Mozambique - Fourth Poverty reduction Support Credit Project

Documentof The World Bank FOR OFFICIALUSE ONLY Report'No.41465 - M Z INTERNATIONALDEVELOPMENT ASSOCIATION PROGRAMDOCUMENT FOR A PROPOSEDCREDIT INTHE AMOUNT OF SDR37.8MILLION (US$60MILLION EQUIVALENT) TO THE REPUBLIC OF MOZAMBIQUE FOR A FOURTHPOVERTY REDUCTION SUPPORT CREDIT December20,2007 PovertyReductionandEconomic Management- AFTP1 AFCS2 AfricaRegion This document has a restricted distribution and may be used by recipients only inthe performance o f their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MOZAMBIQUE - GOVERNMENT FISCALYEAR January, 1-December 31 CURRENCYEQUIVALENTS (Exchange Rate Effective as of September 30, 2007) CurrencyUnit = Metical (MT) US$1 = MT25.80 M T l = US$0.0387 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS BdPES Balanqo do Plano Econ6mico e Social (Review o f the Economic and Social Plan) BIM Banco Internacionalde Moqambique (International Bank of Mozambique) CAS Country Assistance Strategy CEM Country Economic Memorandum CFAA Country FinancialAccountability Assessment CFMP Country FinancialManagement Plan CNCS Conselho Nacional de Combate ao SIDA (AIDSNational Council) CPAR Country Procurement Assessment Review CPS Country Partnership Strategy CTA Confederation of Economic Associations o f Mozambique EU EuropeanUnion FSAP Financial Sector Assessment Program GBS General budget support GDP Gross Domestic Product GNP Gross NationalProduct GoM Government of Mozambique HIPC HeavilyIndebtedPoor Countries IAS International Accounting Standards IBRD International Bank for Reconstruction and Development ICA Investment Climate Assessment ICR Implementation Completion Report IDA International DevelopmentAssociation IFC International Finance Corporation IFRS International FinancialReporting Standards IMF International Monetary Fund INE Instituto Nacional de Estatistica (National Statistics Institute) INSS National Institute for Social Security (National Pension System) JSAN Joint Staff Advisory Note LDP Letter of Development Policy MDGs MillenniumDevelopment Goals MEC MinistryofEducationandCulture MIC Ministry of Industry and Commerce MINAG Ministry of Agriculture  FOR OFFICIAL USEONLY MoF Ministry of Finance M o H Ministry of Health M o U Memorandum of Understanding MOZAL Mozambique AluminiumCompany MPD MinistryofPlanningand Development MoPWH MinistryofPublic Works andHousing MTEF Medium-TermExpenditure Framework MTFF Medium-TermFinancialFramework MYR MidYear Review OE Orqamento do Estado (State Budget) PAF Performance Assessment Framework PAP ProgramAid Partners PAPPA Programme Aid Partners' Performance Assessment PARPA Programa de Acqgo para a ReduqBoda Pobreza Absoluta (Action Plan for the Reductionof Absolute Poverty) PEN National Strategic Plan PER Public Expenditure Review PES Plano Econ6mico e Social PMTCT Preventionof mother-to-child transmission PRGF Poverty Reduction and Growth Facility PRSC Poverty Reduction Support Credit PRSP Poverty Reduction Strategy Plan PSIA Poverty and Social Impact Analysis QAG Quality Assurance Group QUIBB Qualitative Indicators Survey SADC Southern African Development Community SDR Special Drawing Rights SISTAFE IntegratedFinancial Management System TA Technical Assistance UFSA Unidade Funcional de Supervisgo das Aquisiqdes (Central Procurement Supervision Unit) UGE Unidade Gestora Executora (Unit for Budget Execution) UGEA Unidade Gestora Executora das Aquisicdes (Unitfor ExecutionandManagement ofAcquisition) UTRESP Unidade TCcnicapara a Reforma do Sector Publico (Technical Unit for Public Sector Restructuring) VAT Value Added Tax Vice President Obiageli K.Ezekwesili Country Director Michael Baxter Country Program Manager Susan Hume Sector Director Sudhir Shetty Sector Manager John Panzer Task Team Leader Antonio Nucifora This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.   THEREPUBLICOFMOZAMBIQUE FOURTH POVERTY REDUCTION SUPPORT CREDIT TABLEOFCONTENTS I.INTRODUCTION ................................................................................................................................... 1 11. COUNTRY CONTEXT ........................................................................................................................ 1 A. COUNTRY OVERVIEW............................................................................................................................ 1 B. RECENT ECONOMICDEVELOPMENTS INMOZAMBIQUE ............................................................. C. DEBTSUSTAINABILITY .............................................................................................................. D. MACROECONOMIC OUTLOOK............................................................. ...................6 111. THE GOVERNMENT'SPROGRAM:PARPA I1 ........................................................................... 8 IV. BANK SUPPORT TO GOM'S PROGRAM ..................................................................................... 9 A. LINKSTO THE COUNTRYPARTNERSHIPSTRATEGY............................................................................... 9 B. HARMONIZATION DONORS, WITH PARIS DECLARATION AID EFFECTIVENESS,COLLABORATION ON AND WITH THE IMF .......................................................................................................................................... 12 V. THE PROPOSEDPOVERTY REDUCTION SUPPORT CREDIT ............................................... 13 A. OVERALLDESCRIPTION ................................................................................................... B. LEVEL FUNDINGFORPRSC-4 .......................................... OF ..................................................... 14 c. PROGRESSINIMPLEMENTING THE REFORM PROGRAM SUPPO BY THEPRSC ................... D. PROGRESSINIMPLEMENTINGTHEAGREEDPRIORACTIONSFORPRSC-4 ....................... E. AGREED TRIGGERSFORPRSC-5 ......................................................................................................... 33 VI. OPERATIONIMPLEMENTATION ............................................................................................... 34 A. MONITORING SUPERVISION......................................................................................................... AND 34 B. FIDUCIARYASPECTS ............................................................................................... C. DISBURSEMENT AUDITING .............................................................................. AND D. ENVIRONMENTAL,POVERTYAND SOCIALASPECTS ............................................................................ 36 E. RISKSANDRISKMITIGATION ............................................................................................................. 38 ANNEXES ................................................................................................................................................... 41 ANNEX 1:POLICY MATRIX RESULTSFRAMEWORK THEPRSCSERIES...................................... AND FOR 42 ANNEX 2: PERFORMANCEASSESSMENT FRAMEWORK (PAF) FOR 2006 ................................................... 46 ANNEX3: PERFORMANCE ASSESSMENT FRAMEWORK (PAF) FOR2007-2009 .......................................... 50 ANNEX4: IMFPUBLIC INFORMATION NOTE ............................................................................................ 53 ANNEX 5: LETTERDEVELOPMENT OF POLICY .......................................................................................... 57 ANNEX 6: MOZAMBIQUEGLANCE AT A .................................................................................................... 63 The Credit has been prepared by an IDA team consisting o f Antonio Nucifora, Gregor Binkert, Diepak Elmer, Maria Benito-Spinetto, Adelina Mucavele (AFTP 1); Peter Nicholas, Paola Ridolfi (AFCS2); Anne Louise Grinsted, Aniceto Bila, Lurdes Malate (AFCMZ); Louise Fox, Rui Benfica (AFTPM); Patrick Verissimo, Eduardo de Sousa, Daniel D e Sousa, Pedro Arlindo (AFTSR); Christian Albert Peter (AFTEN); Samuel Maimbo (AFTFS), Mazen Bouri (AFTPS); Ana RuthMeneses, Xiaoyan Liang, Jean-Jacques de St. Antoine, Humberto Cossa, Bina Valaydon (AFTH1); Kate Kuper, Uri Raich, Jane Walker, Luiz Tavares, Ali Alwahti (AFTU1); Lisa Bhansali, Guenter Heidenhof, Jose Luis Macamo (AFTPR); Mohamed Khatouri, (AFTKL); Gert van Der Linde, Jonathan Nyamukapa, Modupe Adebowale, Renaud Seligmann (AFTFM); Suzanne F. Morris (LOAFC); Cecile Ramsay (AFTQK); Lourdes Pagaran, Andrew Osei Asibey (AFTRL); Eduardo Brito (LEGAF); Beth Dabak (LEGJR); Slaheddine Ben-Halima, Antonio Chamuco Irina Luca, (AFTPC); Ani1 Bhandari, Dieter Schelling, Jose Domingos Diogo Lopez Chembeze (AFTTR); Wendy Hughes (AFTEG); Isabel Net0 (CITPO). The Peer Reviewers are Edgardo Favaro (PRMED) and Nwanze Okidegbe (ARD). The IDA team collaborated closely with 18 other development partner agencies that also provide general budget support under the Memorandum o f Understanding signed in 2004; this group i s presently chaired by Mette Masst and Torun Reite o f the Royal Norwegian Embassy inMaputo.  CREDIT AND PROGRAM SUMMARY THEREPUBLIC OFMOZAMBIQUE FOURTH POVERTY REDUCTIONSUPPORT CREDIT 3orrower The Republic o f Mozambique [mplementing Agency Ministryof Finance Amount SDR37.8 Million (USD60 million equivalent) Terms Standard IDA terms: 40-year maturity with a 10-year grace period rranching Single tranche to be disbursed upon effectiveness Development The proposed FourthPoverty Reduction Support Credit (PRSC-4) i s the second in a PRSC 3bjectives and series designed to assist the Government o f Mozambique (GoM) to implement key policy Description actions outlined in its Second Action Plan for the Reduction o f Absolute Poverty (known as PARPA I1 by its Portuguese acronym) and in the Performance Assessment Framework agreed by the Government and the 19 external partners that provide general budget support (GBS) to GoM. PARPA I1 i s mainly focused on shared growth and on the need for decentralization. Within this context, PRSC-4 is expected to help the G o M in: (a) the consolidation and deepening o f the institutional reforms in the area o f macroeconomic management; (b) reforms in governance by supporting decentralization to enhance public investments and service delivery at the provincial and district level, and by supporting public sector reform; and (c) economic development by removing constraints to growth, such as infrastructure, and promoting agricultural growth. Benefits The operation will help the Government to maintain macroeconomic stability while it continues to pursue a reform agenda that cannot be fully financed from domestic sources. The reforms,would enable Mozambique to make further progress in reducing absolute poverty, improving the delivery o f services and achieving the MDGs. The alignment with the general budget support programs o f 18 other donors and a joint focus on the priorities set out by the Government in its comprehensive poverty reduction strategy, and on a common set o f indicators to measure progress, should help improve the resource flow and improve aid effectiveness, thereby enhancing the chances of progress towards the MDGs. Risks A first set o f risks is concerned with the potential for macroeconomic instability, which may arise as a result o f terms of trade shocks, deteriorating finances, or unpredictability o f donor disbursements. While terms o f trade shocks and regional instability are exogenous, better public finance management, and the adoption o f MoU's with development partners has made aid flows more predictable. A second set o f risks, relates to the macroeconomic impacts o f new mega-projects in terms o f government exposure including quasi-fiscal activities, ensuring an optimal fiscal/BOP impact and a healthy investment climate, and ensuring the sustainability o f investments. T o minimize these risks, the Bank and the Fund are working closely with the government to strengthen process related to the selection and monitoring o f new mega-projects. A third set o f risks concerns weak administrative capacity to implement reforms. To mitigate this risk, the Government and donors have agreed to develop an integrated strategy for capacity development in public finance management, including at the decentralized level, and to strengthen the coordination and management o f reforms. A fourth set o f risks concerns a deterioration in governance that could compromise economic reforms and poverty reduction efforts. T o mitigate this risk, the Bank has intensified its policy dialogue on governance issues inharmonization with the G19 and has restructured its public sector reform project to support the second phase o f public sector reforms; a new component in support o f capacity building in the judiciary sector has also been included. A final set o f risks concerns the potential impact of HIV/AIDS in reducing human and institutional capacity to deliver public services; it also may pose a contingent liability regarding the future costs o f treating this disease. Should  donor support wane at some point, there would be big pressures for the health budget to pay for it. The Bank is taking the HIV/AIDS pandemic very seriously and is dealing with it as an essential cross-cutting issue in all o f its projects in addition to having two dedicated HIV/AIDS prevention and treatment programs. IProject IDNumber 1P103277 I   INTERNATIONALDEVELOPMENTASSOCIATION PROGRAMDOCUMENT FORA PROPOSEDCREDIT TO THE REPUBLIC OFMOZAMBIQUE FORA FOURTHPOVERTYREDUCTIONSUPPORT CREDIT I.INTRODUCTION 1. This Program Document proposes a Fourth Poverty Reduction Support Credit (PRSC-4) to the Republic of Mozambique for SDR37.8 million (USD60 million equivalent), on standardIDA terms and outlines the triggers for moving to PRSCd. The proposedoperation is an integralpart of the Bank's strategy to support the implementation o f Mozambique's "Second Action Plan for the Reduction o f Absolute Poverty"' (known as PARPA I1by its Portuguese acronym), aided by the Performance Assessment Framework (PAF) agreed by the Government and the nineteen external partners (the G19)2 providing general budget support (GBS). While the PRSC operations will provide financial support for implementing the whole PARPA, they are to be disbursed against the upfront completion o f a number o f specific reform measures identified in the PAF. The proposed operation i s the second in a PRSC series o f three annual single-tranche operations to be delivered over FY07-09. A detailed description of the PRSC series was provided in the PRSC-3 Program Document, which was the first operation o f this PRSC series (Republic o f Mozambique, Third Poverty Reduction Support Credit, Report No. 37970-MZ, approved January 25, 2007). Consistent with the programmatic approach o f the PRSC series, this document will cross-reference the earlier program document, but will present a detailed update on the implementation o f the program. The document `will also provide an update on the macroeconomic developments and overall risks. 11. COUNTRY CONTEXT A. COUNTRYOVERVIEW 2. Mozambique has been a very strong performer in Africa, with rapid growth and poverty reduction, as it recovers steadily from the damage of the civil war. Following political stabilization and market-oriented reforms, and steady improvements in infrastructure, the economy has registered an average annual growth rate o f 8 percent between 1996 and 2006, and incomes have risen considerably. The poverty headcount index has fallen from 69 percent in 1996/97 to 54 percent in 2002103. Economic expansion has been made possible by overall macroeconomic stability, policy reforms and continuing strong donor support, permitting broad-based expansion across 1Segundo Plano de Acq2io para Redu@o da Pobreza Absoluta (PARPA-11). The 19 donors are: African Development Bank, Austria, Belgium, Canada, Denmark, EU, Finland, France, Germany, Ireland, Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, UK, and the World Bank. - 1 -  most sectors o f the economy, and a series o f significant foreign investment projects ("megaproj ects"). As a result, Mozambique's exports increased dramatically in the late 1990s and early 2 0 0 0 ~with average growth rates o f 10.6 percent and 25.4 percent in ~ 1995-1999 and 2000-2006, respectively. Most o f this growth, however, was driven by exports from megaprojects; excluding megaprojects, exports grew by 13.5 percent on average during 2000-2006 (and largely due to good performance in 2006). The sectors that contributed the most to economic growth were agriculture, transport, communications and infrastructure, notably roads. 3. Visible progress occurred in social conditions as evidence of the decline in poverty measured by the latest householdsurvey. In addition to the major reduction in poverty, by 15.3 percentage points between 1996 and 2003, other social indicators have also shown significant improvements: 0 The number o f children in primary school was almost doubled from approximately 2 million to 4 million during 1996 and 2003. 0 Maternal mortality was reduced from an estimated 1,000 per 100,000 live births inthe early 1990sto 408 per 100,000 livebirths in2003. 0 Under 5 mortality rates decreased from 219 to 178 per 1,000 live births. 0 Infant mortality decreased from 147 to 124 per 1,000 live births. The capacity o f the health system was expanded to start providing free ARV treatment for HIV infection. 4. Despite the promising progress, significant challengesremain. The country remains poor ($347 per capita income in 2006), infrastructure i s inadequate, and social indicators are low. Adult literacy rates are low (approximately 47 percent), chronic malnutrition amongst children does not appear to be improving, and life expectancy at birth (42 years) is one of the lowest inAfrica. The country also relies heavily on foreign aid, which makes up about half o f its overall budget. Additionally, the impact o f HN/AIDS and malaria on the population has serious consequences. Malaria alone accounts for 35 percent o f deaths among children below five years o f age, 60 percent o f admissions in pediatric wards, and 40 percent o f overall outpatient consultations. It has been found that in Sub-Saharan Africa, malaria reduces GDP growth by an estimated average o f 1.3 percent per year. As for HIV/AIDS, current projections indicate that in 2010 the Mozambican economy will be 14-20 percent smaller than it would otherwise be due to the impact o fHIV/AIDS. 5. Mozambique is likely to achieve the poverty Millennium Development Goals (MDGs). Assuming that the current trend continues, Mozambique is expected to halve the population living in absolute poverty by 2015. As mentioned, however, reducing hunger and child malnutrition remains a challenge. The MDG for sustainable coverage for water supply i s also likely to be met, with rapid improvements in the provision o f urban water supply, although significant progress i s needed to increase access to water in rural areas. There has also been substantial progress toward other MDGtargets, specifically on improving universal primary education, gender equality and women's empowerment, reducing child mortality, and improving maternal health. Nevertheless, more progress will be required to meet these MDGs, while combating HIV/AIDS,malaria and other diseasesremains a serious challenge. A detailed discussion o fprogress towards each MDGwas include inthe PRSC-3 Program Document. - 2 -  6. Constraintsto private sector development and trade remain substantial, but progress is being made to improve the business environment. Mozambique was among the top five reforming countries in Sub-Saharan Africa in the 2008 Ease o f Doing Business rank, as reflected by an improvement in its ranking by 6 places to 134thout o f 175 co~ntries.~Mozambique i s 129th (out o f 203) on the 2007 Governance Survey Overall Index, surpassing the SSA and low income group averages on all four aspects o f the index (government effectiveness, regulatory quality, rule o f law, and control o f corruption). The country's secondary school (7.1 percent, in 2005) and tertiary (1.2 percent, in 2004) enrollment rates are only a fraction o f the comparators' countries. Mozambique i s ranked 110th out o f 150 countries on the 2007 Trade Logistics Performance Index. Its weakest indicators are quality o f transport and IT infrastructures. The Government's development andpoverty reduction strategy focuses on tackling many o f these concerns. The PRSC series has also supported private sector development, by amongst other things, introducing legislation to allow the registration o f corporations through the official website o f said Government, which helped reduce the start-up time for new firms by almost three months (from an average 113 to 29 days). 7. Progress in public sector governancehas been limited.Despite some progress, implementation o f public sector reforms program, including decentralization, remains slow. Improvements in the efficiency and transparency o f the justice system remain elusive, and corruption and conflict-of-interest remain central issues. Government's response has mainly focused on improving transparency and accountability based on a comprehensive public financial management reform program. B. RECENT ECONOMICDEVELOPMENTS INMOZAMBIQUE 8. Mozambique'seconomic growthcontinues to be strong.Mozambique's GDP growth was 8 percent in2006, and the economy grew 8.3 percent year-on-year duringthe first quarter, and 7.1 percent in the second quarter o f 2007. Agriculture, which employs about 78 percent o f the economically active population, contributed most to GDP during the second quarter of 2007 (31.5 percent). Itwas followed by the manufacturing industry (11.6 percent), transport and communications (9.3 percent), and trade (8.9 percent). The contribution o f the remaining sectors was between5.0 percent (financial services) and 0.8 percent (extractive industries). Looking back at the past decade, the growth record has been remarkable, averaging 8 percent from 1966 to 2006. This performance has been driven by mega-project construction, buoyant donor support, healthy agriculture growth, andforeign direct investmentinservices ~ector.~ 9. Public and private investments continue to grow. Public investment increased from 8.6 percent o f GDP in 2005 to 12.3 percent in 2006. Domestic private Mozambique was the second fastest reformer overall inthe category "Protecting Investors", where its rank jumped 63 places from 96 to 33. Legislation dating from 1888 was replaced with a new commercial code that introduces stricter corporate governance rules and strengthens the rights o f minority shareholders. Significant progress was achieved too inthe category "Starting a Business" (+32 ranks), where the start-up time for new firms fell by almost three months from an average 113 to 29 days. 4 A detailed analysis on the sources o f growth in Mozambique can be found in the Country Economic Memorandum o f 2005, Report No32615-MZ. - 3 -  investmentdecreased from 10.1 percent of GDP in2005 to 7.1 percent in2006. Foreign investments, however, remain strong. During the first semester o f 2007, Mozambique registered a record USD1.8 billion in approved private investments (which compares to the USD847 million in the whole o f 2006), almost entirely inflows o f Foreign Direct Investment (FDI). About US$1.5 billion relates to the Government approval inmid-2007 o f the concession agreement for the exploration o f the Moatize coal mine. An additional USD300 million derives from the approval o f 84 investment projects, mostly in industry (29 projects, for a total o f USD178 million), transport and communications (8 projects, for a total o f USD60 million), and tourism (20 projects, for a total of USD27 million). While 2007 i s likely to be above average, the level o f investments i s expected to remain high, as several new mega-projects are inthe pipelinefor the next few years. 10. Inflation remains in single digits, although it is expected to increase somewhat by the end of the year. Annual inflation declined from 11.2 percent in December 2005 to 9.4 in December 2006, but has since increased slightly to 9.9 percent in August 2007. Core inflation (excluding food and energy) was contained in the 5-6 percent range. Annual average inflation i s expected to increase further by the end o f the year due to the continuing high oil prices and the cyclical price increases in December. Monetary policy continues to be prudent, and aims to keep core inflation insingle digits. 11. Creditto the economy has continuedto grow. Followingthe increase o f22.5 percent in 2005, the 12-month rate o f growth o f credit to the economy grew at 14.3 percent in 2006, and i s projected to expand at around 11 percent in 2007. An IMF assessment indicates that the recorded increase in credit to the economy reflects both structural factors (associated with banks resuming consumer credit following the completion o f their restructuring plans, resulting in healthier balance sheets), as well as borrowing by domestic petroleum distributors related to the syndication o f larger oil import transactions. Lending to the agriculture and rural sector, however, remains minimal. While capital adequacy ratios are still above the minimum, they have continued to decline as a result o f increased lending, and therefore the authorities are closely monitoring the current credit boom. 12. The soundness, depth andprofitabilityof the Mozambiquefinancialsystem continues to improve. The financial system has deepened since the banking systemwas restructured. Sound financial policies and cleaned-up balance sheets, have restored confidence in the banking sector. Nonperforming loans (NPL) have fallen to less than 5 percent o f all loans in 2006 according to Mozambican accounting standards. Banks have also become more efficient, as reflected by the continuous decline in non-interest expenses to gross income since 2004. Greater confidence in the banking system has also ledto a significant decrease inliabilitydollarization andthus less financial vulnerability. 13. Fiscal performanceremains good. Maintainingthe positive trend of the past few years, revenue collections in 2006 were nearly 1.5 percent o f GDP higher than in 2005, mainly led by buoyant corporate tax collections. Early indications are that revenue collections will increase in2007 by a further 0.5 percent o f GDP. Domestic expenditures also increased in 2006, broadly in line with the budget, and fully financed by the higher revenues and grants. Overall budget execution in the first semester o f 2007 was lagging below 50 percent, but i s expected to pick up. The composition o f spending has also continued to improve, with the share o f priority expenditures exceeding the 65 percent - 4 -  PARPA target in 2006, and expected to stay at the same level in 2007. In line with these trends, the domestic current primary balance was 1.6 percent of GDP in2006 (nearly 0.5 percent o f GDP better than programmed under the IMF-supported PRGF), and i s projected to remain positive at 0.7 percent in2007. 14. Real interest rates continueto decrease. Reacting to a downward adjustment in Treasury bill yields and softening inflation, the Bank o f Mozambique (BM) in June 2007 reduced its standing lending facility (FPC) by 200 basis points to 15.5 percent and the standing deposit facility (FPD) by 250 basis points to 10.5 percent. Since then, the RBMhaskept its monetarypolicyunchanged, andinterest rates have remainedflat. This, together with the recent increase in the 12-month inflation rate has reduced the real interest rate for Treasury bills from 10.8 at the end o f April down to 5.9 percent at the end of August 2007. 15. The trade balance improved substantially in 2006, and was stable in the first half of 2007. The trade deficit has improved, despite the oil price shocks, from 11 percent o f GDP in 2005 to around 7.7 percent o f GDP in 2006, led by an acceleration in exports (both mega-projects and other export^).^ The trade deficit i s expected to remain at around the same level in 2007. With prices for commodities booming, and the rebound from the 2005 drought, exports have surged by an estimated 37 percent in 2006. Preliminary data suggest that'exports continued to increase in the first semester o f 2007, and were 3.5 percent above the corresponding value for 2006, mostly due to the contribution o f mega-projects. On the other hand, imports grew by less than 17 percent in2006, driven mainlybymega-project imports. Imports were 3.4 percent above the first semester in2006, mainly drivenby imports o f mega-projects. 16. The foreign exchange market remains stable, and reserves are at a comfortable level. As a result of strong exports, sustained aid inflows, and a tighter monetary policy stance, the exchange rate has remained stable during 2006, while international reserves have remained at a very comfortable level. The Central Bank auction rate on August 29, 2007 was 26.10 MZNper USD against 26.15 at the beginning o f the year. As a result the Bank o f Mozambique (BM) gradually widened the exchange rate bands in both the foreign exchange auctions and interbank market (which it had temporarily introduced in November 2005, in response to mounting exchange rate volatility), and fully restored exchange rate flexibility. Markets have since remained calm with the spread between M C I rates and those quoted by banks narrowing to about 1 percent, while the real effective exchange rate appreciated, reflecting a depreciating U.S. dollar and increasing foreign inflows. International reserves have remained at a very comfortable level. Strong exports, along with sustained aid inflows kept international reserves at comfortable level at around USD 1.4 billion as o f end-September 2007. This corresponds to 4.7 month of import cover, or 6 months excluding mega-projects. 17. There is a stable relationship with the IMF, with recent collaboration anchored on a PRGF, which has now evolved into a Policy Support Instrument With such developments as the MOZAL aluminum smelter, Mozambique's share ofminingand fuel products in merchandize exports has increased from about 10 percent inthe late 1990s to 73.2 percent in 2005. Of the 84 various products exported by Mozambique in2005, aluminum accounted for 72 percent, followed by seafood (6 percent), tobacco (4 percent), sawlogs (2 percent), and raw sugar (2 percent). - 5 -  (PSI) approved by the IMF's Board in June 2007. The sixth and final review of the PRGF was successfully completed in June 2006, and confirmed that the government's successful reform effort have produced solid growth andprice stability. The review found that performance under the PRGF program has been good. All quantitative and structural performance criteria from March 2005 through March 2007 were met except one: base money was above target at end-year 2006 due to a temporary rise in currency demand related to the currency reform.6 This good performance has helped the authorities maintain monetary and inflation control and complete outstanding first-generation reforms. In light o f the sustained macroeconomic stability, supported by the PRGF program, the Board approved the authorities' request for a three-year Policy Support Instrument(PSI) basedon the reform agenda articulatedinthe PARPAI1for 2006-09. C. DEBTSUSTAINABILITY 18. Mozambique faces a low risk of debt distress, as confirmed by a Debt SustainabilityAnalysis carriedout by the Bank and the Fundin 2007, but a prudent new borrowingpolicyremains important.As a result of the MDRI, the NPV o f public external debt i s estimated to be approximately halved, from about 25 percent to about 12 percent o f GDP in2006.7 Mozambique's external debt levels are expected to remain well below their indicative thresholds for debt distress both under the baseline and under various stress tests. Mozambique's public debt i s expected to decline over the medium- to-long term under the baseline, while the stress tests indicate that public sector debt ratios are most vulnerable to a permanently lower GDP growth. Where possible, the authorities should continue to rely on concessional borrowing and grants to minimize future debt service, and any non-concessional financing o f new projects ought to be considered case by case based on economic return, impact on debt sustainability, and potential effects on the financing decisions o f donors and concessional lenders. Also, the authorities would still need to closely monitor any substantial scaling-up o f concessional external borrowing and the issuance o f domestic debt to sterilize the additional liquidity injected from increased government spending. D. MACROECONOMICOUTLOOK 19. The short-term macroeconomic outlook is favorable. The macroeconomic framework i s adequate for the purpose o f the proposed operation. The sixth review o f performance under the PRGF program concluded in June 2007 that the prospects for 2007-2008 remained favorable, including for strong growth, single digit inflation, and the The review also found that public financial management reforms had made good progress with the implementation o f a new version o f the e-SISTAFE and that there had been progress inreforming revenue administration and widening the tax base. Furthermore, the review noted that progress on structural reforms in2006 accelerated, particularlyinthe areas o fpublic sector, labor market, andtrade-related reform. Areas where slower progress was noted included reforms to improve access to finance through an improved lending environment, i.e. legal andjudicial reform, as well as the deepening o f domestic debt markets. More recently, the Second Commercial Debt Buy-Back Operation for Mozambique was completed in October 2007, entailing the cancellation o f USD153 million o f long-term commercial debt (all o f it originated inthe 1970's and 80's). - 6 -  maintenance o f a sustainable external and fiscal situation, as the Government i s committed to take the necessary fiscal measures and pursue a monetary program consistent with a further reduction o f inflation.8 The first review mission o f the IMF Policy Support Instrument (PSI) concluded inNovember 2007 that implementation o f the 2007 program has been satisfactory through September 2007.' The Government remains committed to take measures to continue to strengthenthe banking system, foster private sector development and move forward the public sector reform. After recording an 8 percent growth in2006, real GDP growth i s expected to continue to be strong at 7 percent in2007, and at around the same level inthe next few years (Table 1). The leading sector would be agriculture, followed by wholesale and retail trade, and also transport and communications, and construction. 20. Mozambiqueneeds to implement growth-enhancingreforms and challenging institutional reforms to avoid a slow down in growth in the medium-term. Mozambique appears to be well placed to experience a long period o f sustained per capita growth. It would be hazardous, however, to assume a "business as usual" rate o f 7 percent, because such "growth spurts" rarely extend more than a few years, Mozambique faces meteorological and other risk, the agricultural catch-up i s now exhausted and the sector i s growing at a lesser rate than it did before. Most o f the "easy" growth-enhancing reforms have been done, and aid i s projected to fall as a share o f GDP. The likely growth scenarios for the future - and the corresponding poverty scenarios - will heavily depend on the Government's role inwarding off threats to continued growth, as well as its role in seizing new opportunities for.growth. Only rapid progress in certain key reforms, can keepthe growth rate as highas 7 or 8 percent inthe medium term, and continue the rapid rate poverty reduction o f the past decade. For instance, the 2005 CEM estimates that Mozambique could enhance its growth performance by improving its business climate to East Asian levels. Gains o f up to 1 percentage point per annum could be made by avoiding banking crises, or by improving governance, or by reducing government nonproductive spending. Bigger gains o f up to 3 percentage points per annum could be secured by - in time - improving infrastructure, or by raising access to secondary education." 21. It is critical therefore that the Government pursues a reform program to resolve the key challenges to growth and poverty reduction. The 2005 C E M identifies key constraints to accelerating shared growth are the weak public financial management, the need for key institutional reforms, a poor climate for private sector development, the lack o f adequate infrastructure, the low smallholder agricultural * A preliminary assessment o fperformance duringthe first semester 2007 was done by the most recent IMFmission inAugust 2007 (the mission was mainly focusing onthe budget framework), found that the program i s on track and that revenues appear to be above projections. The next mission to examine performance in first semester 2007 i s planned for early November - while no significant deviations from the program are anticipated, and an updated macro assessment i s expected by the time o f the ROC review. All but one o fthe quantitative assessment criteria for end-June 2007 and all structural assessment criteria through end-September 2007 were observed. The end-June A C for base money was missed by a narrow margin because o f an unanticipated increase inmoney demand. Because o f the permanent nature o f this increase, the government requests the modification o f the related A C for end-December 2007. I OAs part o fthe 2005 CEM (inChapter 6), simulations were carried out using `growth regressions' literature comparing Mozambique's policy performance with that o f some o f the best performers inthe developing world, including East Asian countries. - 7 -  productivity, the impact o f the HIV/AIDS epidemic, and the need to improve significantly the management o f natural resources. Most o f these challenges have been articulated in the PARPA-11, and are part o f the government program, which i s supported by this PRSC series. National income andprices GDP growthrate 7.9 8.4 Nominal GDP ( Mt. billion ) 128.7 151.7 Nominal GDP per capita(inU.S.dollars) 298.0 336.0 Inflation (%, periodaverage) 12.6 6.4 Inflation (%, end-of-period) 9.1 11.2 Money and credit BroadMoney(M2)IGDP 17.6 18.2 BroadMoney(M2, 12 months % change) 16.7 22.1 Credit to the Government (12 months% change) -9.7 .2.2 Credit to the Economy (12 months % change) -2.5 22.5 Investment and savings (excluding grants) Grossdomestic savingdGDP , . . 4.0 1.9 Grossdomestic investmendGDP 18.6 18.7 External sector Exports,f.0.b. (millions of U.S.dollars) 1504.0 1745.0 Of which, exports by megaprojects 1049.0 1263.0 Imports, c i f . (millions 0fU.S. dollars) 2035.0 2467.0 Of which, importsby megaprojects 322.0 423.0 Grossreserves(monthsof import cover; excl. megaprojects) 7.0 5.7 Exchangerate (Mt'OOO per US$,periodaverage) 22.6 23.1 CurrentAccount BalanceiGDP(excludinggrants) -14.6 -16.8 CurrentAccount BalanceiGDP(including grants) -5.4 -9.8 Debt stock and service NPV externaldebdexports 92.3 122.1 Externaldebt service/exports 3.4 2.0 Average interest rate(9ldays T-Bill Rate) 10.5 10.0 Central government (percent of GDP) Revenue(excludinggrants) 13.1 14.1 Grants 7.8 6.6 Expenditureand net lending 25.3 22.9 Overallbalance before grants -12.5 -8.9 Overallbalance -4.7 -2.3 Domesticprimarybalance -3.8 -1.9 Foreignfinancing(net) 2.9 3.6 Domesticfinancing(net) -0.6 -1.5 Privatization 1.9 0.3 Sources: GoM, IMFand Bankestimates(2004.2006) and projections(2007-2009). 111. THE GOVERNMENT'SPROGRAM:PARPAI1 22. In September 2006, the Governmentformally adopted the Second Poverty ReductionStrategy(PARPA 11).PARPA I1is the operationalplanfor the governments' Five-Year Program (2005-2009), and sets out a broad and ambitious agenda o f reforms. PARPA I1builds on the experience o f PARPA I,and was prepared through broad-based consultations with major stakeholders and civil society. The PARPA I1 structure and - 8 -  priorities were discussed inthe Joint Staff Advisory Note (JSAN) presented to the Board on December 19, 2006, and also included in the PRSC-3 program document, and reference i s made to that document for details. 23. The PARPA I1 for the first time includes a strategic matrix of key indicators,a joint effort by the government,donors and civil society. These indicators are integrated into and monitored through the annual instruments o f the Economic and Social Plan (PES in Portuguese) and the BdPES (Ex-post Assessment o f Implementation o f the PES), which i s submittedannually to Parliament. 24. The monitoringof the PARPA I1is open to participationfrom the public and representativesof Civil Society Organizations,throughthe work of the Poverty Observatories. As described in the JSAN, the PARPA I1 was prepared by the Government through broad-based consultations with major stakeholders andcivil society, in a more participatory approach than PARPA I,involving four national and ten provincial Poverty Observatories. The work o f the Poverty Observatories i s ongoing and their meetings provide a forum for broad public consultation to strengthen domestic accountability in PARPA 11 implementation and monitoring. These institutional mechanisms, however, are still in their infancy and have very limited capacity, thereby limitingthe effectiveness ofpublic involvement. 25. While maintaining`itscommitment to improve quality and access to social services, PARPA I1 recognizes that "rapid, sustainable and broad-based growth" warrants more emphasis on the growth of the productiveand private sectors. The strategy envisages small and medium enterprises (SMEs) as the engine o f employment generation. Rural development has a central place in the strategy. An essential role i s attributed to districts as the focus o f development. There i s also a clear recognition o f the challenges related to HIVIAIDS, with a credible strategy for accelerating the national response to the AIDS pandenlic. Overall, the priority areas for public policy to sustain growth and poverty reduction, and improve service delivery are arranged under three pillars:l1 governance; (ii) (i) humancapital; and (iii) economic development. IV. BANK SUPPORTTO GOM'S PROGRAM A. LINKSTOTHE COUNTRYPARTNERSHIPSTRATEGY 26. The PRSC series is a key component of the Country Partnership Strategy approved by the Board in May 2007, and closely aligned to the Government program. Bank support to the PARPA I1is through the Mozambique FY08-11 Country Partnership Strategy (discussed May 30, 2007).12 As government policies and budget are the key instruments for implementingthe PARPA, the Bank is committed to supporting and aligning with the budget process. The indicative lending scenario o f the CPS envisages programmatic support through four consecutive PRSCs, with a focus on supporting Mozambique's efforts in increasing accountability and public voice and ''Key reforms inpublic financial management were treated inthe text o f PARPA I1partly under the pillar o f Governance, and partly under the pillar o f Economic Development. The strategic matrix and the PAF highlightedthe importance ofthese reforms by creating a fourth domain: Macroeconomic Management. 12Mozambique FY08-11 Country Partnership Strategy, Report No. 39395-MZ, April 24,2007. - 9 -  fostering sustainable and broad-based growth. In line with the government program, and as reflected in the CPS, the program supported by the PRSC series recognizes the centrality o f the new growth agenda and the importance o f accelerating shared growth through infrastructure, rural and private sector development, and enhanced governance reforms. The PRSC series is also well aligned with the Bank's principles on conditionality, namely (i)reinforce ownership; (ii)strengthen harmonization; (iii) customize program to country circumstances; (iv) select only critical actions; and (v) ensure transparency and predictability o fprocess (Box 1). 27. Strengtheninggovernance is a key objective of the interventions supported by the PRSC series. The PRSC series is contributing to this overarching objective through several channels, including (i)strengthening the capacity, transparency, and accountability o f state institutions, both at the central level by strengthening PFM systems and at the local level through decentralization; (ii) the demand for better raising governance by supporting participation and oversight by civil society, as for example through the activities associated with the Poverty Observatories; (iii)fostering a competitive and responsible private sector through interventions aimed at improving the business environment and the investment climate; and (iv) contributing to strengthen accountability overall through the process o f joint reviews that monitor progress in implementationo f the PARPA.II.I3 28. Development policy lending will be complemented by investment support and technicalassistance.PRSC support will continue to coexist with investmentsupport to well-articulated sector programs, and with technical assistance to develop government systems and capacities necessary for an increased reliance on them. IDA'Sinvestment portfolio, with 17 projects, i s diverse and supports the three pillars o f the CPS. As o f June 2007, total IDA commitments were $783 million. Details o f the investment programs are inAnnex 4. The share o f policy-based lending inoverall IDA disbursements [inFY04- 06 was below 40 percent], and i s projected to stay at around 40 percent during the CPS FY08-11. The PRSC series supports PFM and public sector reforms, embraces the new growth agenda, and supports the Government's focus on development at the district level. These objectives are also supported by several IDA projects, thereby creating strong synergies. l3Overall, the PRSC series is well aligned with the Bank's strategy to enhance governance and anti- corruption in client countries, as laid out in the paper entitled "Strengthening Bank Group Engagement on Governance and Anticorruption", released in September 2006. - 10-  Box 1: Good PracticePrincipleson Conditionality Principle 1: Reinforce Ownership The proposed operation i s an integral part o f the Bank's strategy to support the implementation o f Mozambique's Second Action Plan for the Reduction o f Absolute Poverty (known as PARPA I1by its Portuguese acronym), and the Performance Assessment Framework (PAF) agreed by the Government and the nineteen external partners (the G19). PARPA I1i s structured around three pillars (Governance, Human Capital, and Economic Development) and is the operational plan o f the Government's Five-Year Program. The first PRSC series was successfully deployed in 2001 and overall progress o f the reforms has been satisfactory as the government continues to pursue a far-reaching reform agenda with the new government elected in December 2004 deepening reforms to reduce poverty. The PRSC series has also been informed by significant amount o f analytical work completed over the past few years, including two PERs (FYO1 and FY03), two CEMs (FYO1 and FY06), a CFAA (FY02), a CPAR (FY03), a Public Financial Management and Fiduciary Risk Assessment with other donors (FY04), a PEFA (FY06) among others, that have been discussed with the government and fed significant input into the policy making process. Principle2: Agree up front with the government and other financial partners on a coordinatedaccountability framework Progress on the reforms is monitored with the aid o f the PAF. Improved service delivery in PARPA priority sectors, i.e. agriculture, health, education, rural water supply, infrastructure, justice and related governance sectors, i s monitored through Joint Sector Working Groups. Progress in achieving all the indicators contained in the PAF i s assessed twice a year through the Joint Review inApril and the Mid-Year Review in September. The sector working groups have become a good mechanism for policy dialogue, donor harmonization, and for reaching agreement between the Government and all the donors involved in a specific sector. Furthermore, a joint Budget Working Group meets on a quarterly basis with the Government to monitor budget execution, particularly in the priority sectors. Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances The PRSC series is designed to focus first on key constraints in cross-cutting areas such as public financial management and the business environment, which are the areas that provided the rationale for the prior actions o f PRSC-3. The series then evolves to support decentralization and shared growth through the incorporation o f triggers for PRSC-4 and PRSC-5. In order to reduce the transaction costs for the Government, the Bank carries out all supervision jointly with the other donors. A Joint Review takes place each year in April (year n). It assesses the performance o f the government in the previous budget year, which corresponds to the calendar year (year n-1).The review focuses on evaluating progress with regard to the indicators defined in the Performance Assessment Framework and makes an overall assessment o f progress. The second event i s the Mid-Year Review in September. This review is mainly forward-looking and formalizes the agreement on the performance indicators and targets for the following year (year n+l). Programmatic lending will be complemented by investment support. PRSC support will coexist with investment support to well-articulated sector programs, and with technical assistance to develop government systems and capacities necessary for an increased reliance on them. Principle4: Chooseonly actionscriticalfor achievingresults as conditionsfor disbursement All the prior actions and triggers o f the PRSC series are indicators contained in the Performance Assessment Framework (PAF) and were selected because o f their criticality for achieving objectives which are consistent with the government's own monitoring framework and to be inline with donor harmonization for general budget support. The results framework for PRSC-4 has 10 prior actions and 12 triggers for PRSC-5. There are no benchmarks. Principle 5: Conduct transparent progressreviews conduciveto predictable and performance-based financial support The Bank's supervision o f the PRSC series i s aligned with the supervision o f the joint General Budget Support program o f the G19. Both the Joint and the Mid-Year Review are a multi-sector exercises, and Bank staff participate in all relevant sectors. Disbursements will be contingent on satisfactory progress towards a subset o f the PARPA's medium-term objectives as set out in the PAF matrix. In addition, the review process i s explicitly designed to allow announcing budget financing amount early in the year in the budget preparation cycle and to disburse early in the budget year, a principle to which the Bank adheres. - 11-  B. HARMONIZATION DONORS, WITH PARISDECLARATIONAID EFFECTIVENESS, ON AND COLLABORATIONWITH THE IMF 29. A Memorandum of Understanding (MoU) has been signed between the Government and 19 donors (G19) providinggeneral budget support, including the World Bank. This M o U is a breakthrough indonor harmonization inMozambique. It is based on a set o f `fundamental principles': (i) predictability and alignment with domestic systems; (ii)monitoring has to be done jointly and that all "conditionality" has to be based on the common PAF; (iii)no separate reporting to the donors i s required; (iv) mutual accountability. Reference i s made to the PRSC-3 document for details (and also the Mozambique Program Aid Partnership website: www.pap.ora.mz ). 30. Implementationof the Paris Declaration is monitored by the G19, the UN agencies and other development partners. The big challenges are to align project aid with the national budget system, integrate it as much as possible with the government's treasury and reporting system, and reduce the number o f Project ImplementationUnits. There has been substantial progress in 2006 and 2007 to bringproject aid on-budget, and the percentage o f development aid now on-budget i s estimated at above 90 percent as o f 2007. As a result, the budget i s increasingly becoming a meaningful instrument for decision-making on resource allocation, and linkingresources to results. The 2007 budget submitted to Parliament made further progress. External resources increased by around 40 percent, most o f which due to recording more o f the project finance in the budget; before these projects were off-budget. Interms o f next steps, after some initial delays, the Government has finalized in September 2007 the multi-currency module to the Single Treasury Account (Conta Unica do Tesouro, CUT) and i s actively encouraging donors to put all their projects on-CUT (which will also ensure that the projects are on-budget). In addition, the public financial management reforms and procurement reforms supported by the G19 (and also supported by this PRSC series) are expected to facilitate increased use o f country systems by IDA and other development partners. 31. The Bank and the IMF cooperate very closely within their respective mandates in assisting the Government to implement the PARPA. In order to coordinate their work programs for the next two to three years, the IMF and the World Bank teams inMozambique organized a one day retreat inMaputo during the first review o f the Policy Support Instrument(PSI) on November 5, 2007. The IMF leads the policy dialogue on macroeconomic policy (including fiscal, monetary, and exchange rate policies), the integrated financial management information system (SISTAFE) and tax and customs reforms. The Bank leads the policy dialogue on public expenditure management, sector structural reforms, reforms o f the civil service, and poverty and social impact analysis. Areas o f close collaboration include banking supervision, financial sector issues, trade issues, the PARPA, and external debt sustainability. The practice o f holding joint IMF-IDA missions has both had synergistic benefits, and has reduced the burden on Government o f multiple missions. Development partners are also involved in specific policy discussions, since all stakeholders agree that many macroeconomic policy outcomes have structural foundations that development partners can usefully support. Even though the IMF i s not a member o f the G19 General Budget Support donors group, the timing o f its missions i s such as to be synchronized with the Joint and Mid-Year Review process o f the G19. - 12-  V. THE PROPOSEDPOVERTYREDUCTIONSUPPORT CREDIT A. OVERALLDESCRIPTION 32. The proposed fourth poverty reduction support credit (PRSC-4) is the second operation in a series of three annual operations supporting the implementationof the PARPA 11. The design and objectives of the PRSC series were elaborated in the Program Document for the PRSC-3, and only a brief summary o f key aspects i s provided inthis document. 33. The PRSC series is fully harmonized within the joint donor (G19) mechanism for the provision of general budget support. All the prior actions and triggers o f the PRSC series are indicators contained in the PAF (see Annexes 2 and 3). IDA'Sfocus will be geared at specific areas, which are a subset o f the PAF (which itself i s a subset o f the strategic matrix o f PARPA 11). This i s an important feature o f the proposed operations as, by relying on the PAF, the PRSC series will remain consistent with the government's own monitoring framework and will also be in line with donor harmonization for general budget support. 34. The PRSCseries supportsa strategicsubset of objectivesfrom the PARPAI1 resultsmatrix. As intermediateoutcomes the PRSC series supports improvements in: (1) Macroeconomic management: Consolidate and deepen institutional reforms to strengthen public financial management system. (2) Reforms in governance: Support public sector reform, and also accelerate decentralizatioddeconcentration to enhance service delivery at the provincial and district level, and empower communities. (3) Economic development: Improve the business environment, by removing constraints to growth, such as infrastructure, and promoting agricultural growth. 35. The PRSC-4 supports specific ongoing reforms which are part of the above program. The PRSC-4 supports reforms to improve macroeconomic management by maintaining at least 65 percent of the budget on priority sectors, continuing the rollout o f e-SISTAFE,strengthening the Central Revenue Authority, continuing the implementation o f the new State procurement system, and increasing the coverage and efficiency o f internal and external audit bodies. The reforms to improve governance focus on the implementation o f a census of civil servants, as a basis to create an integrated payroll management system. Finally, in terms o f economic development, the PRSC-4 supports the government's efforts to increase the amount of road maintenance and rehabilitation, expanding the irrigated area, and expanding the number of farmers who benefit from extension services, inorder to increase the adoption o f new technology. 36. The policy matrix and results framework for PRSC series in Annex 1 presents the specific areas supported by the PRSC series. As indicated above, the PRSC policy matrix and results framework i s a sub-set o f the PAF matrix used by the - 1 3 -  G19.14 It i s worth noting that some o f the entries appear as outcomes (kilometers o f roads in good conditions; areas irrigated). IDA will continue to monitor also the implementationo f the policy actions that make such outcomes possible. 37. The criteria for selecting prior actions and triggers are based on their criticality for contributingto achieve the PARPA-I1 objectives. In summary, these criteria reflect the followingbroad principles: 1. The expected policy or institutional reform is critical to remove a key constraint to poverty reduction and growth (based on the findings o f existing analytical work), or i s an implementation activity o f a reform initiated earlier. 2. They are part o f the Performance Assessment Framework (PAF), and the assessment can be done easily, e.g. verifying whether a law or some regulation has been approved. (All assessments requiringperformance data and analysis are done duringthe Joint Review.) 38. The program supported by the PRSC series has been informed by a significantamountof analyticalwork completedover the past few years. A summary o f the main analytical studies which have informed the design o f the PRSC series was discussed in the PRSC-3 document." The policies and reforms supported by the PRSC focus on the challenges to sustained growth and poverty reduction inMozambique which have been identified inthe stu'dies. B. LEVEL FUNDING PRSC-4 OF FOR 39. The amount of the operationis less than originally anticipated. The amount of each o f the three annual operations in this PRSC series was anticipated at USD70 million, provided performance would remain satisfactory and pending the availability of IDA resources. As discussed inthis document, progress with the implementation of the program continues to be satisfactory, as i s also reflected in the conclusions of the G19 Joint Review in April 2007. However, as a result o f front loading o f IDA commitments in FY06 and FY07, and the reduction in the Country Performance Rating for Mozambique in FY08, however, the available IDA Resources for Mozambique in FY08 (the final year o f IDA-14, hence further front loading is not possible) are less than anticipated; given that funds have already been committed to other operations this fiscal year, the amount available for PRSC-4 i s USD6O million. This amount i s less than the ~~ 14While the 2007-09 PAF indicators will serve as the monitoringframework during the implementationo f the PRSC series, the indicatorsfor 2006 are takenfromthe 2006 PAF (that was basedon PARPA-I).The full PAF matricesfor 2006 and2007-09are presentedinAnnexes 2 and3. This includestwo Public ExpenditureReviews(PER, FYOl andFY03), two Country Economic Memoranda(CEM, FYOl andFY06), a CountryFinancialAccountabilityAssessment (CFAA, FY02), a CountryProcurementAssessmentReview (CPAR, FY03), an InvestmentClimate Assessment (ICA, FY03), a FinancialSectorAssessment (FY03), a Public FinancialManagementandFiduciaryRisk assessmentundertakenwith other donors(2004), aPublic ExpenditureandFinancialAccountability (PEFA) assessmentundertakenwith other donors (2006), a CountryHealthStatusReport (FY05), a PSIA on the impact of school fees (FY05), a study on the effectivenesso f agricultural extension(FY05), a povertyprofilepublishedby the Government (2004), an analysis of changes anddeterminantsofpoverty (FY06) andan agricultural development strategy(FY06). Bank-IMFwork ontracking public expenditures inHIPCcountrieshasalsoplayeda role inprogramdesign. - 14-  commitment o f USD70 million made to government and development partners after the April 2007 Joint Review (but which was before FY08 IDA availability and Mozambique's Country Performance Rating were known). In order to honor IDA'S commitment on the level o f budget support in 2008 (ie., USD70 million during calendar year 2008), the IDA team plans to accelerate the preparation o f PRSC-5 so that at least USDlOmillion of it is disbursedin2008 (and the balance in2009), thereby bringingthe PRSC disbursements in 2008 to the originally agreed level o f USD70 million. The actual amount o f IDA available to Mozambique from 2008 onwards would depend, inter alia, on the amount o f IDA resources in IDA-15 and Mozambique's Country Performance Rating. c. PROGRESSINIMPLEMENTINGTHE REFORM PROGRAMSUPPORTEDBY THE PRSC 40. The reform program continues to be broadly on track as confirmed by the Joint Review in April and the Mid-Year Review in September 2007, as well as the sixth review of the IMF'sPRGF in June 2007. As highlighted above, and detailed in the PRSC-3 program document, the progress on the PRSC and the overall reforms program i s monitored with the aid o f the PAF, in the context o f the joint donor (G19) mechanism for the provision o f general budget support.l6Despite satisfactory progress in implementing the agreed reform agenda, improving access to social and infrastructure services, and strong macroeconomic performance, some weak areas were identified where progress was slower than expected (but there were no reversals): the governance area including civil service reform, judiciary reforms, and decentralization; improvements in the business environment where there were excellent improvements in some areas (registering a business) but not in others (licensing; new labor law; reimbursement o f VAT refunds). 41. The Joint Review in April 2007 considered the implementation of PARPA I1in 2006 to be broadly satisfactory. The review of achievements against the agreed PAF indicators in April 2007 found that there was good progress in terms o f public financial management, and the expansion o f service delivery inhealth and education, but that reforms in the area o f governance and business environment showed a mixed performance. However, agricultural services revealed a poor performance. This issue was raised at the highest political level, and performance in agriculture inthe first semester o f 2007 improved significantly. As noted during the Mid-Year Review o f September 2007, the PAF indicators/targets for agriculture are likely to be met for 2007. The review also noted the need to intensify efforts for rural development. 42. The Mid-Year Review of September 2007 noted that overall progress continued to be good, including an acceleration o f progress in agriculture, but that l6The monitoringofprogresson the reforms i s done through the Joint Sector Working Groups, which also includeGovernmentrepresentatives.The assessment is done onthe basis ofthe indicators containedinthe PAF, andthrough an annual Joint Review conductedinApril. Another review inSeptember sets goals for the subsequent year. The sector working groups havebecome a good mechanismfor policy dialogue, donor harmonization, and for reachingagreement betweenthe Government and all the donors involved ina specific sector. Furthermore, ajoint Budget Working Group meets on a quarterly basis with the Governmentto monitor budget execution, particularly inthe priority sectors. - 1 5 -  additional efforts were necessary inthe fight against corruption, improving the efficiency o f the justice system, strengtheningthe management o f natural resources, and improving the environment for private sector growth. 43. Drawing on information from the Aide-Memoires o f the G19 joint reviews in 2007, this section highlights the recent progress and remaining challenges in the areas supported by the PRSC, with a focus on the prior actions completed under PRSC-4. Macroeconomic Management 44. Mozambique's good macroeconomic performance has been a key element o f the excellent growth record inthe past decade. Moving ahead there i s a need to continuously improve the use o f public expenditures, consolidate macroeconomic stability, and strengthen public finance management. Without improvements in these areas, the country's highgrowth rate will be put at risk. Improve the allocation and use of public expenditures The objective of these reforms is to strengthen the allocation of public expenditures through the budgetpreparation and executionprocess. Thefocus of PRSC-3 and PRSC-4 is on guaranteeing a minimum level of actual expenditures for priority sectors, while PRSC-5 will support alignment of the actual expenditures with the Medium Term Expenditure Framework. 45. There i s need to improve the level of budget execution, and to ensure adequate funding for priority sectors. A key constraint in the 1990s and early 2000s, was the low level o f budget execution, which jointly with the relatively high share o f expenditures channeled to non-priority activities, resulted in low levels o f expenditure in priority sectors (as defined in the PAFWA 11, namely education, health, roads, water and agriculture). In line with government efforts, in recent years there has been an improvement in the level o f budget execution in recent years, and an increasing share o f the budget has been allocated to priority sectors, as defined in the PARPA 11. Actual expenditures in 2005 where at least 65 percent to priority sector (PRSC-3 prior action). Similarly, actual execution of expenditure in thepriority sectors in 2006 was broadly in line with the budgeted total, and total expenditures in priority sectors in 2006 reached 65percent (PRSC-I prior action). Moreover, in general there has been an improvement in the level of budget execution, which on average reached 94.4 percent, in all sectors (compared to 83.4 percent in 2005), with even better performance in the priority sectors (97.4 percent). Compared with previous years, the sectors did not complain about late availability o f funds, indicatingthat budget executionwas fairly smooth. 46. The improvement in budget execution rate was due to several factors. Notably, there were no delays i s the approval o f the annual budget, the implementation o f e-SISTAFE(see below) facilitated a redistribution of the funds (especially inthe internal investment component, resulting in a 100 percent execution), there was improved communication and collaboration between the line ministries and the Ministry o f Finance (MoF), and contributions by the development partners were roughly in line with the treasury plans. 47. Several challenges remain in the area of budget preparation and execution, however, which will constitute the focus o f government efforts over the next few years: - 16-  First, there is still limited information at functional and programming level, which limits the usefulness o f the Budget Execution Report at the level o f the sector and on cross-cutting issues. As part o f the implementation o f e- SISTAFE, the government i s working to adopt functional classifiers which will substantially improve the monitoring of the budget execution. Such information will also strengthen the monitoring of sectoral public expenditures which i s carried out by G19 development partners as part o f the annual Joint Review process. Secondly, while in 2006 the information on the external component improved significantly, there i s still room for improvement. An important step was the transfer in2006 o f the ODAMoz database to the G o M (www.odamoz.niz.org). It is envisaged that from 2007 onwards ODAMoz may serve as the prime information source on commitment and disbursement in the external component o f the budget and it also contains relevant information for the common funds (commitment and disbursement). A challenge i s the integration o f all donors in the ODAMoz, so that it can offer transparent, accessible and complete information. The updating o f the information in the ODAMoz will take place on four fixed deadlines, so as to feed the government's budget cycle (MTEF and OE). To this end the link between the MPD, the MF and other related organizations should be improved so as to ensure that information inthe ODAMoz i s reflected inthe MTEF and the OE. Third, progress with the Single Treasury Account (CUT) proceeded in 2006 with the inclusion of the main common funds, but the direct execution o f expenditure i s still on a very low level and almost none o f the projects entered in the CUT. The multi-currency account should become operational by end- 2007. The GoM remains committed to improve the amount o f percentage o f external funds on-CUT, and has committed to a target of 60 percent by 2009. It is necessary to elaborate an on-CUT guide, with information on classification and reports, so that in 2008 a beginning can be made with the process to include more external funds inthe CUT. Fourth, there i s a need to strengthenthe MTEF and use it as the basis for the sectoral budget allocations, to support programmatic implementation o f PARPA I1(a proposed trigger for PRSC-5). Strewthenmacroeconomicstabilitv bv improving:revenuecollection The objective of these reforms is to raise more domestic revenue to support Mozambique's poverty reduction programs and ultimately reduce aid dependency. PRSC-3 supported the creation of the new Central Revenue Authority (Autoridade Tributaria de Moqambique, ATM), PRSC-4 supported the operationalization of the A T M through the adoption of its Information Technology Plan, and PRSC-5 seeks to consolidate the reform process resulting in an increase in total revenues. 48. Macroeconomic stability and predictability is the crucial foundation for growth andpovertyreduction. As highlightedinthe 2005 CEM, the main challenge in terms of macroeconomic stability i s on the fiscal side, and namely that revenue performance needs to improve because the Government's spending requirements in - 17-  education, health and infrastructure will likely continue to rise, at least pari passu with population. In addition, aid as a percentage o f GDP i s likely to fall from its current very high level o f 15 percent. Hence it is imperative that Mozambique raise more domestic revenueto support its poverty reduction programs and ultimately reduce aid dependency. The plan o f the PARPA-I1 is to raise revenue by 0.5 percent o f GDP annually. A critical aspect o f this program, which i s supported by the PRSC series, i s to improve the organization and capacity o f revenue institutions. 49. The government tax reform program aims to develop a simpler, comprehensive, fair and balanced taxation regime. Ingeneral the performance o f the tax reform process was good, and characterized by continuous efforts to improve the efficiency o f the tax administration, the consolidation o f the taxes and the modernization o f customs proceedings for trade facilitation. As a critical part o f the reforms, the government successfully established the Central Revenue Authority (ATM), which integrates the general administration o f taxes and customs in one single entity, and became operational and started to function formally when its president took office in November 2006 (PRSC-3 prior action). As part o f the reforms, the Information Technology Plan (PDTI) for 2007-2010 of the new Central Revenue Authority was elaborated by end 2006 and approved in June 2007 (PRSC-4 prior action). The finalization and approval o f the Information Technology Plan (PDTI) i s important for the consolidation o f the reform and i s designed to ensure the development o f an adequate system to manage and control information that supports all taxes, in particular in the context o f the integration o f services and the management o f domestic taxes and customs duties. During the 2007, the ATM faces an important challenge in the volume o f work concerning legislation and o f the integration o f human resources and systems, to achieve a harmonious integration o f the former General Directorates o f Customs and o f Taxes. 50. Government efforts in consolidating the tax reforms and strengthening the management of ATM, are resulting in increased total collected revenues. Total revenues continued to grow in 2006 reaching 14.5 percent o f GDP, which i s below the government target, but still represents and increase o f 0.4 percent o f GDP as compared to 2005. This i s in line with the authorities overall program to increase revenues by 0.5 percent o f GDP on an annual basis over the next few years, including reaching 14.9 percent o f GDP in 2007 (a proposed trigger for PRSC-5). The highest growth was in income tax, which however still constitutes a relatively small percentage o f total revenue. Taxes on goods and services continue to represent the most important part o f total revenue, with a weight o f 53 percent, o f which taxes on international trade still are the most important. 51. More progress is still required to recover tax arrears. The amount collected in 2006 was below 60 percent o f the target and i s below the amount collected in 2005. The division for arrears control was created inATM during 2006, with the task to follow and control debts by means o f coercive collection. This led to an increase, relative to 2005, in the number o f cases beingprocessed, but inlower amounts, incases which were close to expiring. Priority for 2007 i s to concentrate on larger arrears and the improvement of the control instruments using information technology. 52. Given the process of regional integration in the SADC, and the inherent loss of revenue from external trade, it will be critical to further enhance the revenue - 1 8 -  collectionefforts, The government is planning to strengthen further the efficiency of tax administration and auditing, and to analyze and review the fiscal benefits code and its implementation. Notably, as part o f the latter, inDecember 2006 the parliament approved new legislation regarding the fiscal regimes for the mining and oil sectors, and the new laws have become effective in mid-2007. The government i s also evaluating measures to ensure the transparent management o f the revenues from the exploitation o f natural resources. 53. With respect to the facilitation of trade, good progresswas made in aligning nationallegislation with internationalconventionsto simplify customs procedures, with the approval o f several regulations. Special attention was also given to inspections and to the strengthening o f the capacity to carry out post-clearance audits. In the course o f 2006 the electronic memorandum was also implemented, which allows for information availability in a timely fashion between the border posts and the clearance terminals, leading to a reduction o f the waiting time for the start o f the customs clearance process. The advanced clearance was also implemented, leading to a reduction of the storage time o f merchandise in the terminals, given that they arrived after the start o f the clearance process. The revision o f the risk profiles contributed to rapid decision-making concerning riskymerchandise or imports, thus accelerating the customs clearance process. On a less positive note, however, the installation o f scanners for merchandise inthe Port o f Maputo has been associated with complaints about the level o f charges, and raised concerns about the possible implications for Maputo's port competitiveness inthe region. Improvethe efficiency and effectiveness of publicfinancialmanagement The objective of this set of reforms is to institute an integrated electronic financial management system (e-SISTAFE). PRSC-3 launched the software on a pilot basis, PRSC-4 rolled out to most ministries at the central level, and PRSC-5 completes the roll out to all Ministries at central andprovincial level. 54. Mozambique's fiduciary accountability has improved significantly in recent years, but challenges remain. The 2005 PEFA highlights that the weakest areas are accounting, auditing and procurement. This i s a matter o f concern in its own right. As articulated inthe 2005 CEM, it will also be critical for growth inthe next decade, because (i)improvedspendingefficiencyisneededto achievebetter servicedelivery, whichin turn is neededto spur growth, particularly in infrastructure, education and health;17 (ii) total expenditure can no longer expand at the rate it used to, and are likely to remain at 24-25 percent o f GDP, making it essential to secure efficiency improvements in the future; (iii)without steady improvement inpublic finance management some o f the high levels o f donor funding may be put at risk. 55. The Government has embarked on a sequenced program of reform, and Public financial management (PFM) systems have shown major improvements in recent years. The reforms started with the approval of a new financial management law in 2001 and accompanying regulations in 2002, which set the basis both for modern accounting procedures and for procurement reform. Based on the PEFA assessment in 2005, the authorities prepared and have been implementing the medium-term `Public 17The PER2003 found that public works are substantially(20-30 percent)more expensiveinMozambique thaninthe region. - 19-  Financial Management Action Plan and Budget' (PFM-APB) for 2006-09, which has been agreed with the donors and is financed through a multi-donor common fund. The APB i s well-structured and the proposed phasing o f implementation is ambitious but feasible. 56. The cornerstoneof the authorities'actionplanto strengthenPublicFinancial Management is the implementation of the integrated electronic financial management system (e-SISTAFE). Following the initial pilot in three ministries inby early 2006 (PRSC-3 prior action), in 2006 the basic functionality of e-SISTAFE was rolled out to most spending ministries (22 Ministries) (PRSC-4 prior action).'8 Following the initial roll out, the full version o f the Direct Budget Execution Module was finalized and rolled out largely according to plan to (almost) all remaining ministries at the central and provincial levels in 2007. The roll-out was accompanied by an extensive training program, involving 1249 users (more or less 6 users per cost center). Users have acquired good operational skills and are now at a level o f beingable to formulate requests for additional functionality. 57. In addition to rollingout of e-SISTAFE, the government has started critical complementaryreformsfocused towards achievingthe benefitsthat the e-SISTAFE can deliver. Within the e-SISTAFE reform, one o f the results with the highest impact in terms o f improvement in Public Finance Management i s direct budget execution (according to the sequence o f commitment, verification, and payment), as this would increase transparency, improve information on public spending and reduce the risk o f diversion o f funds. The roll out and implementation o f e-SISTAFE in all Ministries at central and provincial level by 2007 (a proposed trigger for PRSC-5), allows the transition from the previous system o f advance payments towards a modern system o f direct budget execution. Until recently the old system o f advance payments was still being applied, limiting the impact o f the e-SISTAFE reform. Budget units are now starting to make their payments directly by bank transfer from the Single Treasury Account, which i s essential for the e-SISTAFEto lead to a reduction inbank accounts or cash in the system and achieve its full potential regarding internal control and transparency. Hence, the Ministry o f Finance i s now working to increase the level o f effective direct budget execution for goods and services through e-SISTAFE. Inaddition, the government is also developing a multicurrency module for the single treasury account (CUT) by January 2008, to facilitate inclusion o f all donor-financed projects on-CUT. Further, the government is working on the improvement o f the classifiers (program, functional, regional), so as to provide detail sufficient to permit analysis o f poverty impacts o f government spending. Makethe Stateprocurementsystem for goods and services transparentand efficient The objective of these reforms is to introduce and implement a new procurement system that meets international standards of efJiciency and accountability. PRSC-3 supported the creation of the new central procurement institution. PRSC-4 supports the ~ ~~~ ~ 18The ministries to which the system was rolled-out are now satisfactorily executing their budgets for goods and services and capital expenditure. Payments o f salaries continue to be executed centrally by the accounting department of the Ministry o f Finance. - 20 -  operationalization of the unit. PRSC-5 supports the establishment of a monitoring system to increase transparency and measure the effectiveness of the reforms. 58. Substantial progress was achieved in 2006 in the implementation of the procurement reforms. Revised regulations governing procurement were approved in December 2005 so as to promote competition and transparency. A new central procurement institution, the Functional Unit o f Supervision o f Acquisition (UFSA), was established and staffed, and became operational in 2006 (PRSC-3 prior action). A director, staff and consultants have been appointed, and a website i s also operational (http:/lwww.ufsa.nov.mz). In addition, following the identification of 776 Units for Execution and Management o f Acquisition (UGEAs) at central and provincial level, a first set o f 265 UGEAs had been established (as o f March 2007). Hence, most of the activities envisaged as part of second phase of implementation of the procurement reforms have been carried out (PRSC-Iprior action). These reforms were accompanied by a comprehensive process of capacity building in the application o f the new procurement regulations, aimed at increasing the number of specialized procurement technicians. Specifically around 1600 technicians have beentrained at central, provincial, district and local municipality levels, which will facilitate the adoption o f the new procurement system at the decentralized level. 59. Several challenges remain. Firstly, there are several areas where more progress i s needed. For instance, while most UFSA staff and consultants have been appointed, not all key positions have yet been adequately filled. Also, the link with the key ministries through the sector specialists, as foreseen in the UFSA regulations, has only taken place for the Ministry o f Public Works and Housing (MoPWH). Further, there have been delays in completing the action plan for procurement reforms, the provision o f support to the operation of UGEAs, the elaboration of the plan for the strengthening internal ' controls, and the elaboration o f a model to share information on procurement between provinces/districts. Second, an adequate monitoring system that would allow measurement o f the performance o f the reform remains to be developed (a proposed trigger for PRSC-5). Inthis context, the donors and government have agreed to adopt the OECD/DAC methodology to evaluate national procurement systems.l9Third, there remain various areas o f overlap with the other norms and regulations which need to be clarified (examples: form o f inspections by the IGF and the TA, and the integration with the e-SISTAFE). Increasecoverape andefficiencvof internalaudit bodies The objective of these reforms is to increase efJiciency and accountability by strengthening the internal audit institution (IGF). In order to achieve this PRSC-4 and PRSC-5 support increased capacity of the IGF to conduct audits. 19 About five years have elapsed since the last Country Procurement Assessment Review (CPAR), and the government, development partners and the Bank are planning to carry out a systematic update on the situation o f the procurement system inMozambique. Inthis regard, inearly 2008 the World Bank, in collaboration with the Government's relevant agencies, principally UFSA, and the development partners, will start work to: (i) stock o f what has been achieved inthe implementation o f the procurement take reforms; (ii) determine what are the challenges that remain; and, (iii) suggest how they could be overcome. The assessment will be carried out by using the OECD methodology for the assessment o f national procurement systems. - 2 1 -  60. The internal audit institution (IGF) has been substantially strengthened in recent years; audit coverage is expanding, and follow up of audit recommendations i s beingmonitored. Most recently, in 2006 the government recruited 54 new technicians, thus improving the inspection capacity for the coming years. Also, IGF finalized the basic internal auditing manual. In parallel, there has been substantial progress in recent years in expanding the coverage o f auditing at all levels o f government. The number of audits completed by the IGF almost doubled in relation to 2005 and IGF carried out almost all planned audit activities. From the total target universe (districts and municipalities) 32percent was audited (PRSC-Iprior action). With the exception o f the 3 municipalities from the northern region, all audits foreseen for the districts and the municipalities have been carried out, and the reports almost complete by the end o f 2006. As many as 21 districts, all provinces except ZambCzia, and 30 municipalities were visited, corresponding to 16 percent o f the districts and 91 percent o f the municipalities. The government has also carried out an evaluation o f the compliance on the part o f the audited entities with the recommendations formulated by the IGF. As part o f the evaluation, the government has reviewed follow up on some 200 o f the most relevant recommendations included in previous audit reports, and it found that approximately 70 percent o f these recommendations had been adopted. 61. Areas of weakness remainin the functioning of the internalcontrolsystems. There i s a need to continue to strengthen the coverage o f internal audit at central and decentralized levels (a proposedtrigger for PRSC-5). Inaddition, there several aspects o f internal control which require improvement. First, there are delays in the full implementation o f the Subsystem for Internal Control (SCI), including the institutionalization o f the Internal Control Organs (OCI) in some State bodies. It has not been possible to realize most training activities o f the Subsystem for Internal Control (SCI), owing to the non-availability o f financial resources.2oIn general, the performance o f the Subsystem for Internal Control during 2006 can be considered poor, and moving forward the elaboration and implementation o f the SCI plans should be a priority. An effort by the SCI would pave the way for the OCIs to progressively assume the present role of the IGF, thus allowing the IGF to concentrate on more complex audits and coordination and counsel issues. Second, the internal monitoring and evaluation system i s still weak and the sharing o f information between the different OCIs and the IGF i s not well defined yet. It i s necessary to develop a model for coordination, supervision and reporting o f the activities developed by the OCIs. Third, there remains a need to improve the links with the UTRAFE, in particular with respect to training and access to e- SISTAFEby the auditors. Increasecoverape and efficiency of externalaudit bodies The objective of these reforms is to increase eficiency and accountability by strengthening the external audit institution (Tribunal Administrativo, TA). I n order to *' Activities foreseen within the context o f the SCI, but not realized, include training and integration o f their recently recruited staff inthe various OCIs, the realization o f courses in auditing norms for inspector generals and inspectors at sectoral level, training o f trainers for the SCI, the realization o f a course in financial management for district administrations, and the elaboration o f manuals for specific inspectiodauditprocedures concerning the management o f property, salaries, consigned revenue and procurement. - 22 -  achieve this PRSC-4 and PRSC-5 support increased capacity of the TA to conduct audits and expand audit coverage. 62. Substantial progress has been made in 2006 in improving the capacity and performance of external auditing. The number o f audits realized by the Supreme Audit Institution (Tribunal Administrativo, TA) has increased substantially over the past few years, inparallel with its capacity: Year 2003 2004 2005 2006 Number of audits 5 29 69 167 Numberof inspections 72 17 63. The number o f audits carried out in 2006 was 167, o f which some reports were only finalized in 2007. I n 2006, the auditors completed 115 audit reports, thereby surpassing the target of 70financial audit reports (PRSC-4prior action). O f these, 55 audits were carried out in the districts, for the first time. In addition, 45 audit reports werejudged inthe course o f 2006, which compares with 11 in 2005 and 4 in 2004. This i s a significant improvement, as the judgment i s the final stage o f the audit (and results in either the acquitting or the attribution o f financial responsibility). The good performance in auditing was also markedby the submission of the Report and Opinion on the State Accounts o f 2005 to the Parliament within the term stipulated by law. The reports have now also been made available on the web page o f the TA (http://www.sislog.conlltd),- together with the reports and opinions for the years 1998, 2003 and 2004. During2006 the TA also prepared its Corporate Plan2007-2010. 64. Several challenges remain to increase the operational capacity of the TA. Going forward, it i s important to continue to expand the coverage o f external audit (PRSC-5 proposedtrigger). Inaddition, it will be important that action i s taken to reduce the relative delays in evaluation and judging of the audit processes, and to achieve an acceptable pace in the completion o f audit processes. Holding people accountable and responsible i s an essential element for the creation o f credibility in the systems. It i s important for the TA to use the mechanisms at its disposal to impose sanctions and, when necessary, to forward to the prosecuting authority those processes that contain indications o f crimes committed. Governance 65. Public Sector Governance continues to be an area with mixed performance and remains a serious challenge. Despite some progress, implementation o f planned cross- cutting public sector reforms i s slow. Government has created a Ministry for Public Service (Ministirio da Funpjo Publica in Portuguese language) to coordinate public sector governance reforms and to improve impact o f the reform process. The decentralization efforts o f the Government are notable and much progress was made in 2006 with the introduction o f the investment budget for districts. However, concerns remain about the implementation o f the investment budget and the lack o f appropriate guidelines. Corruption and conflict-of-interest remain central issues. Strenpthen the institutional capacity of local povernment - 23 -  The objective of these reforms was to enhance the decentralization process by clarifying the criteria for the allocation of district grants in the national budget (PRSC-3), supporting the preparation of a (i) clear decentralization strategy (PRSC-4), and a (ii) strategy for capacity building in planning andfinance at local government level (PRSC- 4). Thepreparation of the decentralization strategy has now been postponed beyond the timeframe of this PRSC series (and is therefore no longer a trigger in this PRSC series). The national program for capacity building in planning andfinance at the district level is expected to be completed with delay (now PRSC-5). As a result, the objectives will not be fully met in light of bottlenecks in implementation. 66. There was substantial progress towards greater decentralization in 2006. In line with the effort to transform the district governments into budget units, in accordance with the Law on Local State Bodies 08/2003 (LOLE), the government for the first time allocated Investment Budgets for Local Initiatives (OIIL). As part o f the 2006 national budget, the government allocated to each district an amount o f MT 7 million (considering all districts the total amounted to 3.4 percent o f the national budget). The OIIL represents a significant step in the process o f fiscal decentralization, yet execution was hampered by the late instructions to guide the use o f the funds. The participatory approach introduced in the allocation o f the district budgets at the local level, has created substantial impetus in the expansion o f the local councils in all districts. In the 2007 national budget, in addition to increasing the size of the transfers to the districts to a total o f 3.8 percent of the national budget, the government adjusted the allocation o f the funds to each district based on three criteria: population, surface area o f the district andpoverty index (PRSC-3 prior action). However, there continues to be lack o f clarity about the guidelines for use o f the OIIL, and the Government has recently signaled that they want to reorient the OIIL funds towards activities that directly contribute to "local economic development". The increase infundinghas been going inparallel with increased capacity building activities to strengthen planning and financial management capacity of local administrations. Inaddition, as mentioned above, in2006 there was a significant increase o f audits and inspections at district and municipal level. 67. Despite these positive developments, there have been delays in the preparation of the National Decentralization Strategy. Options for the formulation o f the National Decentralization Policy and Strategy were elaborated in 2006. As highlighted by G19 development partners, there i s a need for clarity on the responsibilities o f various levels o f the State, the fiscal intergovernmental architecture, the relation between the planning/execution on the part o f the sectors and the Local Administration. In addition, there i s a need to clarify issues related to the co-existence o f participatory and consultative democracy and representative democracy. The government has committed to address these shortcomings as part o f a National Decentralization Strategy to be prepared in 2008, which will also benefit from a process o f public consultations (originally a PRSC-4 trigger, but postponed to the next PRSC series in light ofthe new agreedtimeline). 68. Delays have also been experienced in the preparation and design of the National Program of Decentralized Planning and Finance (PDPF). A National PDPF document identifying the main pillars o f the National Program, its objectives, key activities and indicators, has beendrafted in 2007, and i s expected to be approved by the - 24 -  Minister of Planning and Development in early 2008 (originally a PRSC-4 trigger, but postponed to PRSC-5 trigger). The program i s expected to include a focus on developing capacity inplanning and PFM at the local level. The program will provide the basis for a national PDPF project, allowing for a better harmonized support to the provinces and the districts, to be financed by a common fund and through the State budget. ImDrovehumanresources manapementinthe publicsector The objective of these reforms is to improve the payroll management. PRSC-4 supports carrying out a census of the civil service and integratingpayroll management within e- SISTAFE, and PRSC-5 supports the creation of a single registry of State officials and civil servants (Cadastro dos Funcionbrios Publicos, CAF). These measures also provide a sound basisfor a comprehensive reform of civil service wages future PRSC series). 69. There hasbeen importantprogressin the area of publicsector reforms. The government created the National Authority for Public Service (ANFP) in2006, which has become the Ministry o f Civil Service (MCS) in October 2007, and i s responsible for the policies related to the management o f the human resources in the public sector, control and inspection o f the public service, organization o f the public administration, as well as the program o f reforms o f the public sector. In addition, notable achievements inpublic sector reforms since the creation o f the ANFP/MCS are: (i) approval o f Phase I1of the the Public Sector Reform Program, which ensures the continued implementation of the Global Public Sector Reform Strategy; (ii)carrying out a detailed census of civil servants in 2007 and creating an integrated payroll management database (PRSC-4 prior action) and the creating a single registry o f State officials and civil servants (Cadastro dos Funcionbrios Publicos, CAF); (iii) campaign to issue identity cards, in the coordination with the Ministry o f the Interior, aimed at improving the quality o f the services provided to the citizens; (iv) the establishment o f the national Anti-Corruption Forum and the Technical Committee within the context o f the anti-corruption strategy. 70. The government is also in the process of strengthening the civil service payrollmanagement, using e-SISTAFE. The realization o f the census has allowed the creation o f the CAF (a proposed trigger for PRSC-5). The CAF i s an integrated database that allows the development and implementation o f features that support the strategic management o f human resources, including the payroll. The CAF will feed into the e- SISTAFE-compatible payroll module and database already developed in mid-2007, so that the Ministry o f Finance can pay salaries via e-SISTAFE. Salary payments via e- SISTAFE using the new integrated payroll management system is expected to start in early 2008. This reform will also assist the government to eliminate `ghost workers'.21 71. The governmentplansto reformthe publicsector wages in 2008. Inaddition, the data from the census o f all civil servants will provide a sound basis for the preparation o f the new salary policy, which i s planned in 2008. Given the intrinsic link between the salary policy and the databases on personnel, it was decided that the approval and the implementation o f the salary policy should be based on solid information about the human resources o f the State. 21The government's PublicExpenditureReviewof educationin2003 concludedthat as manyas 20 percent ofthe staffinprimaryeducationwere notproperly accountedfor. - 2 5 -  EconomicDevelopment 72. Accelerating shared growth requires improvements in the climate for private sector development, adequate infrastructure, improved smallholder productivity, and tackling key challenges such as the impact o f the HIV/AIDS epidemic, and the need to improve significantly the management o f natural resources. This PRSC series seeks to address some but not all o f these challenges. Improve the insurance and social protection sector The objective of these reforms is to ensure the financial sustainability of the social security system, and to ensure the adoption of best practice and transparency in the management of the Social Security funds. Thepreparation of an actuarial study and the elaboration of an investment strategy are supported in PRSC-5 (originally PRSC-4) and will be implemented aspart of the next PRSC series (originally PRSC-5). 73. The government has undertaken a broad program to strengthen the social security system in Mozambique. In order to improve the system's management and reorganize the Social Security System (INSS), the government has revised the legal framework for social protection, which resulted in parliamentary approval o f the new Law on Social Protection in 2007. It has also started an actuarial study on the Social Security System, which i s expected to be completed in early 2008 (originally a PRSC-4 trigger, but postponed to PRSC-5 trigger). The actuarial study aims to assess the financial sustainability o f the social security system, any quasi-fiscal liabilities, and to identify any required adjustment to the level o f contributions which i s required to cover the services provided by the system. The actuarial study i s also critical to allow the design o f a new investmentstrategy in2008, to ensure the adoption o f best practice inthe management o f the funds. A sound investment strategy will substantially contribute to strengthen the financial system. As part o f the reforms, the government i s also preparing a reform to regulate the private pension funds, following the approval o f the Law on Social Protection, and to complement the reform o f the Social Security System. A consultancy firm has been contracted to elaborate the Regulatory Decree on the PensionFunds, and a report i s expected in2008. Improve conditions for road traffic The objective of these reforms is to improve the quality of road infrastructure. PRSC-4 and PRSC-5 support increases in the extent of rehabilitation and maintenance of the road network. 74. Infrastructure, notably roads, has been identified as one of the top constraints to increased private sector activity in Mozambique. In the context of Mozambique, where about 70 percent o f the population still lives in rural areas, shared growth i s necessarily linked to rural development. This will be complementary to the various mega-projects in the extractive industries sectors, where Mozambique has been very successful. These projects attracted large foreign direct investments and created growth spurts during the construction phase; but they are not labor intensive once completed. Therefore, labor intensive rural and agricultural development i s essential to reduce poverty. - 26 -  75. Good progresswas made in 2006 in the road sector. An important milestone in 2006 was the preparation of the new Road Sector Strategy (RSS 2007-2011) and the finalization o f the Integrated Program o f the Road Sector (PRISE 2007-2009), which i s derived from the RSS. The PRISE has a budget of approximately USD 1 billion over three years, which will require some effort by the Government in terms o f provision the counterpart funds and the provision o f VAT refunds (since some o f the donors do not accept for their project funds to pay for VAT). The PRISE foresees a common approach to the planning and reporting of all activities inthe roads sector, and it will require donors to focus their funding on projects that are part o f the sector program. In addition good progress was made in expanding the maintenance o f the network. The overall conditions of the road network improved in comparison to theprevious years, with thepercentage of roads in good condition increasingfrom 69 percent in 2005 to 73 percent in 2006 (PRSC-4prior action). The rehabilitation of primary and tertiary roads progressed in a satisfactory manner, but performance in the rehabilitation o f secondary roads, and in periodic and routine maintenance was below target. On the other hand the percentage o f roads inpoor condition decreased from 28 percent to 24 percent. Around 3 percent o f the roads network remains `impassable'. 76. Challenges remain in implementing the institutional reforms of the road sector, however. In terms of next steps, the Government needs to rapidly finalize the restructuring o f the Roads Authority (started in 2006), including the recruitment o f staff in accordance with the new organic structure of the Roads Authority. There is also a need to strengthen the planning capacity to ensure timely sourcing o f the necessary financial and human resources, and to improve the information sharing between the various bodies that participate in road management and also with the development partners, under the coordination o f the Road Fund. Promote the construction and rehabilitation of awicultural infrastructure, and increaseaccess to awiculturaltechnolodesand extensioninformation The objective of these reforms is to increase agricultural production by supporting an expansion in the irrigated area (PRSC-4 and PRSC-5), and an increase in the reach of extension sewices (PRSC-4and PRSC-5). 77. The most importantdriver of the reductionin poverty in Mozambiqueover the last decade was agricultural growth, as highlighted in the 2005 CEM. But it is expected that growth in agriculture will start to plateau out after the post-conflict "bounce-back". In order to maintain the pace o f agricultural growth it will be necessary to move to productivity enhancing methods. These will include improved farmer-relevant research, broader dissemination of drought-resistant varieties, the expansion o f irrigation, the encouragement o f outgrower arrangements, the encouragement o f farmer associations, and the exploration of new models for access to financial markets by smallholders. 78. Agriculture grew by 8.6 percent in 2006, which is above the average GDP growth rate of 8 percent, but expansion in irrigatedarea and extensionservices was below target. The good performance was largely a result o f good climatic conditions during the 2005/2006 agriculture season. In fact, the overall performance in the - 27 -  implementation o f reforms and improving service delivery has been somewhat slower than programmed. In order to promote the use of irrigation techniques, the government has undertaken substantial investments in construction and/or rehabilitation of irrigation systems with public funds. I n 2006 the program resulted in around 2,546 hectares benefitingfrom newly constructed and/or rehabilitated irrigation systems, paid by public funds (PRSC-4prior action). While this i s a substantial achievement, it only amounts to around 80 percent o f the government target in increasing irrigated area in 2006. Several constraints have been identified to the rapid rehabilitation and construction o f irrigation infrastructure: (i)the administrative delays in processing these projects, partly due to their complexity; (ii) lackofqualitycontrolservicesfortheconstructionofirrigationworks;(ii) the the high unit costs for the construction and rehabilitation of irrigation infrastructure. The government has taken action to address these constraints and as a result during the first semester o f 2007 it has expanded irrigated areas by an additional 3,240 hectares, corresponding to around 81 percent o f the total target for 2007 (also a proposedtrigger inPRSC-5). To increased reach o f the extension services the government improved the working conditions of the extension agents in 2005/2006 agricultural season, by improving access to means o f transportation and increasing the number o f farmer's field schools, from 84 to 157. I n line with Government's efforts to extend the scope of the agricultural extension services, the percentage of farmers that adopted at least one new technology in 2006 was about 21 percent (PRSC-4prior action). While this represents an improvement (by 13 percent) in comparison to 2005, it i s only about 2/3 o f the target o f 30 percent o f farmers. The improvement is largely due to an increase in the number o f small-scale farmers assisted by public extension, including outsourcing (191,629 small-scale farmers, 77,009 o f whom are women). The improvements in the reach of extension services has continued to accelerate, and inthe first semester o f 2007 as many as 210,000 small scale farmers have already benefited from extension services, which corresponds to 94 percent o f the total target for 2007 (also a proposed trigger for PRSC-5). In addition, in 2007 the government has prepared and approved a new extension services strategy aimed at further strengthening the effectiveness and efficiency o fpublic extension services. 79. Other reforms have also been pursued, including in facilitating the use of land. In 2006, the government also made progress to simplify the processing for the granting o f "user rights" land titles (DUAT), and the percentage o f DUAT requests processed within the period o f 90 days (foreseen in the Land Law) increased to 74 percent. The main causes for the still significant delays are: the delay in the issuing o f opinions by the entities involved in the process, and devolution o f processes with badly formulated projects inorder to be corrected. 80. The critical importance of the agricultural sector for growth and poverty reductionis fully recognized,and the delays in achievingresultson the ground have raisedconcerns at the highestlevel of government. As a result, inaddition to the steps - 28 -  mentioned above to accelerate irrigation provision and increase the reach o f extension services, several additional institutional measures have been taken to ensure that performance inthe agricultural sector accelerates in2007 and 2008. First, a new Minister o f Agriculture was appointedby the President inMarch 2007, and was given the mandate to obtain results on the ground (by taking measures to accelerate agricultural productivity growth). Second, during 2006 the Ministry o f Agriculture (MINAG) drafted,a document highlighting its priorities, which served as the basis for the preparation o f the Medium Term Expenditure Framework (MTEF) for 2008-2010. The MTEF i s expected to facilitate medium-term planning and increase the focus o f government action and investments towards improving the impact in the field. Notably, the MTEF envisages that expenditures on institutional development will decrease substantially, in favor o f investmentsto support production at the local level. Third, inorder to improve the quality o f statistics and the management o f the sector, the Department o f Management Information System was created and became operational in 2006, albeit some technical staff positions remain to be filled. Fourth, the PROAGRI-I1 started in 2006 and i s characterized by the development and application o f new instruments to plan, manage and control the activities o f the Ministryo f Agriculture (MINAG). D. PROGRESSINIMPLEMENTINGTHEAGREEDPRIORACTIONSFORPRSC-4 81. The implementation of the overall program supported by PRSC series is satisfactory. The progress in implementingthe program supported by the PRSC-4 has beendiscussed above, and a detailed list o f the prior actions for the proposed PRSC-4 is summarized below (see also Table 2, for a comparison with earlier indicative triggers). Overall significant progress has beenachieved inpublic financial management, including procurement and auditing, strengthening the management o f human resources in the public sector, and improving the conditions for road traffic. However, some PRSC supported reforms in decentralization, in the social security system, and in agriculture have progressedslower than anticipated. 82. The Government of Mozambique has completed the following prior actions inimplementingthe reformagenda supportedby the PRSC-4: 0 The Ministry o f Finance has ensured that actual expenditure for priority sectors was at least 65 percent o f total expenditures in2006. 0 The Ministry o f Finance has rolled out the basic functionality o f e-SISTAFE to 22 Ministries by end-2006. 0 The new Central Revenue Authority (Autoridade Tributciria de MoCambique, ATM) has elaborated and approved its Information Technology Plan for 2007- 2010. The Ministry o f Finance has continued the implementation o f the new procurement system by completing the following activities inthe second phase o f implementation: (i) UFSAhas beenstaffed; and (ii) website i s operational. UFSA 0 The Inspectorate General o f Finance, inthe Ministryo f Finance (InspecpTo Geral das Financas, IGF) has increased the coverage and efficiency o f internal audit by - 29 -  carrying out the audit o f at least 20 percent o f districts and municipalities by the o f 2006. 0 Mozambique's Court of Accounts (Tribunal Administrativo, TA) has concluded its opinion o f at least 70 financial audits o f Ministries and State agencies in 2006. The Ministry o f Civil Service has completed the census of the Civil Service and the Ministry o f Finance has developed an e-SISTAFE compatible integrated payroll database. 0 The Roads Authority (Administraqiio Nacional de Estradas, ANE) has rehabilitated and maintained the Mozambique's national classified road network to ensure that at least 71 percent o f the classified network was in good or fair conditions by end-2006. 0 The Ministry o f Agriculture has constructed and rehabilitated at least 2,500 hectares o f irrigated area in2006. 0 The Ministry o f Agriculture has increased access to technologies and extension information as reflected by the fact that at least 21 percent o f farmers who have been assisted by public extension services adopted at least one new technology in 2006. - 30 -  I 3 cc) I  I N M I  E. AGREEDTRIGGERS PRSC-5 FOR 83. The next operation (PRSC-5) would support the consolidation of the government's achievements in improving the efficiency and effectiveness of public financial management, by continuing to roll out the e-SISTAFE, raising domestic revenues, implementing the new procurement systems at all levels o f government, and strengthening the internal and external audit bodies. It would also promote economic development by strengthening critical infrastructure in roads and irrigation, improving farmers' access to extension services, and strengtheningthe social security system. 84. The successful conclusion of the Joint Review remains as a key underlying condition. The successful conclusion of the Joint Review, where the performance in all sectors i s thoroughly assessed according to the PAF, continues to be the fundamental condition for going forward with PRSC-5, and for determining the amounts. 85. The PAF triggers that will informthe decision as to whether to proceedwith the preparation of the PRSC-5 fall under the three areas supported by the PRSC series. All the twelve triggers for PRSC-5 are drawn from the 2007-2009 PAF, and only include indicators that will be assessedby the Joint Review o f April 2008. 86. The triggers underpinning government reforms to strengthen macroeconomic management,cover the areas of resource allocation for poverty reduction, institutional reforms to enhance domestic revenue mobilization, budget management, procurement systems, and auditing: The Ministry o f Finance ensures that the total allocation to priority sectors in the 2008 budget i s inline with the MTEF. 0 The Ministry o f Finance rolls out the basic functionality o f e-SISTAFE to 25 ministries,organs, and at least 291 UGEsby end2007. 0 The Ministryo f Finance increases total revenues in2007 by at least 0.5 percent of GDP. 0 The Ministry o f Finance continues the implementation of new procurement system up to the district level by ensuring that the monitoring system is operational, and allows performance measurements establishing baselines for a monitoring system which allows performance measurements (as indicated by: (i) availability o f information on public purchases available from UFSA that show that at least 50% o f contracts o f the public sector were subject to public tender in accordance with the current Mozambican procurement legislation; (ii) information on other modalities o f contract with the due justification in at least 90% at the central level and 50% at the district and provincial level communicated to UFSA; (iii) processofcomplaints,asdefinedinthecurrentMozambicanprocurement the legislation, i s operational and UFSA has data on the process and decisions available). 0 The Ministry o f Finance ensures that at least 30 percent o f central and provincial level bodies have operational internal audit units (also referred to as `internal control units') in2007. - 33 -  0 Mozambique's Court o f Accounts (Tribunal Administrativo, TA) concludes its opinion o f at least 90 financial audits o f Ministries and State agencies in2007. 87. In the area of governance, the triggers continue to support decentralization and the reforms o f the civil service: 0 The Ministry o f Planning and Development approves the National Program for DecentralizedPlanning and Finance. 0 The Ministry of Civil Service creates the single registry o f State officials and civil servants (Cadastro dos Funcionarios Publicos, CAF). 88. Inthe area o f economic development,the triggers support government efforts to foster economic development by adopting reforms to improve the investment climate, and by supporting the provision o f essential infrastructure, such as the road network and irrigation; andbetter agricultural extension services: The Social Security Institute (Instituto Nacional de Seguranqa Social, INSS) completes the actuarial study and the elaboration of its investment strategy. The Roads Authority (Administraqio Nacional de Estradas, ANE) rehabilitates and maintains the Mozambique's national classified road network to ensure that 76 percent o f the classified network will be in good or fair conditions by end- 2007.22 The Ministry o f Agriculture constructs and rehabilitates at least 4,000 hectares o f irrigated area in2007. 0 The Ministry of Agriculture increases access to technologies and extension by ensuring that at least 222,300 small scale farmers are assisted by public extension services in2007, including sub-contracting. VI. OPERATIONIMPLEMENTATION 89. Implementation procedures for the PRSC-4 (in terms of monitoring and evaluation, fiduciary aspects, and auditing; as well as environmental, poverty and social aspects) are the same as those proposedin the programdocumentfor PRSC- 3. Reference is made to that document for all implementation arrangements. Only risks (and mitigating measures) to the reform program are detailed below. A. MONITORINGSUPERVISION AND 90. The Bank's supervision of the PRSCs is aligned with the supervision of the joint General Budget Support program of the G19. As discussed above, the Bank's 22This is the original target from PARPA 11, andthe PAF. However, ANE has recently completed a new road classification survey andthe revised figures from the survey will be incorporated inthe PAF inearly 2008. The new figures, as reported inthe IntegratedProgramofthe Road Sector (PRISE 2007-2009), are as follows: baseline 64% in2006; and the targets are: 67% for 2007; 70% for 2008; 73% for 2009; 75% for 2010 and 77% for 2011. - 34 -  supervision o f the PRSCs i s aligned with the supervision o f the joint General Budget Support program o f the G19. Inorder to reduce the transaction costs for the Government, the Bank carries out all supervisionjointly with the other donors. Inaddition to the two annual joint reviews, the supervision o f the PRSC i s done on a continuous basis in harmonization with the other general budget support donors, through the monthly joint government-donor steering committee meetings. Progress in each sector i s monitored by joint government-donor sector working groups. Bank staff actively participates in these meetings through its staff in the field offices and Washington (through missions or by videoconference). Furthermore, the Bank participates in joint IMF-Bank missions to monitor progress inthe macroeconomic framework. The Bank and the Fundalso monitor jointly progress inimplementing the PARPA-11. 91. The Government,with technicalassistancefrom IDA and other development partners, is workingto strengthenthe monitoringsystem of the Strategic Matrix of PARPA-11,in the context o f the development of an integrated national Monitoring and Evaluation system. Monitoring o f the P A W A I1 i s carried out on the basis o f the `Strategic Matrix' prepared inearly 2006 and included inthe P A W A I1document. Sector working groups, including representatives o f each relevant Ministry, Ministryo f Planning and Development, donors and technical assistance, worked to select the key PARPA I1 objectives in each sector and corresponding results indicators, actions, and output indicators. A Quality Control Group led by the Ministryo f Planning and Development and by the chair o f the G19 was set up to oversee finalization o f the Strategic Matrix and identification o f key indicators. Implementationo f sector specific matrices i s expected to be carried out by line Ministries and sector agencies, while the overall poverty monitoring i s the responsibility o f the National Statistic Institute (INE). The Bank supports the Government's effort to ensure the timely collection and analysis o f the Strategic Matrix indicators to be usedby the relevant agencies implementing the Strategic Matrix: Ministry o f Planning and Development, line ministries and agencies at central, provincial and district levels. In addition, following finalization o f the Strategic Matrix with technical support from the Bank, inJuly 2007 the MonitoringTeam within Ministry o f Planning and Development began preparation o f Technical Notes for each indicator. A national workshop involving M&E units in ministries i s planned for early 2008. The team will then prepare a working plan to define decentralized level o f responsibility in monitoring indicators involving provincial level o f government. Once the monitoring system is inplace, Government will focus on refining the indicators for the 2009 review andupdate o f the Strategic Matrix. 92. Various other activities are underway to strengthen the monitoring and evaluation capacity of Government. Notably, the Government with support from DANIDA has also started a training program of government officials at central and decentralized level in the preparation o f Log-Frame matrices and the carrying out cost- benefit analysis o f projects and activities. B. FIDUCIARYASPECTS 93. Fiduciary aspects and strengthening of the Government's own systems are key in this operation. As indicated in the PRSC-3 document, the public financial - 35 -  management system i s considered reasonably adequate to support the PRSC series. Weaknesses are found in internal control systems, the limited coverage o f the external audit, and the high-level o f off-budget spendingmainly from external project finance. An action plan on PFM reforms (discussed above), focusing on comprehensiveness and financial accountability system i s being implemented. The PRSC series supports implementation o f key reforms in the action plan, in close coordination with the IMF program. Public financial management has been improving steadily in line with government commitment to reform, and the dialogue between the Government and the donors has beenconstructive. C. DISBURSEMENT ANDAUDITING 94. Disbursement and auditing procedures remain the same as indicated for PRSC-3. The proposed credit will be disbursed following standard IDA disbursement procedures. The credit will be released as a single tranche at the request o f the Ministry o f Planning and Development. IDA will deposit the funds in a dedicated foreign exchange account o f the Bank o f Mozambique inFrankfurt. It i s the same account which i s usedby other GBS donors to transfer their GBS contributions, as specified in the MoU. Within two working days, Bank of Mozambique will credit the Metical equivalent counterpart funds to the Transit Account o f the Ministry o f Finance dedicated to GBS funds. It will be transferred from the dedicated GBS Transit Account to the Central Treasury Account in accordance with the treasury plan and will be used as state budget revenue and recorded in the state accounts as such. Auditing procedures are the same as defined inthe MoU. A legally registered, private and independent audit company meeting international standards will perform annual audits based on the quarterly financial reports according to Terms o f Reference attached to the MoU. The audit costs will be met by GoM. The final audit report will be submitted annually to G o M as well as to GBS donors including the Bank no later than three months after the year's end. D. ENVIRONMENTAL, POVERTYAND SOCIAL ASPECTS 95. The reforms related to roads, irrigation, and agriculturalextensions are not expected to have significantenvironmentaleffects, becauseof the systems in placeto manage them. The PRSC series supports policy actions that create the enabling environment to support poverty reduction, and which by themselves do not have a direct environmental impact. It i s expected, however, that the private and public regular investment activities which may result from such policy actions, could have stronger impacts on the environment. The legal framework for the environment i s relatively well developed in Mozambique. The framework for environmental management in Mozambique i s defined by the Law o f the Environment (Law no20/97), which applies to all public and private activities that may influence environmental aspects. All activities that may result in a significant impact on the environment are subject to an Environmental Impact Assessment, which has to precede any issuing o f licenses and investment activity. The Ministry for the Co-ordination of Environmental Affairs (MICOA) i s the main entity responsible for conducting Environmental Impact Assessments. The capacity o f MICOA, however, is limited due to financial and technical - 36 -  capacity constraints, and the potential environmental impacts o f such interventions i s analyzed and monitored by the responsible authority. For example, in the case o f the rehabilitation and construction o f the road network, the National Roads Authority has received institutional strengthening for environmental management under the Bank- supported Roads and Bridges Management and Maintenance Program, in particular through the social and environmental unit of the National Roads Authority. A similar situation prevails in the case o f the expansion o f irrigated agriculture. The Ministry o f Agriculture has received much support - including from the Bank - to build up its capacity to carry out EIA's. The institutional framework for the water sector i s largely consistent with international good practice, and includes the ongoing establishment o f Regional Water Administrations (AMs) responsible for water resource management. Some additional details are providedbelow: 96. Roads rehabilitation and maintenance: IDA'Sproject on Roads and Bridges Management and Maintenance Project (RBMMP) finances routine and periodic maintenance o f the national road network through a pooled fund, while construction and rehabilitation are funded directly by IDA investment lending. As part o f this operation, the Bank has already verifiedthe government capacity to adequately address and mitigate any environmental risks. 97. Irrigation: Although IDA i s not presently involved in financing irrigation in Mozambique (a project focusing on the development o f irrigation i s in the pipeline for FY09), irrigation investments are part o f the second phase o f the government's National Agricultural Program (PROAGRI II), and i s funded by a group o f development partners. As part of the PROAGRI I1 a Strategic Environmental Assessment (SEA) has been carried out in order to provide the Ministry o f Agriculture (MINAG) and other stakeholders with a tool for strategic management o f environment issues that will result in the implementation of PROGAGRI 11. An action plan to mitigate potential negative impacts has been prepared as part of the SEA. Moreover, it should be emphasized that since the late 1990s until present, MINAG has been emphasizing small scale irrigation projects (2 to 20ha), which are less likely to have significant environmental impacts. 98. Extension systems and Integrated Pest Management (IPM): While the Bank i s not directly involved in supporting the agricultural extensions in Mozambique, the relevant Government departments are aware and able to address any negative effects related to the use o f new technologies in agricultural production. The government's extension system supports IPM. During the PROAGRI I,an environmental unit was created within MINAG, which pushed for the establishment o f IPM and safe use o f pesticides. This environmental unit also trained public and private sector extension staff on management o f pesticides. A Pilot Plan for I P M was started and implemented, and the plan i s currently beingrevisedinorder to scale up implementation. 99. Beyond the need to ensure that the environmental impacts of reform supported by the PRSC is mitigated, the sustainable use of Mozambique'snatural resources (land, mining, fisheries, forestry, water) represents a great opportunity for poverty reduction as well as social and economic development, and needs to be strengthened. As outlined inthe 2005 CEM, public revenues from naturalresource rents could be increased from USD31 million to USD82 million per year under current economic conditions, mostly by improving transparency and fairness in the issuing o f - 37 -  licences, quotas and concessions and in the collection and use o f revenue. Sustainable exploitation o f natural resources by communities and individuals should be promoted to contribute directly to poverty reduction and livelihood security. Investments inextractive and exploitative industries can promote further growth and economic activity through providing markets for local goods and services as well as inputs for processing industries. Licensing and taxation o f natural resource use can provide significant revenue for Government, which in turn, can support funding development and poverty reduction programs, especially where (local and global) market demand and prices allow significant margins. However managing these resources i s complex. While GOM legislation and policies recognize and seek to facilitate the role o f different models o f resource use for poverty reduction and development, little attention has been given to the specific mechanisms for: (i)access, (ii)promoting efficient use and (iii)monitoring and compliance with existing norms. This has lead to a situation where regulations appear to have produced unnecessarily complex procedures that create opportunities for rent seekingand corruption, harming both the poor and private commercial interests. Over the next few years IDA, in collaboration with the IMF and other development partners, will work closely with Government to maximize the benefits from the sustainable exploitation o f natural resource. An important step to enhance the revenue collection efforts was the approval by the parliament in December 2006 o f the new laws on the fiscal regimes for the miningand oil sectors, which have become effective inmid-2007. 100. The poverty and social impacts of the policies supported by the PRSC series are expected to be positive. Analysis carried out on the impacts o f growth on poverty reduction in Mozambique, has shown positive links, which has so far not been accompanied by significant increases in inequality. As highlighted in the Program Document for PRSC-3 the poverty reduction impact o f the policies supported by the series i s expected to be significant, increasing the likelihood that Mozambique will reach the first Millennium Development Goal. The specific country policies supported by the PRSC series are not expected to have significant distributional and social impacts, except possibly positive ones arising from the irrigation investments, the expansion of extensions services, and the increased effectiveness o f the tax administration system (as the tax system is considered to be reasonably progressive). E. RISKSANDRISKMITIGATION 101. The risks to this operation fall in the same four areas already flagged in the PRSC-3 document (as risks for the whole PRSC series), and relate to: (i) potential for the macroeconomic shocks, (ii)administrative capacity to implement reforms and decentralization, (iii)deterioration in governance that could compromise economic reforms, and (iv) the impact o f HIV/AIDS. While there continues to be progress in the capacity to mitigate macroeconomic shocks and building administrative capacity, these are long term processes, and it will take a long time for these risks to be eliminated. Additional efforts are required to mitigate risks inthe area o f Governance and inthe fight against HIV/AIDS, and accordingly IDA i s increasing its efforts in these two areas. Details for each o f these four areas are providedbelow: - 38 -  102. One set of risks is concerned with the potential for macroeconomic instability. Instability may arise as a result of terms of trade shocks, climatic shocks, financial sector weakness, regional instability, or unpredictability o f donor disbursements. Some o f these risks are exogenous and could be more important in the long term rather than being o f concern to PRSC-4 itself. Considering the high level o f reserves, the robust increase o f exports over the past five years, a flexible exchange rate regime and low external debt vulnerability, the likelihood o f terms o f trade shocks causing severe macroeconomic instability i s low, even though no stabilization mechanism exists at this point. Mozambique also remains vulnerable to drought, floods and cyclones. To mitigate the country's vulnerability to climatic shocks, the Bank i s working with government to prepare a Country Disaster Risk and Vulnerability Assessments (under the GF DRR Track I1program) which will lead to recommendations to strengthen the disaster response institutions. It i s worth highlighting that the government capacity to handle natural disasters i s improving, as demonstrated by it's the handling o f the response to the floods and the cyclone which affected the central provinces o f Mozambique in early 2007, for which the Government has been widely praised. The new legal framework for the banking sector and strengthened supervision have reduced the risk o f banks accumulating a high share o f non-performing loans, and reduced the vulnerability o f Mozambique's financial sector. Regarding the unpredictability o f donor disbursements, the Government has made significant progress to make them more predictable inthe short andmediumterm, last but not least by signing the M o Uwith the 19 GBS donors and several MoU's for sector support. 103. A second set of risks, relates to the macroeconomic impacts of new mega- projects. Mozambique has huge potential to gain from new mega-project investmentsif they can be proactively identified and marketed, and if the related risks are adequately managed. Major risks related to debt sustainability, government exposure including quasi-fiscal activities, ensuring an optimal fiscal/BOP impact and a healthy investment climate, and ensuringthe sustainability o f investments. To mitigate these risks, the Bank andthe Fundare working closely with government to strengthenprocesses related to the selection and monitoring o f new mega-projects to minimize risks, while maximizing the benefits for economic growth and poverty reduction. 104. A third set of risks concerns weak administrative capacity to implement reforms and effective decentralization. To mitigate this risk, the Government and donors agreed during the Joint Review to develop an integrated strategy for capacity development in public finance management, and to strengthen the coordination and management of reforms. A new strategy for the second phase o f the public sector reforms was agreed with all stakeholders including the development partners and was approved by Cabinet in October 2006. To strengthen capacity at the district level and to improve control mechanisms (auditing). The Government is about to finalize its strategy for capacity building at the decentralized level. Upon finalization o f the strategy, the development partners, including IDA, are planning to integrated several decentralization projects into a national program that i s expected to deliver capacity building and oversight more effectively. 105. A fourth set of risks concerns a deterioration in governance that could compromise economic reforms and poverty reduction efforts. The Joint Review in - 39 -  April 2007 has noted that reforms in the legal andjudiciary fronts are not moving at the desired pace. A deterioration in governance can have negative effects on economic growth and compromise poverty reduction. To mitigate this risk, IDA i s increasing its activities inthe areas o f Governance. Strengthening voice and accountability i s one o f the three pillars o f the Bank's new Country Partnership Strategy approved by the Board in May 2007. IDA already holds an active policy dialogue with the authorities on the subject and closely monitors developments associated with governance. In addition, the restructured Public Sector Reform Project has a new legal sector capacity building component. A further approach to enhance accountability o f the executive i s increased disclosure o f information to the public, particularly regarding financial management. Some progress has been made through the use o f an official internet portal o f the Government, but more effort i s still required. Also, as part o f the activities supported by the CommGAP Trust Fundin Mozambique, IDA is working to enhance citizen's voice, strengthen the media, and modernize the government's communication functions. Last but not least, IDA is working with Government to carry out a program o f beneficiary surveys to increase public involvement inthe monitoring o f service delivery. 106. A final set of risks concerns the impact of HIV/AIDS. This pandemic has two potential impacts: it can reduce human and institutional capacity to deliver public services and it may pose a long-term contingent liability. Free ARV treatment i s rapidly expanding financed by donors. Should donor support wane at some point, then there would be big pressures for the health budget to pay for it. IDA i s therefore working closely with Government and development partners to develop a medium term framework for financial needs in the health sector as a whole, and i s also supporting Government in preparing its applications to the Global Fund for HIV/AIDS. IDA i s taking the HIV/AIDSpandemic very seriously and i s dealing with it as an essential cross- cutting issue in all o f its projects in addition to having two dedicated HIV/AIDS prevention and treatment programs.23 23The Bank is providing financial and technical assistanceto support the government inimplementing its HIViAIDSResponseProject (MAP)which aims to slow the spread ofHIV/AIDS inMozambique and mitigate the effects o fthe epidemic, through prevention, care, treatment and mitigation. The Bank i s also supporting implementation o f the Treatment Acceleration Project (TAP) inMozambique which covers: (i) scaling-up o fHIV/AIDS care and treatment; (ii) strengthening institutional capacity o f M O H for HIV/AIDScare andtreatment; and (iii) facilitating regional learning from the TAP country experiences. - 40 -  ANNEXES - 41 -  M  R 3 I cs) d I  3+ vl m k 0 b E 2 5c W 3 ". E 5 N 9 5 b 2 h m 0 0 N .-e 0 -. N N 0 s - m '? d sc N 0' I 3 I  I I  I \o d I  T 3 1 h n I b d I  t I I   - e N 5 4 6 I 0 VI I H If  le  0 0 0 0 0 D 0  ANNEX4: IMFPUBLICINFORMATION NOTE EXI'ERNAL RflATiONS DEPARTMENT Public InformationNotice (PIN) No. 07/84 FORIMMEDIATERELEASE International Monetary Fund July 24,2007 700 lgthStreet, NW Washington, D. C. 20431 USA IMF Executive Board Concludes 2007 Article IV Consultation with Mozambique On June 18, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with M~zambique.~~ Background The Mozambican economy has continued to perform well in recent years and is increasingly resilient to exogenous shocks. Real GDP growth has picked up in 2006 led by a recovery in agricultural production and construction activities while the trade balance improved due to a surge in exports. Headline inflation has fallen to single digit levels anchored by a prudent monetary stance. The outlook for 2007 is for continued strong growth, inflation in the range of 5-7 percent, and a sustainable fiscal and external position, with some risks related to a further rise in oil prices. Policy challenges remain, however, in sustaining Mozambique's growth takeoff and achieving the Millennium Development Goals (MDGs). The stabilization effort and a first-wave of reforms helped sustain a growth of 8 percent a year, on average, since the early 1990s. Broad-based growth and foreign aid, including debt relief, helped reduce poverty and improve social indicators. The experience of countries that have kept growth accelerating over the long run suggests a need to consolidate macroeconomic stability and implement second-generation reforms, including a scaling-up of basic services to address human capital and infrastructure gaps. 24 UnderArticle IV of the IMF'sArticles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusseswith officials the country's economic developments and policies. On returnto headquarters,the staff prepares a report,which forms the basisfor discussion by the Executive Board. At the conclusion of the discussion,the Managing Director, as Chairman of the Board,summarizesthe views of Executive Directors, and this summary is transmittedto the country's authorities. - 53 -  The arrangement under the Poverty Reduction and Growth Facility (PRGF) helped maintain macroeconomic stability in the face of exogenous shocks and addressed the structural weaknesses identified in the Ex Post Assessment (EPA, IMF/04/53). Overall performance under the program has been good, which has helped the authorities maintain inflation control and a comfortable level of international reserves in the face of exogenous shocks. The authorities also completed reforms identified in the EPA-particularly in strengthening revenue mobilization by creating a central revenue authority (ATM), improving expenditure efficiency through the rollout of a government financial management information system (e-SISTAFE), and addressing vulnerabilities in the financial system. The three-year Policy Support Instrument (2007-1 0) is focused on consolidating macroeconomic stability to sustain Mozambique's growth takeoff in the context of scaled-up foreign aid. Fiscal policy will be reinforced to finance additional priority spending in a sustainable manner and ensure that a scaling-up of aid-financed expenditures reaches the most productive and pro-poor sectors. Monetary control will anchor inflationary expectations while a flexible exchange rate regime will help maintain competitiveness and a comfortable level of international reserves to cushion against exogenous shocks. The structural program aims at improving the business environment by deepening the financial system and reducing the cost of doing business, as well as strengthening the fiscal and transparency regime of the natural resource sector. Institutional and capacity building need to keep pace with the rapid structural transformation of the economy and facilitate the implementation of second-generation reforms. Executive Board Assessment Executive Directors agreed with the thrust of the staff appraisal. Directors commended the Mozambican authorities on the impressive macroeconomic performance and overall satisfactory program performance since the last Article IV consultation. They noted that the economy has been resilient to numerous exogenous shocks, and the outlook is for continued strong growth, moderate inflation, and a sustainable fiscal and external position. Progress has also been made in reducing poverty. Directors agreed that there are policy challenges related to sustaining Mozambique's growth takeoff and to achieving the MDGs. The strategy to consolidate macroeconomic stability in the context of a continued scaling-up of foreign aid and the acceleration of a second wave of reforms outlined in the authorities' poverty reduction plan (PARPA II) for 2006-09, to be monitored under the new Policy Support Instrument arrangement, should help sustain strong broad-based growth. Directors noted that consolidating macroeconomic stability would require persevering with sound fiscal and monetary policies, as well as prudent public debt management and public finance reforms. In this regard, the medium-term fiscal framework will need to continue to target an annual 0.5 percent GDP revenue increase and no recourse to financing from the domestic financial system. This should help contain inflation and allow private sector credit to expand further and - 54 -  decrease its cost, while maintaining competitiveness and debt sustainability and reducing aid dependency. Directors agreed that the 2007 budget was appropriate as it targeted a 0.5 percent of GDP rise in domestic revenue with the share of priority expenditures exceeding 65 percent of total spending. The rollout of the public financial administration system (e- SISTAFE) to all public entities at the central and provincial level, and direct execution of a greater share of current spending should improve monitoring of expenditures. The finalization of guidelines to include donor-funded projects in the single treasury account (CUT) and e-SISTAFE as well as the opening of a multicurrency CUT should be expedited to encourage the donors to transfer projects on CUT. Directors noted that the public sector reform program is at a critical juncture. They looked forward to the installation of a clean integrated payroll database based on a civil service census and the piloting of program budgeting. The government's decentralization strategy should be clarified and well sequenced with sufficient capacity building and reporting systems to ensure accountability of budgetary resources. This would help address concerns about the accountability and transparency of district spending. Directors looked forward to visible results of the anti-corruption strategy and judicial sector reform. Directors supported the Bank of Mozambique's policy framework of base money targeting, in conjunction with a flexible exchange rate regime. They welcomed the abolition of the exchange rate band, which demonstrates the commitment of the authorities to a flexible exchange rate regime, and which should help cushion against exogenous shocks and improve competitiveness. Directors emphasized that second-generation institutional reforms are critical to sustain economic growth. A private sector led growth strategy calls for a strengthening of the business environment, particularly a deepening of the financial sector while strengthening the supervisory framework. Directors welcomed the approval of the new mining and petroleum fiscal laws, and looked forward to the timely adoption of their implementing regulations. They also encouraged the adoption of new model contracts in the mining and petroleum sectors while ensuring that all new sizable projects abide by the principles of the new fiscal regime and the core principles of the Extractive Industries Transparency Initiative. Directors welcomed the good progress made in seeking financing for the transfer of majority ownership of the Cahora Bassa hydropower plant from Portugal to Mozambique. They noted the authorities' renewed commitment to non-recourse financing so as not to increase the government's liabilities to commercial creditors, and ensure transparency and accountability. These principles could be applied to all future infrastructure projects, while encouraging greater private participation to reduce risks to debt sustainability. Directors emphasized that the timely implementation of the strategic action plan to reduce the cost of doing business will be key to promote export diversification and - 55 -  generate employment. In this regard, high fees charged for scanning freight is a concern, as they increase export/import transaction costs. It is expected that the next Article IV consultation with Mozambique will be held within 24 months, subject to the provisions of the Executive Board decision on consultation cycles in program countries. Public hformafion Notices (PINS)form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINSare issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINSare also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. - 56 -  ANNEX5: LETTER DEVELOPMENT OF POLICY <: MXX'IST~~RTU PXANIF~CACAOE RESENVOINTMENTO REP BtIC'A DE MOCA111BIQL'E DA GAIXINEI'E: DO NIN Oficin n"381/MPD/GM/2007 Subject: Lcttcr oDcvelopmentPolicyfor the FourthPavertyReductionSupport Credit (PRSC It? Ucar Mr. 7hAlick, I.Iam writing on behalf of the Goveniment of the Republic of Illozatnbique,to mqucst a Credit to iitiarw the FourthPow% Reduction Suppnrt Credit (PRSC-lV) in the amount of lISD60 million from the International Development Association (IDA),'go- kupport thc continuingreform prngramme under the proposed Poverty ReductionSupport Credits. This request comes in the context of the Memorandum of Understanding(Moll) bettvccn the Government of the Republic o f Mombique and inteenintionalaid partners, includingthe World Hank Group, signed in Maputo on April 5, 2004. The MoU Q nes tlic participatit's approach to the provision o f budget support, amongother related measures. 2' The aforementioned Credit wilt help to meet the financing Moz;mbi,cpe faces to irnpIenicnt the Second Action Pian for Absolute Poverty (PARPA-II), throughthc Economic and Social annual budget(OE) Rx the year 2008, 'I'he I"rogr~mme 3. As set out in the 2005-09 Five Year Pwgraiiime, the Government has as the main objective thc reductionofche levels of absolute poverty in Mowmbiquc. To achieve .this goal, PARPA-II presents a strategy and progrmrne focused on the tbltowing key priorities areas: human capital dewiopmont (including education, health and iiccess to potable waterer); governance (gcwd guveniunce, legality and justice including public and legal sector reform); cconarnic development (ineluding the promotion of national entrepreneurship arid infrastructure development); and cross- cuttingissues includingenvironment, i.IIV/AlDS and gender. 4. *I C .proudspmific of the progress made under PAWA-I which 'Thc ol3,jcctivc of PARPA-! was to reduce the inciderice o f absolutepoverty to less than SO percent by 20IO, Overview of Recent P~oprcss 5. PARPA implementaxion in 2005 was broadly positive, as noted in the April 2007 Joint Review involving tl-e Govcrnmcnt and the I~ro~amme Partners (PAPS) Aid includingIDA, The Mozambicaneconomy continue grow strongly achieving a CiDP growth rate OF8 percent in 2006 and a rat@of tionjust below 10 percent - 57 -  by December 2006. ut-thcmore, satisfactory progress was made in health. education, and water and sanitation service deli he integrationof the PES, OE and the Medium Te nanciiig Fmmework P) and the strertgthening the BaIango do PES ( ) to monitor the P us provcd to be a suceess. Significant iinprov tative p ~ e r t ) ranalysis aid dissetnitiation, Steps tu improve the monitoring s wcre also noted. 6. The monitoringof the PXRPA continued tcr improve and there was some progress towards the key indicator in the PES and in the PAPS`~ ~ Assessment~ ~ ~ Fmwmcwork (PAt;) of crrsuring ~ h cintegrution of the PES, OR and CF'MP arid strengthening the BdPES. The expctidihircs in priority xcctom werc &S.IUJ;, in tine die titrget of 6S!4 al" rlic total, of w 54% went to education atid health (hence attaining the 50% PRSPAF irid s), PerfOrnlancc against PESRAF targets in piiblic service delivery was e, In education, pcrformance was broadly sn-track and nil targets were ex In health, PAF indicators continue to show positive prop nto the average uptake cifservices h surpassed the target defined in 2006. Positive progress was made both in PESPAF and Milleniiiuin 13evelaprnent Goats (MDC) indicators. Although the 200G PESiPAF targets were met, HLVIAIDS remains qne of the greatest threa to Mozambique'sdevcl nt and once again a stranger and bcttcr ccwrdinilrcdg, sitivc niulzi-sect( sporisei s needed. In terms of the enviromtient for private sector development, significant progcss w;fs rnadc in 2007. Thesc progresses are rdlecrrd in the improvemerit of Mozambiquerankingby 6 places to position 134 aut of 178 cconarnics inthe 2008 ness Survey, relcase tembor 2007, reflecting the gavcrnm t. Mo~arnbiquewas the top iivc rcfuming COLI Sdiaraii Africa. hifozarnbiqiie was the second fhstest rclbmer overall in the category "Protecting Inv~stors",whcre~its rankjumped 63 places from 96 to 33, The 1888 Commercial Code was replaced with a new one that introduces stricter corporatc governance rules and strcngthcns thc rights of ininority sharchol t progress WEB achieved too in the category `5 ), where die stat- e months from an Code for Registry oF Legal h 2006, simplified the procedures for busiiiess regi ovemment approved a decree in September 2006, w ffectivc as soon as it is d on the govcrnmcnt's ofxcial wcbsitc. As result of these reforms it is now ta open a business in30days, comparedto 153 days in2005. 8. The impact of this progress on povcrty rtxhction continues to be significant. The last householdsurvey, completedin 200212003, shows that poverty incidence (based anthe headcaunr index) declined to 54 percent in2063 (from 69,4 percent in 1997), and is expectedto decline fhher. 9. `She Govenmetit's cotnnii nt to addressing tlrc Millennium Ikvtlopment Goals (MI)Gsf remains strong. This is rcflcctcd in the PARPA-II, w h s e key summarized in a matrix, along with indicators incfuded in the Performance - 58 -  Assessment Framework (PAP) agreed with the G~~vernmentdirect budget support '3 p&rtnen, to pcnnie monikxjng. The Programme defined instruments will be im through Government system with monitu evaluation reported in nment's nnnuai Economic and Social Plan nd the annual State Budget(OE) that are submittedto the Iktiamerrt for approval, 1O.The Government's progymme baing submitted for suppart: PRSC-IV includes three main coin Chat are an integwl part.of the wider PARPA, PES, and PAF matrices.They are: oeeonumic Mamag 11.'The Goverment remainscointnittd ta maintain macroeconomicstability, improw public financial rtlanagem , and enhmcc govcmance. 'ihe Government is also committed to ensuring that budget allocation to priority sectors are in line with the CFMP, and to continue to implement nieasuresto streagtthen revenue tnobilization y and ringof the budget '1I'he Government wiil imp1 ion of the new p t system, and cxpand fficiency of internaland cx a) 'The Ciovemment wiI1maintainrnacrcmxmrmicstability through adheringto an appropriate macroeconomic framcwork with consistent fiscal and monetary poticics. It will also continue to i ve public financial thro monitoring closely and allocatin resources to pro-p in b) 'I%e 6QVertIIRent WiiI also Continue udgetq eEcicncy, transparency and accountability by c e md implementing APE). SpccLEicaIly, in the Ministry of Finance and all its the rail-out to all . e) The Government Continues to be comm mobilization,The process was sta through restructuringt 'I"axcsand Audit (DNIA),to be in ted with the CustomsDirectorate (DGA) under the new Central Revenue Authority (AT) whi late 2005 and whose by-law were approved in 2 several measur~swere adopted aiming to improve collection m d widen the tax base. including (is an payers; (ii)an iticrcase af tax its of large tax payers, including mega prqjects; (iii)P Grnplificatianof tax declaration forms; (iv) intensifleationof Gscal education and sarnmunicatiancampaigns at centnil zand provincial levels; and (v) a reduction it1 average time to release imported goods tit the border. In addition, the lnfsmtationT'ecknohgyPlan(PDTII) for 2007-2010 was approved by Government in June and a revenue collection network, that electronically consolidates all clmsiCed revenues and links them to e-STSTAFB {e 'l"ributag8o) has n developed and awaits the approval of financing from the - 59 -  developtmnt partners. In par xfonns, eff'ective total revenue have increased from 14.1YO 005, to 15.6% in 2006, and we tf to reach 16.1% hy ihe end of 2087. 'I'kc Government wili also continue implementation of the procurement reforms. Followingthe approval of the new Procurement e%t%blishd the central proCUrEmen$ in arid made opewtional during 2007. We will also pursue the estabiishment of a monitoringsystem to incrcase transparency and masure the tivencss af the ~C~QITW, in 1 th (3tECI)IP)AC methodology for the ssmcnt ofnationalprocureinen nrs. The Government is also imprcrving the timeliness and yuoiity o f the natianal accounts, auditing and budgetary reporting, To this ptirpose we have a1 audit iiistitutiun(tCif) to conduct audits such that thc numberofaudits completedby the 'fGFdmost doubledinrelation to 2005,and %F cmied ouC almost all planned audit activities, The Government is working to k&binue to strengthen the coverage of internal audit at ces.lual and decenrralixed levels uiid to address other aspects of internaf control which require improvement, 'The Government is also working to increaw efficiency and accountability, by strengthening the capacity of the 'Trihunal Administrativo, which is our Supreim Audit institution, to conduct inore audits and expand thc audit coverage. Govern! nee '12,The Government aims to' improye go nmw by scvcrd tneaswes listed abovc, such as strengthen Public Financial Management and bringing public procurement in tine .Iintcrnationrpl practice, In addition, thc Govemtncnt is restructuringits key sectoral minis s to be more responsive tu citizen needs from the district lcvel; it is pursuing decentralization by increasing budget excuution in .provincesand districts, and decentralizingthe delivery of' specified services to lncail authorities, to expand community participation and gavermcnt accountclbility; and is interisiking the fight against camption, nent is working to prepare 8 National Decentralization Strategy in 2008, which will also benefit from a process ~f public consultations. 'The strategy is being prepared with the help of the World Bank and othcr partners, and is expected to clarify the legal, regulatory,ar stitutiunal framework tbr TCVC~UCraisingand spendingresponsibilitiesarid ions of subnationatunits (provinces, districts, and inuni alities) and mcmiroring of subnational fiscal opcrations. The sequencing the strategy will pay d administrativecapacity of subnationalunits and need to mai as well as fiscal sustainability, In addition, the Gavernmant the National Prngrarn of Dcccntralimi ort the coptlcity for planningand finance at the decentralized level. The - 60 -  stmtcgy has been drafted in 2007, and is expected to be ready for my approval shortly. The document w i l l define the main pillars ofthe National Program, its objectives, key activities and indi hf The Government is also ovirtg its payroll management, and in this con it has carried out in 20 census of thc civil servicc. The data from Census are currcntly being verified and will lead to 'the creation o f a single registry of State ofticials and civil survwts (Cndastro dos Agcntcs c ios Puhticos, CAF). CAF wiil allow the dcvelopment and implcmcntation of features that support the strategic mmnagement of human ingtkc payroll.Notably, the CAF will be used as the database fir the new integrated payroll management system within e-SISTAFE, allowing the payment of salaries via e-SISTAFE. Tiicse measures will also provide a sound basis for ti comprehcnsive refotm of civil service wages in fun~r~ years. Ecommic Development 13.Recoynizing the tnain role of the pri sector in the ec nt, Government policies and s have improve the developmentofprivatesector activities, and reinforcedthe role of the market in the economy, as described above. In addition to introdwing improvements io the busincss environment, the Government aims 10 accelerate economic dav through thc development of the invcstrneiit strategy of the National In Social Security (INSS) as a hnnisnr to improve the insurance a protectivn sectow, developing ter infrastructure, aid incrcasing agricultural productivity. i Ctovernnient is worlcjrtg to ensure h e flnwcial w s t bitity of the socia1 security and ta c n w e the adoptionof best practiceand transparency in thc man t ofthe Social Security funds. The preparation of rn actuarial study and the elaboration aT rm investment strategy are expected to be complctcdshortly, and form the basis for the refom of the system. Tlhe Covcrment is also working to improve the quality of road infrastructure, by increasingthe extent of mh atitiun*md~ a ~ afthe roadn e ~ ~ ~ $ ~ ~ Towards this purpose, the Go lent has continued rhe renewal process of the National Road Ad (AXE) started in 201)6 appointment ofnew Di as welX as staff'rng of ANE headq egations. In this context, the decree &at crmted ANE Decree nr. 20 dated May 2003, was recently reviewed in April 3,2007, alte item2 of Article 8 to mxmitlodate the renewalprcxxss, k) 'I'hc Government is also itss ing farmers to increase agricuItural psaductivity by supporting an expansion inthe irrigated area, and an increasingthe capacity and reach ofextension scrviccs. 'The Gfovcmicntis promotingthe adoption of ? - 61 -  techniques, aid has un rtaken subst;atltisI investmcnts in ion and/or rehabilitationof i tirrn systems with public furrds, 'X'he so prepared a strategy fur th on services aid has of the exztnsiori services conditions ofthe extension agents, notably by i cess to means of transportationaid increasing the number of far 157. Growth in agricultural productian in 2006 was strong at around 9940~but this was partly due to a rebound &an-the climatic shacks of 2005. 'I'he Govertinicnt's strong intentionis to SL rnwtliinagricultural production through the ~nea~ures lis rKIM,SUrCS CulT&f y beingctrnsidered. Conclusiori rk aims at consolidating inacroeeonamie stability, and is mnsiste . , diurn-term goal of r - reduction through strong broad-based economic growth, TFie G committed to the everatl objective w f poverty reduction through sustainable ceanornic growth. 1%is, therefore3,the tiowrn~i~w~t's that iDA will grant she: hope requestedCredit to tion ofthe proposed programtne. With highestconsideration, 7-0: Robert Zoellick, President The World lZank 1818HStreet, N.W. W;ashingtan, D.C. 20433 U.S,A. - 62 -  ANNEX6: MOZAMBIQUE AT A GLANCE Mozambique at a glance 12/2/07 Sub- Key Development Indicators Saharan Low Mozambique Africa income Age distribution, 2006 (ZOOS) Male Female Population,mid-year (millions) 20.1 770 2,403 10-74 Surface area (thousand sq. km) 802 24,265 29,215 60-64 Populationgrowth (Oh) 1.8 2.3 1.8 50-54 Urban population (% of total population) 35 36 30 4 0 4 GNi (Atlas method, US5 billions) 6.5 648 1,562 30-34 GNI per capita (Atlas method, US$) 320 842 650 20-24 GNI per capita (PPP, international 5) 1,220 2,032 2,698 10-14 0-4 GDP growth (%) 8.0 5.6 8.0 20 IO 0 10 20 GDP per capita growth (%) 6.1 3.2 6.1 percent (most recent estimate, 2000-ZOOS) Poverty headcount ratio at 51 a day (PPP, %) 36 41 Poverty headcount ratio at 52 a day (PPP, Oh) 74 72 Under-5mortality rate (per 1,000) Life expectancy at birth (years) 42 47 59 Infant mortality (per 1,000 live births) 100 96 75 Child malnutrition (X of children under 5) 24 29 Adult literacy, male (%of ages 15 and older) 45 1/ 69 72 Adult literacy.female (Ohof ages 15 and older) 50 50 Gross primary enrollment, male (% of age group) 111 98 108 Gross primary enrollment. female (% of age group) 94 86 96 Access to an improved water source (% of population) 43 56 75 Access to improved sanitation facilities (% of population) 32 37 38 OMozambique OSub-Saharan Africa Net Aid Flows 1980 1990 2000 2006 /US$ millions) Net ODA and official aid 167 998 876 1,286 jrowth of GDP and GDP per capita (%) Top 3 donors (in 2005): United States 9 62 116 96 15 7 United Kingdom 11 43 83 81 Sweden 36 136 46 79 Aid (% of GNi) 4.7 42.2 21.5 21.1 Aid per capita (US$) 14 74 49 65 Long-Term Economic Trends 90 95 00 05 Consumer prices (annual % change) 4.2 43.7 12.7 13.2 GDP implicit deflator (annual % change) 4.1 34.1 12.0 6.0 -+-GDP - GDP per capita Exchange rate (annual average, local per US5) 32.4 929.1 15,227.2 24,982.1 Terms of trade index (2000 = 100) 85 109 100 155 1980-90 1990-2000 2000-06 (average annualgrowth %) Population, mid-year (millions) 12.0 13.4 17.9 20.1 1.1 2.9 2.0 GDP (US5 millions) 3,526 2,512 4,310 6,948 -0.1 5.7 8.2 /% of GDP) Agriculture 0.0 37.1 22.9 28.3 6.6 4.9 7.9 lndustly 0.0 18.4 23.4 25.9 -4.5 12.8 9.6 Manufacturing 10.2 11.7 15.5 10.2 12.4 Services 100.0 44.5 53.7 45.8 6.7 2.8 7.8 Household final consumption expenditure 96.7 92.3 79.5 75.6 -1.6 2.9 4.8 General gov't final consumption expenditure 12.2 13.5 9.0 11.1 -1.1 4.2 8.1 Gross capital formation 7.6 22.1 31.O 19.3 4.1 10.0 2.3 Exports of goods and services 10.9 8.2 17.5 41.4 -6.8 13.1 19.8 imports of goods and services 27.4 36.1 37.0 47.5 -3.8 5.0 7.2 Gross savings -6.9 2.1 11.5 13.3 Note: Figures in italics are for years other than those specified. 2006 data are preliminary. .. indicates data are not available. a. Aid data are for 2005. 1/ Adult literacy. total (%of ages 15 and older). Development Economics, Development Data Group (DECDG) and AFTPl calculations - 63 -  Mozambique Balance of Payments and Trade 2000 2006 IGovernanceIndicators, 2000 and 2006 (US$ millions) Total merchandise exports (fob) 364 2,381 Total merchandise imports (cif) 1,163 2,914 Net trade in goods and sewices -815 -421 Current account balance -1,042 -1,125 as a % of GDP -24.2 -16.2 Regulatoryquality Workers' remittances and Ruleof law compensation of employees (receipts) 37 57 Controlof corruption Reserves, including gold 745 1,241 0 25 50 15 100 Central Government Finance 02006 Country'spercentilerank (0-100) 02000 higher values imply bsller rafmgr (% of GDP) Current revenue (includingcurrent grants) 15.2 21.1 Source Kaufmann-Kraav-Mastruul World Bank Tax revenue 10.5 13.4 Current expenditure 11.7 14.7 Technology and Infrastructure 2000 2005 Overall current surplusldeficit -8.5 -7.2 Overall surplus/deficit -5.2 -1.7 Paved roads (Ohof total) 18.7 Highest marginal tax rate (Oh) Fixed line and mobile phone Individual 20 32 subscribers (per 1,000 people) 8 40 Corporate 35 32 High technology exports ("hof manufacturedexports) 9.2 7 5 External Debt and Resource Flows Environment (US$ millions) Total debt outstanding and disbursed 7,258 4,631 Agricultural land (Oh of land area) 61 62 Total debt service 96 392 Forest area (Oh of land area) 24.9 24 6 Debt relief (HIPC, MDRI) 449 1,937 Nationally protected areas (Oh of land area) 5 8 Total debt (Ohof GDP) 168.4 66.7 Freshwater resources per capita (cu. meters) 5,068 Total debt service (Oh of exports) 12.5 13.3 Freshwater withdrawal ( O hof internal resources) 0.6 Foreign direct investment (net inflows) 139 154 C02 emissions per capita (mt) 0.07 0 08 Portfolio equity (net inflows) 0 0 GDP per unit of energy use (2000 PPP $ per kg of oil equivalent) 2.0 2 4 lCompositlon of total external debt, 2006 IDA, 667 Energy use per capita (kg of oil equivalent) 402 441 IBRO, 0 / 5 Olher multi- (US$ millions) laleml 476 IBRD Total debt outstanding and disbursed 0 0 Disbursements 0 0 Principal repayments 0 0 Interest payments 0 0 IDA Total debt outstanding and disbursed 760 667 Disbursements 98 190 Private Sector Development 2000 2006 Total debt service 8 11 Time required to start a business (days) - 113 IFC (fiscal year) Cost to start a business (Ohof GNI per capita) - 85.7 Total disbursed and outstanding portfolio 99 115 Time required to register property (days) - 42 of which iFC own account 99 115 Disbursementsfor IFC own account 49 13 Ranked as a major constraint to business Portfolio sales, prepayments and (Ohof managers surveyed who agreed) repayments for IFC own account 3 7 n.a. n.a. MlGA Gross exDosure 114 238 Stock market capitalization (% of GDP) Bank capital to asset ralio (Oh) 8.2 6.5 Note: Figures in italics are for years other than those specified. 2006 data are preliminary 12/2/07 ..indicatesdata are not available. -indicates observation is not applicable. Development Economics, Development Data Group (DECDG) and AFTPl caicuiatinos. - 64 -  Millennium Development Goals Mozambique W/thselected targets to achleve between 1990 and 2015 (estimate closest to dale shown, +/- 2 years) Goal 1:halve the rates for $1 a day poverty and malnutrition 1990 1995 2000 2005 Poverty headcount ratio at $1 a day (PPP, % of population) 37 9 36 2 362 Poverty headcount ratio at national povertyline (% of population) 69.4 54.4 Share of income or consumption to the poorest qunitile (%) 6.5 5.4 Prevalence of malnutrition (% of children under 5) 27.0 26 0 23 7 6 13 (% of people ages 15-24) Propoltion of seats held by women in national parliament (%) of one-yearolds immunized, %) Maternalmortalityratio (modeled estimate, per 100,000 live births) 1,000 Births attended by skilled health staff (% of total) 44 48 Goal 6: halt and begin to reverse the spread of HiWAIDS and other major diseases Prevalence of HIV (% of population ages 1549) Contraceptiveprevalence (% of women ages 15-49) Incidenceof tuberculosis (per 100,000people) Tuberculosis cases detected under DOTS (%) C02 emissions (metric tons per capita) GDP per unit of energy use (constant 2000 PPP $ per kg of oii equivalent) Personal computers (per 1,000 people) Youth unemployment(% of total labor force ages 15-24) iducation indicators (Oh) IMeasles Immunization (%of I-year oids) I ICT Indicators (per 1,000people) I 501 ` O 0 1 2000 2002 2005 I 1 1990 1995 2000 2005 +Primary netenrollment ratio -4%- Ratioofgirlsto boysinprimary& Sub-SaharanAfrica 0Fixed+ mobilesubscribers sewndary education 0 Mozambique 0 internetusers Note: Figures in italics are for years other than those specified. .. indicates data are not available. 12/2/07 Development Economics, Development Data Group (DECDG). - 65 -  - 66 -