Public Information Notice No. 03/148

Public Information Notice: IMF Concludes 2003 Article IV Consultation with the Republic of Mozambique

December 22, 2003

On December, 10, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Mozambique.¹

Background

Mozambique's performance under the authorities' program during the first three quarters of 2003 continued to be satisfactory. Manufacturing output, construction, and services performed strongly during the first half of 2003, and the target of real GDP growth of 7 percent for the year as a whole appears achievable. After peaking in May 2003 owing to the impact of drought on food prices and the appreciation of the South African rand against the metical, the 12-month rate of inflation declined to 13.6 percent in November (under the program, end-year inflation was targeted at 10.8 percent). Average commercial bank lending rates have declined from 37 percent to 30 percent since end-2002, with interest rate spreads remaining high at 19 percent.

The government's fiscal program for 2003 seeks to contain the domestic primary deficit at 3.7 percent of GDP, with tax revenue strengthening as a result of the implementation of the new code for the personal and corporate income taxes approved in 2002, the full-year effect of a new and more transparent fiscal incentives code, and a significant increase in the specific taxes on domestic petroleum products implemented in May 2003. Available information for the period through September 2003 indicates that the government's deficit was lower than programmed, reflecting a lower level of locally financed capital outlays owing to delays in project execution associated in part with shortfalls in external assistance.

External developments during the first half of 2003 continued to be influenced by exogenous shocks and large scale foreign investment projects. For the year as a whole, the external current account deficit after grants is expected to widen to 15 percent of GDP (12 percent in 2002), reflecting an increase in investment in the mega projects during the second half of the year.

The consultation discussions focused on the macroeconomic policies for 2004-06 and the government's plans to address pending structural reforms to broaden and sustain growth and further reduce poverty. Real GDP growth is projected to increase to over 8 percent in 2004 largely because of the coming on stream of MOZAL II (the expansion of the aluminum smelter) and the gas pipeline, and end-year inflation is targeted to fall to 9 percent. The government's domestic primary deficit is projected to decline to 3.4 percent of GDP in 2004, owing to a further strengthening of revenue and steps to start addressing the significant increase in the government's wage bill that has taken place in recent years. The overall deficit after grants, however, would be somewhat higher than in 2003.

Discussions on structural issues concentrated on the authorities' plans to remove a number of obstacles to private sector development. Particular attention was paid to (i) reducing red tape and simplifying the regulatory framework; (ii) addressing labor rigidities that hinder competitiveness; (iii) improving basic infrastructure; (iv) reforming the judicial system; and (v) moving ahead with reforms to increase efficiency in the public sector. In addition, the staff discussed with the authorities several recommendations to address remaining vulnerabilities in the financial system made by a joint team from the Fund and the World Bank in the context of the Financial Sector Assessment program (FSAP).

Executive Board Assessment

Executive Directors welcomed the opportunity to review, under the new guidelines on assessments of countries with a longer-term program engagement, the experience with the four Fund-supported programs since 1987. Directors commended the Mozambican authorities for their pursuit of sound macroeconomic policies and wide-ranging structural reforms over the past fifteen years. The authorities' efforts have led to the strong growth of the economy, a strengthening of the international reserves position, substantial debt relief, and a steady decline in poverty rates in a context of political stability. Notwithstanding the considerable progress that has been made, Mozambique remains a very poor country with significant weaknesses and vulnerabilities, including institutional capacity constraints and the negative impact of HIV/AIDS. Directors therefore urged the authorities to persevere in their efforts to consolidate macroeconomic stability and accelerate and deepen structural reforms with a view to sustaining economic growth, encouraging employment creation, and further reducing poverty.

Directors commended the authorities for the satisfactory implementation of their economic program, which was manifested in Mozambique's continued favorable economic performance during 2002 and 2003. Output growth has remained strong, the international reserves position has been strengthened, and significant progress has been made in implementing structural reforms, including by taking important steps to mobilize additional revenue. Directors also noted the advances made toward achieving Mozambique's poverty reduction strategy (PARPA) objectives, especially in the areas of health and education. In particular, they were encouraged by the preliminary information from the recent National Household Survey that the proportion of the population living below the poverty line in 2002 fell below the PARPA's 2005 target of 60 percent.

Directors welcomed the government's economic program for 2004, which seeks to maintain macroeconomic stability and addresses an important agenda of unfinished reforms. They emphasized that achieving the program's fiscal targets will require a further strengthening of government revenue and a close monitoring of current expenditure. Crucial specific steps in this regard will be improvements in tax administration, early introduction of an automatic mechanism of adjustment for the specific fuel taxes, and prompt implementation of the withholding of the income tax on the salaries of government employees. Directors also underscored the importance of limiting the wage increase for government employees to projected inflation and exercising strict control over the payroll in order to contain the recent sizable increases in the wage bill. Key priorities going forward will be to evaluate and address the challenges posed by HIV/AIDS while making progress toward the achievement of the Millennium Development Goals. Directors welcomed the authorities' intention to integrate the monitoring of the PARPA and the budget execution into a single document, which could be the basis for the next review of the PRSP in early 2004.

Directors urged the authorities to press ahead with ongoing efforts to improve public expenditure management and fiscal transparency by adhering to the revised timetable for introducing the new financial management system (SISTAFE) and by bringing all extrabudgetary activities within the budget framework, especially in view of the likely expenditure pressures associated with next year's elections. They encouraged the authorities to move forward vigorously on public sector reform, with the support of the World Bank, including by reducing employment redundancies in some sectors.

Directors called on the authorities to closely monitor monetary developments, particularly in light of the resurgence of inflation in 2003 and the volatility of broad money growth. The authorities should tighten liquidity conditions as needed, and limit interventions in the foreign exchange market to cushioning the impact of temporary shocks and achieving the program's reserves targets.

Directors called on the authorities to implement promptly the recommendations resulting from the FSAP exercise. Strengthened monetary and exchange rate management will be essential in Mozambique, particularly in view of the high degree of dollarization. This will include steps to enhance the consistency between the central bank's sales of foreign exchange and the pace of expenditure financed with external support, to improve the use of indirect monetary instruments, to better coordinate the actions of the central bank and the Ministry of Finance, and to strengthen the balance sheet of the central bank. Directors welcomed the comprehensive program of technical assistance being developed by Fund and World Bank staff, in close coordination with the authorities, to support the implementation of the FSAP recommendations.

Directors emphasized that the authorities should give priority to addressing the remaining vulnerabilities in the financial sector. They urged the authorities to monitor developments in the financial system very closely and to strengthen bank supervision in line with internationally-accepted practices. In addition, the diagnostic reviews of the main banks will help identify appropriate remedial actions and enable a gradual move toward international accounting standards (IAS). It will be important to lower the wide bank spreads and expand access to credit by fostering competition in the financial system, improving loan recovery procedures, and reviewing land tenure regulations to facilitate the use of land as collateral. In addition, the regulatory framework for microfinance activities should be reviewed to facilitate access to financial services by the poor.

Directors stressed the need to broaden growth and stimulate employment in the manufacturing, services, and rural family sectors by enhancing human capital and removing obstacles to private sector development. They encouraged the authorities to reduce red tape; improve basic infrastructure; reduce labor rigidities by simplifying procedures for hiring expatriates and lowering retrenchment costs; and press ahead with the reform of the judicial system to speed up the administration of justice and strengthen the enforcement of contracts. Directors called for the prompt approval of the regulations for the anti-money laundering law passed in 2002, and for the development of legislation on the combating of the financing of terrorism. Several Directors underscored the importance of improving market access for Mozambique's exports.

Directors encouraged the authorities to redouble their efforts to complete the bilateral agreements with remaining Paris Club creditors, and they urged the non-Paris club creditors who have not yet done so to provide debt relief on HIPC Initiative-comparable terms.

Directors welcomed Mozambique's participation in the Fund's General Data Dissemination System. They underscored the need for a determined effort to address remaining weaknesses in the statistical system, based on the recommendations made in the context of the recent data Reports on the Observance of Standards and Codes exercise.

Looking forward, most Directors expressed readiness to consider a successor low-access PRGF arrangement based on a strong program, which would help the authorities address the remaining challenges. A few other Directors encouraged consideration of other possible forms of engagement outside of a formal Fund arrangement.