent in 1997 to 54 percent in 2003). This represents a more sustained growth takeoff relative to those seen in many other post-conflict economies. As such, Mozambique appears well placed to achieve the United Nations Millennium Development Goal of halving the poverty rate by 2015. However, its per capita income is $303 (well below the sub-Saharan Africa average of $580), and almost a third of the population still lives on less than $1 a day. Sustaining Mozambique’s impressive growth takeoff is thus key to ensuring swifter and deeper poverty reduction. Recent IMF staff research on Mozambique to be presented in our forthcoming book, Post-Stabilization Economics in Sub-Saharan Africa: Lessons from Mozambique, thus focuses on second-generation reforms to consolidate macroeco-nomic stability, enhance productivity growth, and ensure a virtuous cycle of natural resource use.

Mozambique’s growth takeoff since the end of its civil war has been impressive and comparable to that of several fast-growing Asian economies, particularly the ASEAN-4,¹ India, and Vietnam. Its commitment to the stabilization effort, success in implementing first-generation structural reforms, and substantial donor assistance helped make this growth possible. The support of the international community, including the International Monetary Fund and World Bank, also helped Mozambique sustain its reform momentum and expand such basic services as primary education and health. Political stability and the consolidation of democracy in three general and presidential elections, which yielded a fairly unified government with a firm commitment to stability and growth, have helped underpin growth.

However, now that the post-stabilization rebound has largely run its course and first-generation reforms have been completed, more must be done to sustain Mozambique’s growth takeoff and further ease poverty. Mozambique has relatively sound political institutions, a favorable geography, and low income inequality—conditions common to many countries that have seen sustained growth takeoffs. What, then, may be the major constraints to sustaining Mozambique’s takeoff in the years to come?

According to a benchmarking exercise comparing the characteristics of fast-growing Asian and post-stabilization sub-Saharan Africa countries with those of Mozambique,² the country must make more progress in enhancing all levels of voice and participation at the institutional level, given the relatively high degree of societal fractionalization and regional disparities, so that more areas and groups benefit from growth. Mozambique’s economic institutions—particularly in terms of regulatory quality and the rule of law—are also relatively weak, though improving. Regarding the rule of law, it is possible to sustain growth while building institutions over the longer term, especially if efforts are made to invest in human capital and further integrate Mozambique into the global economy.

At the macroeconomic level, the consolidation of overall stability and a second wave of reforms would likely help Mozambique accumulate more capital and enhance its productivity growth. Inflation should be firmly anchored to single-digit levels, and real exchange rate overvaluations should be avoided. In this regard, it would be important for Mozambique to pursue a prudent macroeconomic policy mix and fine-tune its monetary policy framework.

Peiris (forthcoming) argues that fiscal policy could continue to focus on achieving the Millennium Development Goals but should be carefully managed to ensure long-term fiscal sustainability and avoid a loss of competitiveness. Foreign aid inflows amounting to about 15 to 20 percent of GDP could continue to be fully spent as long as they are allocated to, and reach, the most economically and socially productive priority sectors through a strengthening of public financial management systems. This would help elicit a supply response and mitigate the so-called “Dutch disease” effect of aid. The Heavily Indebted Poor Countries and Multilateral Debt Relief Initiatives have reduced Mozambique’s debt levels and provided it with the fiscal space to maintain a relatively high level of expenditures. Given the low tax-to-GDP ratio and the need to guard against aid volatility and gradually reduce donor dependence, however, an annual average revenue increase of 0.5 percent of GDP should continue to be targeted through the Medium-Term Fiscal Framework. This can be achieved by widening the tax base and improving revenue administration. This approach would provide an exit strategy from aid dependence in the long run and ensure that at least recurrent spending could be financed from domestic resources. In this manner, the government could firmly anchor inflationary expectations and avoid recourse to unsustainable domestic borrowing to offset declining external assistance that could occur in the future, particularly after 2015.

In a shock-prone economy like Mozambique’s, more consistent and sophisticated management of monetary and exchange rate policy is also critical. Saxegaard and Peiris (forthcoming) argue that the use of monetary policy for stabilization purposes in sub-Saharan Africa poses a number of challenges that have not been fully analyzed in a literature focusing mainly on the conduct of monetary policy in industrial countries and emerging markets. They attempt to incorporate these elements in a dynamic stochastic general equilibrium (DSGE) model, estimated using recently developed Bayesian estimation techniques on data for Mozambique, and to use such a model to analyze the conduct of monetary policy in Mozambique in response to aid and numerous other exogenous shocks. To the authors’ knowledge, this is the first attempt at estimating a DSGE model for sub-Saharan Africa, except possibly for South Africa. Their results confirm that a “spend and absorb” response to aid shocks is probably best in normal circumstances, although in a more realistic setting in which the economy is prone to a wider set of shocks a “lite” inflation-targeting regime would perform best at minimizing macroeconomic volatility. The transition to a full-fledged inflation-targeting regime would require a deepening of domestic financial markets and building the Bank of Mozambique’s forecasting capacity and credibility through greater central bank autonomy and transparency.

The export sector, particularly manufacturing exports, is often the engine of growth. Mozambique’s impressive export performance mainly reflects natural-resource-based megaproject exports. Thus, Saxegaard (forthcoming) analyzes the causes underlying the comparatively lackluster performance of the non-megaproject export sector. Although the real effective exchange rate (REER) does not imply that Mozambique’s competitiveness has been deteriorating, Saxegaard suggests that the REER may have been temporarily overvalued in times of tight exchange rate management in Mozambique. This calls for greater exchange rate flexibility to cushion against exogenous shocks and avoid real exchange rate overvaluation. In addition, there is some evidence that many of the country’s traditional export products may be facing declining world demand. This, coupled with the concentration of exports, suggests that efforts should be made to diversify the export base. Doing so would require structural reforms to improve competitiveness, including reducing the cost of doing business. In this regard, Lledo (forthcoming) identifies the top constraints to sustained private sector development in Mozambique as limited access to finance resulting from a poor institutional lending environment, followed by infrastructure gaps and by burdensome regulatory procedures to license, register, and inspect businesses, employ workers, and trade.

The efficient and transparent management of natural resources is vital to ensure a virtuous cycle of resource use. Mozambique has proven resources of coal, diamonds, gold, titanium, and petroleum, as well as the potential to produce hydropower. But countries rich in natural resources have seldom attained sustained growth. To avoid the “resource curse” that has plagued much of sub-Saharan Africa, Mozambique needs (1) an efficient tax and regulatory regime to attract investment while maximizing benefits to the economy, and (2) more transparent management of resource revenue. Hartley and Otto (forthcoming) show how such an approach is being put in place in the mining sector in Mozambique by enacting a new mining fiscal regime in line with best international practices and by strengthening transparency by considering adherence to the principles of the Extractive Industries Transparency Initiative.