## _wp09165

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---

### I. Introduction
- Purpose: assess external price competitiveness for Mozambique using indicators and an exchange rate assessment based on the macroeconomic balance (MB), equilibrium real exchange rate (ERER), and external sustainability (ES) approaches, extending methods from Lee et al (2008) to developing economies.
- Context:
  - The metical has appreciated substantially in nominal and real effective terms during recent months, potentially reducing Mozambique's external price competitiveness and affecting economic development.
  - Traditional exports (excluding megaprojects) are small and poorly diversified—concentrated in tobacco, sugar, cotton, prawns and cashews—and are weather sensitive and prone to terms of trade shocks.
- Policy framing: restoring external price competitiveness requires both exchange rate/monetary policy adjustment and structural measures: raising labor market flexibility and reducing transportation costs.

### II. Indicators of External Price Competitiveness
- Principal indicators: real effective exchange rate (REER) and terms of trade.
- Recent movements (preserve exact numeric values):
  - REER appreciated by 24 percent during the year through March of 2009.
  - Nominal effective exchange rate appreciated by 23 percent over the same period.
  - Bilateral nominal movements during the year through February of 2009:
    - Metical appreciated by 22 percent in nominal terms against the euro.
    - Metical appreciated by 27 percent in nominal terms against the rand.
    - Metical appreciated by 1 percent in nominal terms against the dollar.
  - Real bilateral movements during the year through January of 2009:
    - Metical appreciated by 17 percent in real terms against the euro.
    - Metical appreciated by 37 percent in real terms against the rand.
    - Metical appreciated by 6 percent in real terms against the dollar.
- Terms of trade sensitivity and composition:
  - REER of Mozambique is more sensitive to variation in its terms of trade for goods than for services.
  - Principal commodity exports: aluminum, bulk electricity, natural gas, tobacco, sugar, cotton, prawns, cashews.
  - Principal commodity imports: machinery and equipment, vehicles, fuel, chemicals, metal products, foodstuffs, textiles.
- Cyclical comovement:
  - Trade deficit tends to increase when the metical has appreciated in real effective terms, raising the current account deficit.
  - This comovement is strengthened when abstracting from megaprojects (aluminum, bulk electricity and natural gas), which accounted for 76 percent of exports and 22 percent of imports in 2007.

### III. Exchange Rate Assessment — Methodology and Estimation Results

- Data and estimation commonalities:
  - Panel data: annual observations for 182 economies, 1973 through 2008 (unbalanced panel); projections 2009 through 2014 for comparative purposes.
  - Estimation method: generalized method of moments with lagged instruments.
  - Medium run parameters: semi-elasticity of the ratio of the current account balance to output with respect to the REER of -0.155; medium run equilibrium nominal output growth rate of 11.2 percent. All estimates based on five year projections and expressed in percent.

A. Purchasing Power Parity (long run)
- Panel unit root tests (Levin, Lin and Chu (2002); Im, Pesaran and Shin (2003)) decisively support stationarity of the logarithm of the REER.
- Long run PPP application indicates the metical is overvalued by 256 percent in real effective terms.

B. The Macroeconomic Balance (MB) Approach
- Framework: panel regression modeling the ratio of the current account balance to output with explanatory variables (including aid and remittance inflows for emerging and developing economies).
- Estimation snippet (restricted specification) — preserve numeric values exactly:
  - Relative old age dependency: -0.136***
  - Relative income: 0.012***
  - Relative income growth: -0.513***
  - Oil trade balance: 0.346***
  - Relative fiscal balance: 0.220***
  - Initial net foreign assets: 0.047***
  - Aid inflows: 0.141**
  - Observations: 1,326
  - R Squared: 0.390
- Application to Mozambique — exact estimates:
  - Estimated current account norm: -3.8 percent of output.
  - Underlying current account balance estimate: -7.8 percent of output.
  - Implied REER overvaluation: 26 percent in real effective terms.
- Drivers noted:
  - Important contributors to current account norm: relatively low old age dependency and high aid inflows (positive); relatively low income, relatively high income growth, high oil trade deficit, high net foreign debt (negative).

C. The Equilibrium Real Exchange Rate (ERER) Approach
- Framework: panel regression modeling the logarithm of the REER with explanatory variables including terms of trade, relative productivity, relative government consumption, net foreign assets, aid and remittance inflows.
- Estimation snippet (restricted specification) — preserve numeric values exactly:
  - Terms of trade for goods: 0.146***
  - Relative productivity: 0.392***
  - Relative government consumption: 1.524***
  - Observations: 1,607
  - R Squared: 0.526
- Application to Mozambique — exact estimates:
  - Implied REER overvaluation: 41 percent in real effective terms.
  - High terms of trade for goods is an important positive contributor; relatively low government consumption is an important negative contributor.
  - Contribution of relative productivity restricted to zero (variable not observed).

D. The External Sustainability (ES) Approach
- Framework: panel regression modeling the ratio of the net foreign asset (NFA) position to output; current account norm derived to stabilize NFA/GDP around estimated medium run equilibrium.
- Estimation snippet (restricted specification) — preserve numeric values exactly:
  - Relative old age dependency: 1.376***
  - Government net debt: -0.247***
  - Observations: 1,012
  - R Squared: 0.849
- Application to Mozambique — exact estimates:
  - Estimated NFA/GDP norm: -18.4 percent of output.
  - Implied current account norm: -1.9 percent of output.
  - Underlying current account balance estimate: -7.8 percent of output.
  - Implied REER overvaluation: 38 percent in real effective terms.
  - Relatively low old age dependency is an important negative contributor; government net debt contribution restricted to zero (variable not observed).

E. Summary of Exchange Rate Assessment Results — exact overvaluation estimates
- Macroeconomic Balance (MB): 26 percent (REER)
- Equilibrium Real Exchange Rate (ERER): 41 percent (REER)
- External Sustainability (ES): 38 percent (REER)

- Table 4 summary notes (preserve numeric entries exactly):
  - MB: CAB/GDP norm -3.8; CAB/GDP underlying -7.8; REER overvaluation 25.6 (percent)
  - ERER: REER overvaluation 40.8 (percent)
  - ES: NFA/GDP -18.4; CAB/GDP norm -1.9; CAB/GDP underlying -7.8; REER overvaluation 38.4 (percent)

### IV. Policy Recommendations and Implications
- Economic impacts of substantial currency overvaluation:
  - Decreasing output relative to potential via reduced export demand and increased import demand.
  - Raising trade and current account deficits and draining official foreign exchange reserves.
  - Reducing potential output over the medium run by diverting resources away from comparative advantage industries as FDI declines.
  - Fostering continued aid dependence if high aid inflows drive REER appreciation that stifles development.
  - Exacerbating external instability and business cycle volatility when the export base is concentrated in megaprojects.
- Policy prescription (preserve recommended sequencing and conditions):
  - Adjust monetary policy to gradually restore external price competitiveness through nominal effective depreciation.
  - Favor a gradual adjustment because nominal depreciation is inflationary; pace should vary with projected inflationary pressure.
  - Low projected inflation offers an opportunity to restore competitiveness faster; the ongoing global economic crisis (reduced imported inflationary pressure) presents such an opportunity.
- Complementary structural measures:
  - Stimulate growth in the traditional export sector.
  - Raise labor market flexibility.
  - Reduce transportation costs.

### Appendix — Data and Methodology Notes (key data sources and variable definitions)
- Panel data coverage: annual observations for 182 economies, 1973 through 2008; projections 2009 through 2014; unbalanced panel.
- Mozambique data/projections sourced from the macroeconomic framework associated with the 2009 Article IV Consultation with the International Monetary Fund where possible.
- Other economies: April 2009 vintage of the World Economic Outlook database.
- Effective exchange rate data: Information Notice System database.
- Net foreign asset position data: International Investment Position database.
- Other data: World Development Indicators database.
- Variables in each approach (as specified):
  - MB dependent variable: ratio of current account balance to output; regressors include relative old age dependency, relative population growth, relative income (log PPP per capita), relative income growth, oil trade balance, relative fiscal balance, lagged NFA/GDP, official aid receipts/GDP, remittance receipts/GDP.
  - ERER dependent variable: log(REER, CPI-based); regressors include log(terms of trade for goods), log(terms of trade for services), log(output per worker, PPP, relative), relative government consumption, NFA/GDP, aid receipts/GDP, remittances/GDP.
  - ES dependent variable: NFA/GDP; regressors include relative old age dependency, log(income per capita PPP, relative), government net debt/GDP.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09165.pdf*

### 1. Estimation Results for the Macroeconomic Balance Approach......................................... 11

### 1. Estimation Results for the Macroeconomic Balance Approach

### Major themes
- Presentation of estimation results for the Macroeconomic Balance Approach.
- Relation to medium-run equilibrium values and current account balances (see Figures list).

### Content signposts (from source)
- Section appears on page 11.
- Related figure: "7. Current Account Balance versus Estimated Medium Run Equilibrium Value" (Figure 7).

### 2. Estimation Results for the Equilibrium Real Exchange Rate Approach

### Major themes
- Presentation of estimation results for the Equilibrium Real Exchange Rate Approach.
- Comparison between Real Effective Exchange Rate and estimated medium-run equilibrium values (see Figures list).

### Content signposts (from source)
- Section appears on page 13.
- Related figure: "8. Real Effective Exchange Rate versus Estimated Medium Run Equilibrium Value" (Figure 8).

### 3. Estimation Results for the External Sustainability Approach

### Major themes
- Presentation of estimation results for the External Sustainability Approach.
- Comparison of net foreign asset positions with estimated medium-run equilibrium values (see Figures list).

### Content signposts (from source)
- Section appears on page 15.
- Related figure: "9. Net Foreign Asset Position versus Estimated Medium Run Equilibrium Value" (Figure 9).

### 4. Summary of Exchange Rate Assessment Results

### Major themes
- Consolidated summary of the exchange rate assessment across approaches.

### Content signposts (from source)
- Section appears on page 17.

### Figures (listed in source)
- 1. Real Effective Exchange Rate versus Nominal Effective Exchange Rate
- 2. Nominal Effective Exchange Rate versus Nominal Bilateral Exchange Rates
- 3. Real Effective Exchange Rate versus Real Bilateral Exchange Rates
- 4. Real Effective Exchange Rate versus Terms of Trade
- 5. Real Effective Exchange Rate versus Trade and Current Account Balances
- 6. Real Effective Exchange Rate versus Estimated Long Run Equilibrium Value
- 7. Current Account Balance versus Estimated Medium Run Equilibrium Value
- 8. Real Effective Exchange Rate versus Estimated Medium Run Equilibrium Value
- 9. Net Foreign Asset Position versus Estimated Medium Run Equilibrium Value

### Appendix
- Appendix material beginning on page 18.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09165.pdf*

### References..............................................................................................................

### _wp09165 - References

### I. Introduction
- The metical has appreciated substantially in nominal and real effective terms during recent months, potentially reducing Mozambique's external price competitiveness and affecting economic development.
- This paper assesses external price competitiveness for Mozambique using indicators and an exchange rate assessment based on the macroeconomic balance (MB), equilibrium real exchange rate (ERER), and external sustainability (ES) approaches, extending methods from Lee et al (2008) to developing economies.
- Traditional exports (excluding megaprojects) are small and poorly diversified—concentrated in tobacco, sugar, cotton, prawns and cashews—and are weather sensitive and prone to terms of trade shocks.
- Restoring external price competitiveness requires both exchange rate/monetary policy adjustment and structural measures: raising labor market flexibility and reducing transportation costs.

### II. Indicators of External Price Competitiveness
- Principal indicators: real effective exchange rate (REER) and terms of trade.
- Recent movements:
  - REER appreciated by 24 percent during the year through March of 2009.
  - Nominal effective exchange rate appreciated by 23 percent over the same period.
- Bilateral nominal movements during the year through February of 2009:
  - Metical appreciated by 22 percent in nominal terms against the euro.
  - Metical appreciated by 27 percent in nominal terms against the rand.
  - Metical appreciated by 1 percent in nominal terms against the dollar.
- Real bilateral movements during the year through January of 2009:
  - Metical appreciated by 17 percent in real terms against the euro.
  - Metical appreciated by 37 percent in real terms against the rand.
  - Metical appreciated by 6 percent in real terms against the dollar.
- Terms of trade sensitivity:
  - REER of Mozambique is more sensitive to variation in its terms of trade for goods than for services.
  - Principal commodity exports: aluminum, bulk electricity, natural gas, tobacco, sugar, cotton, prawns, cashews.
  - Principal commodity imports: machinery and equipment, vehicles, fuel, chemicals, metal products, foodstuffs, textiles.
- Cyclical comovement:
  - Trade deficit tends to increase when the metical has appreciated in real effective terms, raising the current account deficit.
  - This comovement is strengthened when abstracting from megaprojects (aluminum, bulk electricity and natural gas), which accounted for 76 percent of exports and 22 percent of imports in 2007.

### III. Exchange Rate Assessment

A. Purchasing Power Parity (long run)
- Panel unit root tests (Levin, Lin and Chu (2002); Im, Pesaran and Shin (2003)) decisively support stationarity of the logarithm of the REER.
- Application indicates the metical is overvalued by 256 percent in real effective terms (long run PPP estimate).
- Persistent REER appreciation has caused a large divergence from estimated long run equilibrium.

B. The Macroeconomic Balance (MB) Approach
- Framework: panel regression modeling the ratio of the current account balance to output with explanatory variables (including aid and remittance inflows for emerging and developing economies).
- Data: 182 economies, period 1973 through 2008; estimated by generalized method of moments with lagged instruments.
- Restricted estimation highlights significant influences on current account balances in medium run equilibrium, including aid inflows for emerging and developing economies.
- Estimation results excerpt (restricted specification):
  - Relative old age dependency: -0.136***
  - Relative income: 0.012***
  - Relative income growth: -0.513***
  - Oil trade balance: 0.346***
  - Relative fiscal balance: 0.220***
  - Initial net foreign assets: 0.047***
  - Aid inflows: 0.141**
  - Observations: 1,326
  - R Squared: 0.390
- Application to Mozambique:
  - Estimated current account norm: -3.8 percent of output.
  - Underlying current account balance estimate: -7.8 percent of output.
  - Implied REER overvaluation: 26 percent in real effective terms.
  - Important contributors to current account norm: relatively low old age dependency and high aid inflows (positive); relatively low income, relatively high income growth, high oil trade deficit, high net foreign debt (negative).

C. The Equilibrium Real Exchange Rate (ERER) Approach
- Framework: panel regression modeling the logarithm of the REER with explanatory variables including terms of trade, relative productivity, relative government consumption, net foreign assets, aid and remittance inflows.
- Data and estimation: generalized method of moments, 182 economies, 1973–2008, lagged instruments.
- Restricted estimation indicates primary drivers in medium run: terms of trade for goods, relative productivity, relative government consumption.
- Estimation results excerpt (restricted specification):
  - Terms of trade for goods: 0.146***
  - Relative productivity: 0.392***
  - Relative government consumption: 1.524***
  - Observations: 1,607
  - R Squared: 0.526
- Application to Mozambique:
  - Implied REER overvaluation: 41 percent in real effective terms.
  - High terms of trade for goods is an important positive contributor; relatively low government consumption is an important negative contributor.
  - Contribution of relative productivity restricted to zero (variable not observed).

D. The External Sustainability (ES) Approach
- Framework: panel regression modeling the ratio of the net foreign asset (NFA) position to output; current account norm derived to stabilize NFA/GDP around estimated medium run equilibrium.
- Data and estimation: generalized method of moments, 182 economies, 1973–2008, lagged instruments.
- Restricted estimation results excerpt:
  - Relative old age dependency: 1.376***
  - Government net debt: -0.247***
  - Observations: 1,012
  - R Squared: 0.849
- Application to Mozambique:
  - Estimated NFA/GDP norm: -18.4 percent of output.
  - Implied current account norm: -1.9 percent of output.
  - Underlying current account balance estimate: -7.8 percent of output.
  - Implied REER overvaluation: 38 percent in real effective terms.
  - Relatively low old age dependency is an important negative contributor; government net debt contribution restricted to zero (variable not observed).

E. Summary of Exchange Rate Assessment Results
- A variety of indicators and assessment approaches indicate the metical is overvalued in real effective terms.
- Overvaluation estimates:
  - Macroeconomic Balance (MB): 26 percent (REER)
  - Equilibrium Real Exchange Rate (ERER): 41 percent (REER)
  - External Sustainability (ES): 38 percent (REER)
- Table 4 summary notes:
  - MB: CAB/GDP norm -3.8; CAB/GDP underlying -7.8; REER overvaluation 25.6 (percent)
  - ERER: REER overvaluation 40.8 (percent)
  - ES: NFA/GDP -18.4; CAB/GDP norm -1.9; CAB/GDP underlying -7.8; REER overvaluation 38.4 (percent)
- Note: Overvaluation estimates are based on a medium run semi-elasticity of the ratio of the current account balance to output with respect to the REER of -0.155, and a medium run equilibrium nominal output growth rate of 11.2 percent. All estimates are based on five year projections, and are expressed in percent.

### IV. Policy Recommendations
- Substantial currency overvaluation could significantly impede Mozambique's economic development by:
  - Decreasing output relative to potential via reduced export demand and increased import demand.
  - Raising trade and current account deficits and draining official foreign exchange reserves.
  - Reducing potential output over the medium run by diverting resources away from comparative advantage industries as FDI declines.
  - Fostering continued aid dependence if high aid inflows drive REER appreciation that stifles development.
  - Exacerbating external instability and business cycle volatility when the export base is concentrated in megaprojects.
- Policy prescription:
  - Adjust monetary policy to gradually restore external price competitiveness through nominal effective depreciation.
  - Favor a gradual adjustment because nominal depreciation is inflationary; pace should vary with projected inflationary pressure.
  - Low projected inflation offers an opportunity to restore competitiveness faster; the ongoing global economic crisis (reduced imported inflationary pressure) presents such an opportunity.
- Structural policy measures to complement monetary adjustment:
  - Stimulate growth in the traditional export sector.
  - Raise labor market flexibility.
  - Reduce transportation costs.

### Appendix (Data and Methodology Notes)
- Panel data: annual observations for 182 economies, 1973 through 2008, with projections 2009 through 2014; unbalanced panel.
- Sources:
  - Mozambique data/projections from the macroeconomic framework associated with the 2009 Article IV Consultation with the International Monetary Fund where possible.
  - Other economies from the April 2009 vintage of the World Economic Outlook database.
  - Effective exchange rate data: Information Notice System database.
  - Net foreign asset position data: International Investment Position database.
  - Other data: World Development Indicators database.
- Variables used in approaches:
  - MB dependent variable: ratio of current account balance to output; regressors include relative old age dependency, relative population growth, relative income (log PPP per capita), relative income growth, oil trade balance, relative fiscal balance, lagged NFA/GDP, official aid receipts/GDP, remittance receipts/GDP.
  - ERER dependent variable: log(REER, CPI-based); regressors include log(terms of trade for goods), log(terms of trade for services), log(output per worker, PPP, relative), relative government consumption, NFA/GDP, aid receipts/GDP, remittances/GDP.
  - ES dependent variable: NFA/GDP; regressors include relative old age dependency, log(income per capita PPP, relative), government net debt/GDP.

*Source: _wp09165 - References (IMF PDF content provided).*

### References

### _wp09165 - References

### References list

- Im, K., M. Pesaran, and Y. Shin, 2003, “Testing for Unit Roots in Heterogeneous Panels,” Journal of Econometrics, Vol. 115, pp. 53–74.
- Isard, P., 2007, “Equilibrium Exchange Rates: Assessment Methodologies,” IMF Working Paper No. 296 (Washington: International Monetary Fund).
- Lee, J., G. Milesi-Ferretti, J. Ostry, A. Prati, and L. Ricci, 2008, “Exchange Rate Assessments: CGER Methodologies,” IMF Occasional Paper No. 261 (Washington: International Monetary Fund).
- Levin, A., C. Lin, and C. Chu, 2002, “Unit Root Tests in Panel Data: Asymptotic and Finite-Sample Properties,” Journal of Econometrics, Vol. 108, pp. 1–24.

*Source: _wp09165 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09165.pdf_