Republic of Mozambique and the IMF

News Brief: IMF Completes Third Review Under Mozambique's PRGF Arrangement and Approves In Principle US$11 Million Disbursement

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Mozambique—Letter of Intent,
Technical Memorandum of Understanding

Maputo, September 5, 2001

The following item is a Letter of Intent of the government of Mozambique, which describes the policies that Mozambique intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Mozambique, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1. This letter supplements the government's letter, with annexed of economic and financial policies and technical memorandum of understanding, dated December 1, 2000. It describes progress under the government's program for July 2000-June 2001 supported by an arrangement under the Poverty Reduction and Growth Facility (PRGF) and proposes quantitative and structural performance criteria and benchmarks through the end of 2001.

2. The government regrets that the recapitalization of Banco Austral (BA) did not proceed as planned. However, as explained below, implementation of actions to resolve BA is now well advanced and prior actions (Table 1) relating to this issue have been put in place. On this basis, we are therefore requesting a waiver for non-observance of the related performance criterion for end-March on the recapitalization of BA. In addition, we are requesting a waiver of the performance criterion on the submission to the National Assembly of a new public accounting law; the government decided to delay submission of the law until September 2001 to allow time to develop a more comprehensive public financial administration law.

3. Mozambique's economic and social conditions were adversely affected in 2000 by the worst floods in Mozambique's history. Real economic growth fell from 7.5 percent in 1999 to 2.1 percent in 2000, the lowest rate in almost a decade. Despite a substantial increase in donor assistance for emergency and reconstruction imports, the metical depreciated sharply in the aftermath of the flood, and flood-related shortages of basic goods contributed to a surge in inflation; the 12-month change in the consumer price index rose to a peak of almost 17 percent in October, before declining to 11.4 percent in December.

4. All of the quantitative performance criteria for end-December 2000 were observed (Table 2). The domestic primary fiscal deficit increased from 3.4 percent of GDP in 1999 to 6.5 percent of GDP in 2000 to accommodate spending related to the floods as well as higher social spending. However, as a result of an initial delay in budget approval, both current expenditure on goods and services and capital outlays were somewhat lower than programmed. The increased spending was more than covered by considerable emergency assistance. The ceiling on net domestic assets of the central bank was observed, in part reflecting lower government borrowing. The floor on net international reserves was met by

a wide margin, with the gross international reserves of the central bank rising to US$745 million or the equivalent of more than six months of imports of goods and nonfactor services. This higher-than-programmed build-up in net foreign assets of the banking system translated into unforeseen growth in reserve money and broader monetary aggregates. The central bank acted to tighten monetary conditions by offering treasury bills in greater amounts and real interest rates on deposits became positive. However, broad-money growth still increased to 42 percent during 2000 as compared to the programmed expansion of 34 percent.

5. Despite severe localized flooding in the lower basin of the Zambezi river, economic activity is rebounding in 2001. Aided by the first full year of production at the new MOZAL aluminum smelter, and continuing reconstruction spending, economic growth is expected to reach 9.6 percent in 2001. All quantitative targets established as performance criteria for end-June were observed. During the first half of 2001, fiscal policy was in line with the program that envisaged the continuation of higher spending, including expenditures for flood reconstruction, financed with continued high external assistance. With higher revenues and lower current expenditures than budgeted for the first semester, the overall deficit (after grants) and the primary deficit was about 0.6 percent of GDP less than programmed. The ceiling on net domestic assets of the central bank was, with the aid of lower government borrowing, met by a comfortable margin as was the floor on net international reserves. However, reserve money was again higher than programmed, reflecting the accumulation of net foreign assets coupled with the valuation effects of the depreciation of the metical. After easing in the latter part of 2000, pressures on the exchange rate and domestic prices resumed. The metical depreciated by 28 percent between December 2000 and June 2001 and the 12 month rate of inflation which had fallen to less than one percent in the first quarter, reached 7.4 percent in July

6. Macroeconomic policies through the end of 2001 are geared to ensuring stability, containing the 12-month rate of inflation to 7 percent. Taking into account the revenue performance to date, total tax and nontax revenues are expected to be slightly higher than budgeted at 12.4 percent of GDP. Current non-interest expenditures are expected to be in line with the budget. The budgeted wage bill is sufficient to accommodate the costs of hiring 4,000 additional teachers and 800 nurses, a 17 percent wage increase for civil servants effective from April 1 and regular promotion and grade increases. Expenditures on goods and services and transfers are being contained to budget levels. Capital spending is expected to be 2.4 percent of GDP higher than budgeted, reflecting some carryover of donor-financed reconstruction spending initially envisaged for 2000, and the effect of the depreciation of the metical on the domestic currency valuation of foreign-financed capital spending. In addition, the costs of resolving BA (recapitalization net of sales proceeds, and the cost of funding the pension liabilities) are likely to exceed the costs of recapitalization included in the budget However, the domestic primary deficit, net of the costs of resolving BA will be limited to 6.2 percent of GDP, in line with the deficit as originally budgeted on the same definition. Given the uncertainties relating to these operations, for the purposes of program monitoring in the remainder of 2001, the performance criterion on the implementation of the fiscal program will be the domestic primary deficit, net of the costs of resolving BA (as defined in the attached updated technical memorandum of understanding). The interest costs of the domestic debt to resolve BA (estimated at around 0.7 percent of GDP in 2002) will need to be accommodated in budgets for subsequent years through offsetting cuts in non-essential spending.

7. As explained below, the costs of resolving BA are expected to be met mainly through the issuance of government securities to the new owners. To the extent that payments in cash are required, the central bank will take offsetting actions to sterilize these amounts. The central bank has already acted to tighten monetary conditions. Reserve requirements were raised by over 3.5 percent to 11.5 percent with effect from July and the interest rate on liquidity support operations (facilidade permanente de cedência) was increased from 22.5 percent to 34.9 percent. At the same time, the central bank took steps to broaden the market for treasury bills by allowing direct sales to the non-bank private sector. As a result, the 12-month rate of growth of broad money is expected to decline from 43.5 percent at end June 2001 to 19 percent at end-December 2001.

8. Progress with structural policy implementation has been made in the areas of tax policy and administration, public sector reform, and fiscal accountability (Table 3). In respect to fiscal accountability, the government's efforts were underscored by the completion of a fiscal transparency assessment and its publication by the IMF. However, the submission of a new public accounting law to the National Assembly--a structural performance criterion for end-March 2001--was delayed as the government decided to expand the scope of this legislation by developing a more comprehensive public financial administration law. A final draft of this law was submitted to the Parliament in September 2001. The new law includes provisions for (i) integrating all main areas of budget execution (budget preparation, treasury and debt management operations, tax collection, accounting and control) by using standard accounting principles and compatible and integrated databases; (ii) recording all stages of expenditure execution (allocation, commitment, verification, payment, and reporting); (iii) reducing the lengthy carryover period; (iv) improving cash management through better and more centralized control of actual receipts and payments; and (v) adopting modern principles of fiscal responsibility and transparency. In parallel with the preparation of this law, the government will prepare the relevant regulations.

9. The other structural performance criterion for end-March 2001 envisaged the recapitalization of two insolvent commercial banks in which the government held minority stakes. While the recapitalization of one of those banks (Banco Comercial de Moçambique) took place as envisaged, the private shareholders of Banco Austral (BA) ultimately declined to participate in its recapitalization. Fearing adverse systemic repercussions, the government purchased the private shares for US$1 and the central bank intervened the bank on April 3. An interim management team was appointed with a mandate to reassess BA's financial position, prepare it for reprivatization as soon as possible, collect amounts due on the loan portfolio, and implement adequate financial and operational safeguards.

10. The central bank instructed the interim management of BA not to commit to lending beyond existing contracts and to avoid any increase in the stock of outstanding loans. A team of external experts has been hired to secure original contract documents for the bank's loans and assist in the preparation of a detailed inventory of all assets. BA's position is being closely monitored by the central bank, weekly reports (on liquidity) and monthly accounts, including movements in the loan portfolio, and the monthly profit and loss statement, are being supplied to the staffs of the Fund and the World Bank. As well as constituting a prior action for completion of the review, provision of these monthly reports will continue until the resolution of BA is finalized. Since intervention, the stock of BA's outstanding loans has declined. The government will not inject any capital into BA before the bank is taken over by the new owners.

11. An independent audit as of December 2000 confirmed that, in addition to relying on liquidity support from the central bank, BA is insolvent. The resolution of BA is likely to entail a total cost to the budget of the order of 4 percent of GDP. The government is determined to minimize this cost by controlling losses in the period before the bank is sold and by implementing a transparent, equitable and efficient asset recovery program, recognizing that this will be important for the credibility of the financial system and to demonstrate that the use of public funds is minimized. In addition, steps are being taken to minimize the liquidity implications of these costs.

12. The government has taken steps to recover assets and is determined to pursue recovery of overdue loans to the full extent of the law. To seek settlement of overdue claims, the interim management published a general call to delinquent debtors and privately contacted the 100 largest of them, after which all delinquent debtors who failed to pay were publicly summoned in the press to do so. A detailed loan recovery plan, as prepared by external consultants is now being implemented focusing on collections from the 80 largest borrowers (who account for 74 percent of the bad debt portfolio). Since the government intervened, judicial proceedings have been initiated to collect bad loans in the amount of Mt. 65 billion (out of a total of Mt. 737 billion). Should the potential buyer of BA decline the nonperforming loans, the government is considering options that would allow it to use the same powers (of "execução fiscal") it has to collect taxes in recovering the assets of BA's overdue borrowers. In addition, the central bank is, with assistance from a Fund advisor, revising restrictions on bank lending to employees and shareholders; new regulations on connected lending to be issued by end-October will introduce lower limits on this lending in relation to banks' capital.

13. The government contracted an international management consulting company to assist with BA's sale to a reputable international bank. Based on the advice received from this company and discussions with Fund and World Bank staff, the government developed a compressed schedule for the sale of BA. Following the distribution of a detailed information memorandum, the government received in late June letters from six parties reconfirming their interest; after further assessment of BA's financial situation, two of them submitted bids in late July. The government invited one of these bidders to begin negotiations, simultaneously with any enquiries that the bidder might want to undertake. The government intends to recapitalize BA mainly through the issuance of bonds and short term instruments so as to minimize the immediate liquidity implications of the sale, and avoid the moral hazard of a large injection of cash into the bank.

14. The government has identified new high-priority areas for its structural reform agenda for 2001, which include the key measures listed in Table 4. Following the rationalization of indirect taxes and introduction of the VAT in 1999-2000, the government will proceed with a comprehensive reform of income and profit taxes in support of its objectives to increase medium-term revenue, simplify procedures for tax calculation and payment, and spread the tax burden more equitably by increasing the tax base. Drawing on technical assistance from the IMF and a bilateral donor, the tax reform will overhaul corporate, personal, and complementary taxes and introduce simplified computation and payment procedures. The government intends to prepare a draft of the new income tax law (lei de bases do sistema tributário) by October 2001 for submission to the National Assembly by end-December 2001 (a performance criterion). At the same time, the government intends to streamline the stamp tax; increase the rates of the current car license fee (manifesto de veículos), replace the fee by a more equitable and efficient annual tax in the context of the income tax reform; and implement the recently approved Municipal Tax Code.

15. The reforms in the areas of tax policy and administration included, as further significant steps during 2001, the drafting of a new code of fiscal incentives for investment that was completed in May and the preparation of a plan for the creation of a central revenue authority that was completed in June. Also, the Ministry of Planning is launching a large taxpayer unit in Maputo by the end of the year.

16. In July 2001, the government published the necessary regulations for the implementation of the 1999 Financial Institutions Act, thus completing the new regulatory framework for Mozambique's financial sector. By end-October the central bank will announce the legal framework for consolidated supervision and will start training its staff in order to initiate consolidated supervision of related financial institutions as soon as possible. The accounts of concerned institutions will be audited on this basis beginning from January 1, 2002. The central bank also started using in July 2001 a computerized clearing system for metical-denominated balances.

17. In April, the Council of Ministers approved the Action Plan for the Reduction of Absolute Poverty 2001-05 (PARPA), which is being presented to the Boards of the World Bank and the IMF as the full PRSP and will provide the framework for support under the PRGF arrangement. In this context, the government is committed to achieving further progress in reducing poverty and is prioritizing public expenditure towards that end

18. The government is tracking expenditures on all the PARPA priority areas, to which the resources freed by debt relief under the HIPC Initiative are allocated. It introduced the interim tracking procedures, and the first results were presented in the quarterly budget execution reports for the first and second quarters of 2001. To establish a permanent system of tracking expenditure programs and priorities, the government implemented a new functional classification of expenditure for the state budget that conforms to the IMF's Manual on Government Finance Statistics. The new functional classification encompasses a more detailed breakdown of expenditure and will permit monitoring government outlays on particular areas. It will be linked through a coding system to budget preparation, approval, execution, and reporting. The new classification system is being applied beginning with the preparation of the budget for 2002.

19. The government is moving forward with legal reforms. Among ongoing projects, the new commercial code will be submitted to the National Assembly by end-December 2001 after consultations with the private sector; the new law on money laundering was cleared by the Council of Ministers in April and was submitted to the National Assembly. An arbitration court was created in Maputo in March 2001 based on a law passed in 1999 and additional courts are being established in the provinces. Meanwhile, the government has been working on proposals for a restructuring of the Ministry of Justice, which were considered at a seminar on March 21-22. In April, the government published a policy statement on the role and functions of the Ministry and began implementing measures to strengthen the Ministry and related agencies. Work is continuing on the preparation of the strategic plan for the whole justice system, which is expected to be finalized by the end of 2001. In the meantime, the Ministry of Justice has begun to implement actions to address issues which have already been identified, including measures to expedite court proceedings.

20. 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 he program.

21. The government of Mozambique believes that the policies and measures set forth in its letter and memorandum on economic and financial policies dated December 1, 2000, as well as in this letter, are adequate to achieve the objectives of the program, but it will take any further measures that may become appropriate for this purpose. During the remaining three year period of the PRGF arrangement, Mozambique will continue to consult wit 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 three-year arrangement and while Mozambique has outstanding financial obligations to the Fund arising from 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.

22. In view of the measures taken or to be taken, and to permit completion of the third review under the PRGF arrangement, the government requests waivers for the nonobservance of the two structural performance criteria at end-March 2001. The government also requests disbursement of the fourth scheduled loan under the PRGF arrangement, in the amount of SDR 8.4 million, following the completion of the third review under the arrangement. In view of the delay in completing the third review, we agree to the setting aside of the end-June 2001 performance criteria and we now expect the fifth disbursement under the PRGF arrangement to be available on or after April 15, 2002, subject to completion of the fourth review, and observance of the end-December 2001 quantitative and structural performance criteria set out in Table 4. The government of Mozambique will conduct with the Fund a fourth review of the three-year PRGF arrangement not later than April 30, 2002. At the time of the fourth review, we would present our program for 2002, and seek an extension and further rephasing of the arrangement. The government of Mozambique is determined to fully implement its program and to comply with the targets set out in this letter.

23. The government has recently finalized its PRSP and implemented a number of additional structural reforms specified at the time of the decision point in April 2000. On this basis, the government requests that the Boards of the Fund and the Bank reach a determination that Mozambique has reached its completion point under the enhanced HIPC Initiative. The government reiterates its commitment to see to it that debt service resources freed up following the completion point under the enhanced HIPC Initiative will be channeled to the priority areas identified in the PRSP and looks forward to continuing to work with the international community towards the objective of poverty reduction in Mozambique.

Sincerely yours,

Luísa Dias Diogo
Minister of Planning and Finance
Ministry of Planning and Finance
Adriano A. Maleiane
Bank of Mozambique

Use the free Adobe Acrobat Reader to view the Tables (184 kb PDF file)

Technical Memorandum of Understanding
On Selected Concepts and Definitions Used in the Monitoring of the
Second-Year PRGF Supported Program September 5, 2001

The purpose of this technical memorandum of understanding (TMU) is to describe concepts and definitions that are being used in the monitoring of the second year of the Poverty Reduction and Growth Facility (PRGF)-supported program, including the following:

  • central government domestic primary deficit;
  • central government revenue;
  • net domestic assets, net international reserves, and reserve money of the Bank of Mozambique;
  • new nonconcessional borrowing contracted or guaranteed by the government or the Bank of Mozambique with a maturity of more than one year;
  • short-term external public debt outstanding;
  • external payments arrears; and
  • foreign program assistance

This memorandum also describes the adjusters that will be applied to certain quantitative targets of the program.

Central government domestic primary deficit

The central government domestic primary deficit is defined as central government revenue, less noninterest current expenditure, less locally financed capital expenditure, less locally financed net lending, and excluding the cost of bank restructuring/recapitalization. Net lending is derived as gross lending to enterprises through acordos de retrocessão (excluding acordos de retrocessão that were required by donors), plus food aid disbursed but not collected in the period, minus repayments by enterprises of loans obtained through acordos de retrocessão and through refinancing agreements with the Bank of Mozambique, minus food aid collected but not disbursed, in the period. The cost of bank recapitalization/restructuring is for the purpose of the program defined as the government's contribution to the costs of recapitalizing Banco Comercial de Moçambique (BCM) in 2001 (Mt 234 billion) and, in relation to Banco Austral (BA) the sum of (i) the cost of the real estate purchase from BA in April (Mt 200 billion); (ii) the conversion of the long-term loan of Mt 641 billion from the BM (Bank of Mozambique or BCM) to BA into a government obligation; and (iii) cash and government securities issued to the new owners of BA to raise the capital of the bank to meet minimum prudential requirements less (iv) the gross amount paid to the government by the purchasers of BA.

The central government encompasses all institutions whose revenue and expenditure are included in the state budget (orçamento do Estado): central government ministries, agencies, and the administration of 11 provinces. Although local governments (33 municipalities, or autarquias) are not included because they are independent, the bulk of their revenue is registered in the state budget as transfers to local government.

Central government revenue, expenditure, and financing

Revenue is defined to include all receipts of the National Directorate of Taxes and Audit (Direcção Nacional de Impostos e Auditoría, DNIA), the National Directorate of Customs (Direcção Nacional de Alfândegas, DNA), and the net receipts from privatization received by the National Directorate of State Assets (Direcção Nacional do Património do Estado).

For the purposes of program monitoring, revenue is considered as collected at the time when revenue is received by the DNIA from private agents or other government collecting agencies in cash or checks, or through transfer into a DNIA bank account.

Expenditure is defined as government outlays transferred from treasury accounts to other government accounts or private sector accounts and includes spending reported to the National Directorate of Public Accounting (despesas liquidadas) and any further treasury advances (operações de Tesuoraría) that have been transferred out of treasury accounts but whose use has not yet been reported to the National Directorate of Public Accounting. Any expenditure arrears will be treated like expenditure for the purpose of monitoring the ceiling on the domestic primary deficit.

For program monitoring purposes, expenditure carried out in the current budget year but accounted for as expenditure under the previous budget (período complementar) is treated as spending during the current budget year.

The financing of the budget deficit is measured as transfers into treasury accounts and from these accounts to accounts of the institutions included in the central government, as defined above, and private sector accounts. All treasury accounts held at the central bank are being monitored for purposes of measuring the financing of the budget deficit. There are no treasury accounts outside the central bank.

Any discrepancy between the overall deficit (revenue less expenditure, as defined above) and its financing will be included as "unallocated revenue/expenditure" in the budget balance.

Net domestic assets

Net domestic assets of the Bank of Mozambique are defined as reserve money minus net foreign assets of the Bank of Mozambique. The foreign currency component of reserve money and the net foreign assets are valued at program exchange rates; net foreign assets are defined to exclude the effect of any stock adjustments in medium- and long-term liabilities.

The central bank's foreign currency-denominated assets and liabilities are converted in its balance sheet to meticals at actual exchange rates. For purposes of program monitoring, these amounts are converted into U.S. dollars at the agreed program exchange rate.

Stock adjustments in the central bank's medium- and long-term liabilities are understood to mean any changes that are not the result of foreign exchange flows, such as write-offs, interest capitalization, etc.

Net international reserves

Net international reserves are defined as reserve assets minus reserve liabilities. The BM's reserve assets include (i) monetary gold; (ii) holdings of SDRs; (iii) reserve position at the IMF; (iv) holdings of foreign exchange; and (v) claims on nonresidents, such as deposits abroad. Reserve assets exclude assets pledged or otherwise encumbered, including but not limited to assets used as collateral or guarantee for a third-party external liability (assets not readily available.) The BM's reserve liabilities include (i) all short-term foreign exchange liabilities to nonresidents with original maturity of up to and including one year; and (ii) all liabilities to the IMF.

New nonconcessional debt contracted or guaranteed by the government or the Bank of Mozambique with maturity of more than one year

The term "debt" will have the meaning set forth in Point 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000. Government debt is outstanding debt owed or guaranteed by the Republic of Mozambique or the Bank of Mozambique (but does not include debt of any political subdivision or government-owned entity with separate legal personality that is not otherwise owed or guaranteed by the Republic of Mozambique).

The government will not contract or guarantee external debt with original maturity of one year or more with a grant element of less than 35 percent, calculated using a discount rate based on Organization for Economic Cooperation and Development (OECD) commercial interest rates. This performance criterion applies not only to debt as defined in Point 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000, but also to commitments contracted or guaranteed for which value has not been received.

Stock of short-term external public debt outstanding

The government will not contract or guarantee external debt with original maturity of less than one year. This performance criterion applies not only to debt as defined in Point 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt adopted on August 24, 2000, but also to commitments contracted or guaranteed for which value has not been received. Excluded from this performance criterion are short-term import-related trade credits.

External payments arrears

The government undertakes not to accumulate payment arrears on external government debt with original maturity of one year or more owed or guaranteed by the government, with the exception of external payments arrears arising from government debt in the process of being renegotiated with creditors, including Paris Club creditors.

Foreign program assistance

Foreign program assistance is defined as grants and loans received by the Ministry of Planning and Finance through BM accounts.


The quantitative targets (floors) for the central bank's net international reserves will be adjusted upward (downward) for any excess (shortfall) of foreign program assistance.

The quantitative targets (ceilings) for the central bank's net domestic assets will be adjusted upward (downward) for any shortfall (excess) of foreign program assistance.

The quantitative targets (ceilings) for the central bank's net domestic assets will be adjusted downward to the extent that eligible bank reserves fall short of 11.51 percent of resident deposits in commercial banks, excluding government-earmarked funds (fundos consignados), at the end of each quarter.