Moçambique: Um Bom Exemplo, um Caso de Sucesso na Redução da Pobreza

Full Text : http://www.imf.org/external/pubs/ft/scr/2007/cr0736.pdf Republic of Mozambique: Fifth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Financing Assurances Review - Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Mozambique © 2007 International Monetary Fund January 2007 IMF Country Report No. 07/36 Republic of Mozambique: Fifth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Financing Assurances Review—Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Mozambique In the context of the fifth review under the three-year arrangement Under the Poverty Reduction and Growth Facility, and financing assurances review, the following documents have been released and are included in this package: • the staff report for the Fifth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Financing Assurances Review, prepared by a staff team of the IMF, following discussions that ended on October 25, 2006, with the officials of the Republic of Mozambique on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on December 1, 2006. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF; • a staff statement of December 18, 2006 updating information on recent developments; • a Press Release summarizing the views of the Executive Board as expressed during its December 18, 2006 discussion of the staff report that completed the review; and • a statement by the Executive Director for the Republic of Mozambique. The documents listed below have been or will be separately released. Joint Staff Advisory Note of the Poverty Reduction Strategy Paper Letter of Intent sent to the IMF by the authorities of the Republic of Mozambique* Memorandum of Economic and Financial Policies by the authorities of the Republic of Mozambique* Poverty Reduction Strategy Paper Technical Memorandum of Understanding* *Also included in Staff Report The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information. International Monetary Fund Washington, D.C. INTERNATIONAL MONETARY FUND REPUBLIC OF MOZAMBIQUE Fifth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, and Financing Assurances Review Prepared by the African Department (In collaboration with other departments) Approved by David Nellor and Anthony Boote December 1, 2006 • Discussions for the fifth review under the Poverty Reduction and Growth Facility (PRGF) arrangement were held in Maputo during October 11–25, 2006 by a staff team comprising Messrs. Clément (head), Peiris, Lledó, and Hartley (all AFR), and Ms. Kvintradze (PDR). Mr. Sulemane (OEDAE) also participated in the meetings. The team was assisted by Mr. Fischer, the Resident Representative in Mozambique. Mr. Baxter, Mr. Binkert, and Mr. Nucifora (all World Bank) joined the discussions. The mission overlapped with a MCM multi-topic mission, and benefited from recommendations of recent Fund Technical Assistance (TA) missions on the reform of the tax system and public financial management. The mission met with the honorable Prime Minister, and Ministers of Finance, Development and Planning, Justice, Mining, Labor, Trade and Industry, the Governor of the Bank of Mozambique, and senior government officials. The mission coordinated its work with a Joint Review of Program Aid Partners (PAPs) i ncluding the World Bank. • The attached letter of intent (LOI) and memorandum of economic and financial policies (MEFP) from the Minister of Finance and Governor of the Bank of Mozambique (Appendix I) reviews the performance under the PRGF arrangement during April-September 2006, and sets out the policies and program monitoring issues for the remainder of 2006 and 2007. The authorities are requesting changes to the adjustors on the indicative targets on the Net International Reserves (NIR) for 2007, as defined in the technical memorandum of understanding (TMU). • The government that took office in 2005 has shown a strong commitment to implement and monitor the PRGF-supported program. Provincial elections are due in 2007, followed by Presidential and Assembly elections in 2009. The structural reform agenda articulated in the Plano de Acção para Redução da Pobreza Absoluta II (PRSP II or “PARPA II” in Portuguese) for 2006–09 that has been submitted to the World Bank and Fund by the Government includes the implementation of a second wave of reforms. As a result, donor support is expected to remain strong. 2 Contents Page Executive Summary ...................................................................................................................3 I. Background............................................................................................................................4 II. An Economic Rebound Supported by a Good Program Performance ..................................5 III. Policy Framework................................................................................................................8 A. Strengthening Fiscal Policy and Institutions to Manage a Scaling-up of Aid .......10 B. Fine-tuning Monetary and Exchange Rate Policy...................................................11 C. Management of Natural Resources .........................................................................12 D. Improving the Investment Climate .........................................................................13 E. Other Issues .............................................................................................................14 IV. Program Monitoring and Risks..........................................................................................15 V. Staff Appraisal ....................................................................................................................15 Box 1. Scaling-up of Aid and PFM reforms in Mozambique ...................................................9 Figures 1. Real Growth Rates and Inflation..................................................................................18 2. Exchange Rates............................................................................................................19 3. Monetary Aggregates and Interest Rates, Jan. 2003–March. 2006 .............................20 4. Fiscal and External Sector Indicators, 2000–06 Projection .........................................21 5. Progress in Meeting the Millennium Development Goals...........................................22 Tables 1. Selected Economic and Financial Indicators, 2004–09 ...............................................23 2. Government Finances, 2004–09 ..................................................................................24 3. Monetary Survey, 2004–09..........................................................................................26 4. Balance of Payments, 2004–09....................................................................................27 5. Balance of Payments of Megaprojects, 2002–08.........................................................28 6. Expenditure in PARPA Priority Sectors, 2004–07 ......................................................29 7. Financial Soundness Indicators for Banking Sector, 2000–06 ....................................30 8. Millennium Development Goals, 1990–2004..............................................................31 Appendices I. Letter of Intent .............................................................................................................32 Attachment I. Memorandum of Economic and Financial Policies .................34 Attachment II. Technical Memorandum of Understanding.............................47 II. Relations with the Fund ...............................................................................................53 III. Relations with the World Bank Group.........................................................................60 IV. Statistical Issues ...........................................................................................................68 3 EXECUTIVE SUMMARY • Macroeconomic performance has remained strong in 2006. Growth has picked up led by strength in the construction sector and a recovery in agricultural production. Despite the spike in domestic petroleum prices, the core inflation rate decelerated to single digit levels supported by a prudent monetary policy, making the end-year headline inflation target within reach. Despite a higher oil import bill, an improvement in the trade balance and sustained donor inflows should lead to a comfortable external position. • Program performance in 2006 is satisfactory. All quantitative and structural performance criteria were met while three out of five structural benchmarks were met, with the remaining two measures implemented with a slight delay. Preliminary data show that all indicative quantitative targets for end-September have also been met. Overall, the 2006 quantitative and structural program has remained broadly unchanged. • A revenue over-performance and restraint on current spending underpins a betterthan- programmed fiscal consolidation in 2006. Revenue collections are 0.4 percent of GDP above target while domestic-related expenditures are roughly in line with the program at end-June 2006. The domestic primary deficit will be slightly lower than originally envisaged for 2006 reflecting higher revenues and lower current expenditure. Importantly, the share of priority expenditure is expected to be above the PARPA I target for 2006 as donor-financed project execution picks up at the end of the year. • The strategy to consolidate macroeconomic stability in the context of a scaling-up of foreign aid should sustain strong growth. A key macroeconomic challenge is to strengthen fiscal policy to finance additional priority spending in a sustainable manner and ensure that a scaling-up of aid financed expenditures reaches the most productive and pro-poor sectors without jeopardizing macroeconomic stability. Monetary control will anchor inflationary expectations in the context of a flexible exchange rate regime. • The outlook for 2007 is a continuation of strong growth, a further deceleration of inflation, and the maintenance of a sustainable external and fiscal situation. The 2007 budget envisages a scaling-up of aid financed expenditures supported by a continued 0.5 percent of GDP rise in domestic revenue. The Bank of Mozambique (BM) will continue to target base money and facilitate absorption of the additional foreign aid while a strengthening of Public Financial Management (PFM) systems ensure a better monitoring of expenditures. • The PARPA II accelerates the implementation of a second wave of reforms to sustain broad-based growth and achieve the Millennium Development Goals (MDGs). In the fiscal area, reforms will focus on establishing the Central Revenue Authority (ATM), the rollout of e-SISTAFE (Public Financial Administration System) to all tiers of government, and reinvigorating the public sector reform program. The structural program also aims at improving governance and reducing the costs of doing business as well as strengthening the tax and transparency regime of the natural resource sector and megaprojects. 4 I. BACKGROUND 1. Mozambique is a success story in Sub-Saharan Africa, benefiting from sustained large foreign aid inflows, strong and broad-based growth and deep poverty reduction. The main achievements during the PARPA I period (2000–05) were sustaining economic growth of 8 percent per year on average, and reducing the poverty headcount index from 69 percent in 1997 to 54 percent in 2003. Substantial progress was also made in the social sectors including a doubling of the number of children in primary school, reductions in infant and maternal mortality, and beginning the provision of Anti-Retro-Viral (ARV) treatment for HIV infection, partly financed by resources made available by the Highly Indebted Poor County (HIPC) initiative. 2. Mozambique’s prospects of achieving the MDGs depend critically on consolidating macroeconomic stability in the context of a scaling-up of aid and the implementation of a second wave of reforms. Now that the post-conflict rebound has largely run its course and first generation reforms are completed—there is a need for a second wave of reforms to sustain rapid pro-poor growth. In addition, the achievement of non-income-related MDGs in areas such as primary school completion, gender equality, and HIV/AIDS call for a scaling-up of basic services without jeopardizing macroeconomic stability. The key macroeconomic challenges are: • Managing a continued scaling-up of foreign aid by strengthening fiscal policy to finance and monitor additional priority spending in a sustainable manner; • Fine-tuning of monetary and exchange rate policy in coordination with fiscal policy to efficiently “spend and absorb” foreign aid while cushioning against exogenous shocks and maintaining competitiveness; • Reducing the cost of doing business to improve the investment climate and promote employment generation; and • Buttressing the management of natural resources. 3. Without these reforms and perseverance with the macroeconomic stabilization effort, economic growth and poverty reduction could suffer. Given Mozambique’s trackrecord of strong macroeconomic performance and relatively high foreign exchange reserves, it would seem well-placed to request a Policy Support Instrument (PSI) as a successor to the current PRGF-supported arrangement expiring in July 2007, as a mechanism to monitor its Sub-Saharan Africa: Growth and Poverty Reduction Episodes Country Period Growth1 Poverty2 Ghana 1988-1998 2 -1.86 Uganda 1993-2003 3.2 -3.9 Kenya 1989-1998 -0.2 -0.94 Tanzania 1992-1999 0 0.53 Botswana 1984-1994 4.8 -4.5 Mozambique 1996-2003 6.3 -2.6 1/ Annual average percentage change in real per capita GDP (national currency, constant prices). 2/ Average annual change in incidence of poverty (headcount index). Source: PARPA II 5 own ambitious reform and stabilization program and provide a signal for continued strong donor support. II. AN ECONOMIC REBOUND SUPPORTED BY A GOOD PROGRAM PERFORMANCE 4. The economy remains resilient to exogenous shocks in 2006. Real GDP growth is expected to accelerate to about 8 percent in 2006 led by strong growth in the construction sector and a rebound in agricultural production as a result of good rainfall, which ended the localized drought of 2005.1 A prudent monetary policy helped bring down core (non-food) inflation to single-digit levels despite the impact of the spike in domestic petroleum prices. The cumulative headline inflation rate has also slowed down since May to 4.8 percent in September reflecting lower food prices, putting the year-end inflation target, 7 percent, within reach, though continued global oil price volatility poses some inflationary risk (Table 1 and Figure 1). 5. The external position strengthened led by a strong export performance. Megaproject exports remained buoyant (29 percent year-onyear growth) in the first semester of 2006 supported by the continued boom in commodity prices, particularly aluminum while traditional exports surged by 66 percent in U.S. dollar terms led by a recovery in cashew, sugar and seafood export volumes. On the other hand, imports grew by less than 12 percent due to the impact of the pass-through of higher oil prices on private consumption and lower than expected donor-financed project imports. This improvement in the trade balance contributed to a relatively stable and liquid foreign exchange market. The net international reserve (NIR) targets for end-June and September 2006 were met while the real effective exchange rate has appreciated by nearly 10 percent since end-2005, partly owing to the rand’s depreciation 1 Real GDP growth of 7.7 percent in 2005 may be revised slightly downward due to the impact of the drought. III. POLICY FRAMEWORK 12. The medium-term policy framework aims at consolidating macroeconomic stability in the context of a scaling-up of foreign aid (MEFP paragraph 12). The authorities recognize that effectively spending and absorbing foreign aid amounting to more than 15 percent of GDP at present is a key challenge for the medium-term.5 As such, the 2007 and medium-term macroeconomic framework envisages a spending and absorption of a scalingup of foreign aid (Table 1 and Figure 4).6 To minimize potential “Dutch-Disease” effects, the additional spending including MDRI resources will continue to be allocated to the most economically and socially productive priority sectors and closely monitored through a strengthening of PFM systems (Box 1 and Table 6). In addition, to guard against aid volatility and gradually reduce donor-dependence in the long-term, the Medium-Term Fiscal Framework (CFMP) targets an average revenue increase of 0.5 percent of GDP per year. A more consistent monetary and exchange rate policy also has a role to play by firmly controlling inflation to single-digits levels and cushioning against exogenous shocks through monetary control and exchange rate flexibility, respectively. 5 The review mission and the authorities exchanged preliminary views on assumptions and policy-tradeoffs in developing scaling-up scenario’s. These scenarios will be further elaborated and presented during the Article IV discussions in early 2007. 6 The medium-term macroeconomic framework has been revised to take into account the 2007 budget, scalingup of foreign aid, as well as domestic and international economic developments. 9 Box 1. Scaling-up of Aid and PFM reforms in Mozambique While a scaling-up of aid can play an important role in achieving the MDGs, it also poses a number of macroeconomic challenges that could be partially mitigated by strengthening PFM systems. The macroeconomic consequences of aid inflows depend critically on what the government decides to do with the additional resources. Given Mozambique’s social needs and infrastructure gaps, it is clear that additional aid should be spent but in a prudent manner. Unless all spending is on imports, this higher demand for domestic goods will induce an appreciation of the real exchange rate and thus discourage the expansion of exports, thereby hurting long-term growth. This is what is often called the ‘Dutch Disease’ effect of aid. To illicit a supply response, particularly productivity growth in the nontradable sector, a strengthening of PFM systems is key to ensure resources reach the most economically and socially productive priority sectors (e.g., infrastructure, education, and health). PFM systems in Mozambique have shown major improvements according to the latest PEFA assessment, and will be further strengthened through the implementation of a medium-term e- SISTAFE Action Plan and Budget (APB) for 2006–09. The CFMP is closely aligned with the PARPA II priorities. It was for the first time, approved by the Council of Ministers in 2006, making it a credible tool to guide the preparation of subsequent budgets. It should be possible from next year to identify programs through the budget formulation module of e-SISTAFE, and to track priority expenditures defined in PARPA II on a real time basis. According to the APB, e-SISTAFE will be extended to all line ministries by mid-2007, and progressively rolled out to districts and municipalities. New functionalities will also be implemented, particularly a payroll and pension module in 20071 as it was identified by the PEFA assessment to be a major remaining fiduciary risk. Challenges remain in executing donor-financed projects through the CUT and e-SISTAFE. In addition, the use of national procedures such as procurement, financial reporting and audit needs to be further strengthened in close collaboration with donors, particularly at the subnational level. Source: PEFA (2006) ____________ 1/ Payments of salaries continue to be executed centrally by the accounting department of the Ministry of Finance. 1. Financial and budget execution in operation in all ministries at the central, provincial and district levels, and in the municipalities and public enterprises. 2. The module of payment of salaries and pensions implemented. 3. The budget formulation module implemented (Phase II). 4. The asset management module and procurement interface implemented. 5. The ATM revenue management module implemented. 6. Program budgets under preparation by ministries. 7. The debt management module implemented. 8. The internal audit module implemented. 9. The Data Processing Centre (CPD) operating as an effective and sustainable unit. 10. Project Implementation Unit for SISTAFE operating as an effective and sustainable unit. Source: Authorities’ PFM APB (2006) Text Box 1: Projected e-SISTAFE Outputs, 2006-2009 10 13. The acceleration of the structural reform agenda, as detailed in the PARPA II strategic matrix, should sustain strong broad-based growth (about 7–8 percent) and thus promote poverty reduction.7 In addition to a prudent monetary and fiscal policy framework in the context of a flexible exchange rate regime, deeper institutional reforms aim to: (i) promote good governance; (ii) buttress the investment climate and ease growth constraints; and (iii) strengthen the transparency of natural resource management and megaprojects. A. Strengthening Fiscal Policy and Institutions to Manage a Scaling-up of Aid 14. The 2007 budget envisages a scaling-up of foreign aid and an associated increase in spending focused towards achieving the PARPA II targets (Table 2). Despite a nearly 0.2 percent of GDP revenue loss related to tariff reform, total domestic revenue is envisaged to rise by about 0.5 percent of GDP through: (i) a rationalization of unwarranted tax exemptions (e.g., VAT, and interest income on treasury bills); (ii) collection of new tax arrears amounting to about 0.2 percent of GDP; (iii) the resumption of quarterly updating of the specific fuel tax rate including recovering the real reduction due to non-indexation in 20058; (iv) higher non-tax revenues related to buoyant commodity prices; (v) and a continued improvement in tax administration in line with recent Technical Assistance (TA) from the Fund (MEFP, paragraph 15). Priority public investments will increase significantly. Most of these expenditures will be financed by foreign grants, and will be accompanied by sufficient counterpart funds and current spending for maintenance and operations (Table 6). The wage bill will increase to 7.5 per cent of GDP as envisaged in the CFMP, including a hiring of about 10,000 teachers and 3,000 health workers in line with their sectoral strategies. Transfer payments in 2007 are higher due to pension payments and the on-going gradual decentralization of spending. If a revenue shortfall materializes, the authorities have agreed to cut non-priority expenditures to meet the NCG target. Overall, the scaling-up of program aid will permit a higher domestic primary deficit with no recourse to domestic financing, allowing for a healthy increase in credit to the economy. 15. The implementation of medium-term revenue mobilization and PFM strategies will help maintain macroeconomic stability. The government is currently embarking on a medium-term tax policy and revenue administration reform effort benefiting from Fund TA that will be closely monitored within the Ministry of Finance (MEFP, paragraph 16 and 17). The focus in 2007 will be on preparing the ground work for further tax policy reform in the 2008 budget, and undertaking audits of VAT refunds and any related payment arrears to 7 The Joint Staff Advisory Note (JSAN) provides a summary of the key pillars of the PARPA II and staffs’ advice on key priorities for strengthening PARPA II and for ensuring effective implementation. 8 The updating of the specific fuel tax started in October 2006. 11 Sept. Dec. Jun. Sept. Total sterilization 7,193 9,557 5,148 8,572 Net foreign exchange sales 5,798 8,461 6,493 8,906 Net T-bill issuance 1,395 1,096 -1,345 -334 Memo: Net foreign exchange sales 80.6 88.5 126.1 103.9 Net T-bill issuance 19.4 11.5 -26.1 -3.9 Net foreign exchange sales 289 393 260 355 Source: Bank of Mozambique (In percentage of total sterilization) (In millions of USD) Mozambique: Intervention Policy Mix 2005 2006 (In millions of MTn) large infrastructure contractors.9 In addition, the phased integration of the core functions of both tax and customs administration will be supported by initiating the implementation of the strategic plan of the ATM. Among others, specific measures in the PFM APB for 2007 include (MEFP, paragraph 18): • rolling out e-SISTAFE to 22 additional ministries and organs at the central and provincial levels by end-January 2007 (structural benchmark); • the development of a payroll and pensions e-SISTAFE functionality by mid- 2007, based on a integrated payroll database; and • the opening of a limited number of separate foreign currency accounts within the CUT by end-March 2007 (structural benchmark) to facilitate inclusion of all donor-financed projects.10 16. Improving public service delivery and ensuring value for money in spending will also require steadfast pursuit of the Phase II of the public sector reform program (MEFP paragraph 36). The clear action plans of Phase II, such as the installation of an integrated payroll database, based on a comprehensive census completed by end-April 2007 (structural benchmark, MEFP Table 3) are important steps in the right direction. This process and the restructuring of line ministries should also be supported by a strengthening of the sectoral strategies. The government’s gradual approach to devolving resources to provinces and districts until e-SISTAFE is rolled out to the local level, while undertaking a comprehensive review of the institutional framework for the revenue and spending responsibilities of subnational units by end-June 2007, will also allow for improved accountability and fiscal control. B. Fine-tuning Monetary and Exchange Rate Policy 17. A key monetary policy challenge is to sterilize the liquidity injected by the government spending foreign aid. With a view to achieving its inflation target and anchoring expectations, the BM approved a long-term monetary policy strategy document that defines a broad money intermediate target compatible with the base money operational target. This document will be communicated to 9 The government will develop an arrears payment schedule, if needed, and ensure that VAT charged on supplies of projects is included in the final price of a contract. 10 While a single currency CUT has technical and transparency benefits, this measure can be seen as a transition measure for donors that are constrained by their own rules. All donors should be encouraged to put their funds into the CUT as soon as possible. 12 financial markets (MEFP, paragraph 19). In 2007, base money growth will be limited to 15 percent to reach the inflation objective of 6 percent at end-2007. Excess liquidity will be mopped up relying mostly on foreign exchange sales (up to a maximum of the NIR floor, as in 2006) to absorb foreign aid financed expenditures with treasury bill issuances to smooth seasonal liquidity fluctuations. 18. To avoid undue movements in inflation and the exchange rate a fine-tuning of the monetary and exchange rate policy operations will also be needed. The BM will continue to improve liquidity forecasts with the help of the MF and introduce repurchase operations (repo’s) to fine-tune daily liquidity variations (MEFP, paragraph 20). The BM also recognizes that greater exchange rate flexibility will support the monetary-targeting framework and help cushion against exogenous shocks by maintaining a comfortable level of international reserves. In this context, the BM will gradually remove the temporary band in the foreign exchange market when conditions permit. The strong growth in non-traditional exports point to no significant loss of competitiveness since end-2005. Measures to deepen the interbank market through a code of conduct, facilitating firm quotation and encouraging forward transactions as envisaged under MCM TA should also help minimize excess volatility and an overshooting of the exchange rate in a relatively thin market. C. Management of Natural Resources 19. Megaprojects in the mining and petroleum sectors have put Mozambique on the global Foreign Direct Investment (FDI) map, which should be accompanied by international best practices in the tax and transparency regime.11,12 Now that investor confidence in Mozambique is stronger, the authorities recognize that the fiscal contribution of new projects in these sectors could be substantially increased by reducing generous tax exemptions (MEFP paragraph 32). As such, the Council of Ministers will approve a new draft Mining Fiscal Regime law in line with international best practice (structural performance criterion, end-December 2006). In the interim, the Government will ensure that any new mineral resource project agreements will adhere to the principles of the new draft Mining Fiscal Regime law. In the petroleum sector, the government will avoid signing any new Exploration and Production Concession (EPCs) contracts that are not now under negotiation until a more specific petroleum tax regime is in place to avoid case by case negotiation of petroleum tax and production sharing terms. The government is also considering following the Extractive Industries Transparency Initiative (EITI) principles to improve transparency, revenue management and governance in the oil, gas and mining 11 The mining sector is broadly interpreted to include Mozal, a megaproject, which produces aluminum billets from imported alumina using electricity generated by the Cahora Bassa hydroelectric plant. 12 To date, the only major petroleum project operating in Mozambique is the Pande-Temane gas extraction project including a pipeline to South Africa. More recently, four international companies have been granted the right to start drilling for oil. 13 sectors as well as any expansion of related megaprojects to continue to attract quality investments and ensure sustainable exploitation of natural resources. 20. The transfer of ownership of Cahora bass dam to Mozambique is an historical event that needs to be carefully secured. An agreement to transfer majority ownership of the 2,075 MW Cahora Bassa hydropower plant from Portugal to a Mozambican parastatal, Hidroelectrica de Cahora Bassa (HCB) was signed on October 31, 2006. This opens up the possibility of further hydropower development on the Zambezi, in particular a proposed Mphanda Nkuwa project (1,300 MW in the first stage with potential for 2,275 MW) 60 km downstream of Cahora Bassa, and the development of a second, 600 MW, power house on the North Bank of Cahora Bassa itself, providing tremendous potential for export of power, energy intensive industries, and benefits to agriculture and aquaculture from better water control. The agreement calls for a payment of US$950 million to Portugal in installments during the course of 2006–2007. In this regard, the government has reiterated its commitment to:13 • Seek nonrecourse financing for the purchase of majority ownership so not to increase the government’s liabilities to commercial creditors; • Ensure transparency of both the process and the final financing package; that HCB is managed in a commercially efficient manner; that HCB is audited by external auditors; and that HCB is subject to the regular concession and tax regimes; and • Identify and incorporate into the fiscal accounts and budget documents fiscal risks and quasi-fiscal transactions, if any, with TA from the international community. D. Improving the Investment Climate 21. To make Mozambique the location of choice for FDI and employment generating domestic investment, the government will implement a strategic plan to reduce the cost of doing business with the assistance of the Fund and World Bank (MEFP, paragraph 30). Financial sector reforms in 2007 to reduce the cost of finance and improve access include: (i) deepening domestic debt markets; (ii) preserving the BM’s net worth while strengthening its supervisory functions and modernizing its accounts; (iii) making all banks compliant with international accounting, loan classification and provisioning standards; and (iv) supporting a sound expansion of the non-bank financial sector (MEFP, paragraphs 20–25). In November, 2006, the Assembly also approved the first reading of the bill to reduce customs duties on consumer goods from 25 to 20 percent to all trading partners in January 2007 (MEFP, paragraph 28). The PARPA II strategic matrix is, 13 A joint IMF-World Bank-IFC-MIGA mission will take place soon to discuss the financing modalities of the ownership transfer. 14 however, sparse on actions to accelerate the contract enforcement process, address the backlog of legal cases and labor disputes, and use of land-use titles as collateral (MEFP, paragraphs 37–38). In addition, the provision of infrastructure services, partly in the hands of state-owned or public-participating institutions remains weak.14 This calls for a clear strategy to address the infrastructure gaps including through transparent sales of remaining publicparticipating enterprises (MEFP, paragraph 11 and 31).15 E. Other Issues 22. Progress was made in reaching debt rescheduling agreements in the context of the enhanced HIPC Initiative and maintaining external debt sustainability. In October, 2006, the Japanese government cancelled all of Mozambique’s commercial debt to Japan. Portugal (the remaining Paris club creditor to provide HIPC relief) has expressed an intention to sign an agreement by end-2006. Of the remaining non-Paris Club creditors that have not delivered debt relief, negotiations with Algeria, Libya and Iraq are proving difficult. In this respect, the authorities look forward to continuing support from the Fund. Negotiations were completed with Romania in October, 2006, and the authorities continue to maintain contact with non-Paris club and commercial creditors, and continue their good faith negotiations, to facilitate a collaborative agreement with them. External financing appears to be secured to cover the total outstanding debt to four private creditors (Brazil, India, Czech Republic and Former Yugoslavia) by the commercial debt buy-back operation. Authorities expect to carry out the debt buy-back once the World Bank finalizes procedures for the financing of the operation. As part of the financing assurances review, the staff finds that adequate safeguards remain in place for further use of Fund resources related to these renegotiations. 23. Mozambique is building a consensus to introduce current account convertibility. A new foreign exchange law will be submitted with a slight delay to the Assembly by end- March 2007. Following approval of the new law and issuance of related regulations, the authorities intend to accept their obligations under Article VIII sections 2, 3, and 4 of the Fund’s Articles of Agreement. 24. The statistical agency is in the process of revising its historical national accounts series, and requires further assistance to compile and disseminate quarterly GDP estimates, trade and producer price statistics, and report on megaprojects. 14 Public-participating institutions are defined as enterprises with some private equity participation. 15 The restructuring of public and public-participating enterprises are not expected to result in an absorption of liabilities to the budget. 15 IV. PROGRAM MONITORING AND RISKS 25. The sixth review under the PRGF arrangement is expected to be completed no later than end-June 2007 conditional on meeting the end-December 2006 quantitative and structural performance criteria (MEFP, Tables 1 and 3). The government intends to continue to monitor its program with the existing multi-disciplinary committee, and the research department of the MF will collect and analyze information on megaprojects and state-owned public-participating enterprises by end-March 2007 (MEFP, paragraph 12). 26. On the risks to the program, the staff notes that a weaker-than-programmed revenue performance, a continuing rise in global oil prices, and a hasty implementation of fiscal decentralization, could undermine the government’s macroeconomic targets. 27. The BM is continuing to address the remaining weaknesses identified in the Fund’s safeguards assessment (MEFP, paragraph 26). V. STAFF APPRAISAL 28. The pursuit of prudent macroeconomic policies and a first wave of structural reforms have yielded good results in terms of strong growth and moderate inflation. Mozambique achieved most of the key PARPA I targets including poverty reduction and progress in social sectors supported by a satisfactory program performance and substantial donor assistance. Debt relief under the HIPC initiative also played a role. Program implementation has remained good in 2006, with all quantitative and structural performance criteria met through July 2006 and a largely unchanged program for end-2006, setting the stage for a continued robust macroeconomic performance. 29. The economy is rebounding from the drought and oil price shock. Real GDP growth has picked up in 2006 led by a recovery in agricultural production while the trade balance is improving due to a surge in exports. The end-year headline inflation target is within reach anchored by a prudent monetary stance, with some risks related to the evolution of food and domestic fuel prices. The outlook for 2007 is a continuation of strong growth, a further deceleration of inflation, and a widening of the external current account deficit financed by a scaling-up of foreign grants. 30. The strategy to consolidate macroeconomic stability in the context of a continued scaling-up of aid and the implementation of a second wave of reforms should help sustain strong broad-based growth. A key macroeconomic challenge is to strengthen fiscal policy to finance additional priority spending in a sustainable manner and ensure that a scaling-up of aid reaches the most productive and pro-poor sectors. The staff would also like to emphasize the importance of adopting a new mining fiscal regime by end-2006 and adherence to the principles of the EITI. A better monitoring of megaprojects and public16 participating enterprises is also essential. Without these reforms, institutions may not keep pace with the rapid structural transformation of the economy, and growth could suffer. 31. The 2007 fiscal framework envisages spending the scaled-up foreign aid to pursue the MDGs. To maintain macroeconomic stability, a continued 0.5 percent of GDP rise in domestic revenue is targeted while the share of priority expenditures will exceed 65 percent of total spending. The rollout of e-SISTAFE to most public entities at the central and provincial level by end-January 2007 should ensure a better monitoring of these expenditures. Moreover, donor-funded projects brought on budget should, with the help of the donors, be included in the CUT and e-SISTAFE. 32. Public sector and governance reforms need to be closely monitored. The installation of a clean integrated payroll database based on a civil service census should help rightsizing the civil service in line with more comprehensive sectoral strategies. The lack of visible results of the anti-corruption strategy and judicial sector reform also needs to be addressed to improve public perceptions and maintain a constituency for reform. 33. The government’s fiscal decentralization strategy should be clarified before a further devolution of resources. Ambiguities concerning the division of revenue raising and spending responsibilities of subnational units, and concerns regarding the capacity of some districts and municipalities to effectively absorb and account for resources need to be addressed. This will help clarify the fiscal implications of the decentralization process. 34. A more consistent monetary policy framework should help consolidate price stability and maintain a viable external position. The staff welcomes the BM’s clear policy statement to continue to target base money in the context of a flexible exchange rate regime to control inflation and cushion exogenous shocks. In this regard, it is important to bestow greater exchange rate flexibility and eliminate the temporary exchange rate band when the conditions permit. Undue exchange rate fluctuations could be minimized by a finetuning of operations and deepening interbank markets. 35. The Cahora bassa dam transaction should be prudently managed. The staff welcomes the renewed commitment to seek non-recourse financing for the transfer of majority ownership of the Cahora Bassa hydropower plant from Portugal to HCB so not to increase the government’s liabilities to commercial creditors, and ensure transparency and accountability. 36. The development of a strategic plan to reduce the World Bank’s cost of doing business indicators will be important to attract investment and generate employment. In this regard, while the new draft labor law represents an improvement on the current law, it does not significantly improve Mozambique’s ranking in labor market flexibility in the region. As such, staff would welcome steps to address remaining rigidities down the road. 37. Mozambique’s financial system is expanding in a sound manner. Risk based supervision and the introduction of international accounting, loan classification and provisioning standards should help ensure stability of the banking system. The restructuring of the national pension fund (INSS) and strengthening of the supervisory framework for the growing non-bank financial sector is also important. 38. The staff welcomes progress in liberalizing trade, debt rescheduling, and exchange system reforms. The staff looks forward to the lowering of the maximum tariff level to all trading partners and submission of a new foreign exchange law consistent with Article VIII, Sections 2, 3 and 4 of the Fund Articles of Agreement in the context of the authorities’ stated intentions to accept the obligations of Article VIII, Sections 2, 3 and 4 in the near future. The authorities are encouraged to continue to negotiate in good faith with all of their external creditors to reach an agreement consistent with that provided by the Paris Club. 39. Given Mozambique’s track-record of strong macroeconomic performance and program implementation, the authorities’ consideration to request a PSI is welcome. A PSI could be an ideal mechanism to monitor the government’s ambitious reform program over the medium-term and sustain the growth momentum. 40. The staff recommends completion of the fifth review and financing assurances review under the PRGF arrangement. 41. The staff welcomes the intention of the authorities to make public the staff report, the letter of intent, and the MEFP. Table 2. Mozambique: Government Finances, 2004–09 2008 2009 Est. Est Orig. Prog. Prog. Orig. Prog. Prog. Prog. Prog. Total revenue 16,838 21,418 26,052 26,669 31,089 31,342 36,556 42,858 Tax revenue 15,598 18,534 23,043 23,660 27,672 27,367 32,163 37,889 Taxes on income and profits 3,548 4,469 5,488 6,115 6,953 7,105 9,165 11,469 Taxes on goods and services 9,416 10,873 13,283 13,274 15,813 15,717 18,012 20,738 Of which : on petroleum products 1,663 1,806 2,321 2,321 2,778 2,744 3,199 3,669 Taxes on international trade 2,284 2,816 3,680 3,680 4,211 3,856 4,203 4,794 Other taxes 350 376 591 591 694 687 783 889 Nontax revenue 1,241 2,884 3,010 3,010 3,418 3,975 4,393 4,969 Total expenditure and net lending 32,607 34,582 50,355 50,281 59,140 66,106 71,456 78,746 Current expenditure 19,006 21,092 26,832 26,457 31,232 31,681 35,286 39,605 Compensation to employees 9,195 10,691 13,345 13,274 15,747 15,683 17,944 20,235 Goods and services 4,727 5,012 6,907 6,639 7,639 7,812 8,703 9,813 Interest on public debt 1,321 1,248 1,576 1,433 2,416 2,078 1,674 1,686 Domestic 910 789 1,081 1,073 1,875 1,818 1,271 1,127 External 411 459 496 360 541 260 403 559 Transfer payments 3,763 4,141 5,003 5,111 5,430 6,109 6,965 7,870 Domestic current primary balance -847 1,574 797 1,645 2,274 1,739 2,943 4,939 Capital expenditure 12,543 12,819 21,592 21,667 25,474 30,881 33,015 36,204 Grant finance projects 3,085 1,918 5,030 4,915 5,424 11,672 12,372 12,952 Projet loans 3,564 3,148 4,783 4,522 5,478 4,296 4,553 4,767 Locally financed 4,074 4,335 5,670 6,465 7,445 7,927 9,550 11,855 Grant-financed special programs 1,197 2,151 4,764 3,886 5,451 5,034 5,336 5,586 Direct financing 623 717 928 1,463 999 937 996 1,043 Expenditure financed with fund for the concession mine of Tete ... 550 417 417 677 1,014 207 0 Net lending 1,058 671 1,931 2,157 2,434 3,544 3,155 2,938 Of which: locally financed -79 -94 -137 -174 -161 -156 -178 -203 Domestic primary balance, before grants, above the line 2/ -4,842 -2,667 -4,736 -4,646 -5,010 -6,033 -6,429 -6,713 Unallocated revenue (+)/expenditure (-) 3/ -310 -293 0 0 0 0 0 0 Overall balance, before grants (below the line) -16,079 -13,457 -24,303 -23,612 -28,050 -34,764 -34,900 -35,888 Grants received 10,053 9,975 19,992 19,904 18,462 24,992 26,879 28,565 Project 6,185 4,938 10,722 10,263 11,875 17,644 18,704 19,581 Nonproject 3,868 5,037 5,655 6,027 6,587 7,348 8,175 8,983 MDRI assistance via the central bank 6/ 0 3,615 3,615 0 0 0 Overall balance, after grants -6,026 -3,482 -4,310 -3,707 -9,589 -9,772 -8,021 -7,323 Central bank transfer of HIPC Initiative assistance by the IMF 484 388 0 0 0 0 0 0 Net external financing 3,788 5,035 8,725 7,753 10,356 10,965 10,234 10,117 Disbursements 6,937 5,219 9,256 8,033 10,643 10,682 10,733 10,887 Project 3,564 3,148 4,783 4,522 5,478 4,296 4,553 4,767 Nonproject 3,373 2,071 4,473 3,511 5,165 6,386 6,179 6,120 Cash amortization -668 -734 -948 -697 -964 -730 -706 -770 Investment abroad 4/ -2,481 550 417 417 677 1,014 207 0 Net domestic financing 7/ -728 -2,335 -4,518 -4,150 -872 -1,297 -2,332 -2,928 Of which: MDRI from the IMF -3,615 -3,615 Privatization 5/ 2482 394 104 104 104 104 119 134 Memorandum items: MDRI debt relief from IDA ... ... . ... 31,034 ... ... ... ... MDRI debt relief from the AfDF ... ... . ... 13,468 ... ... ... ... MDRI saving on total debt service ... ... . ... 851 ... 981 1151 1326 Domestic primary balance, before grants, below the line 2/ -5,152 -2,960 -4,736 -4,646 -5,010 -6,033 -6,429 -6,713 Balance on MDRI deposit account with the central bank 0 0 2,687 2,687 1,792 1,792 897 0 Grants and loan disbursements 16,990 15,194 29,248 27,938 29,105 35,673 37,611 39,452 Bonds issuance for strengthening the balance sheet of the central bank ... 1,500 1,500 1,501 1,500 1,500 1,500 0 2006 2007 (In millions of MTn) 2004 1/ 2005 25 Table 2. Mozambique: Government Finances, 2004-09 (Concluded) 2008 2009 Est. Est. Orig. Prog. Prog. Orig. Prog. Prog. Proj. Proj. Total revenue 12.6 14.0 14.4 14.4 14.9 14.9 15.4 16.0 Tax revenue 11.7 12.1 12.7 12.7 13.2 13.0 13.5 14.1 Taxes on income and profits 2.7 2.9 3.0 3.3 3.3 3.4 3.8 4.3 Taxes on goods and services 7.1 7.1 7.3 7.1 7.6 7.5 7.6 7.7 Of which: on petroleum products 1.2 1.2 1.3 1.2 1.3 1.3 1.3 1.4 Taxes on international trade 1.7 1.8 2.0 2.0 2.0 1.8 1.8 1.8 Other taxes 0.3 0.2 0.3 0.3 0.3 0.3 0.3 0.3 Nontax revenue 0.9 1.9 1.7 1.6 1.6 1.9 1.8 1.9 Total expenditure and net lending 24.4 22.6 27.8 27.1 28.3 31.4 30.0 29.3 Current expenditure 14.2 13.8 14.8 14.2 14.9 15.1 14.8 14.7 Compensation to employees 6.9 7.0 7.4 7.1 7.5 7.5 7.5 7.5 Goods and services 3.5 3.3 3.8 3.6 3.7 3.7 3.7 3.7 Interest on public debt 1.0 0.8 0.9 0.8 1.2 1.0 0.7 0.6 Domestic 0.7 0.5 0.6 0.6 0.9 0.9 0.5 0.4 External 0.3 0.3 0.3 0.2 0.3 0.1 0.2 0.2 Transfer payments 2.8 2.7 2.8 2.8 2.6 2.9 2.9 2.9 Domestic current primary balance -0.6 1.0 0.4 0.9 1.1 0.8 1.2 1.8 Capital expenditure 9.4 8.4 11.9 11.7 12.2 14.7 13.9 13.5 Of which: locally financed 3.1 2.8 3.1 3.5 3.6 3.8 4.0 4.4 Net lending 0.8 0.4 1.1 1.2 1.2 1.7 1.3 1.1 Of which: locally financed -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Domestic primary balance, above the line 2/ -3.6 -1.7 -2.6 -2.5 -2.4 -2.9 -2.7 -2.5 Unallocated revenue (+)/expenditure (-) 3/ -0.2 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Overall balance, before grants (below the line) -12.0 -8.5 -13.4 -12.7 -13.4 -16.5 -14.7 -13.4 Grants received 7.5 6.5 11.0 10.7 8.8 11.9 11.3 10.6 Project 4.6 3.2 5.9 5.5 5.7 8.4 7.9 7.3 Nonproject 2.9 3.3 3.1 3.2 3.2 3.5 3.4 3.3 MDRI assistance via the central bank 6/ 0.0 0.0 2.0 1.9 0.0 0.0 0.0 0.0 Overall balance, after grants -4.5 -2.0 -2.4 -2.0 -4.6 -4.6 -3.4 -2.7 Central bank transfer of HIPC assistance by the IMF 0.4 0.3 0.0 0.0 0.0 0.0 0.0 0.0 Net external financing 2.8 3.3 4.8 4.2 4.9 5.2 4.3 3.8 Disbursements 5.2 3.4 5.1 4.3 5.1 5.1 4.5 4.1 Project 2.7 2.1 2.6 2.4 2.6 2.0 1.9 1.8 Nonproject 2.5 1.4 2.5 1.9 2.5 3.0 2.6 2.3 Cash amortization -0.5 -0.5 -0.5 -0.4 -0.5 -0.3 -0.3 -0.3 Investment abroad 4/ -1.9 0.4 0.2 0.2 0.3 0.5 0.1 0.0 Net domestic financing -0.5 -1.5 -2.5 -2.2 -0.4 -0.6 -1.0 -1.1 Privatization 5/ 1.9 0.0 0.1 0.1 0.1 0.0 0.1 0.1 Memorandum items: Domestic primary balance, before grants, below the line 2/ -3.9 -1.7 -2.6 -2.5 -2.4 -2.9 -2.7 -2.5 Balance on MDRI deposit account with the central bank 0.0 0.0 1.5 1.4 1.3 0.9 0.4 0.0 Grants and loans disbursements 12.7 9.9 16.1 15.0 13.9 16.9 15.8 14.7 Bonds issuance for strengthening the balance sheet of the central bank ... 1.0 0.8 0.8 0.7 0.7 0.6 0.0 Nominal GDP (in millions of MTn) 133,510 153,041 1 80,831 185,696 208,970 210,490 238,125 268,531 Sources: Mozambican authorities; and IMF staff estimates and projections. Note: Takes into account delivery of MDRI in January 2006 and reflects changes in quantitative targets in line with projected program adjustors. 6/ Includes the transfer of both MDRI and HIPC assistance from the central bank to the budget in 2006. 1/ The quasi-fiscal deficit of the Bank of Mozambique, amounting to MTn 3,455 million (or 2.5 percent of GDP) is not included. 2/ Revenue minus noninterest current expenditure minus locally financed capital expenditure and locally financed net lending. Unallocated revenue and expenditure are included in the primary balance. (In percent of GDP, unless otherwise specified) 2004 1/ 2005 2006 2007 5/ Includes in 2004 the US$123 million (2.0 percent of GDP) concession fee for the Moatize coal mine concession. 4/ Tracks the movements in the government account set up abroad with the proceeds of the Moatize coal mine concession. 3/ Residual discrepancy between identified sources and use of funds. Total expenditure in PARPA priority sectors 19,033 22,017 32,468 41,184 in percent of GDP 14.3 14.4 17.5 19.6 in percent of total expenditure (excl. bank restruct costs, net lending, and interest payments) 63.0 66.3 69.5 68.1 Education 6,317 6,621 9,362 12,823 Primary 5,325 5,639 7,753 10,403 Health 3,183 4,209 6,855 7,258 HIV/AIDS 123 220 682 484 Infrastructure development 3,982 6,205 7,482 8,347 Roads 3,112 4,697 4,675 3,871 Sanitation and public works 870 1,508 2,807 4,476 Agriculture and rural development 1,322 1,306 1,543 3,931 Governance and judicial system 2,936 2,948 5,864 5,988 Security and public order 1,753 1,470 2,001 2,964 Governance 483 608 2,815 1,573 Judicial system 699 869 1,048 1,452 Other priority areas 1,170 736 680 1,452 Social actions 201 213 341 484 Labor and employment 123 109 147 242 Total PARPA expenditures in percent of GDP Education 4.7 4.3 5.0 6.1 Primary 4.0 3.7 4.2 4.9 Health 2.4 2.8 3.7 3.4 HIV/AIDS 0.1 0.1 0.4 0.2 Infrastructure development 3.0 4.1 4.0 4.0 Roads 2.3 3.1 2.5 1.8 Sanitation and public works 0.7 1.0 1.5 2.1 Agriculture and rural development 1.0 0.9 0.8 1.9 Governance and judicial system 2.2 1.9 3.2 2.8 Security and public order 1.3 1.0 1.1 1.4 Governance 0.4 0.4 1.5 0.7 Judicial system 0.5 0.6 0.6 0.7 Other priority areas 0.9 0.5 0.4 0.7 Social actions 0.2 0.1 0.2 0.2 Labor and employment 0.1 0.1 0.1 0.1 Total PARPA expenditures in percent of total expenditures Education 20.9 19.9 20.1 21.2 Primary 17.6 17.0 16.6 17.2 Health 10.5 12.7 14.7 12.0 HIV/AIDS 0.4 0.7 1.5 0.8 Infrastructure development 13.2 18.7 16.0 13.8 Roads 10.3 14.1 10.0 6.4 Sanitation and public works 2.9 4.5 6.0 7.4 Agriculture and rural development 4.4 3.9 3.3 6.5 Governance and judicial system 9.7 8.9 12.6 9.9 Security and public order 5.8 4.4 4.3 4.9 Governance 1.6 1.8 6.0 2.6 Judicial system 2.3 2.6 2.2 2.4 Other priority areas 3.9 2.2 1.5 2.4 Social actions 0.7 0.6 0.7 0.8 Labor and employment 0.4 0.3 0.3 0.4 Source: Mozambican authorities (Ministry of Finance); and staff estimates and projections. Table 6. Mozambique: Expenditure in PARPA Priority Sectors, 2004–07 1/ 1/ PARPA stands for National Action Plan for the Reduction of Absolute Poverty, which is the Portuguese acronym. (In millions of meticais, unless otherwise indicated) 30 2000 2001 2002 2003 2004 2005 2006 1/ Capital adequacy Regulatory capital to risk-weighted assets -2.13 5.49 14.01 17.03 18.65 16.00 13.10 Regulatory Tier I capital to risk-weighted assets -2.07 6.03 11.97 14.67 15.97 13.57 11.39 Capital (net worth) to assets -2.70 8.22 9.42 9.01 9.51 8.04 6.42 Asset composition and quality Sectoral distribution of loans to total loans Agriculture 19.00 18.00 15.00 12.73 9.45 8.49 8.40 Industry 27.00 25.00 22.00 16.94 11.94 16.77 20.07 Construction 5.00 4.00 4.00 5.20 3.35 4.13 5.86 Commerce 23.00 20.00 17.00 18.13 21.29 27.36 26.93 Transportation and communication 5.00 7.00 5.00 7.08 7.19 5.83 6.59 Other 22.00 27.00 36.00 37.14 36.18 35.05 27.75 of which: Private 2/ 7.63 12.12 13.03 13.42 Housing 7.10 8.18 4.24 4.00 Diverse 3/ 22.41 15.87 17.78 10.33 Foreign exchange loans to total loans 40.24 64.69 69.87 70.77 67.33 63.91 54.18 Nonperforming loans to gross loans 4/ 17.76 23.43 21.98 14.43 6.42 3.82 3.71 Nonperforming loans net of provisions to capital 4/ 35.00 11.00 9.39 7.91 1.70 0.89 2.16 Earnings and profitability Return on assets 0.04 0.14 1.59 1.24 1.43 1.81 2.26 Return on equity ... 3.51 22.10 16.29 18.73 27.42 32.84 Interest margin to gross income ... 10.22 61.39 56.83 60.15 58.01 59.16 Noninterest expenses to gross income ... 16.92 67.03 72.18 71.24 65.85 54.02 Personnel expenses to noninterest expenses ... 51.71 44.67 45.68 45.21 45.35 58.20 Trading and fee income to gross income ... 33.09 39.68 45.49 41.87 43.78 42.46 Spread between reference loan and deposit rates (90 days, local currency) ... 14.00 19.00 17.39 14.67 11.48 15.00 Goal 1: Eradicate extreme poverty and hunger Income share held by lowest 20 percent .. .. 6.0 .. .. .. National household survey poverty incidence 2/ .. .. 69.4 .. 54.1 .. Malnutrition prevalence, weight for age (percentage of children under 5) .. .. 26.0 26.0 24.0 24.0 Poverty gap at 1 U.S dollar a day (PPP) (in percent) .. .. 12.0 .. .. .. Poverty headcount ratio at 1 U.S dollar a day (PPP) (percentage of population) .. .. 38.0 .. .. .. Poverty headcount ratio at national poverty line (percentage of population) .. .. 69.0 .. .. .. Prevalence of undernourishment (percentage of population) .. .. 58.0 .. 45.0 45.0 Goal 2: Achieve universal primary education Literacy rate, youth total (percentage of people ages 15-24) 49.0 .. .. .. .. .. Persistence to grade 5, total (percentage of cohort) .. .. .. 52.0 .. .. Primary completion rate, total (percentage of relevant age group) 24.9 24.5 25.4 16.2 22.1 29.0 School enrollment, primary (percentage, net) .. .. .. 56.0 56.0 71.0 Goal 3: Promote gender equality and empower women Proportion of seats held by women in national parliament (in percent) 16.0 .. 25.0 25.0 30.0 30.0 Ratio of girls to boys in primary and secondary education (in percent) .. .. .. 75.1 78.6 82.3 Ratio of young literate females to males (percentage ages 15–24) 47.9 .. .. .. .. .. Share of women employed in the nonagricultural sector (in percent of total nonagricultural employment) 11.0 .. .. .. .. .. Goal 4: Reduce child mortality Immunization, measles (percentage of children ages 12–23 months) 59.0 65.0 61.0 71.0 77.0 77.0 Mortality rate, infant (per 1,000 live births) 158.0 .. .. 122.0 .. 104.0 Mortality rate, under-5 (per 1,000) 235.0 .. .. 178.0 .. 152.0 Goal 5: Improve maternal health Births attended by skilled health staff (in percent of total) .. .. 44.2 .. 48.0 48.0 Maternal mortality ratio (modeled estimate, per 100,000 live births) .. .. .. 1,000 .. .. Goal 6: Combat HIV/AIDS, malaria, and other diseases Children orphaned by HIV/AIDS .. .. .. .. 470,000 470,000 Contraceptive prevalence (percentage of women ages 15-49) .. .. 6.0 .. 17.0 17.0 Incidence of tuberculosis (per 100,000 people) 167.1 .. .. .. .. 460.2 Prevalence of HIV, female (percentage ages 15-24) .. .. .. .. .. .. Prevalence of HIV, total (percentage of population ages 15-49) .. .. .. .. 12.0 12.0 Tuberculosis cases detected under DOTS (in percent) .. .. 46.8 44.5 45.5 45.9 Goal 7: Ensure environmental sustainability CO2 emissions (metric tons per capita) 0.1 0.1 0.1 0.1 0.1 .. Forest area (percentage of land area) 26.0 .. .. 25.0 .. .. GDP per unit of energy use (constant 2,000 PPP U.S. dollars per kilogram of oil equivalent) 1.0 2.0 2.0 2.0 2.0 2.0 Improved sanitation facilities (percentage of population with access) .. .. .. .. 27.0 .. Improved water source (percentage of population with access) .. .. .. .. 42.0 .. Nationally protected areas (percentage of total land area) .. .. .. .. 8.4 8.4 Goal 8: Develop a global partnership for development Aid per capita (current U.S. dollars) 74.7 78.3 56.6 49.0 54.5 63.2 Debt service (PPG and IMF only, percentage of exports, excluding workers' remittances) 17.0 30.0 18.0 2.0 5.0 3.0 Fixed line and mobile phone subscribers (per 1,000 people) 3.5 3.7 4.1 7.6 26.9 26.9 Internet users (per 1,000 people) 0.0 .. 0.1 1.1 4.4 7.1 Personal computers (per 1,000 people) .. .. 1.8 3.3 5.0 5.8 Total debt service (percentage of exports of goods, services and income) 26.0 31.0 19.0 12.0 6.0 5.0 Unemployment, youth female (percentage of female labor force ages 15-24) .. .. .. .. .. .. Unemployment, youth male (percentage of male labor force ages 15-24) .. .. .. .. .. .. Unemployment, youth total (percentage of total labor force ages 15-24) .. .. .. .. .. .. Other Fertility rate, total (births per woman) 6.2 .. 5.9 5.7 5.4 5.4 GNI per capita, Atlas method (current U.S dollars) 170 140 170 210 230 270 GNI, Atlas method (billions of current U.S. dollars) 2.3 2.1 2.9 3.8 4.4 5.3 Gross capital formation (% of GDP) 22.1 25.5 20.6 33.5 25.9 20.1 Life expectancy at birth, total (years) 43.2 .. 43.8 42.6 41.9 41.8 Literacy rate, adult total (percentage of people ages 15 and above) 33.5 .. .. .. .. .. Population, total (millions) 13.4 15.3 16.7 17.9 19.1 19.4 Trade (in percent of GDP) 44.2 62.1 41.9 61.3 72.3 68.3 Source: World Development Indicators database, April 2006; and Mozambican authorities. 1/ Figures in italics refer to periods other than those specified. basic calorie needs. The cost of this basket represents the food poverty line in each domain; a nonfood poverty line was also obtained. Households are defined as poor if their daily per capita expenditure is less than the total poverty line (sum of food and nonfood poverty lines). Table 8. Mozambique: Millennium Development Goals, 1990–2004 2/ A household survey was conducted between 1996–97 and 2002–03 to determine poverty incidence. The methodology included a basket of goods that satisfies APPENDIX I Maputo, Mozambique October 24, 2006 Mr. Rodrigo de Rato Managing Director International Monetary Fund Washington, D.C. 20431 U.S.A. Dear Mr. de Rato: 1. On behalf of the Government of Mozambique, we hereby transmit the attached memorandum of economic and financial policies (MEFP) that sets out the objectives and policies that the Government intends to implement in the remainder of 2006 and 2007, as well as the underlying macroeconomic policy framework consistent with the PARPA II. The attached revised technical memorandum of understanding (TMU) defines the terms and conditions of the program. 2. The Government of Mozambique continues to make progress in implementing the 2004-06 program supported by the three-year arrangement under the Poverty Reduction and Growth Facility (PRGF), which was approved by the Fund’s Executive Board on July 6, 2004. All quantitative performance criteria at end-June 2006 and the structural performance criterion through end-July 2006 were achieved. The program for the remainder of 2006 is broadly unchanged while the 2007 and the medium term framework have been revised to take into account the 2007 budget, a scaling-up of foreign aid, domestic and international economic developments, and Plano de Acção Para a Redução da Pobreza Absoluta II (PARPA II). 3. The resources released as part of the MDRI have been incorporated in the execution of the 2006 budget and included in the medium term fiscal framework (MTFF) to be spent on poverty-reducing “priority” expenditures identified in the PARPA II. 4. In support of its objectives and policies, the Government of Mozambique hereby requests the disbursement of the sixth loan under the current PRGF arrangement in the amount of SDR 1.62 million (1.4 percent of quota) on the completion of the fifth review. 5. Looking ahead, the policies set out in the MEFP continue to aim to consolidate macroeconomic stability and sustain strong broad-based growth through a second wave of reforms in order to achieve the Millennium Development Goals (MDGs). The performance criteria and benchmarks for the sixth and final review under the PRGF arrangement will be based on the end-December 2006, and through end-April 2007 targets as set out in Tables 1 and 3 of the MEFP. While the current PRGF arrangement expires in July 2007, indicative targets for end-June 2007, end-September 2007 and end-December 2007 are also set forth in Table 1. 6. The Government of Mozambique intends to accept its obligations under Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement following the approval of the new foreign exchange law which will be submitted to the Assembly by end-March 2007. The delay in the submission of the new draft foreign exchange law to the Assembly is related to the need to build a consensus among all stakeholders. The government remains committed to a flexible exchange rate regime. 7. The Government of Mozambique will provide the Fund with such information as the Fund may request in connection with the progress made in implementing the economic and financial policies and achieving the objectives of the program. 8. The Government of Mozambique believes that the policies and measures set forth in the MEFP are adequate to achieve the objectives of its economic program for 2006 and 2007 supported by the PRGF arrangement, but it will take further measures to that end if deemed necessary. During the implementation of the arrangement, the Government of Mozambique will consult with the Managing Director on the adoption of these measures and in advance of revisions to the policies contained in the MEFP, at the initiative of the Government or whenever the Managing Director requests such a consultation. 9. The government of Mozambique is considering the possibility to request a Policy Support Instrument (PSI) at the end of the current PRGF-supported program. As such, the government wishes to negotiate the new PSI at the time of sixth review under the current PRGF arrangement. Sincerely yours, / s / Manuel Chang Minister of Finance / s / Ernesto Gouveia Gove Governor Bank of Mozambique Attachments: Memorandum of Economic and Financial Policies Technical Memorandum of Understanding ATTACHMENT I Memorandum of Economic and Financial Policies of the Government of Mozambique for the Fifth Review Under the PRGF Arrangement October 24, 2006 1. The Government of Mozambique is committed to continue to consolidate macroeconomic stability and to achieve sustained economic growth and poverty reduction through the pursuit of prudent macroeconomic policies and a second wave of structural reforms. The strategy to achieve these goals in 2006–09 is set out in the Plano de Acção Para a Redução da Pobreza Absoluta II (PARPA II) that has been recently submitted to the management of both the International Monetary Fund (IMF) and World Bank. The Government’s economic program is supported by the IMF with a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF), which was approved on July 6, 2004. This Memorandum of Economic and Financial Policies (MEFP) reviews the performance under the PRGF-supported program (January 2006–September 2006) and describes the policies and targets for the remainder of 2006 and 2007. I. RECENT PERFORMANCE UNDER THE PRGF-SUPPORTED PROGRAM 2. In 2006, economic performance remains favorable. Led by strength in the agriculture and construction sectors, real GDP growth has continued to be broad-based and is expected to accelerate slightly, from 7.7 percent in 2005 to 7.9 percent in 2006. Good rainfall, following the 2005 drought, resulted in a regular harvest season and has improved food security. Reflecting lower food prices, the cumulative headline inflation rate has slowed down since May to 4.8 percent in September, putting the year-end inflation target, 7 percent, within reach, although higher world oil prices may add pressures on price stability. The foreign exchange market has remained stable following the introduction of a temporary exchange rate band in the interbank foreign exchange market (MCI) in November 2005. The net international reserves (NIR) target for end- June 2006 was met and spread between the MCI rate and rates quoted by banks and bureaus has narrowed, and the real effective exchange rate has appreciated by about 5 percent since end-2005. 3. Fiscal performance for the first semester of 2006 was better than programmed. Revenue collection is above target led by buoyant corporate and VAT tax collections, and domestic-related expenditures are in line with the program. This resulted in a lower domestic primary deficit. However, the share of priority spending was somewhat below target reflecting a low rate of project execution so far. 4. Progress has been made in reforming revenue administration and widening the tax base. The general tax law and the law creating the Central Revenue Authority (ATM) were promulgated in February 2006. The implementing regulations for the ATM law were approved by the Council of Ministers with a slight delay in July 2006 (structural benchmark) and the ATM strategic plan has been completed. The organic law of tax tribunals was also approved in April 2006, and operationalized with the selection of professional judges. In addition, the following measures were implemented: (i) identifying and collecting tax arrears; (ii) increasing the number of taxpayers to 360,000; and (iii) conducting a larger number of tax audits. 5. Public Financial Management (PFM) reforms have made good progress. The medium-term fiscal framework (CFMP) is closely aligned with the objectives of PARPA II, and was, for the first time, approved by the Council of Ministers in May 2006. The Government is implementing a new version of the e-SISTAFE (Homoine version) software to enable effective direct budget execution (according to the sequence of commitment, verification, and payment) for goods and services, and rolled out the system to the Ministries of Finance, Planning, Education, Agriculture, Health, and Public Works, at the central and provincial levels (structural performance criterion) since July 2006. To avoid having to go through a cumbersome process of converting the budget proposals into e-SISTAFE, a simplified new IT system (Phase I of the new budget formulation module) was implemented, and was ready in time to support the preparation of the 2007 budget. Good progress was made in integrating donor-financed projects into the 2007 budget ceilings including through the issuance of accounting guidelines, while challenges remain in bringing those projects on to the treasury single account (CUT). Pending the implementation of a new revenue collection network, revenue departments current’s IT system (RCN) was updated to classify revenues according to SISTAFE’s needs when they are transferred to the CUT and help with the treasury’s financial programming capacity. Finally, a prioritized strategy was developed by end-September 2006 (structural benchmark) to progressively rollout e-SISTAFE to districts based on their administrative and infrastructure capacity. 6. Monetary policy has remained prudent. The performance criterion on base money was met for end-June 2006. This helped the introduction of the new family of meticais (MTn) proceed smoothly on July 1, 2006. Interest rates increased following the removal of interest rate caps in government securities auctions completed in March, albeit declining in August following the Bank of Mozambique’s (BM) decision to lower its Facilidade Permanente de Cedência (FPC) rate alongside the deceleration in inflation. Net credit to the government (NCG) was lower than programmed, which also contributed to keeping broad money growth below its end-June target. 7. Prudential ratios of the banking system have remained sound. The ratio of nonperforming loans to total loans has remained below 5 percent while the requirement to provision 50 percent of their foreign currency-denominated loans to nonexporters since July 2005 has led to a deceleration in foreign currency loan growth. Moreover, credit growth to the economy has remained strong, and the commercial banking system appears to be well capitalized. Finally, in order to strengthen the balance sheet of the BM, securities in an amount of MTn 1.5 billion were issued to BM in June 2006 as envisaged in the program. 8. In the area of accounting, the BM adjusted its Chart of Accounts in September 2006 (structural benchmark) to allow for: (i) the valuation of foreign exchange gains/losses consistent with International Financial Reporting Standards (IFRS); and (ii) the preparation of BM’s financial statements for 2005 in compliance with IFRS in parallel to the financial statement prepared under the current accounting standard. The revision of the Chart of Accounts of the commercial banking system, consistent with IFRS, is being finalized, but a circular will be issued by end-November 2006 (originally planned by end-September 2006; structural benchmark). 9. Progress on structural reforms in 2006 accelerated, particularly in the areas of public sector, labor market, and trade-related reforms. The government is strengthening efforts in the area of public sector reform through the second phase of the strategic action plan (2006-2011). The plan was approved by the Council of Ministers in October 2006, with a special focus on decentralization. A public service authority (ANFP) was recently established, reporting directly to the President, to give the reform a stronger impetus. In addition, a preliminary draft of a strategy paper on decentralization has been prepared including fiscal issues. The new draft Labor law has been approved by the Council of Ministers and submitted to the Assembly. In the area of trade reforms, in January 2006, the maximum import tariff rate applicable to SADC trading partners was lowered from 25 to 20 percent. With respect to the latter, the government continued negotiations with Angola, Tanzania and Zambia in order to reach agreements similar to the ones concluded with Zimbabwe and Malawi in 2005. In addition, the Government has continued with streamlining licensing procedures through “one stop shops”, computerizing the company registry, and the e-Government portal, and pursuing bilateral free trade arrangements as recommended in the Diagnostic Trade Integration Study (DTIS). 10. However, less progress was made to increase access to finance through deeper reforms that would improve the lending environment, such as legal and judicial reform, the use of collateral, and availability of creditor information, as well as deepening of domestic debt markets. Despite the initiation of commercial sections in the Judicial Tribunals of the city of Maputo, Sofala and Nampula, further capacity building is needed with the help of donors, including the World Bank. The remaining weaknesses in the justice sector and backlog of cases are also causing an increasing impediment not only in dealing with criminal cases and corruption, but in relation to labor issues and the development of a vibrant private sector. In addition, challenges remain in the implementation of new national procedures such as procurement, accounting, reporting and audit which needs to be further strengthened with close collaboration with donors, in particular at the district level 11. Little progress has been made in collecting the necessary information to monitor adequately the mega-projects and the eleven public enterprises, as well as the 164 participating enterprises. While the unit to monitor the megaprojects has not been created as envisaged under the program, the government has decided to create a research department within the Ministry of Finance in 2006, with a key function to gather information on megaprojects, and public and participating enterprises. II. THE POLICY AGENDA FOR 2006 AND 2007 12. The policy framework, which aims at consolidating macroeconomic stability, is consistent with the medium-term goal of sustaining poverty reduction through strong broad-based economic growth. The Government is committed to continue to implement measures to strengthen revenue mobilization and the transparency and monitoring of the budget execution including the MDRI resources, to fine-tune monetary policy, and to reinvigorate and accelerate the structural reform agenda in the context of PARPA II. Furthermore, the Government intends to continue to monitor its program with the existing multi-disciplinary committee, particularly through reinforced coordination between the BM and the Ministry of Finance (MF). The research department of the Ministry of Finance will collect and analyze information on megaprojects and public enterprises by end-March 2007.The pricing mechanism will continue to be implemented automatically and transparently for all petroleum products. 13. All end-2006 quantitative targets are within reach. The 2006 fiscal stance will reflect additional priority expenditures identified in the 2006 budget that were contingent on the MDRI while domestic revenues are expected to reach 14.4 percent of GDP as originally envisaged. It is also anticipated that the share of spending on priority sectors out of total primary expenditures will exceed the 65 percent target as donor-financed project execution picks up at the end of year. Overall, the domestic primary deficit will be 2.5 percent of GDP with a negative net domestic banking financing of 2.5 of GDP. This along with an unchanged base money target will help achieve the 7 percent inflation target while the comfortable level of international reserves will help cushion against exogenous shocks. 14. Prospects for 2007 remain favorable with a continuation of strong economic growth and control of inflation to single digit levels. Central to achieving these objectives will be a gradual fiscal strengthening backed by an average revenue increase of 0.5 percent of GDP per year and a prudent monetary policy. The 2007 budget is based on the CFMP. The structural reform agenda, as detailed in the PARPA II strategic matrix, includes a second wave of reforms to sustain broad-based growth and poverty reduction. In addition to fiscal reforms to increase revenue mobilization and strengthen expenditure management, the Government will deepen institutional reforms to (i) promote good governance, (ii) buttress the investment climate and ease growth constraints, and (iii) strengthen the transparency of natural resource management and megaprojects. To maintain competitiveness and a comfortable level of international reserves, the BM will bestow greater exchange rate flexibility in the foreign exchange market. 15. The 2007 budget envisages a scaling-up of aid and an associated increase in priority spending focused towards achieving the PARPA II targets including sufficient counterpart funds to ensure a smooth execution of donor-financed projects. There will be no recourse to domestic financing. Total domestic revenue is envisaged to rise by 0.5 percent of GDP compared to 2006 by broadening the tax base through a continued increase of the number of taxpayers, elimination of unwarranted tax exemptions, collection of new tax arrears amounting to about 0.2 percent of GDP, and quarterly updating of the specific fuel tax rate, and finalize discussions with the interested parties on the efficient use of container scanners. The expenditure side will reflect a 7.5 percent ratio of the wage bill to GDP as envisaged in the MTFF, including a hiring of about 10,000 teachers and 3,000 health workers. The share of spending on priority sectors (above 65 percent), particularly education, health, and infrastructure, has been agreed with the donors and will be closely monitored. 16. The government will continue to improve the efficiency of the tax system by sequentially implementing its tax policy reform benefiting from Fund technical assistance. Progress on tax reform will be closely monitored within the MF. In the first semester of 2007, tax policy measures will be defined to equalize the treatment of interest income on different assets, streamline and simplify the tax system for small and mediumsized enterprises, and reduce VAT exemptions. An external audit will be undertaken with the assistance of donors to assess the amount of arrears on VAT refunds due to contractors of large infrastructure projects, particularly in the road sector. On the basis of this audit a payment schedule will be defined to clear the arrears. Going forward, the government will ensure that VAT charged on supplies of projects be included in the final price of a contract. 17. The next phase of the revenue administration reforms (2007-10), to be supported by a multi-donor common fund, will focus on establishing the ATM as a sustainable, semi autonomous institution, and improving operational performance to help achieve the medium term revenue targets. The Government is committed to supporting the phased integration of the core functions of both tax and customs administration by initiating the implementation of the strategic plan of the ATM in late 2006 and 2007 following the appointment of a President of the ATM in October 2006. Revenues administration measures envisaged in 2007 include: (i) reducing the levels of stop filing, especially with respect to large taxpayers; (ii) initiating procedures to recover tax arrears generated during 2005 and 2006; (iii) providing a better service to taxpayers by reducing the average time to resolve VAT refunds claims; (iv) establishing an audit plan for 2007 at the DGI aimed at broadening audit coverage for domestic taxes; (v) facilitating trade through the reduction of the average time to release imported goods at the border; and (vi) implementing the IT Plan (PDTI). 18. The medium term PFM Action Plan and Budget (APB) for 2006–2009 agreed with the donors includes the following main elements: rollout of the budget execution module to all central and provincial entities, and its customization to district and municipalities needs; the introduction of Phase II of the budget formulation module; and the development of new modules and functionalities. Specific measures of the APB include: • First, all budgetary operations for goods and services of Financial Management Departments (DAFs) of at least 22 additional ministries and organs (see attached list in the TMU), at the central and provincial levels, will be executed through the e-SISTAFE by end-January 2007 (structural benchmark). • Second, the Inhassoro version, the software that will allow for the closure of the 2006 budget and the production of the financial accounts of the state within e-SISTAFE, as well as the report generation facility will be operational by end-2006. • Third, the development of a payroll and pensions functionality is a high priority for 2007. It is, however, dependent on the census of the civil service scheduled to be completed by end-April 2007 (structural benchmark). This census will provide a unique biometric identification number for each public employee and be used to develop an integrated payroll database that will be compatible with e-SISTAFE. Following this, the e-SISTAFE payroll functionality will be ready by end-June 2007 and the pension functionality by end-September 2007. • Fourth, a district version of e-SISTAFE, customized to their needs, will be rolled out to only 27 out of 128 districts in 2007, duly taking into account their administrative capacity and infrastructure conditions. • Fifth, the Phase II of the budget formulation module will be tested and ready for use by end-June 2007, to fit in with the 2008 budget calendar. • Sixth, to automate revenue collection and classify all government revenues before transferring the funds to the CUT, a fully articulated business case will be prepared by end-June 2007 to implement a revenue collection network (RCN) based on the already developed IT structure of e- SISTAFE. • Seventh, to facilitate the inclusion of all donor-financed projects within the CUT, a limited number of separate foreign currency accounts will be opened within the CUT by end-March 2007 (structural benchmark), and be subject to the SISTAFE regime. • Finally, the implementation of the asset management system and procurement interface to e-SISTAFE will be moved forward by the development of requirement specifications and tender by end-June 2007. 19. On monetary policy, the BM will continue to target base money with a view to achieving its inflation target. A long-term monetary policy strategy document was approved by the executive board of the BM in October 2006 that defines an intermediate target compatible with the base money operational target, a new format for the monetary policy committee, and specifies its communication policy. To achieve the inflation objective of 6 percent by end-2007, base money growth will be limited to 15 percent or slightly higher than nominal GDP growth to take into account the ongoing financial deepening. In addition, the monetary authority remains committed to a flexible exchange rate regime and to that effect will gradually widen the temporary exchange rate band in the foreign exchange market when conditions permit. 20. The BM will continue to improve liquidity management, and deepen financial markets as part of the Financial Sector Technical Assistance Program (FSTAP). In this context, the MF, in turn, will improve the preparation of cash-flow projections and communicate it to the BM in a timely manner with Fund technical assistance. Moreover, with World Bank technical assistance, the BM will finalize a master repurchase agreement by end-May 2007. The BM and the MF will agree, through a memorandum of understanding, to shift the costs of managing monetary policy to the budget starting in 2008 with Fund technical assistance. 21. The BM introduced a new family of meticais on July 1, 2006 (1000 old family of metical is equal to one new family of meticais, MTn). The BM expects about 90 percent of MTn in circulation by end-2006. The BM intends to open five provincial agencies, (three before end-December 2006) to help complete the introduction of the MTn and enhance the payment system. 22. The BM will also continue to strengthen and modernize its supervisory functions. In this regard, training to adopt a risk-based supervision approach will start in 2007, at which time the new inspection manuals will also be used. A proposal on the new organizational structure of the banking supervision department consistent with the Integral Strengthening Plan for Banking Supervision will be approved by end- December 2006. These organizational changes will also strengthen on-site and off-site monitoring. 23. The Government remains committed to strengthening the balance sheet of the BM. To this end, the Government will issue the last tranche of 1.5 billion MTn recapitalization bond to the BM by end-June 2007. 24. The BM is implementing a timetable to adopt International Financial Reporting Standards (IFRS) in the banking system and strengthen loan classification and provisioning in line with international best practices in 2007. The BM will issue its financial statements in line with IFRS in 2007. The BM will also ensure compliance with the new standards in the banking sector. The new regulation on the assessment, classification and provisioning of credits as well as a regulation on integral risk management for credit institutions and finance companies will be approved by end-2006, and become effective beginning 2007. 25. The Government is committed to supporting a sound expansion of the non-bank financial sector. The BM will continue to license and supervise microfinance deposittaking institutions to facilitate enhanced access to finance by rural households and smalland- medium sized enterprises. The strengthening of the social security and supplementary pension system is also being undertaken as part of a new law on social protection, which has been submitted to the Assembly. As part of the restructuring of the National Social Security Fund (INSS), an actuarial study will be completed before the end of 2007. In the meantime, guarantees of minimum benefits will be limited until the full study is carried out. The Government also plans to enhance the regulatory and supervisory framework for supplementary pensions and INSS together with the insurance sector, including by strengthening the capacity of the Inspecção Geral de Seguros (IGS), the industry regulator. 26. The BM is committed to implement in 2007 all the remaining actions needed to address weaknesses identified in the context of the Fund’s safeguards assessment mission conducted in June 2004. In particular, progress is being made in making the necessary adjustments so that the balances in the BM’s accounting records match the balances confirmed by the correspondents and other third parties. The reconciliation of monetary data with audited financial statements and its review by the internal audit department will be completed by end-December 2006. 27. Regarding the foreign exchange system, a new foreign exchange law taking into account comments from all stakeholders and the Fund, will be submitted with a slight delay to the Assembly by end-March 2007. Following approval of the new law and issuance of related regulations, the authorities intend to accept their obligations under Article VIII sections 2, 3, and 4 of the Fund’s Articles of Agreement. 28. The Government expects to further liberalize the trade regime during 2007 by extending the reduction of the maximum import tariff rate from 25 to 20 percent for all trading partners, and has submitted a legislative authorization bill to the Assembly to this effect. During 2007, the government will continue ongoing Economic Partnership Agreement (EPA) negotiations, with technical advice under the Integrated Framework. 29. The Government looks forward to completing the buyback operation for its commercial debt in early 2007 with the financial assistance of the World Bank and the Government of Norway. The Government recognizes the importance of reaching rescheduling agreements with all bilateral creditors in the context of the enhanced HIPC Initiative. It has intensified efforts to negotiate with good faith with all Paris Club and non-Paris Club creditors that have not yet delivered debt relief, and hopes that progress would be made in reaching agreements with its remaining creditors as soon as possible including commercial creditors. In this regard the Government of Mozambique looks forward to the continuing support of the Bretton-Woods institutions. 30. The Government of Mozambique is conscious that despite its efforts to improve its investment climate during the year 2006, its ranking in the ease of doing business, as assessed in the Doing Business report 2007, has worsened to 140th place. The recent authorization to publish the bylaws of firms electronically may help to improve the ranking. However, it is not sufficient to make Mozambique’s business environment the most competitive in SADC by 2015. To address this challenge and significantly improve the investment climate in Mozambique, the Government will develop a strategic action plan by end-March 2007 with the assistance of the World Bank to implement key reforms covering the period 2007-15. In 2007, the four key actions envisaged will include: • Further simplifying the process to start up a business by expanding the computerization of the registration process to all the provinces. • Adopting a system of inspections that would be business friendly and better coordinated across the several ministries that undertake inspections. • Making it less costly and time-consuming to close a business by simplifying process and increasing the recovery rate for viable businesses to overcome a short-term cash flow crisis, and insolvent businesses to be rapidly liquidated. 31. The Government will continue to restructure and encourage private participation in public enterprises, particularly infrastructure services. A decision was made by the Council of Ministers in May 2006 to develop a new restructuring plan for PETROMOC that would improve efficiency. The new restructuring plan will be completed by end-June 2007 for its adoption by the Council of Ministers by end-September 2007. The Government with the help of the World Bank will continue to put in place measures to assist the state-owned electricity company (Electricidade de Moçambique, EDM) to improve performance, including through a performance contract and the operationalization of the regulator (CNELEC) by end-June 2007. 32. The Government recognizes the importance of improving the fiscal regime of mineral and petroleum resource projects. Accordingly, the Council of Ministers will, before the end of November 2006, approve a new draft Mining Fiscal Regime law (structural performance criterion, end-December 2006). A law would be submitted to Parliament for its first session of 2007. In the interim, the Government will ensure that any new mineral resource project agreements will adhere to the principles of the new draft Mining Fiscal Regime law. While the new draft law will be the essential foundation for an improved mining fiscal regime, the Government will also strengthen its negotiating tools, including by developing a model contract and the capacity to undertake timely feasibility studies and financial modeling. With regards to the petroleum sector, the government will request for technical assistance from the international community to make the model contract more specific, and narrow the range of items for bidding or negotiation. After December 31, 2006 the Government will avoid signing any new Exploitation and Production Concession Contracts (EPCs) in the petroleum sector until a new comprehensive petroleum fiscal regime is in place that would be embodied in the general tax law so as to avoid case by case negotiation of petroleum tax terms. 33. Improving governance remains a priority of the Government. The Government is considering following the Extractive Industries Transparency Initiative (EITI) principles with regard to management of natural resources. The Government is already participating in a number of seminars on the EITI principles ending with a seminar in Maputo in January 2007. It is expected that the Government will consider to adhere to the EITI principles after the January seminar. Thereafter all new related agreements, in particular the future exploitation of coal, oil and natural gas as well as any expansion of related megaprojects will follow the EITI principles. 34. With regard to the governments’ anti-corruption strategy, operational action plans will be developed in five sectors by end-December 2006. The actions and outcomes undertaken by those sectors will be disseminated and closely monitored by dedicated committees within the reform umbrella, and a number of pending cases in the central bureau for anti-corruption will be executed in 2007. 35. In the context of the implementation of the Anti-Money Laundering Law, the Government is also committed to creating a financial investigation unit as soon as the law is adopted by the Assembly, hopefully during its March 2007 session. 36. Building on the lessons highlighted in the review of Phase I of the public sector reform program (2001–06), the Phase II document (2006-10) consists of three pillars: (i) human resource management including payroll systems; (ii) performance evaluation and wage policy; and (iii) decentralization and improving public service delivery. As part of its initial tasks the ANFP, is now carrying out a census of all civil servants to clean up the database and arrive at a unique number of total civil servants that may identify possible inexistent workers. By end-June 2007, the government will also identify clear options and a timetable for the wage reform, which is expected to result in the approval of a new wage policy in 2008. In addition, a decentralization strategy will be approved by the Council of Ministers by end-June 2007 that proposes, among other things, a clear legal, regulatory, and institutional framework for revenue raising and spending responsibilities of subnational units (provinces, districts, and municipalities) and monitoring of subnational fiscal operations. 37. The Decreto Lei do Ordenamento do Território and the urban land use regulations were approved by the Council of Ministers in October 2006. This decree will enact a policy for land use which facilitates the reduction of costs and time involved in transactions, and which would then be submitted to the Assembly for approval. The government remains committed to conducting an economic analysis of urban land markets (formal and informal) as well as an associated poverty and social impact analysis (PSIA) of urban land tenure regulations, with the assistance of the World Bank. The government is preparing a draft strategy for slum improvement. 38. The Government will reinvigorate the reform of the judicial reform with the help of the international community. The Penal Procedure Code will be approved by Council of minister by end-December 2006 and submitted to the next session of the Assembly. The organic law of judicial tribunals is expected to be approved by the Assembly in the next session of the Assembly in early 2007. A new insolvency law is also under preparation and will be submitted to the Assembly in early 2007. III. PROGRAM MONITORING 39. The semiannual quantitative performance criteria for end-December 2006 and indicative targets for end-March 2007, will be used to evaluate the implementation of the program for the remainder of 2006 and 2007 are shown in Table 1 of this memorandum, with further definitions and explanations contained in the annexed Technical Memorandum of Understanding. In addition, the Government has specified in Table 3 a list of structural performance criteria and benchmarks for 2006 and 2007. 40. The Government understands that its ability to request the disbursement of the seventh loan under the PRGF arrangement will be contingent upon the observance of the performance criteria for end-December 2006 set out in Table 1 and 3; and the completion of the sixth review under the program, which is expected to take place before end- June 2007. In reviewing developments under the program during the sixth review, particular attention will be paid to the implementation of measures aimed at broadening the tax base and rolling out the e-SISTAFE, the 2007 budget, monetary and financial sector reform, reducing the cost of dong business, and improving the fiscal regime and transparency of mineral resource exploitation and megaprojects as well as their net contribution. APPENDIX III Mozambique: Relations with the World Bank Group (November 8, 2006) Partnership in Mozambique’s Development Strategy 1. The Mozambican government’s development strategy is set forth in the poverty reduction strategy paper (PRSP), termed the PARPA (Plano de Acção para a Redução da Pobreza Absoluta e Promoção do Crescimento Económico, or Action Plan for the Reduction of Absolute Poverty), which was approved in April 2001 by the council of ministers and endorsed in September 2001 by the Boards of the World Bank and the IMF. The PARPA focuses on six “fundamental areas” aimed at promoting human development and creating an environment for broad-based growth: macroeconomic and financial management, good governance, education, health, agriculture, and basic infrastructure (roads, water, and energy). The overall perspective is that poverty can most quickly be reduced by pursuing a strategy of broad economic growth, which, in turn, is crucially dependent on the maintenance of democratic and sociopolitical stability. The government issued progress reports on the PARPA in 2003, 2004 and 2005, restating its commitment to reduce poverty by pursuing policies that help to create an environment for broad-based growth. In addition, the Program Assistance Partners, which now includes 17 donors and the World Bank, with the IMF as an observer, has undertaken biannual reviews, jointly with the government, of the entire government program since 2004, using a common performance asssesment framework (PAF), in order to serve as the basis for a further shift from project finance toward budget support. It has harmonized and streamlined donor conditionality and is expected to reduce government transaction costs. The government is in the process of finalizing the second PARPA, which includes a monitoring and evaluation framework, the Strategic Matrix, which which will be reviewed by joint sector working groups until the next Joint Review of September 2006. 2. The Fund and the World Bank will continue to cooperate closely, within their respective mandates, in assisting the government to implement its medium-term poverty reduction and growth strategy and the related reform agenda, as presented in the PARPA and updated in the annual progress report and PAF. The Fund and the Bank will initiate work on the Joint Staff Assessment on the PARPA II in the second half of 2006. 3. The Fund will continue to lead the policy dialogue on macroeconomic policy, (including fiscal, monetary, and exchange rate policies), the integrated financial management information system (SISTAFE), and tax and customs reforms. The Bank will continue to lead the policy dialogue on public expenditure management, sectoral structural reforms, the reform of the civil service, and the Poverty and Social Impact Analysis (PSIA). Areas of close collaboration include banking supervision and financial sector issues, trade issues, the PARPA and its further development, and external debt sustainability. Bank Group Country Assistance Strategy 4. The current CAS (FY04-07) is a Results-based strategy, prepared jointly with IFC and MIGA. Preparation of a new Country Partnership Strategy jointly with four donors has started in support of the agenda of the Paris Declaration on Harmonization. The Bank is coordinating with partners through a peer review process and harmonization of analysis and results frameworks. The three pillars of the current CAS are (i) improving the investment climate, (ii) expanding service delivery, and (iii) building capacity and accountability. A CAS Progress Report, an evaluation of the Bank’s program during the first two years of implementation has been completed and presented to the Board in March 2006. The focus of the Bank’s lending program is on programmatic support through four rolling Poverty Reduction Support Credits (PRSCs), of which the first two credits have been approved and fully disbursed. Fiduciary issues are fully taken into account within the scope and sequencing of the PRSCs. The shift to programmatic lending through the PRSCs was underpinned by the Bank’s core diagnostic economic and sector work, including the public expenditure review and PSIA. While a series of PRSCs is the largest single element in the lending program, the shift from traditional investment lending to program lending is being phased in gradually. Selected investment projects are targeting institutional strengthening, capacity building, transport infrastructure, water, agriculture, and communications. Commitment Amount US$ m FY07 23% 11% 10% 52% 4% Human Development Public Sector and Decentralization Agriculture and Rural Development Infrastruture Private Sector and Mining 5. To date, the World Bank Group has approved 7 adjustment operations, 2 development policy operations, one investment guarantee and 47 investment operations totaling approximately US$3 billion The CAS financing plan for FY04-FY07 included lending financing, grant resources and guarantee coverage for $560 million, of which $438 million ($258 in investment operations and $180 million in two Poverty Reductions Support Program credits) and $30 million in an IBRD guarantee have been approved. A further two investment operations and one PRSC credit are scheduled to be delivered before the end of the CAS period. The graph above illustrates the distribution of the current portfolio by main sectors. 6. The World Bank has been actively supporting the government of Mozambique’s macroeconomic program since 1986 through a series of structural adjustment operations. The last, the Economic Management and Private Sector Operation (EMPSO), was approved by the Bank Board in August 2002 for US$120 million. The EMPSO supported the government’s program of consolidating macroeconomic stability and laying the foundations for sustained private sector-led growth over the medium term. It included measures to make the budget more transparent (including accounting for external aid flows), conduct a public expenditure review, strengthen the financial sector while aiming to eliminate government ownership in the sector, and liberalize the telecommunications and air transport sectors in order to facilitate further private participation. Since 2004, the Bank’s quick-disbursing assistance has taken the form of development policy lending through PRSCs, which have been developed in tandem with the Joint Review/Performance Assessment Framework process referred to above. The first two PRSCs were presented to the Board in July 2004 and in September 2005; they were valued at US$60 million and US$120 million respectively. A third PRSC credit, and the first operation supporting the PARPAII, is curently under preparation for delivery in FY07. 7. The World Bank has been an active partner in supporting the government in improving education and strengthening capacity building in key public institutions. The Education Sector Strategic Program (US$71 million—FY99) supports the implementation of the National Education Strategy, whose objectives are the promotion of sustained improvements in the quality of Mozambique’s labor force, and greater gender and regional equity in economic opportunities. The Higher Education Project (US$60 million—FY02) supports the entire higher education system, including both public and private institutions of higher education. The Technical and Vocational Education and Training project (US$30 million —FY06) is the first operation in the tertiary and vocational education area. 8. In health, the Health Sector Recovery Project (US$98.7 million—FY96, closed in 2003) supported the government’s broad Health Sector Recovery Program, especially by reducing infant and child mortality. The HIV/AIDS Project (US$55 million—FY03) assists the government in carrying out its National Strategic Plan to Combat STDs and HIV/AIDS. The HIV/AIDS Treatment Acceleration Project (US$21 million―FY04) assists the Government in scaling up ongoing HIV/AIDS treatment initiatives using a combination of public/private/NGO partnerships to serve vulnerable groups. A new health operation is under preparation for FY07. 9. In the area of transport and infrastructure, the Bank has three active projects. The Railways and Ports Restructuring Project (US$100 million—FY00) aims at increasing the operating efficiency of the three major port-rail systems in Mozambique. The Roads and Bridges Project (US$162 million—FY02) aims at improving road infrastructure, sector policies, and management, and the Beira Railway Project (US$110 million―FY05) aims to improve the cost-effectiveness and efficiency for freight and passenger rail transport in the Zambezi Valley and beyond. The second phase of the Roads and Bridges project is under preparation for FY07 10. In the water sector, one project - the National Water Development Project I (NWDP I) (US$36 million—FY98) closed on October 31, the National Water Development Project II (NWDP II) (US$75 million plus US$15 supplemental—FY99, FY04) - support improvements in service delivery standards, coverage, water resources management, and management capacity in both rural and urban areas. The NWDP II also supports private sector management of water services in five major cities. 11. Another important part of the Bank’s portfolio focuses on strengthening the investment climate and encouraging private sector participation. The current Bank CAS has been prepared jointly with the International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency (MIGA). IDA currently has one operation, the Enterprise Development Project (US$26 million—FY00, scheduled to close in FY06) which aims at broadening the base of private participation in the Mozambican economy. The Mineral Resource Management Capacity Building Project (US$18 million—FY01) seeks to increase institutional capacity in the sector, and alleviate poverty. The Communications Sector Reform Project (US$14.9 million—FY02) seeks to increase private sector participation in the postal, air transport, and telecommunications sectors. 12. As regards public sector reform, the Public Sector Project (US25.6 million―FY03) seeks to upgrade the quality of public services, reduce red tape, and improve access to public services. The Municipal Development Project (US$33.6 million―FY01) aims to strengthen the institutional capacity of municipal government and pilot a municipal grant mechanism to finance investment. Finally, the Decentralized Planning Financing Project (US$42 million―FY04) supports improvements to the institutional capacity of district administrations. The Financial Sector Technical Assistance project (US$10.5 million— FY06) supports implementation of the recommendations of the Financial Sector Assessment Program jointly conducted with the Fund in 2003. 13. The Bank is also involved in agriculture, energy, and the environment. The Agricultural Sector Public Expenditure Program (US$30 million—FY99), which will close at the end of 2005, is a sectorwide assistance program (SWAP) that seeks to improve the impact of public expenditure in developing an enabling environment for sustainable and equitable growth in the rural sector. The Gas Engineering Project (US$26 million—FY94), which closed in 2003, supported pre-investment in the Pande-Gas Project and provided capacity building to the government for negotiation of megaprojects. This operation supported capacity and technical assistance for negotiation and implementation of the Southern Africa Gas project, a pipeline financed by SASOL of South Africa with equity participation of IFC and guarantee coverage of MIGA (US$30 million—FY04. The Energy Reform and Access Project (US$40.2 million—FY04), which supports reform of the power sector, in particular the separation of distribution, transmission, and generation functions, aims at increasing the number of electricity connections, solar energy distributors, and seeks to provide a more efficient service. The World Bank Group is also supporting sustainable use of natural resources with two operations in environment: the Coastal and Marine Biodiversity Management Project (US$9.7 million—FY00), which pilots an integrated approach to achieving sustainable development, focusing on two main coastal areas, and the second credit of a Transfrontier Conservation Areas and Tourism project (US$20 million plus US$10 million in a Global Environment Facility grant—FY06). A Market-led Smallholder Development project of US$30 million was approved in FY06. 14. The Bank’s program also encompasses economic and sector work to support the three pillars of the CAS, involving work on the following: • Improving the Investment Climate. Economic and sector work completed over the past two fiscal years included a strategy for rural growth and income creation and a country economic memorandum on sustainable growth and poverty reduction, which also analyzed the sources of growth. Technical assistance is currently being provided in procurement reform, mining and on commercial debt reduction. A PSIA on labor market and a PSIA on land are planned for preparation in FY06–FY07, together with a study on regional growth poles. • Expanding Service Delivery. Work completed has involved a country status report on health; a technical assistance on health budget management; a report on the status of the health Millennium Development Goals; a Poverty and Social Impact Assessment (PSIA) on primary school fees; an assessment on labor markets and technical education; a study on private sector competitiveness; a study on local service delivery; and a report on water resource management. Ongoing and planned studies include a poverty assessment, a rural strategy, a country environmental and social assessment. • Building Capacity and Accountability Investing in People. Work completed includes a country procurement assessment report, a legal and judicial assessment, an institutional governance review including a survey on corruption, a public expenditure review and ongoing technical assistance on public expenditure management. • Monitoring and Evaluation. The Bank is providing technical assistance to the Government in finalizing and monitoring its first PRSP M&E system, the Strategic Matrix of PARPAII. The Bank is also supporting preparation of a Monitoring Plan to implement the Strategic Matrix. IMF-World Bank Collaboration in Specific Areas 15. Fund and Bank staff maintain a close working relationship, especially with respect to (i) analyses and reforms in public expenditure management; (ii) the PARPA and accompanying annual updates and joint staff assessments; (iii) the financial sector and banking supervision; (iv) PSIA; (v) tax issues; and (vi) trade issues: Public expenditure management. The Fund and the Bank jointly emphasize the urgent need to further improve public expenditure management, accountability, and transparency. The two institutions support policy reforms in the areas of budget formulation, execution, and monitoring. The IMF assists the authorities in introducing the integrated financial management information system (SISTAFE), and several donors, including the World Bank, provide financial support and policy advice for this reform. Under the Fund’s leadership, a group of 10 donors set up a common fund for this large undertaking. The Bank’s PRSC emphasizes budget comprehensiveness and budget execution reporting. The Bank and the government have worked together since September 2000 on a public expenditure review, the first volume of which was issued in December 2001 and the second in September 2003. • Poverty reduction strategy paper. The Fund and Bank worked together with the government during 1999–2001, while the PARPA was being produced, and drafted the joint staff review, which was presented to the Board in September 2001. The government issued annual progress reports in 2003, 2004 and 2005 and the staff presented their joint staff assessments to their respective Boards. • The Fund and the Bank are finalizing preparation of a JSAN on the Government’s revised PARPA, officially approved at the end of September 2006. The PARPAII incorporates an M&E system. The Strategic Matrix. • Financial sector. The Fund and the Bank have worked together on the financial sector. The banking sector in Mozambique has repeatedly shown weaknesses in the past, requiring recapitalizations and intervention. Following the FSAP conducted in Mozambique during the first semester of 2003, the Fund and the Bank continue to advise the authorities on strengthening financial supervision and accounting standards to prevent the recurrence of such problems in the future. A technical assistance program is under preparation. • PSIA. As part of the preparation for future Bank budget support and a possible successor program supported by a new Poverty Reduction and Growth Facility (PRGF) arrangement, the Fund and the Bank have agreed to review closely the poverty and social impact of the key reforms that are being implemented. A pilot PSIA, advising the government on the impact of an increase in specific fuel taxes, was undertaken in 2002. A second PSIA, on the impact of reducing primary schooling fees, was completed in October 2004. A third PSIA will be undertaken during FY06 with a focus on Land, and a fourth one in FY07 on Labor Market. • Taxes. The Fund has taken the lead in this area. The government issued a new income tax law in 2002 and a revised code of fiscal incentives for investors. The Bank has been supportive of the policies proposed. Further reforms to strengthen tax revenues and to improve the efficiency of tax administration are part of Mozambique’s regular dialogue with the Fund. • Trade. The Fund and the Bank have worked together since the early 1990s on trade issues concerning general reductions in tariffs, the variable tariff on sugar introduced in 1999, and the reduction in the export tariff on raw cashews. The Fund and the Bank are involved in reforming the customs administration in Mozambique. The Bank is cooperating with the donors (particularly USAID) and the government in executing the studies on trade policy required for the Integrated Framework. 16. Between 2006 and 2007, disbursements under World Bank investment projects are expected to reach around US$125 million on average a year. World Bank Loan and Grant Operations, 1999-20051 (In millions of U.S. dollars) 1999 2000 2001 2002 2003 2004 2005 Actual Est. Est. I. Project Credit Disbursements 79.4 97.5 51.6 85.2 89.4 140.6 169.8 Established operations Household Energy (6/89) 2/ 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Economic and Financial Management (10/89)2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Education II (12/90)2/ 2/ 2.5 0.0 0.0 0.0 0.0 0.0 0.0 Industrial Enterprise (12/89)2 7.6 2.0 0.0 0.0 0.0 0.0 0.0 Agricultural Service Rehabilitation Development (2/92)2 2.5 0.7 0.0 0.0 0.0 0.0 0.0 First Road and Coastal Shipping (6/92)2 12.5 4.0 0.0 0.0 0.0 0.0 0.0 Capacity Building: Human Res. Dev. (11/92) 11.3 4.5 2.8 0.0 0.0 0.0 0.0 Capacity Building: Public Sector & Legal Institutional Development (11/92) 0.9 0.7 0.0 0.0 0.0 0.0 0.0 Maputo Corridor (1/93)2 -0.1 0.0 0.0 0.0 0.0 0.0 0.0 Rural Rehab.(3/93)2 3.8 2.0 0.3 0.0 0.0 0.0 0.0 Food Security (4/93)2 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Local Government (6/93)2 3.1 0.0 0.0 0.0 0.0 0.0 0.0 Second Road and Coastal Shipping (4/94)2 16.9 26.5 11.4 9.7 17.5 0.0 0.0 Financial Sector Capacity Building (4/94)2 2.0 1.4 0.3 0.0 0.0 0.0 0.0 Gas Engineering (6/94)2/ 2/ 1.5 1.1 1.6 1.8 0.4 0.0 0.0 Health Sector Recovery (11/95)2 12.0 17.2 17.4 14.4 5.6 0.0 0.0 National Water I (2/98) 1.3 1.7 2.4 3.9 4.5 7.5 7.70 Agricultural Sec. PEP (2/99) 0.5 0.9 4.2 3.8 3.9 3.9 3.8 General Education (2/99) 1.0 0.5 1.2 6.9 14.7 19 159 Railway and Port Restructuring (10/99) 0.0 1.9 3.6 22.3 8.2 22.6 10 National Water II (6/99) 0.0 1.4 2.8 4.4 5.1 9.1 22.7 Enterprise Development (01/00) 0.0 2.3 3.0 2.9 3.4 4.5 4.6 Flood Emergency Recovery (4/00) 0.0 28.7 -0.2 0.0 0.0 0.0 0.0 Coastal and Marine Biodiversity (6/00) 0.0 0.0 0.3 0.4 0.3 3.7 1.6 Newest operations Municipal Development (7/01) 0.0 0.0 0.3 4.3 4.6 3.6 6.4 Roads and Bridges I (7/01) 0.0 0.0 0.0 4.3 0.5 39.1 44.6 Communications (11/01) 0.0 0.0 0.0 1.2 2.8 1.8 2.0 Mineral Resources Project (3/01) 0.0 0.0 0.2 1.4 4.1 5.5 3.2 Higher Education Project 1 (3/02) 0.0 0.0 0.0 3.4 9.2 10.0 14.2 HIV/AIDS (3/03) 0.0 0.0 0.0 0.0 2.7 2.3 10 Public Sector Reform (3/03) 0.0 0.0 0.0 0.0 1.2 1.5 1.5 Energy Reform and Access Project (8/03) 0.0 0.0 0.0 0.0 0.0 1.6 5.4 Decentralization Planning (11/03) ... ... ... ... ... 4.9 4.5 Beira Railway (10/04) 0 7.5 Treatment Acceleration Program (6/04) 0 4.3 II. Adjustment operations 150.0 0.0 0.0 63.5 70.7 60.0 60 Economic Management Reform Operation (12/98)2 3 150.0 0.0 0.0 0.0 0.0 0.0 0.0 Economic Management and Private Sector Operation 0.0 0.0 0.0 63.5 70.7 0.0 0.0 PRSC 1 (06/04) ... ... ... ... ... 60.0 ... PRSC 2 ... ... ... ... ... ... 60 Source: World Bank 1 Date of Board approval in brackets. 2 Closed 3 Grant Press Release No. 06/289 FOR IMMEDIATE RELEASE December 18, 2006 IMF Executive Board Completes Fifth Review Under the Three-Year PRGF Arrangement for Mozambique and Approves US$2.4 million Disbursement The Executive Board of the International Monetary Fund (IMF) today completed the fifth review of Mozambique's economic performance under the Poverty Reduction and Growth Facility (PRGF) arrangement for Mozambique in an amount equivalent to SDR11.36 million (about US$17.0 million), see Press Release No. 04/153. The completion of the review enables the release of an amount equivalent to SDR 1.62 million (about US$2.4 million), which will bring total disbursements under the PRGF arrangement to an amount equivalent to SDR 9.7 million (about US$14.6 million). The Executive Board also accepted, as part of the financing assurances review, that adequate safeguards remain in place for further use of Fund resources. Following the Executive Board's discussion on Mozambique's economic performance, Mr. Murilo Portugal, Deputy Managing Director and Acting Chair, stated: “Mozambique’s prudent macroeconomic policies, together with a first wave of structural reforms under its PRGF-supported program, have yielded strong economic growth, moderating inflation, and solid progress towards the objectives set out in its poverty reduction strategy. Continued solid policy implementation will play a pivotal role in consolidating macroeconomic stability, sustaining economic growth, reducing inflation, and enabling the efficient absorption of scaledup foreign assistance, under the second wave of reforms envisaged in the Plano de Acção para Redução da Pobreza Absoluta II (PARPA II) for 2006–09. Donor-financed projects should be integrated into the Treasury Single Account and e-SISTAFE with the help of the donors while clear guidelines on the use of national systems for the disbursement of aid could be disseminated. Over the medium term, the links between PARPA II targets and the budget should be strengthened to reflect comprehensive fiscal planning and costing of programs and policies. “The achievement of these objectives will require strengthened fiscal policy and an investment climate enhanced by lowering the cost of doing business and continuing to squarely address governance issues. While the new draft labor law represents an improvement on the current law, the authorities are encouraged to take steps to address the remaining rigidities to labor market flexibility. The authorities are also encouraged to adopt a new laws on the mining and petroleum fiscal regimes. Adherence to the core principles of the Extractive Industries Transparency Initiative should strengthen the transparency of natural resource management and megaprojects. “In the context of scaled-up aid and acceleration of reforms, the 2007 budget envisages a 0.5 percent of GDP rise in domestic revenue with the share of priority expenditures exceeding 65 percent of total spending. The impending rollout of the new e-SISTAFE (public financial administration system) should also ensure a better monitoring of priority expenditures. A cautious approach is warranted in devolving resources to subnational levels, with proper sequencing, supported by sufficient administrative capacity—particularly at the district level. “The reinvigoration of the public sector reform program under a new public service authority is welcome. In particular, the installation of a clean, integrated payroll database based on a civil service census should help rightsize the civil service in line with more comprehensive sectoral strategies. The anti-corruption and judicial sector reform should be accelerated, in order to improve public perceptions and strengthen the constituency for reform. “The authorities’ commitment to seek non-recourse financing for the transfer of majority ownership of the Cahora Bassa hydropower plant from Portugal to Mozambique will avoid an increase in the government’s liabilities to commercial creditors, and to ensure transparency and accountability. “The Bank of Mozambique’s stated policy of pursuing base money targeting in conjunction with a flexible exchange rate regime is welcome. This framework will help keep inflation under control, and cushion against exogenous shocks. In this regard, a more consistent monetary policy stance will be supported by greater exchange rate flexibility, when conditions permit. Parliamentary approval of the new foreign exchange law will allow Mozambique to establish full current account convertibility. “The Fund stands ready to remain engaged with Mozambique as it builds on its track record of strong macroeconomic performance and program implementation,” Mr. Portugal said. Statement by Peter Gakunu, Executive Director for Republic of Mozambique and Jose Alves Sulemane, Advisor to Executive Director December 18, 2006 The Mozambican authorities wish to thank staff for their constructive dialogue and well written reports, which clearly identify the challenges for macroeconomic stabilization and poverty reduction as well as the policy options available to the country. The authorities remain confident that the Fund will continue to be engaged to ensure that the objectives of the reform agenda are achieved. Mozambique’s macroeconomic performance in 2006 continues to be strong, with international reserves at a comfortable level. Program performance has been satisfactory and all quantitative benchmarks and structural performance criteria for end June and September achieved. The real effective exchange rate has appreciated during 2006, essentially due to the Rand’s depreciation against the US dollar. The authorities are in broad agreement with the thrust of the issues identified by staff in the report. Recent Economic Developments Growth Performance Positive developments in agriculture and construction sectors facilitated a favorable economic performance in 2006. Real GDP growth increased slightly from 7.7 percent in 2005 to an estimated 7.9 percent in 2006. Annual inflation declined from 6.4 percent in 2005 to 4.8 percent in September 2006, despite the effects of high oil prices. The economy remained relatively resilient to exogenous shocks during 2006. Fiscal Policy Revenue mobilization was better than programmed for the first semester of 2006, due to improvements in corporate and VAT tax collections, and is expected to reach 14.4 percent of GDP in 2006. The general law and the law creating the Central Revenue Authority (ATM) were promulgated in February 2006, while implementation regulations were approved by the Cabinet in July 2006, and the strategic plan for the ATM completed. To improve the tax base as well as the efficiency of the tax collection authorities, measures taken include implementing the organic law for tax tribunals; identifying and collecting tax arrears; increasing the number of taxpayers; and conducting a larger number of tax audits. Domestic expenditures are within program expectations, resulting in a lower domestic primary deficit. Positive developments have been achieved on implementation of public financial management (PFM) reforms. The medium term fiscal framework (CFMP) approved by the Council of Ministers, would be in line with the PARPA II. There have also been improvements in information technology (IT) packages for budget execution and its rollout to other line ministries, including phase I of the new budget formulation module. Good progress has also been made in integrating donor–financed projects into the budget ceilings, including issuance of accounting guidelines. In this regard, the budget for 2006 took into account the delivery of MDRI resources (January 2006), which will be allocated to identified expenditures. Monetary Policy The authorities have been pursuing a prudent monetary policy stance in 2006. The introduction of the new family of meticais (MTn) proceeded smoothly. Prudential ratios in the banking system have also remained sound and the ratio of non-performing loans to total loans maintained at below 5 percent. Growth in foreign currency loans has decelerated due to the requirement for commercial banks to provision 50 percent of their foreign currency-denominated loans to non-exporters. The Central Bank has adjusted its Chart of Accounts to allow for: (i) the valuation of foreign exchange gains/losses consistent with International Financial Reporting Standards (IFRS); (ii) the preparation of the Central Bank’s financial statements for 2005 in compliance with IFRS and in parallel with the financial statement prepared under the current accounting standard. Structural Reforms Progress in structural reforms accelerated, especially in the areas of public sector, labor market, and trade-related reforms. Phase II of the strategic action plan for the period 2006-2010 was introduced and a public service authority (ANFP) reporting directly to the President established in the first semester of this year. The draft strategy paper on decentralization has been prepared with the inclusion of fiscal issues. In addition, the draft Labor law has been approved by Cabinet and submitted to the Parliament. In January 2006, the maximum tariff rate applicable to SADC trading partners was lowered from 25 to 20 percent, and legislation was submitted and discussed in Parliament for an extension of this measure to all applicable trading partners, beginning in 2007. Bilateral trade negotiations are under way with Angola, Tanzania and Zambia on terms comparable to agreements concluded with Zimbabwe and Malawi in 2005. Moreover, the government has continued to streamline licensing procedures with the creation of “one stop shops”, in addition to the computerization of the company registry, and the use of the e-Government portal as a means to ensure a friendly business environment. Outlook and Policies for 2007 Growth Performance The authorities’ macroeconomic policy framework for 2007 is consistent with the medium term goal of sustaining poverty reduction by ensuring broad-based economic growth of about 7 percent as stated in PARPA II. To ensure compliance with program objectives, the authorities will continue to monitor the program through reinforcing coordination between the Ministry of Finance and the Central Bank. Information on the impact of large projects and public enterprises will be continuously monitored while the pricing mechanism for all petroleum products will be implemented automatically and transparently. Associated with this favorable economic condition, inflation is projected to remain at single digit levels. Fiscal Policy The Government is committed to continue to implement measures to enhance and strengthen domestic revenue mobilization and ensure transparency in budget execution, taking into account, priority expenditures defined in PARPA II. Revenues are projected to reach 14.9percent of GDP in 2007, an increase over 2006. The budget for 2007 envisages a scalingup of aid and thus increased expenditure on priority areas. There is no recourse to domestic financing of the budget. Revenue enhancing measures relate to the increase in the number of taxpayers, elimination of unwarranted tax exemptions, collection of tax arrears, updating the specific fuel tax, and ensuring efficiency in the customs area. The government is strongly committed to the establishment of the ATM, given that all prior actions have been completed. These are expected to gradually evolve into an autonomous institution to ensure operational efficiency. The authorities are aware of the importance of facilitating prudent public financial management (PFM) and have agreed on a detailed action plan and budget (APB) with donors for the period 2006-2009. The APB includes, rollout of budget execution module to all central and provincial entities; transformation to Phase II of the budget formulation module; and developing new module functionalities. Other aspects of the PFM reform include payroll and pensions functionalities; ways of addressing PFM in the context of decentralization; inclusion of donor-financed projects within the Treasury Single Account (CUT); and implementing the asset management system and procurement interface to e-SISTAFE. Monetary Policy Monetary policy will continue to target base money to achieve the inflation target for 2007. The long term monetary policy strategy defines the intermediate target compatible with the base money operational target, and the Bank of Mozambique (BM) will continue to improve liquidity management. To strengthen the balance sheet of the Central Bank, the government is committed to issuing the last tranche of 1.5 billion MTn by end-June 2007. In view of this, the Ministry of Finance will facilitate improvements on preparation of cash-flow projections and ensure prompt communication to BM. To enhance the payment system, BM intends to open five provincial agencies, starting at the end of 2006. The BM will continue to modernize its supervisory functions and will also start to implement a timetable for adopting IFRS in the banking system. In addition, new regulations on the assessment, classification and provisioning of credit, including regulation on integral risk management for credit institutions and finance companies, will become effective in 2007. The BM will continue to license and supervise microfinance deposit-taking institutions to facilitate access to finance by SMEs and rural households. The authorities will also in coordination with the industry regulatory body, enhance regulatory and supervisory framework for pensions within the insurance sector,. Regarding reforms in the foreign exchange system, a new foreign exchange law that will include comments from all stakeholders will be submitted to the Parliament by end-March 2007. Upon approval of the law and its related regulations, the authorities intend to accept obligations under Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement. Structural Reforms The authorities are aware of the structural challenges facing the economy and the requirements for an action-oriented approach that would include high level of commitment and leadership in pursuing the reform agenda. The government in collaboration with the World Bank, will develop a strategic action plan by end-March 2007 that will outline issues of simplification of processes to start up a business, expanding the computerization of the registry process in all provinces, adoption of inspections that are business friendly, including the cost of closing a business. The authorities are conscious of the importance of FDI. In this regard, the government is applying international best practices in tax structure and transparency in mining and other natural resources projects. A draft Mining Fiscal Regime law will be approved before end-2006, and the government will avoid signing any new Exploitation and Production Concession Contracts in the petroleum sector until a new and comprehensive package is put in place. The government is considering to adopt the Extractive Industries Transparency Initiative (EITI), and is already participating in seminars and workshops on the subject to guide the way forward. Improving governance remains a priority of the authorities, and progress achieved in Phase I of the public sector reform program (2001-2006) has resulted in the launching of Phase II for 2006-2010, based on three pillars relating to (i) human resources management including payroll systems; (ii) performance evaluation and wage policy; and (iii) decentralization and improving public service delivery. Another key activity is the completion of the census of civil servants and consequently the creation of a unique database to manage human resources within the public sector. The government is committed to conducting an economic analysis of urban land markets (formal and informal). Related to this subject, Cabinet has, in October 2006, approved a Decree on urban land use regulations. This decree, when submitted to Parliament, will be enacted into a policy for land use to reduce transactions costs. In addition to the above, the government will continue to make reforms in the judicial sector. The Cabinet is expected to approve by end December 2006 the Penal Procedure Code, which will then be submitted to Parliament. Two more legal packages will be analyzed by the Parliament in 2007, namely: the organic law of the judicial tribunals and a new insolvency law. Most of the reforms in this area are closely supported by international partners. Conclusion The prospects for the Mozambican economy remain favorable and the authorities have expressed strong commitments to implementing the reform agenda as spelled out within PARPA II. The authorities request the completion of the fifth review and the financing assurances under the PRGF. Finally, the authorities wish to thank the international community and the Fund for their continued support. They strongly commit themselves to ensure that the objectives and policies set forth under the PRGF are achieved.