Public Information Notice No. 02/70

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Mozambique

July 9, 2002

On June 17, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mozambique.¹

Background

Economic activity has recovered strongly from the devastating floods that reduced growth in 2000 to less than 2 percent. Aided by a rebound in agricultural output, post flood reconstruction activity, and the first full year of production by the MOZAL aluminum smelter, growth reached almost 14 percent in 2001, bringing average growth for the last two years close to the annual average of 8½ percent recorded in the second half of the 1990s. Near-term prospects point to a continuation of this pace of growth in 2002, fueled by further large-scale private foreign investment.

However, inflation, which had subsided in early 2001 to less than 1 percent, rose to 22 percent at year's end, reflecting an overly expansionary monetary stance that went hand in hand with a depreciation of the metical. The central bank responded by tightening monetary policy from mid-2001 through higher reserve requirements, interest rates, and sales of foreign exchange and government bonds. This tightening of liquidity enabled the 12-month rate of broad money growth to decline from 45 percent in September 2001 to 30 percent in March 2002 and the metical to remain stable since October 2001. As a result, cumulative inflation in the first five months of 2002 was less than 1 percent.

The fiscal outturn for 2001 was stronger than programmed. Revenues were ½ of one percent GDP higher than programmed and the primary fiscal deficit was correspondingly lower than programmed. The government incurred significant outlays (2.3 percent of GDP) on bank restructuring, which were financed mostly by issuing bonds to the banks concerned.

External developments in 2001 were more favorable than envisaged under the program. The current account deficit (including grants) narrowed in 2001 to under 11 percent of GDP as MOZAL's aluminum exports contributed to a further narrowing of the trade deficit, which has been more than halved since 1999. Aided by this strong performance, net international reserves were increased by US$7 million despite a shortfall of US$120 million in external assistance.

Problems with two of Mozambique's largest banks were the focus of policy discussions. Accordingly, one of the banks (Banco Austral) was sold to a reputable international bank; the other (Banco Internacional de Moçambique) was recapitalized by the current shareholders. Steps have been taken to strengthen banking supervision and establish accountability for losses in the banking sector.

Important progress was made in key fiscal reforms with the passage of a new public financial management law and parliamentary consideration of a new income tax law. Despite further delays in developing a strategic plan for the justice system, a draft was circulated in February 2002, and detailed plans for the four branches of the system are expected to be finalized during the year.

Executive Board Assessment

Directors welcomed the strong recovery of economic activity in 2001 from the devastating effects of the floods in the previous year, and the good prospects for continued rapid growth in the period ahead. Directors commended the authorities for continuing their impressive record of broad-based reform, which formed an essential backdrop for the recent inflows of foreign direct investment and Mozambique's strong growth performance. They observed that the Mozambican economy is now reaping the rewards of sustained implementation of sound policies, in terms of macroeconomic performance and a strengthened institutional framework. They expressed concern about the impact of drought, and welcomed the authorities' action to address emerging localized food shortages.

Directors noted that inflation had abated in recent months, following its acceleration in 2001. They urged the authorities to persevere with the recent tighter stance of monetary policies to ensure that the inflation rate returns to single digits in 2002. Improved monetary control would require closer coordination of fiscal and monetary policies, Directors noted, and in this regard they recommended that the pace of foreign exchange sales by the central bank be consistent with externally financed budgetary spending and the international reserves target.

Directors agreed with the emphasis placed on fiscal adjustment over the medium term to support external and fiscal sustainability while safeguarding priority spending. They welcomed the authorities' efforts to strengthen tax collection and improve public expenditure management. They noted that further progress in both of these areas will be fundamental to safeguard expenditures in support of Mozambique's poverty reduction strategy (PARPA) and to reduce the current high levels of aid dependence. Directors stressed the importance of ensuring that the new income tax law enters fully into force at the beginning of 2003, and that it would be prudent to delay any reduction in tax rates under the new law until the desired increase in collections had been firmly established. Directors welcomed the passage of the new financial management law, which establishes the basis for greater transparency, efficiency and accountability in the budgetary process in line with key recommendations of the fiscal transparency ROSC completed last year. The challenge now is to follow through on these legislative changes and put in place improvements in public expenditure management. In this regard, Directors urged the authorities to implement the action plan developed by a recent technical assistance mission from the Fund's Fiscal Affairs Department. At the same time, Directors pointed out the importance of an appropriate sequencing of key reforms—including the need to define more clearly the role of government and hence the size of the civil service before embarking on a salary reform.

Directors expressed disappointment about the delay in finalizing the integrated reform plan for the judicial system. While recognizing the complexity of such a project, they considered it indispensable to the government's long-term growth strategy and strongly urged the authorities to complete the plan without further delay.

Directors commended the authorities for the successful sale of Banco Austral, despite some delays relative to the authorities' own tight timetable. Nevertheless, the emergence of a capital shortfall in the largest bank, BIM, underscored the need for further actions to strengthen the financial system. They therefore urged the authorities to send a strong signal of the need for greater discipline in the financial system by pushing ahead with rigorous and transparent loan recovery and strengthening accountability for the problems in the banking sector. Directors also stressed the importance of enhancing banking supervision and strongly supported the government's stated objective of ending all government participation in commercial banks. Directors supported the government's request to participate at an early date in the Financial Sector Assessment Program. They also commended the recent approval of anti-money laundering legislation.

Directors were encouraged that Mozambique remained well placed to maintain external debt sustainability despite adverse developments in the world economy since reaching its completion point under the enhanced HIPC Initiative. They noted, though, that there remained significant risks over the medium term, and suggested that the projections embodied in the authorities' poverty reduction strategy be updated to incorporate more fully the macroeconomic implications of HIV/AIDS. Directors observed that a key challenge is to muster domestic resources and to achieve broad-based economic growth, thus maximizing the impact on employment and poverty impact. In this regard, they encouraged the authorities to give priority to creating an environment favorable for the development of medium and small-size business enterprises, and to include more detailed plans in this area in the next revision of the PARPA.

Directors agreed that the current flexible exchange rate regime has served Mozambique well and that high levels of external assistance had not so far resulted in a sustained real appreciation of the metical or other symptoms of aid-induced Dutch disease, as underscored by strong export growth. While competitiveness had not been compromised, Directors stressed the need to closely monitor aid inflows. They commended the authorities for maintaining a liberal trade regime, and welcomed their intention to reduce the top tariff rate in 2003, and to accept the obligations of Article VIII, Sections 2, 3 and 4.

Directors noted that Mozambique had made progress in completing bilateral agreements with Paris Club creditors. They also stressed the importance of strengthening debt management capacity, to ensure that obligations remaining after HIPC and other debt relief are serviced in a timely manner and that new borrowing remains within the country's payments capacity. Directors were concerned about the difficulty in reaching agreement with official non-Paris Club and commercial creditors, and urged these creditors to play their full part in debt relief for Mozambique. Some Directors also endorsed the suggestion that an escrow account could be established, into which estimated payments for these creditors would be set aside.

Directors noted that Mozambique's data are adequate for surveillance purposes, but weaknesses were still evident, especially in national accounts and balance of payments statistics. Thus, Directors welcomed Mozambique's participation in a data ROSC during 2002.