Mozambique - Rehabilitation Program Project

Document of The World Bank FOR OMCIAL USE ONLY CA /. - AC) Report N.- P-4100-MOZ REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 45.5 MILLION TO THE PEOPLE'S REPUBLIC OF MOZAMBIQUE FOR A REHABILITATION PROGRAM May 30, 1985 ITs document bh a resricted dlsbuow and my he used by reciplents only In the perfermace of tei soffica dade. lb content mya o orwise be dsco widho Wed Bak ahdutiou.  CURRENCY EQUIVALENTS Currency Unit = Metical (pl. Meticais) US$1 = 42.85 Meticais (April, 1985) M1.00 = US$0.023 ABBREVIATIONS AND ACRONYMS AGRICOM - State Enterprise for Trade in Rural Areas BOM - Bank of Mozambique BOROR - State Agricultural Input Supply Enterprise CNSP - National Wage and Price Commission FRELIMO - Front for the Liberation of Mozambique (National Governing Party) IFAD - International Fund for Agricultural Development HIDROMOC - State Enterprise for Hydraulic Equipment INTERQUIMICA - State Enterprise for Foreign Trade of Chemical and Plastic Products INTERMAQUINA - State Enterprise for Foreign Trade of Industrial Equipment INTERMECANO - State Enterprise for Foreign Trade of Vehicles INTERMETAL - State Enterprise for Foreign Trade of Metals PAE - Economic Action Program, 1984-86 PU - Procurement Unit RITES - Rail India Technical Services UDAT - Directorate of Maintenance of the State Secretariat of Road Transport FISCAL YEAR Government of Mozambique: January 1 - December 31  FOR OMCIL USE ONLY MOZAMBIQUE REHABILITATION PROGRAM SUMMARY OF THE PROPOSED CREDIT Borrower: People's Republic of Mozambique Executing Agencies: Ministries of Agriculture; Industry and Energy; Construction and Water; Ports, Railways, and Merchant Marine; and the State Secretariats of Road Transport and Light Industry, under the coordination of the Bank of Mozambique. Credit Amount: SDR 45.5 million (US$45 million equivalent) Terms: Standard Purpose: The proposed IDA Credit-the Bank Group's first operation in Mozambique-would help meet the country's priority economic rehabilitation needs within the context of the Government's Economic Action Program (PAE) for 1984-86. The PAE is designed to initiate the process of correcting structural imbalances and rehabilitating the economy. It focusses on increasing agricultural production and trade, and calls for actions to improve the supply of inputs and basic consuner goods to smallholder farmers, to provide price incentives and to improve the financial situation of enter- prises. The PAE also provides for the introduction of a tighter credit policy, changes in interest rates, and a review of exchange rate policy. While implementation of the PAE is just beginning, its directives provide a reference point for the proposed first IDA lending operation focussed on the rehabili- tation and maintenance of those investments and economic services which may be expected to generate some immediate production response. The proposed credit would help finance part of the Government's 1985/86 program of imports of equipment, spare parts and raw materials, as well as related technical assistance, in the key industry, transport, and agri- culture sectors. This document has a resticted distnbution and may be used by recpients ondy in the perornne ofr their official duties Its contents may not otherwie be discosed without World Bank authotion.  - ii - Risks: The main risk associated with the proposed credit is that procurement and deployment of goods and services to be financed under the credit and the related induced production may be hampered by the Govern- ment's limited implementation capacity and the diffi- cult security situation which affects parts of the country's rural areas. Appropriate consideration was given to these aspects at the design stage. Emphasis placed on detailed identification of beneficiary activities and entities, simplification and clarifi- cation of operating arrangements, as well as sharply focussed technical assistance measures, would help mitigate the risk associated with implementation capacity constraints. Attempts are currently being made to improve the overall internal security situa- tion through diplomatic channe-ls. While security conditions remain difficult in some rural areas, the impact on activities to be supported under the credit should be minimal, since every attempt has been made to target the activities to be supported under the credit to the more secure areas. A long term risk is that the Government might delay initiating key economic reforms provided under the PAE or defining concrete ways to tackle the needed reforms, thus failing to create a sustained recovery environment. Estimated Disbursements: -US$ millions- IDA FY 1986 1987 1988 25.0 15.0 5.0 Economic Rate of Return: Not applicable Staff Appraisal Report: None IBRD 18436  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE PEOPLE'S REPUBLIC OF MOZAMBIQUE FOR A REHABILITATION PROGRAM 1. I submi: the following report and recommendations on a proposed rehabilitation program credit to the Republic of Mozambique for SDR 45.5 million (US$45 million equivalent) on standard IDA terms. PART I - THE ECONOMY 2. The People's Republic of Mozambique becsme the 148th member of the World Bank in September 1984. An economic report entitled -Mozambique: An Introductory Economic Survey", which is based on the findings of an economic mission that visited Maputo in November 1984, is being prepared for distribution to the Executive Directors in early June 1985. These findings are summarized below. Basic economic data and selected social indicators are summarized in Annex I. 3. Despite a relatively well-endowed natural resource base, Mozambique has been beset with financial and economic difficulties since Independence in June 1975. In part, these difficulties can be traced back to the socioeconomic conditions which the country inherited at Independence, natural calamities, and difficult security conditions. These factors, combined with policy shortcomings associated with the Government's approaches to the development of the economy, have contributed to the critical situation which Mozambique faces today. Country Background 4. The People's Republic of Mozambique, located on the southeastern coast of Africa, is bounded on the north by Tanzania, on the south by Swaziland and the Natal Province of South Africa; and on the west by Malawi, Zambia, Zimbabwe, and the Transvaal Province of South Africa (see map IBRD 18436 attached to this report). It has a total area of 799,380 square kilometers, larger than England, France, and Portugal combined. It has a lengthy coastline of 2,470 kilometers with some major and minor ports. The three principal ports - Maputo, Beira, and Nacala - provide outlets for the trade of neighboring landlocked countries and the Transvaal Province of South Africa. 5. There are almost 100 river basins in the country, the most important being the Limpopo, Save, Zambezi, Lurio and Rovuma. Nany of these rivers have considerable potential for hydroelectric power generation and irrigated agriculture. Mozambique also appears to have sizeable mineral resources, although geological surveys are still incomplete. Few mineral resources have been exploited so far. Coal is the most abundant mineral, with reserves estimated at 7.5 billion tons. There are also  - 2 - deposits of tantalite, iron ore, bauxite, zinc, tin, copper, manganese, asbestos, fluorite, uranium, and natural gas. Extensive in-shore and off-shore petroleum exploration is presently being carried out by foreign firms under risk contracts. 6. Mozambique's population was estimated at 13.6 million on January 1, 1985, and is overwhelmingly rural (87 percent of the population lives in rural areas). Population growth has accelerated to 2.6 percent per annum in recent years (from 2.4 percent per annum in 1970-75 and 2.0 percent per annum in 1960-65). Population projections for the year 2000 vary between 20 and 24 million. The Government has no policy of intervention to modify fertility or the overall rate of population growth. The average population density in January 1985 was 17 inhabitants per square kilometer. Socioeconomic Conditions at Independence 7. FRELIMO (Frente de Libertaclo de Mocambique) assumed power in 1975 after a ten-year armed struggle to liberate the country from Portuguese rule. The new government inherited an economy largely geared to the service needs of South Africa and other neighboring countries, and an incipient high-cost industrial sector based on imported raw materials and spare parts and on a steady supply of easy credit. The economy also exhibited other serious distortions. In agriculture, the land was divided between some 1.7 million traditional African farms averaging 1.4 hectares and 4,500 European commercial farms averaging over 500 hectares. Non-Africans dominated modern sector employment by force of superior education opportunities. 8. The development of Mozambique as a service economy to South Africa was linked to the surge of coal and gold mining in the Transvaal region since the late 1890s. This event greatly expanded South Africa's demand for cheap labor and for a convenient port through which to export its mineral output. Mozambique was in a good position to satisfy both these requirements. It provided an average of more than 80,000 workers per year to the South African mines, and carried trade flows via the railroad linking the Transvaal Province with the port of Lourenco Marques (now Maputo). Under agreements with the Portuguese Government, 60 percent of the workers' wages were withheld, and an equivalent amount in gold, at the official price of US$34.13 per ounce, was credited to Portugal, which sold the gold at the higher market rate. As workers received the deferred wages in escudos at the official rate of exchange, the difference between the official price of gold and its free market price represented a profit for Portugal. These profits, along with revenues from transit services to South Africa, Rhodesia (now Zimbabwe), Zambia, and Malawi, were usually sufficient to offset chronic deficits in Mozambique's merchandise trade account. 9. Mozambique was extremely vulnerable to the mass exodus of Portuguese settlers that occurred at Independence. It is estimated that between 1974 and 1976, the number of Portuguese permanent residents fell from 250 thousand to 15-20 thousand. This population movement decimated whole sectors of the economy. For example, the critical port and railway sector lost some 7,000 skilled and semi-skilled workers. Gone also were most of the plantation and factory owners, settler farmers, shopkeepers,  -3- government administrators, and professionals. To make matters worse, departing settlers destroyed factories and farms, depleted inventories, and in some cases either slaughtered livestock herds or transferred them to South Africa. Despite the Government's substantial recourse to external technical assistance and the high priority given to education, lack of skilled and semi-skilled workers continues to be, ten years after Independence, a major constraint to the country's development efforts. Exogenous Constraints to Development 10. Service Exports. Mozambique has found it difficult to maintain its traditional exports of services since Independence. Trade flows have been diverted from Maputo since the completion of the South African ports of Richards Bay and Saldanha Bay in the mid-1970s. Mozambique's earnings remittances have been reduced because South Africa cut back the number of Mozambicans working in its mines. Starting in 1978, South Africa also stopped paying part of the Mozambican workers salaries in gold at the fixed price of US$34.13 per ounce. Moreover, from 1976 to 1980, Mozambique closed its borders with Rhodesia in support of United Nations' sanctions. This action is estimated to have cost Mozambique about US$150 million per year in foregone foreign exchange earnings. 11. Internal Security. In addition to the direct losses from the border closure, Mozambique's support for the liberation movement in Rhodesia exposed it to other retaliatory measures and led to the formation of armed bands which have since been operating against the Government of Mozambique with support from various other external sources. Over the years, these bands have concentrated their attacks on economically vital targets: the transport network, the transmission lines of the Cahora Bassa dam, the oil pipeline, and rural stores. Despite the Nkomati Accord between South Africa and Mozambique, signed in March 1984, the conflict has not abated. Today, armed bands operate in most of the country's eleven provinces. 12. Natural Calamities. Rainfall in Mozambique is generally favorable for crop production. However, the country has suffered greatly from erratic rainfall patterns in certain regions since the mid-1970s. Severe flooding in 1977-78, prolonged droughts starting in 1982 and extending into 1985 in parts of the country, and a cyclone in 1984, have devastated large areas in the central and southern regions. The recent droughts have substantially reduced the water flow in several of the main rivers, contributed to shortfalls in agricultural production, and caused losses of human life and economic assets. According to UN sources, as many as 100,000 people may have died in the southern provinces of Gaza and Inhambane alone, during the worst 12-month period of 1982-83. Progress in the Social Sectors 13. The Government has attempted to pursue its stated objectives for the country under difricult conditions, and some notable successes have been achieved, particularly in the social sectors. Today, the country's literacy rate is 28 percent as compared to only 7 percent in 1975. The effects of the high priority given to education are apparent in the 1980 census data, which show literacy rates for the 15-24 years cohort reaching  -4- 40-50 percent, as opposed to less than 8 percent for the over-60 population. However, much still needs to be done to eliminate the country's shortage of technical skills. 14. The Government has also given a high priority to upgrading health services. The proportion of central government expenditures now devoted to health -- about 7 percent in recent years -- is slightly higher than the norm (about 5 percent) for Sub-Saharan Africa. Some 3,250 workers (the majority paramedics) have been trained since 1975. Moreover, Mozambique has been a pioneer among developing countries with regard to the establishment of a broad-based primary health care system, and the use of a restricted list of essential drugs. It is estimated that today about 50 percent of all Mozambicans have access to preventive health care, and about one-third to curative care. Average life expectancy has been raised from 41 years of age in 1975 to 44 years today. The supply of high level personnel has not yet regained pre-Independence levels. Despite the Government's efforts, there are still only 404 physicians in Mozambique, yielding an average population per physician ratio of 33,000. 15. Wnile having accomplished much to reduce illiteracy and disease, the Government has not been as successful in the economic sphere. Some of the reasons for this were mentioned earlier (paras. 10-12). Others have to do with the unrealistic choice of priorities in the allocation of resources and weaknesses in economic management. Socialization of the Economy 16. Development priorities in Mozambique are determined by FRELIMO. Twu Party congresses have been held since Independence. The Third Congress, held in 1977, determined the policy of socialization of the economy followed by the Government up to 1983. The Third Congress directed the State to: (i) develop and consolidate its role in the economy; (ii) promote socialization of the agricultural sector; (iii) accelerate the industrialization process, with emphasis on heavy industry in the medium and long-term; (iv) prepare a Ten-Year Plan for the 1980s; and (v) improve training and economic management. 17. Development of the State Sector. Government intervention in the private sector had already been going on since Independence, prompted by the need to keep activities going after the mass departure of Portuguese residents. After the Third Congress, this process continued, in part because of continued abandonment or economic sabotage. The Government also nationalized the coal and petroleum industries on grounds of strategic importance to the country, and created new enterprises. Today, state-owned and managed enterprises dominate the economy. The only activities with significant private involvement are road cargo transport, retail trade, petty services, and smallholder agriculture. The performance of state enterprises has been generally disappointing. 18. Socialization of the Agricultural Sector. At the Third Congress, the move toward construction of socialism was stated to require, in the  - 5 - agricultural sector, the accelerated development of state farms and of producer cooperatives, around which communal villages (aldeias comunais) would be established. State-owned enterprises were considered the quickest means to satisfy the country's export requirements and the raw materials needs of industry, as well as urban food requirements. The development of communal villages was expected to facilitate the provision of agricultural training, social services, and the resolution of transportation and marketing problems. 19. The attempt to socialize the agricultural sector has so far succeeded only in the limited sense that the State has come to dominate marketed production. However, production of state farms has been hindered by a number of factors, including management difficulties, chronic shortages of spare parts, fuel and other agricultural inputs, and poor maintenance of equipment. 20. Although the Third Congress held that the development of cooperative farms was to be actively supported, this objective was clearly in a distant second place to the development of the state farms. During the four years following the Congress, only 2 percent of agricultural investment was allocated to cooperative farms as compared to 90 percent allocated to state farms. The smallholder family subsector, which accounts for the bulk of the rural population, was neglected, except for the Government's attempt to develop -People's Shops- to stimulate trade in rural areas. These shops, for lack of managerial skills, mismanagement of warehouses, inadequate transport infrastructure and vehicles, and corruption, were transfered to the private sector in 1979. 21. Acceleration of the Industrialization Process. For industry, the Third Congress determined short-term priorities to include State assumption of concrol over the sector; production increases coming mainly from existing capacity; and promotion of both export-oriented and import-substituting industries. However, agriculture as well as other sectors were unable to generate sufficient foreign exchange to accommodate purchases of imported raw materials, spare parts and capital goods. As a result, the industrial sector today operates at only a fraction (estimated at 20-30 percent) of installed capacity. 22. Ten-Year Plan. Directed by the Third Congress, the Government prepared a Ten-Year Plan which expressed the determination to achieve three main objectives by 1990: (i) development of a powerful and efficient state sector, particularly in agriculture; (ii) collectivization of the countryside, where communal villages would include ten million people (60 percent of the population projected for 1990); and (iii) the effective launching of heavy industry, particularly iron and steel. Projects related to the achievement of these objectives were to absorb a large proportion of the public investment program's expected resources. Other objectives included increasing production of consumer goods and improving training.  -6- 23. The public investment program included projects to produce agriciltural commodities, textiles, iron and steel, machinery, aluminum, gas, basic chemicals, coal, electricity, construction materials; building of dams, bridges, roads; and the initiation of oil prospecting. Some projects envisaged in the agricultural sector, textiles, electricity, and dam and road projects, have been concluded, and others, including oil prospecting, are underway. Among these projects high priority has been given to developing a powerful state sector in agriculture, where large, heavily mechanized projects would be expected to produce export crops and substitute for food imports consumed in urban areas. 24. The priority given to the state sector in the allocation of resources in agriculture has implied a continued scarcity of resources for producer cooperatives, which in the plan were expected to produce the bulk of the fooderops consumed by the rural population. This, combined with successive natural calamities, internal security problems, and the nearly total neglecr of support for family farms contributed to the critical food shortage which exists in the countryside today. Moreover, the emphasis on state farms has pushed the achievement of the plan's second main objective (rural collectivization) - which depends on the spontaneous movement of families into communal villages - well beyond 1990. Achievement of the third objective, acceleration of the industrialization process, is also threatened by the poor performance of state farms, which were counted upon to generate the additional investment resources. 25. Implementation of the directives described above has run into considerable problems - as reflected in Mozambique's macroeconomic performance, discussed below - related, iater alia, to the lack of effective mechanisms for choosing among alternative investments and the rehabilitation needs of the economy; excessive centralization of decision making; neglect of economic and financial considerations in the resource allocation process; and shortage of management skills. Macroeconomic Performance 26. Economic Growth. Mozambique's GDP is estimated to have declined at an annual average rate of about 2 percent in real terms between 1973 anti 1983. Except for a halt in this downward slide during 1976-80 (when GDP Ls estimated to have expanded at an average annual rate of 2.5 percent in real terms), GDP is estimated to have declined, by 1983, to about two-thirds of its level in 1973, or a fall of 50 percent in real GDP per capita. The recovery observed in 1976-80 reflected a resumption of economic activities following the disruptions in the years prior to and immediately following Independence. However, this recovery was short-lived, partly as a tesult of the exogenous factors described in paragraphs 10 to 12 above, but also due to deteriorating equipment and other infrastructure, and inadequate supplies of spare parts and raw materials. 27. Monetary and Fiscal Aspects. In recent years, government expenditures have consistently exceeded revenues, and state enterprises  - 7 - have suffered persistent operating losses. This has had as a counterpart substantial recourse to credit from the banking system, and external borrowing. As a result of sWostantial credit expansion to the public sector in recent years, the money supply rose from 44 percent of GDP in 1980 to nearly 95 percent of GDP in 1984, inevitably leading to sustained pressure on domestic prices. There are no comprehensive statistics on consumer prices cr other indices of inflation. The National Wage and Price Commission has estimated that the official price of traded goods doubled between 1974 and 1983. However, official prices are not representative of prices actually prevailing in the economy through the black market reflecting, as acknowledged by the Fourth Congress, the problems of 'too much money chasing too few goods, and price controls associated with rationing. 28. Balance of payments. High levels of imports, combined with a collapse of commodity and service exports, have led to current account deficits averaging 23 percent of GDP in recent years. Foreign borrowing has not been sufficient to close this gap. As a resu?t, not only has the Government experienced a total loss of reserves, but it accumulated payments arrears, at end 1984, after rescheduling (para. 30), amounting to US$545 million. As a reflection of this deterioration of the country's balance of payments and its highly distorted price system, the domestic currency (metical) trades on the parallel market at up to 1,500 per US$ while the official rate is maintained at 43. External Debt and Creditworthiness 29. At end-1984, Mozambique's outstanding debt reached US$2.4 billion, inluding arrears. Over 95 percent of the debt is bilateral public debt, oi -vhich 40 percent is owed to OECD member countries, 27 percent to centrally planned econcmies, and 21 percent to OPEC countries. 30. Faced with grim foreign exchange prospects, and having accumulated arrea~rs at end-1983 which it could not honor, the Government of Mozambique approached its creditors to reschedule its debts. It requested that the US$285 million in arrears, at end-1983, plus principal and interest of about US$1 billion due in 1984-86, be rescheduled for repayment after 1990. At a Paris Club meeting in October 1984, it was agreed to reschedule debt service on long-term obligations falling due in 1984 and the first half of 1985. Ninety-five percent of these service payments have been postponed to 1990-1995. However, this still leaves an estimated US$550 million in payments due in 1984-86 to be rescheduled, an effort in which the Government has been engaged in the past year. 31. In addition to efforts to improve the maturity structure of the debt, the Government is relying on official sources for the bulk of the external resources :equired to support its program to rehabilitate the economy. Moreover, given the country's extremely difficult economic conditions, future debt service obligations will have to be kept as lot' as possible. Consequently, Mozambique will have to depend on assistance at concessionary terms over the next few years.  -8- PART II - PROSPECTS FOR ECONOKIC RECOVERY 32. The Fourth Party Congress (held in 1983) began a process of change of some of the earlier directives which it recognized were in part responsible for the deterioration of the economy. It allowed for greater participation of the domestic and foreign private sectors in economic activities (a new foreign investment code was issued in 1984 which reads favorably to foreign investors); proposed a slowdown of socialization of the agricultural sector; increased support to smallholder family production and private commercial farmers; directed that resources for the industrial sector be allocated to rehabilitation needs, rather than to new investment; and postponed the completion of some development projects. On the basis of its diagnosis of conditions in agriculture and in othe- sectors, and a reassessment of macroeconomic policies, the Fourth Congress set up a number of broad directives which, along with an Economic Action Program for 1984-86, are expected by the Government to help stem and reverse the country's economic deterioration. Economic Action Program, 1984-86 33. The Government's Economic Action Program (PAE) - which served as the basis for the 1984 debt rescheduling under the auspices of the Paris Club -- constitutes a promising effort toward economic adjustment. The PAE focuses primarily on measures designed to implement the Fourth Congress' directives regarding the agricultural and industrial sectors, and macroeconomic management. Agricultural and Industrial Policies 34. The Fourth Congress directed that state farms should be consolidated and restructured. The present medium-term objectives for state farms are: to maximize the use of land presently uuder cultivation, minimize new investment, and use existing equipment more efficiently. The Fourth Congress also directed that greater attention be given to the smallholder family and private commercial subsectors. In order to promote the family subsector, the Government was directed to mobilize resources, guarantee the marketing of production, and establish producer prices that would provide a real financial return to the farmer. With regard to the private commercial subsector, the stated policy is to provide sufficient rural credit, and to pursue fiscal and price policies that would enable such operations to increase production profitably. Reflecting the new focus on the smaliholder family subsector in agriculture, industrial priorities emphasize production of basic consumer goods. 35. In line with the new directives, the PAE proposes that the smallholder family subsector i^ to receive, in addition to farm implements, seeds, and consumer r,oods, training in appropriate agricultural techniques, and in technical and economic management. It also proposes that producer prices be adjusted in a manner which will provide sufficient production incentives. Rehabilitation in industry wiil focus on firms producing textiles, shoes, garments, tools, household goods, and agricultural implements.  -9- Macroeconomic Policies 36. The PAE also proposes measures regarding public finance, employment, wages and prices, and credit, to address the balance of payments and budgetary difficulties, and the large deficits of state enterprises. 37. Public Finance and Investments. ntere is a general call for increased efficiency in the collection of tax and nontax revenue. In order to reduce the State's current expenditures, the Government will, regarding the wage bill: (i) sustain effective expenditures at existing levels; (ii) restrict and control new recruitments; (iii) exercise strict discipline in promotions and professional reclassification; and (iv) compensate warranted salary increases with reduced employment of less skilled labor. Expenditures on materials will be governed by 'rules on expenditures' which aim at greater rationality and austerity, particularly in the use of imported materials. New investments may be undertaken, but only if they pass tests of technical and financial viability, bring a positive contribution to the balance of payments, and are assured of having the necessary human, material, and financial resources. The focus in the short to medium-term is to be on improving the efficiency of investment, and on completion of ongoing projects which will have a positive impact on the balance of payments. The state enterprises are to be restructured into more manageable units, are to adopt accounting practices appropriate to effective management, and are to be given administrative anud financial autonomy to facilitate response to new incentives. 38. Employment, wages, and prices. The PAE states that the Government will streamline its operations and transfer managers from the state apparatus to the productive sectors. Prices will be linked to the normal costs of production and enterprises will be encouraged to reduce costs. The PAE proposed an additional measure to improve the performance of export enterprises: a foreign exchange retention system, whereby export enterprises will be allowed to retain a portion of their foreign exchange earnings, for purchase abroad of needed inputs. 39. Money and credit. The Bank of Mozambique will complete a review of its credit portfolio and reschedule enterprises' debts in line with assessments of the enterprises' recovery possibilities. Lending, limited to the real needs of the enterprises, will be strictly controlled. The banking network will be expanded to encourage personal savings. The PAE also stated that a study would be undertaken to evaluate the possibility of adjusting interest rates. A study is also under way to update the basket of currencies to which the metical is linked. Balance of Payments and External Capital Requirements 40. The requirements of external resources to support the Government's PAE have been assessed for the period 1985-87. (See Annex I for detailed balance of payments projections and underlying assumptions.) Assuming that the Mozambican authorities will be able to reschedule debt service payments due in 1984-86 (US$550 million), net additional resource transfers averaging about US$150 million over the three-year period would  - 10 - be required to finance imports of raw materials, spare parts, and consumer goods to avert continued decline in capacity utilization and family sector production. The cumulative financing gap of about US$450 million would have to be financed by concessionary loans and grants, so as not to aggravate further Mozambique's critical external debt situation. Program Implementation 41. The Government has started implementation of some of the measures proposed. It has, inter alia : (i) transferred to family farmers, cooperatives, and private commercial farmers, land and equipment belonging to a large agricultural enterprise, and is giving these subsectors support in the form of technical assistance, inputs and consumer goods; (ii) doubled the producer price of cashews, the bulk of which are produced by family farmers, as well as increased the price of other agricultural products; (iii) liberalize the prices of some animal products and food crops; (iv) restructured some state enterprises into more manageable units, and endowed them with technical personnel to improve management; (v) allowed a number of export enterprises to benefit from the foreign exchange retention system; (vi) raised the official prices of some consumer goods and services; (vii) issued credit guidelines which demand greater rigor in lending and control over the use of funds; and (viii) started a national savings campaign, and created 250 'savings boxes' in enterprises, cooperatives, state agencies, and military facilities, for the sale of time deposit certificates. Additional Measures Required 42. The Government's current stabilization and rehabilitation efforts should at least contribute to stemming the country's economic deterioration. Prudent management of government resources is an essential element of the PAE, as well as the measures to improve the performance of state enterprises, and the devolution of some activities to the private sector. Another important factor is the availability of external resources for accelerating the inflow of imports of raw materials, spare parts, and consumer goods so essential for the successful implementation of the PAE. Curtailment of monetary growth, improvement in local food supplies, the increased volume of imports of raw materials, spare parts, and consumer goods, careful husbanding of budgetary resources, and physical rehabilitation of infrastructure should generate the necessary impulses for bringing about the necessary turn-around in the economy. 43. Of the various problems that would remain unresolved despite implementation of the PAE, two merit special mention. First, the current shortages and excessive black market price levels of goods in the country can be largely attributed to three closely-interrelated factors: (i) overvaluation of the currency; (ii) low levels of domestic production and import availability; and (iii) price controls. Devaluation and increased volume of imports may minimize the interaction of the first two factors. However, black market price levels may persist with a continuation of general price controls. The situation could be exacerbated if the import supplies needed to facilitate a decline in prices were not forthcoming. It will also take some time before increases in domestic production capacity can augment the supply of local goods and thus affect price levels.  - 11 - 44. The second area of major concern has to do with the limited capacity of economic institutions. The supply of managerial and technical skills required to operate the vast system of state enterprises is well below the current requirements of the economy, in quantity as well as in quality. The Government is well aware that the country's overextended public sector hinders economic recovery and has embarked on redeploying workers to productive employment. It has also begun to enhance the state enterprises' management and financial accountability. However, given the extremely difficult economic conditions and the need to cope with immediate issues of economic stabilization, it will be some time before any significant results can be achieved, and progress on institutional reforms can be made only gradually. 45. While emergency rehabilitation efforts proceed, the Government should also undertake measures that would help to set the stage for sustained economic development in the future. Such measures should include: (i) improving the institutional and policy environment for private sector activity generally, and for smallholder agriculture in particular (including, for example, further liberalization in marketing and pricing); (ii) the carrying out of a critical assessment of public enterprises, including the identification of measures to reduce their deficits; (iii) a review of the country's current and future manpower and training needs; and (iv) developing a public expenditure program that would facilitate a more efficient allocation of resources and a reduction of budgetary deficits. 46. The country's economic ills are complex and the adjustment process to modify the course of the economy will require time and will have to rely on substantial concessionary external assistance. The Government's time frame for implementation of the Economic Action Program is 1984-86. But this time frame was predicated on the assumption of a marked improvement in the security situation following the signing of the Nkomati Accord in March 1984. Since the internal security situation has not improved, it is likely that the period of implementation will need to be extended. There also remain some aspects of the program for which implementation mechanisms are still to be developed. Therefore, it will be some time until appropriate relationships between prices, costs, incomes, and production are established and the impact of existing distortions is eased out of the system. The risks of failure of the program lie in a possible weakening of political commitment and willingness to run the full course, attempts to abort or modify the program in the wake of emerging transitory problems, in the continuation of a difficult security and economic environment, and less than the required availability of external resources to support the program. PART III - PROPOSED BANK GROUP STRATEGY 47. The Government's Economic Action Program (PAE) for 1984-1986, described in Part !I above, identifies many of the principal economic and institutional constraints facing the country and signals a willingness on the part of the Government to follow a more pragmatic approach to economic policy. It is expected that the discussion of the Bank's first economic report on Mozambique will permit the Bank to initiate a policy dialogue  - 12 - with the Government. Nonetheless, given the newness of the Bank's relationship with Mozambique, it will take some time before a comprehensive country strategy can be developed. For example, considerably more economic and sector work is required before some aspects of macroeconomic and sectoral policy issues can be discussed in detail with the Government. 48. Relations between the Government of Mozambique and the IMF are also at an early stage of development. The IMF Article IV consultation mission which visited Mozambique in late March-early April 1985 reviewed the economic situation and will recommend measures regarding, inter alia, public revenues and expenditures, exchange rate adjustments, and pricing policies. While interested in IMF assistance in principle, the Government has stated that it will take some time to develop the internal consensus, detailed analyses, and statistical base required for a comprehensive IMF program. Our emerging strategy for Mozambique is being closely coordinated with that of the IMF. 49. In light of the critical economic situation prevailing in Mozambique, and steps being already taken, the Bank should support the Government's emergency rehabilitation efforts. At the same time, the Bank should begin to assist with the design and implementation of institutional and policy reforms needed to ensure that short-term injections of foreign exchange will ultimately result in the sustained recovery and development of the Mozambican economy. The focus of these reforms, and of Bank operations, in the coming years is expected to be on : (i) improving the institutional and policy environment for private sector activity generally 3nd for smallholder agriculture in particular; (ii) encouraging government to streamline and improve efficiency of the state sector; (iii) increasing the supply and rationalizing the allocation of skilled manpower; and (iv) developing a public expenditure program consistent with a more rational use of government resources. In addition, the Bank can play an important role in promoting human resource development through support of the Government's continuing efforts to improve the country's health and education systems. 50. It is clear that the Government's program to rehabilitate the economy will take several years to implement. Therefore, it is expected that the first rehabilitation credit, presented in this report, will be followed up by a second-phase operation. This proposed second rehabilitation credit would help to sustain the largely procedural reforms gained in the first operation and would also provide a vehicle for supporting the implementation of macroeconomic and sector policy measures expected to be introduced by the Government. 51. Over the coming year, work will begin on a number of tasks designed to set the stage for a longer-term policy dialogue and project pipeline. A Bank Energy Assessment Mission visited Mozambique in April-May 1985 t_ investigate that sector's problems and prospects. It is expected that the Report of the Energy Assessment Mission will identify ways in which the Bank could best support priority rehabilitation and technical assistance needs in the power sector. The more general issue of the country's critical shortage of skilled manpower (particularly in the area of economic management) would be addressed through a separate technical assistance credit for which an identification mission is planned for mid-1985.  - 13 - 52. The economic and sector work program for FY86 further emphasizes the need to support improvements in economic management and the speedy rehabilitation of key sectors. To these ends, the ESW program provides for a study of Mozambique's planning and budgeting system and sectoral reviews. The Government has also agreed in principle to carry out a critical assessment of the country's public enterprises. This proposed assessment would seek to identify the major problems currently facing the most important of these enterprises - management, pricing and exchange rate policies, manpower shortages, and so forth -- and on the basis of these findings propose a plan for their rehabilitation or, where circumstances warrant, their liquidation or transfer to private ownership. The findings of the various missions and studies would serve as the principal inputs to the formulation of a comprehensive country strategy. PART IV - PROPOSED REHJAILITATION PROGRAM AND CREDIT Background to the Credit 53. Tie proposed program credit was identified in the course of the Economic Mission to Mozambique in November 1984. At that time the Government of Mozambique presented an outline five-year Emergency Rehabilitation Program defining priority foreign exchange needs for all sectors. It was agreed to limit the focus of possible IDA support to the industry, transport, and agriculture sectors which are the key sectors for implementing the Government's strategy for economic rehabilitation. Subsequently the Government prepared and sent to the Bank a more detailed proposal covering the immediate imports and technical assistance needs in these sectors. An appraisal mission which visited Mozambique February 4-16, 1985 completed the process of reviewing the Government's proposals and detailing criteria for selecting specific beneficiary activities and entities, and related implementation arrangements. 54. The proposed credit was negotiated in Washington, D.C., May 6-9, 1985. The Mozambican delegation was be led by Ms. Yasmin Patel, Director of International Relations of the Bank of Mozambique. There is no separate staff appraisal report for the proposed credit. A Credit Sutmary is at the front of this report and supplemental data are contained in Annex III. Objectives and Description 55. The proposed IDA credit would help meet Mozambique's priority economic rehabilitation needs within the context of the Government's Economic Action Program (PAE) for 1984-86 designed to initiate the process of correcting structural imbalances and rehabilitating the economy (see paras. 33-41). While implementation of the PAE is just beginning, its directives provide a suitable reference point for the proposed first IDA lending operation oriented to Mozambique's immediate economic needs and focussed on the rehabilitation and maintenance of those investments and economic services which may be expected to generate some immediate production response. The proposed credit would help finance part of the Government's 1985/86 program of imports of equipment, spare parts and raw materials, as well as related technical assistance, in industry, transport,  - 14 - and agriculture, which are the key sectors for economic rehabilitation. The specific beneficiary institutions and activities to be supported in the three sectors have been identified on the basis of demonstrated needs for inputs requiring foreign exchange as well as availability of complementary inputs such as qualified staff and production, distribution, and organizational capabilities necessary to increase output rapidly. Technical assistance would be provided to strengthen institutional and technical capacity and to help the Government carry out policy and sectoral studies. 56. It is clear that there must be continuity and a gradually increasing policy content to efforts to assist the Government of Mozambique with its rehabilitation program in order to maximize the chances that injections of foreign exchange and technical assistance inputs will result in the resumption of sustained economic growth and development. It is expected that assistance for rehabilitation of the economy would be continued in the years to come, building on the experience in implementing this credit, on the results of economic and sector work currently under way or planned, and on the expected detailed discussions of the Government with the Bank and the IMF on macroeconomic questions. 57. Industry. The Government's policy in the industry sector is to increase capacity utilization, especially of firms manufacturing consumer goods, to gradually lift the controls on enterprises, and to encourage private entrepreneurs. The proposed credit would help to finance the import requirements of enterprises producing basic consumer goods. The bulk of these goods would be sold in rural areas and act as incentives for agricultural production. Firms which produce essential intermediate goods or goods which have the potential to earn foreign exchange would also be assisted. The firms selected all have considerable unused capacity and have the technical and managerial capacity to increase output quickly. 58. Twenty firms producing the following consumer products - food products, cigarettes, beverages, textiles, shoes, hygiene goods, bicycles, and motorcycles - were selected as beneficiaries of credit proceeds. Three firms producing the following intermediate products - paints, glues, and wooden handles for agricultural implements, as well as a firm repairing heavy agriculture, transport, and construction equipment - were selected. The two firms producing tires and batteries were selected since they provide intermediate products essential for the proposed vehicle maintenance program described in para. 59 below. Three sugar refineries were included since these enterprises produce a consumer product, and also have a potential for earning foreign exchange through filling their export quota to EEC countries and the USA. Altogether 33 manufacturing enterprises were selected from the country total of 300. Under the credit these firms would be able to purchase raw materials (US$14.4 million), spare parts (US$9.1 million), and equipment (US$4.0 million), and to contract for technical assistance (US$1.9 million). About US$100,000 would be provided for a study of the structure and recent performance of the sector, which would assist the Government in establishing its institutional and investment priorities in the sector. Annex V provides further details on the sector and the selected beneficiaries.  - 15 - 59. Transport. In addition to generating foreign exchange through provision of transit services (rail and port) to neighboring countries, the transport system provides agriculture with the necessary inputs and moves agricultural produce to the urban centers or to the ports for export. However, along with other sectors, transport traffic in Mozam ique has declined significantly over the last ten years. The Government's strategy for recovery is to catch up with deferred maintenance of ports and railways infrastructure, improve availability of locomotives, improve coastal shipping, and maintain roads and vehicles. Since timely normal maintenance is the most effective means of increasing transport reliability, preventing further deterioration in transport services, and extending the life of vehicles to prevent cost,'ler rehabilitation efforts, the credit would support spare parts requirements for maintenance of large trucks, small trucks, and four wheel drive vehicles (US$6.4 million), as well as for locomotives (US$1.9 million), over a twelve-month period. Equipment for truck workshops (US$0.3 million) and locomotive workshops (US$0.4 million) and technical assistance (US$0.4 million) would be provided. In addition, US$100,000 would he provided to, inter alia, update the 1978 Transport Survey, which would assist the Government in establishing its transport investment policies. Annex VI provides further details on the sector, the proposed maintenance component, and the selected beneficiaries in the transport sector. 60. Agriculture. The most urgent priority at present in agriculture is to provide basic inputs principally to smallbolder farmers to help ensure that they can produce basic foodstuffs for themselves and their families and for sale on the market. Assistance would conform to low-input farming systems that rely on family labor, hand tools, and non-hybrid seed. On this basis the credit would provide US$1.7 million in foreign exchange for 1,500 tons of certified seed for the major food-crops (e.g., maize, beans, groundnuts, sorgbum). This represents about 30 percent of the total estimated annual requirements of seed for the smallholder sector. The proposed credit would also provide US$1.4 million in foreign exchange for importing 500,000 hoes, 500,000 machetes, 50,000 axes, 50,000 files, and US$0.8 million for importing I mili'-n jute sacks. There are also significant shortages of spare parts for pumps and engines used by commercial irrigated medium scale and smallholder farmers operating in the vicinity of Maputo whose output is essential for feeding the urban population. The credit would therefore provide US$0.5 million for purchase of up to 50 new irrigation pumps plus accessories, as well as US$0.5 million for spare parts required to repair existing irrigation equipment. The Ministry of Agriculture would identify local farmers or cooperatives with demonstrated managerial skills who could benefit most effectively from such replacement pumps or spare parts. Annex VII provides further details on the agricultural sector and selected beneficiaries. Costs and Financ-ing 61. The proposed credit of US$45 million equivalent would be allocated as follows: US$29.5 million for industry, US$9.6 million for transport, US$5.0 million for agriculture, and US$0.9 million for program implementation and studies. The table below summarizes key items to be financed in each sector. The credit would finance about 5  - 16 - percent of Mozanbique's non-oil merchandise imports in the period 1985-86 and meet about 19 percent of the gross external capital requirements of the country for the same period. Sector or Raw Materials Equipment Technical Activity and Spare Parts and Tools Assistar e Total - --------US$ million- Industry 23.50 4.00 2.00 29.50 Transport 8.25 0.70 0.65 9.60 Agriculture 2.20 2.80 - 5.00 Program Implementation - 0.05 0.85 0.90 TOTAL 33.95 7.55 3.50 45.00 The Government estimates that the local currency costs of implementing the rehabilitation activities to be supported by the proposed credit, for purchase of local raw materials and equipment, hiring of additional workers, and local transport, would be more than US$101 million equivalent Cbased on the official exchange rate). Of this amount US$95 million equivalent would be incurred in the industrial sector, including purchase of locally grown agricultural produce (such as sugar cane) for processing. The Government would ensure that these required local funds, including credit resources, would be made available in a timely fashion to the various executing agencies (Section 3.01 of the Development Credit Agreement). Coordination with Other Agencies 62. In 1982 bilateral and multilateral agencies provided an estimated US$244 million to Mozambique for capital investments and US$80 million for technical assistance and cooperation, of which about half went to the agriculture sector. Since that time, because of Mozambique's deepening economic crisis, the bilateral agencies, including those representing France, Netherlands, the Nordic countries, Switzerland, United Kingdom, and USA, have increased their support for importation of key raw materials, spare parts, and equipment to more than US$50 million in 1984-85. The proposed credit has been designed to complement the foreign exchange support of these agencies. Support for maintenance of vehicles and locomotives would be an important complementary input to support by other agencies for ports and railways rehabilitation. Support for seeds and agricultural implements would complement efforts by several agencies to meet Mozambique's short-term needs in this area and would take effect about the time a US$12 million IFAD credit for seeds and tools is completed in June, 1985. Program Implementation 63. The Bank of Mozambique (BOM) would he responsible for coordination, monitoring, and supervision of program implementation, and for preparing disbursement applications. The BOM has cppointed a Program Coordinator, with qualifications and experience satisfactory to the Association, who participated in negotiations of the proposed credit.  - 17 - A Procurement Unit (PU) would be established in the Ministry of External Trade to help implement the key procurement and distribution activities associated with the credit. A condition of credit effectiveness would be that the PU is established, fully staffed, and operational under terms and conditions satisfactory to the Bank (Section 5.01 of the Development Credit Agreement). The PU would include staff seconded from the major state-owned trading firms, as well as an expatriate procurement adviser, accounting adviser, and logistics adviser whose qualifications, experience and terms and conditions of employment would be satisfactory to the Association. The Unit would be responsible for, inter alia, review and approval of: lists and specifications of goods and technical services to be purchased, methods to be used in procuring such goods and services, award of contracts, and methods for the distribution of such goods. INTERQUIMICA, the staLe trading firm responsible for procuring raw materials and chemicals, INTERMETAL, responsible for procuring metals, INTERMAQUINA, responsible for procuring equipment, or INTERMECANO, responsible for procuring vehicles and related spare parts, would be formally responsible for procurement and award of contracts, subject to approval by the PU. An interministerial committee made up of representatives of the Ministries of Agriculture, Ports, Railways and Merchant Marine, Industry and Energy, Construction and Water, and Foreign Trade, and the State Secretariats of Road Transport and Light and Food Industry was responsible for preparing the Government's request. The same participating agencies would nominate designated officials to serve as liaison persons with the Program Coordinator, who would convene meetings with these officials and with the PU regularly to review progress and to recommend steps to improve implementation if necessary (Schedule 4 of the Development Credit Agreement). 64. With the minor exception of pumps and accessories to be distribu- ted to farmers in the Maputo area, the specific heneficiaries, activities, and amounts to be supported under the credit were identified at appraisal. In industry the selected beneficiaries would submit detailed equipment, spare parts, and raw materials lists to the responsible Ministry or Secretariat, who would in turn submit these lists to the trading firms and the PU, for review and approval. Many of these beneficiaries have already completed these draft lists. In transport the twenty dealer organizations in Mozambique would submit detailed lists, on the basis of the criteria agreed at appraisal, to the Secretariat for Road Transport. A Rail India Technical Services (RITES) team currently under contract witb the railways would help prepare the locomotive maintenance equipment list. In agricul- ture specifications for seeds would be prepared by BOROR, the parastatal organization responsible for distribution of seeds, for hand tools and jute sacks, by AGRICOM, the parastatal organization responsible for agricultural marketing, and for irrigation pumps, accessories, and spare parts, and by HIDROMOC, the state enterprise responsible for distribution of hydraulic equipment and for related services.  - 18 - 65. No special on-lending mechanism is required, since imported goods would be provided to beneficiaries on a cash basis. A significant number of beneficiary enterprises would have no problem coming up with the required local funds and, given the fact that these enterprises would be engaged in high priority activities, if necessary they would be able to borrow funds. The Government would ensure that loans in local currency would be provided to participating firms and enterprises as required, subject to normal procedures (Section 3.01 (b) of the Development Credit Agreement). 66. Purchase of imported goods by beneficiary institutions would be on the basis of official exchange rates. It is, however, unlikely that the prevailing differences between the official and parallel market exchange rate would lead to windfall profits to intermediaries from illegal resales. Existing distribution arrangements in Mozambique limit the degree to which economic rents can be appropriated by intermediaries. Firms are required to sell their products through established channels at Government-administered prices and the state run distribution system targets goods to specific consumer groups. In the transport sector dealer- ships operate a system of recording purchases to ensure that individuals do not purchase excessive numbers of spare parts. Pricing Measures 67. The Government has, in its PAE, committed itself to improve the incentives to food and export crops production and the financial situation of enterprises. In addition the Government has provided assurances that it would take all necessary measures to ensure that prices for goods produced by participating industrial enterprises are established at levels which are at least equal to actual costs, including appropriate allocation for administration, interest payments, adequate maintenance, and depreciation (Section 4.02 of the Development Credit Agreement). This would serve as an initial step towards the more comprehensive changes necessary to create incentives for increased production which will be developed in the course of discussions by the Government with the Bank and the IMF as well as through a proposed study of parastatal enterprises under discussion with the Government. Procurement 68. All items to be financed under the credit are needed most urgently and procurement speed is therefore important. The Procurement Unit described in para. 63, which would include technical assistance experts familiar with Bank procurement procedures, will play a key role in ensuring proper screening of and expediting procurement decisions. Procurement under the proposed credit would be in accordance with the Guidelines for Procurement under World Bank Loans and IDA Credits'. All individual supply contracts of US$1 million and above would be subject to international competitive bidding (as modified for structural adjustment and program loans). Purchases of goods costing between US$250,000 and US$1 million would be under limited international bidding procedures. Goods costing less than US$250,000 would be under international shopping. Local shopping would be permitted for purchases of vehicles, office equipment, and furniture necessary for program implementation. Specific brands of  - 19 - spares made only by one manufacturer would be purchased directly from the manufacturer; all such contracts of US$250,000 or above would require prior review by IDA. A contract with procurement consultants at an estimated cost of US$700,000 would be financed under the proposed credit. Disbursement and Retroactive Financing 69. Disbursements would be made against the foreign exchange costs of eligf.ble imports, against the total costs of services provided by consultants for technical assistance and for studies, and against the total costs, less taxes, of vehicles, office equipment, and furniture for program implementation. To facilitate disbursements, a Special Account would be established by the BOM with a foreign commercial bank satisfactory to the Association (Section 2.02 (b) of the Development Credit Agreement). An amount of US$5 million would be withdrawn by the Government from the credit account and deposited into the Special Account upon effectiveness of the Credit Agreement. Upon receipt of satisfactory evidence that expenditures financed out of the Special Account are eligible for financing and that goods are purchased in accordance with the agreed procurement procedures, the Special Account would be replenished by IDA through further disbursements. For contracts or purchase orders of less than US$200,000 equivalent, reimbursements would be made against statements of expenditure. Supporting documents related to these contracts would be retained in the BOM and made available on request to the Association. In order to ensure early implementation of the program, the Government may shortly request a Project Preparation Facility (PPF) advance of up to US$500,000 to establish the PU and to contract procurement consultants. Upon credit effectiveness the amount e pended under the PPF together with accrued charges would be withdrawn from the credit account. Retroactive financing of up to US$1.7 million for purchase of seeds would be required. The credit is expected to be fully disbursed by March 31, 1988. It is expected that the bulk of purchases of goods would be completed in one year with technical assistance and studies to be completed by June 30, 1987. Accounts, Aud it, and Monitoring 70. The BOM would maintain records and separate accounts in respect of the proposed program. These accounts and financial statements would be audited each fiscal year by independent auditors acceptable to the Association and the audited accounts and records and auditors' report would be furnished to the Association not later than four months after the end of each fiscal year. The BON would also maintain records adequate to record and monitor the progress of the program, and would prepare and furnish to the Association a complecion report on the costs and benefits resulting from the program. 71. During supervision Bank staff would selectively monitor the distribution of agricultural inputs. In the case of inputs to rural areas, this would be handled through visits to provincial warehouses and through review of distribution records. An ongoing IFAD project is utilizing this method, and records of various state-owned distributing firms and agencies are reported to be well kept.  - 20 - Benefits and Risks 72. The proposed credit would support the Government's initial steps towards economic recovery and provide a basis, along with the Economic Report and Government/IMF discussions, for a dialogue on macroeconomic and sectoral policy issues upon which future Bank operations in Mozambique would be based. The credit would help the Government carry out sectoral studies and would also help to strengthen the institutions responsible for foreign trade. 73. The proposed credit would lead to increased output of consumer, intermediate and export goods through increased capacity utilization and physical output of participating firms. The improved supply of basic consumer goods would, in turn, provide a greater incentive to farmers to produce marketable surpluses. In transport the credit would help to end further deterioration in transport capacity and result in increased distribution of goods to and from rural areas. Over 13,000 trucks and four wheel drive vehicles and eighty locomotives would be maintained by means of inputs financed under the credit. In agriculture smallholder farmers would be enabled to plant about 37,500 ha of maize, 18,000 ha of groundnuts and 3,500 ha of sorghum. Irrigation equipment would contribute to increasing the area of double-cropped irrigated land significantly. 74. The main risk associated with the proposed credit is that procurement and deployment of goods and services to be financed under the credit and the increased induced production may be hampered by the Government's limited implementation capacity and the difficult security situation which affects parts of the rural areas. Appropriate consideration was given to these aspects at the design stage. Emphasis placed on detailed identification of beneficiary activities and entities, simplification and clarification of operating arrangements, as well as sharply focussed technical assistance measures would help mitigate the risk associated with implementation capacity constraints. Efforts are being made through diplomatic channels to improve the overall security situation. While security conditions remain difficult in the rural areas the impact on activities to be supported under the credit would be minimal, since every attempt has been made to target the activities to be supported under the credit to the more secure areas. A long term risk is that the Government might delay initiating key economic reforms provided under the PAE or defining concrete ways to tackle the needed reforms, thus failing to create a sustained recovery environment. It should be recognized that the process of reforming the Mozambican economy is bound to be long and difficult. Appropriate kinds and levels of donor assistance during the critical initial years of adjustment would greatly contribute to sustaining this process. PART V - LEGAL INSTRUMENTS AND AUTHORITY 75. The draft Development Credit Agreement between the People's Republic of Mozambique and the Association and the Recommendation of the Committee provided for in Article V, Section 1(d) of the Articles of Agreement are being distributed to the Executive Directors separately.  - 21 - 76. A condition of effectiveness would be the establishment, staffing, and operation of a Procurement Unit under terms and conditions satisfactory to the Association. Other special conditions of the project are listed in Section III of Annex III to this report. 77. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 78. I recommend that the Executive Directors approve the proposed Credit. A. W. Clausen President Attachments Washington, D.C. May 30, 1985  -22 A141 T - SOCIIAL rKDTCIL