Republic of Mozambique and the IMF
Press Release: IMF Completes Review Under Mozambique's PRGF Arrangement and Approves US$11.84 Million Disbursement
June 23, 2003
Free Email Notification
Mozambique, Republic of—Letter
of Intent and
Memorandum of Economic and Financial Policies
Mr. Horst Köhler
The Executive Board of the IMF approved a three-year arrangement for Mozambique under the Poverty Reduction and Growth Facility (PRGF) on June 28, 1999. At the time of the fourth review, which was completed on June 17, 2002, this arrangement was extended for a period of 12 months, providing more time for the implementation of the government's reform agenda. In the attached memorandum, the Government of Mozambique describes progress in implementing its program and lays out its policy intentions through the end of the current arrangement. The government has also prepared a Progress Report on the implementation of the National Action Plan for the Reduction of Absolute Poverty (PARPA), which has been submitted to the Executive Boards of the IMF and the World Bank.
As indicated in paragraph 7 of the memorandum, all structural performance criteria under the program have been observed. However, the end-June 2002 quantitative performance criterion on the primary deficit was exceeded by a small margin because of a shortfall in revenues. Domestic primary expenditures were contained below the program projection during the second half of the year, and the end-December 2002 indicative target for the domestic primary deficit was observed. Steps have also been taken to address vulnerabilities in the banking system, a major factor behind the delay in completing this review.
The government of Mozambique believes that the policies and measures set out in the attached memorandum are adequate to achieve the objectives of its program, and will take any further measures that may become appropriate for this purpose. On this basis, the government requests (i) a waiver in respect of the non-observance of the quantitative performance criterion on the domestic primary deficit, (ii) the completion of the fifth review, and (iii) the disbursement of the sixth loan under the arrangement. The government understands that the current extended PRGF arrangement will expire before it is able to request disbursement of the seventh loan.
After the expiration of the current arrangement, Mozambique will continue to consult with the Managing Director on the adoption of any measures that may be appropriate, at the initiative of the government or whenever the Managing Director requests such a consultation. Moreover, after the period of the PRGF arrangement and while Mozambique has outstanding financial obligations to the Fund arising from loans under the arrangement, the government will consult with the Fund from time to time at the initiative of the government, or whenever the Managing Director requests consultation on Mozambique's economic and financial policies. The government of Mozambique will provide such information as the Fund requests in connection with the progress made in implementing the economic and financial policies and achieving the objectives of the program.
Memorandum of Economic and Financial Policies of the Government of Mozambique for the Period through December 2003
I. Recent Developments and Program Implementation
1. Macroeconomic developments under the program supported by the PRGF arrangement have been favorable, with real GDP growth estimated at 7.7 percent in 2002. Construction activity associated with large-scale foreign investment projects has been very strong, while agricultural output growth is estimated at 8 ½ percent in 2002 owing to a continued recovery in food crops from the effects of the 2000 floods and important increases in some cash crops, particularly sugar. At the same time, the 12-month rate of inflation declined from 21.9 percent at end-2001 to 9.1 percent at end-2002. Following a sharp decline in inflation through October 2002, prices have risen at a faster pace in recent months largely because of the effects of drought and floods on some agricultural products, the increase in oil import prices in the last quarter of 2002 and early 2003, and the recent strengthening of the South African rand. As a result, the 12-month rate of inflation rose to 14.7 percent in April 2003.
2. Although revenue collections relative to GDP were higher than programmed in 2002, total revenue in nominal terms turned out lower than the program's indicative target. Income tax revenue performed strongly, but the collection of import taxes and excises failed to meet expectations, with petroleum taxes accounting for about half of the revenue shortfall. Since domestic primary spending in nominal terms was lower than programmed, the end-December indicative target for the domestic primary deficit (excluding bank restructuring costs) was observed. Relative to GDP, the deficit was equivalent to 3.6 percent, compared with 3.4 percent in the program, because of a lower than projected GDP. The end-June 2002 performance criterion on the domestic primary deficit, however, was exceeded by a small margin.
3. The government's domestic financing needs amounted to Mt 800 billion (0.9 percent of GDP) in 2002 due to the issuance of government bonds to complete the recapitalization of Banco Austral, in line with the terms of its sale to Amalgamated Banks of South Africa (ABSA) in 2000. Excluding these bonds, net domestic borrowing turned out negative in 2002, as external budget support (net of debt service payments) exceeded the amount envisaged in the program.
4. A total of Mt 133 billion corresponding to the recovery of non-performing loans from Banco Austral (BA) was transferred to the government during 2002. These resources were used for the retirement of bonds issued to recapitalize BA. In addition, nonperforming loans that are fully provided for and considered unrecoverable by BA have been transferred to the government for a nominal sum of one metical, and the government has begun to pursue the collection of these loans using special powers (execução fiscal) where necessary. Since the last quarter of 2002, the government has been reporting on its debt collection efforts in the quarterly budget execution reports.
5. Spending on PARPA priorities accounted for 18.4 percent of GDP and almost 65 percent of noninterest current and capital spending in 2002, compared with 66 percent in 2001. Within this total, expenditures on education and health were equivalent to 4.9 and 3.8 percent of GDP, respectively, while other priority spending, including rural development, governance, justice and security, accounted for 9.7 percent of GDP.
6. Monetary policy was tightened in line with the program during 2002, which contributed to the improved inflation performance. The end-June 2002 performance criteria for the net domestic assets of the central bank and net international reserves and the indicative target for reserve money were observed, as well as all the indicative targets for these variables for end-September and end-December 2002. A slowdown in the growth of broad money to 20 percent during 2002, from 30 percent in 2001, contributed to a greater stability of the metical, which depreciated by only 2.3 percent against the US dollar during 2002, compared with 36 percent the previous year. Placements of Treasury bills led to a marked increase in interest rates through August 2002, which was accompanied by a significant decline in credit growth to the private sector. Monetary conditions have eased somewhat subsequently, as interest rates on central bank instruments have been lowered gradually.
7. Further progress was made in 2002 in implementing reforms in the areas of tax policy and public expenditure management, and in strengthening banking supervision (Table 2). The program's two structural performance criteria were observed with the introduction in June 2002 of a new fiscal incentives code that establishes standard concessions for foreign investors, including transparent rules for investors in large projects, and the approval in July of the codes for new corporate and personal income taxes that were introduced in 2003. Structural benchmarks covering other tax policy measures were also met, including the introduction of regulations eliminating the stamp tax on transactions subject to the VAT and the approval of regulations for a new vehicle tax. Moreover, key steps were taken towards implementing a new system of public expenditure management (SISTAFE) with the publication of a decree establishing regulations under the Financial Management Law and the contracting of local and foreign experts to develop supporting software systems. In line with the program's other two benchmarks, a standardized and comprehensive reporting format was adopted in June for all inspections conducted by the Department of Banking Supervision (DBS), and quarterly reports in this format are being prepared for all the institutions supervised by the Bank of Mozambique (BM).
II. Program for the Remainder of 2003
A. Implementation of the PARPA
8. The policies set out in this memorandum are in line with the poverty reduction strategy presented in the 2001 PARPA and the first progress report on its implementation, which was completed by the government in February 2003. In particular, the government will seek to achieve the PARPA targets and outcomes for 2003, ensuring that the budgetary allocations and other policy interventions reflect these priorities. The attainment of high and sustainable growth through the creation of an enabling environment for the private sector, supported by the maintenance of macroeconomic stability, remains central to this strategy.
B. The Macroeconomic Framework
9. With a moderation in the pace of agricultural growth, the government's economic program for 2003 assumes a real GDP growth of about 7 percent. Following the recent impact on prices of exogenous shocks and the strengthening of the rand, policies will be geared at lowering the 12-month rate of inflation to below 11 percent in December 2003, from 14.7 percent in April 2003. Net international reserves are targeted to increase by US$45 million during 2003, to US$683 million by year's end (about 5 months of imports of goods and services), a level considered prudent in light of the uncertain timing of external aid flows. Mozambique will continue to pursue a flexible exchange rate policy under the program, and the sales of foreign exchange by the BM will be managed in a manner consistent with sterilizing the monetary expansion that would otherwise result from externally financed government expenditure.
Fiscal Policy, Tax Reform, and Public Expenditure Management
10. Fiscal policy in 2003 will continue to support macroeconomic stability and the objective of reducing aid dependence over the medium term. The government's fiscal program envisages a further increase in tax revenue relative to GDP, a slight increase in the domestic primary deficit, and a decline in the net indebtedness of the government with the banking system. At the same time, with no further outlays for bank recapitalization- other than debt service on bonds already issued for this purpose—and lower external assistance, total government spending and the overall fiscal deficit after grants would both decline to 28.7 percent of GDP and 3.9 percent of GDP, respectively, in 2003.
11. Total revenue is projected at 14.3 percent of GDP in 2003. Tax receipts are expected to rise by 0.7 percentage point of GDP, with most of this increase accounted for by the new income tax introduced this year, while nontax revenue would fall owing to lower receipts from privatization and an expected decline in the recovery of nonperforming loans from Banco Austral relative to the high levels achieved in 2002. Within tax revenue, the taxation of civil servants' incomes through withholding is expected to yield 0.3 percent of GDP. In addition, the government is confident that the smaller deductions envisaged in the new tax law will more than compensate for any loss arising from the decision to reduce the rate of the corporate tax from 35 to 32 percent. In any event, corporate tax collections have been projected conservatively, recognizing that a drop in administrative efficiency may occur while the tax service becomes fully familiar with the new simplified system. Further administrative gains are also expected in VAT collections because of recent efforts to combat smuggling. These gains, however, will be partly offset by the impact on customs revenue of a reduction in the top import tariff rate from 30 percent to 25 percent. The government has taken all necessary steps to ensure that the new income tax law is fully applicable to incomes generated from January 1, 2003. All the required legal and regulatory procedures have been established. With donor support, a publicity campaign is underway, tax officials have been trained, and the required computer systems will be put in place by August 2003.
12. Regarding excise taxes, in May the government increased by a weighted average of 62½ percent the specific taxes on petroleum products, in order to offset in part the erosion experienced by this tax because of inflation in recent years. This step will be followed in early 2004 by a further increase in these taxes and the adoption of an automatic mechanism of adjustment.
13. The fiscal program for 2003 envisages an increase in the nominal wage bill of 25.8 percent relative to 2002 owing to (i) an adjustment of 21 percent in the minimum wage effective April 1, 2003, which translates into an average wage increase of 17 percent for government employees; (ii) automatic promotions under the new career system; (iii) the hiring of 6,900 people in the PARPA priority areas of health, education, and security, which in line with current practices will be certified by the administrative tribunal; and (iv) full compensation of tax payments for those employees who became subject to the income tax this year. Because of the above, the wage bill is expected to rise to 7.6 percent of GDP in 2003, from 7.3 percent in 2002. The government intends to use the results of the annual proof of identity for all civil servants (prova de vida) to update the payroll and the personnel information system (SIP) database. The fiscal program also provides for an increase in spending on goods and services to 3.9 percent of GDP to meet the cost of opening new schools and health posts and the local elections scheduled for October 2003. Capital spending would fall by 1½ percentage points of GDP, to 12.7 percent of GDP, largely because of a decline in external project financing, while net lending would decline by 4 percentage points of GDP owing mainly to the completion of the bank restructuring program and lower assistance to public entities. The domestic primary deficit would be contained at 3.7 percent of GDP in 2003.
14. In 2003, spending on PARPA priorities would account for almost 68 percent of noninterest current and capital spending and would increase to 18.7 percent of GDP. Within this total, outlays on health and education are projected at 4.9 percent of GDP and 4.3 percent of GDP, respectively. The 2003 budget includes a contingency reserve of around Mt 350 billion (0.3 percent of GDP) to cover expenditure that may arise because of drought and floods.
15. Reforms are also continuing in tax administration. Key steps have been taken to ensure that the customs service operates effectively when the three-year program of management support from Crown Agents expires in mid-2003. Also, a General Director of Customs has been appointed and the remaining four key management positions have been filled. At the same time, other problems which had been an obstacle to the development of a well-motivated and fully staffed service have been addressed. In particular, 257 customs officials who were not meeting the minimum requirements for the new customs career stream were removed from the payroll in December 2002, and there is no longer a backlog of pending staff disciplinary cases. Improved procedures have been put in place to deal with disciplinary issues, including the appointment of an experienced lawyer to ensure expedited action in the future. At the same time, local staff have been assuming responsibilities previously met by international consultants, and additional technical assistance is being provided to the customs department in the areas of internal investigation and information technology.
16. The government is preparing for the establishment of a central revenue authority (Autoridade Tributária de Moçambique) (ATM) that will comprise the Domestic Tax Administration Directorate (DNIA) and the General Directorate of Customs (DGA). Initial work has focused on defining the scope of the ATM, its degree of legal autonomy, the relationship with the Ministry of Planning and Finance (MPF), and its organizational structure. In addition, an action plan for the implementation of the ATM was approved by the MPF by end-May 2003. The plan addresses the crucial issue of the relationship between the reforms being undertaken by DNIA and the DGA and the transition to the ATM. To support public confidence in the tax regime through a transparent system of tax appeals, before end-May 2003 the government will submit to the National Assembly an organic law for the tax tribunals. Moreover, before end-October 2003 the government will approve a new statute transforming the DNIA into a General Directorate.
17. The government gives high priority to implementing the new financial administration system (SISTAFE), which is expected to play an important role in improving transparency and efficiency in the management of public resources. In October 2002, the conceptual model for SISTAFE and the action plan for its implementation were finalized by the coordination unit (UTRAFE) and approved by the MPF. The action plan calls for the implementation of the SISTAFE in 2003 in the Ministries of Planning and Finance (MPF) and Education, and for its extension to all ministries, including their provincial branches and all districts and municipalities, by end-2004. To facilitate an effective coordination of all external support for the implementation of the plan, a memorandum of understanding has been agreed with donors, specifying their role and the rules and modalities of their support. Based on these rules, UTRAFE has hired international consultants to strengthen the unit's implementation capacity in key areas and to define the technical requirements of the computer system. In this connection, the procurement process for the prototype of the computer system was initiated in late April 2003, and the tender process for the pilot project will begin by end-June 2003. Implementation of this pilot project in the MPF and the Ministry of Education will start by end-October 2003. In preparation for the implementation of the SISTAFE, the government has begun to request quarterly information on the execution of all donor-financed projects. The last quarterly budget execution report for 2002 already includes information on these projects.
Monetary Policy and the Financial Sector
18. Monetary policy will be aimed at reducing the 12-month rate of inflation to below 11 percent in December 2003. In line with this objective, the BM will seek to contain the growth of broad money at 18 ½ percent during the year. Reflecting the impact of relatively high interest rates and the restructuring of the two largest banks, the growth of credit to the private sector slowed during 2002. The monetary program for 2003 envisages an increase of 15 percent in credit to the private sector. The central bank will monitor price developments closely and will be ready to adjust the interest rates on its instruments as needed to achieve the program's inflation objective.
19. In line with recommendations made by a recent Fund-World Bank mission that conducted an evaluation of the financial system under the Financial Sector Assessment Program (FSAP), the Bank of Mozambique (BM) intends to improve liquidity management. To that end, in the second half of 2003 technical assistance needs will be identified and steps will be taken to streamline traded monetary instruments and develop a core inflation index. Moreover, the accounting standards used to compute the net profits of the central bank will be reviewed.
20. Important steps will be taken during 2003 to strengthen the health of the banking system. In this regard, the progress made by the Banco Internacional de Moçambique (BIM) to improve its financial position and increase its operational efficiency will be monitored closely. Moreover, the government remains committed to implementing International Accounting Standards (IAS) for banking institutions, a complex process that will be carried out gradually and will require substantial technical assistance. To manage this process, by end-July 2003 the BM will identify training requirements for its staff and will assess the next steps to implement IAS, including the establishment of a steering committee with representation from the BM, audit firms, and the commercial banks, in line with recommendations made by the FSAP mission.
21. To assess the possible impact of the move toward IAS on the financial sector, the four largest banks of the system will be subjected to diagnostic reviews that will be undertaken by reputable international accounting firms in accordance with international audit standards, including on confidentiality. For this purpose, terms of reference are being prepared in consultation with Fund and World Bank staff, and donor funding for the reviews is being sought. Once the auditing firms are selected, the reviews are expected to be completed within the following three to four months.
22. The reviews will indicate the impact of implementing IAS on the entire balance sheets (as well as off-balance sheet items) of the four banks, and should provide information regarding the adequacy of each bank's reserves, provisions, and capital position under IAS. Additional tasks of the diagnostic reviews will include (i) the identification of changes to laws, regulations, and the current Mozambican Chart of Accounts that would be required to enable IAS implementation; (ii) an assessment of training needs and other costs for the DBS to allow effective supervision of banks operating under IAS; and (iii) the provision of recommendations regarding the timetable for implementing IAS in the banking sector.
23. As a parallel process to the convergence to IAS, the government is also committed to complying with the Basel Core Principles on Effective Supervision (BCP). In this regard, based on an assessment prepared by the FSAP mission and the information to be provided by the diagnostic reviews referred to above, within two months after the completion of the diagnostic reviews the DBS will develop a timetable for implementing loan-loss provisioning standards consistent with accepted international practices. Moreover, before end-October 2003 the BM will issue instructions to financial institutions detailing the practical steps for consolidated supervision, in view of ongoing efforts to introduce supervision on a consolidated basis. In addition, the BM will start negotiations to sign protocols for cooperation with the supervisory authorities of Portugal and South Africa. The FSAP identified several areas where technical support is required in order to strengthen the DBS. The BM will work closely with Fund and World Bank staff to identify priorities for technical assistance and will seek donor support for this purpose.
24. In addition to the above, the BM will continue with other efforts to strengthen supervision. On-site inspections of each bank will be conducted at least once every 12 months, and the newly required bank quarterly reports will be used to follow-up on the implementation of actions identified in the context of on- and off-site inspections. Moreover, the DBS will apply existing procedures to ensure that those institutions that have not yet submitted plans for unwinding connected lending do so without further delay.
25. A new Financial Institutions Law was submitted to Parliament in March 2003, which gives the BM sole responsibility for issuing and revoking licenses for financial institutions; provides for automatic application of most penalties for non-compliance with prudential regulations; and makes managers of financial institutions personally liable for gross violations of banking regulations.
External Sector Issues
26. Further efforts aimed at liberalizing the trade system have been made in recent months. Specifically, effective January 2003 the government reduced the top tariff rate from 30 percent to 25 percent. In addition, legislation to accept Article 7 of the GATT and move from the current Brussels system of valuation to the more uniform and transparent WTO system was approved by the Council of Ministers in 2002.
27. The government recognizes the crucial importance of timely debt-service payments in view of Mozambique having reached its enhanced HIPC Initiative completion point in September 2001 and agreement with the Paris Club creditors in November 2001. The government has already signed bilateral agreements with eight Paris Club creditors under the aegis of the Agreed Minute of November 2001, and has continued to seek agreement with four other Paris Club creditors as well as with non-Paris club creditors on comparable terms. To that end, the deadline for reaching bilateral agreements with the remaining Paris Club creditors has been extended to end-June 2003. An agreement on HIPC terms with India is expected to be signed in the near future, and efforts are being made to settle a dispute with one Paris Club creditor regarding a small amount of debt service payments. Moreover, commercial creditors have been offered alternatives for debt resolution, including debt buy-back and conversion options.
28. The government has decided to strengthen its debt management capacity to ensure debt sustainability. As a first step, the existing database for public debt was fully updated in March 2003. Technical assistance is being provided by Debt Relief International and other donors, and a debt strategy workshop will be held during the third quarter of 2003.
29. During the period of the PRGF-supported program, the government will not impose or intensify restrictions on payments and transfers for current international transactions; will not introduce multiple currency practices; and will not impose or intensify import restrictions for balance of payments reasons. Furthermore, the government will not incur any external payments arrears (continuous performance criterion). In this connection, delays in payments related to cases where debt-restructuring agreements are still pending notwithstanding good faith efforts by the government will not be considered arrears.
C. Other Structural Reforms, Governance, and Statistical Information
30. Progress has also been made towards the reform of the legal and judicial system. In particular, the strategic plan for the entire system and the operational program for reforming its four branches (Ministry of Justice, the Supreme Court, the Administrative Court, and the Attorney-General) have been completed and are being discussed with World Bank staff. Moreover, an inter-ministerial legal reform commission (CIREL) was created in August 2002 to oversee the reform process. The government recognizes that the reform of the sector will be a lengthy process, and is therefore focusing on some immediate actions that would yield quick results. Priority areas include a selective revision of the civil process law, a strengthening of the capacity of the notary registries, and the establishment of a judicial inspection unit to improve the quality of judicial services.
31. The government has decided to accelerate plans for public sector reform, focusing on decentralizing government activities, addressing corruption, and improving the effectiveness of the civil service through training and salary reforms. By August 2003, all ministries are expected to complete a mapping of current operations and an identification of those areas that should be restructured. Restructuring plans are being integrated under a central policy unit in charge of the reform and it is expected that key ministries, including some related to PARPA priority areas, will begin the restructuring process during the remainder of 2003. Salary reform will be introduced in each ministry after an assessment of staffing needs.
32. In recent months some technical problems in updating the computer system have led to delays in the provision of relevant macroeconomic information. The government is fully committed to addressing these problems and to regularizing the flow of information as soon as possible to permit a timely assessment of developments under the program. In this regard, starting in May 2003 the government will resume publication and will provide Fund staff with the budget execution report corresponding to the preceding quarter, with a lag not exceeding 45 days. Moreover, the data corresponding to monthly government revenues (in detail according to the fiscal table) will be provided to Fund staff with a lag not exceeding one month, starting in April 2003. In addition, the government has begun work to broaden the coverage of debt statistics to include the non-guaranteed debt of the domestic private sector.
D. Program Monitoring
33. The indicative targets and structural benchmarks that will be used to evaluate the implementation of the program are shown in Tables 1 and 3 of this memorandum. In addition, the government has specified in Table 4 a list of structural measures to be taken during the second half of 2003. As in the past, the program's floor on net international reserves (NIR) and the ceiling on net domestic assets (NDA) will be adjusted for higher or lower disbursements of external budget support than envisaged in the program. In addition, a similar adjustor has been included for external debt-service payments. A number of prior actions drawn from this memorandum are shown in Table 3. The government understands that its ability to request disbursement of the sixth loan under the extended PRGF arrangement will be contingent upon the observance of these actions and continued non-incurrence of external payments arrears.
Table 3. Prior Actions and Structural Benchmarks
Table 4. Structural Measures Envisaged by the Authorities for the Second Half of 2003
Initiation of tender process for the pilot SISTAFE to be implemented in the MPF and Ministry of Education End-June 2003 Install computerized system for the registration of personal and corporate income tax payments August 2003 Develop a timetable for implementing loan-loss provisioning standards consistent with accepted international practices. Within two months of completion of the banks' reviews Approval by the Council of Ministers of a new statute transforming the DNIA into a General Directorate as part of the integration of current reforms and the transition to the CRA October 2003 Issuance of instructions to financial institutions detailing the practical steps for consolidated supervision October 2003 Implement the pilot SISTAFE in the MPF and Ministry of Education December 2003
Initiation of tender process for the pilot SISTAFE to be implemented in the MPF and Ministry of Education
Install computerized system for the registration of personal and corporate income tax payments
Develop a timetable for implementing loan-loss provisioning standards consistent with accepted international practices.
Within two months of completion of the banks' reviews
Approval by the Council of Ministers of a new statute transforming the DNIA into a General Directorate as part of the integration of current reforms and the transition to the CRA
Issuance of instructions to financial institutions detailing the practical steps for consolidated supervision
Implement the pilot SISTAFE in the MPF and Ministry of Education