Mozambique - Economic Recovery Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT Report No. 16472 MOZAMBIQUE ECONOMIC RECOVERY CREDIT (CREDIT 2384-MOZ) April 9, 1997 Macroeconomics I Southern Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Metical (MT); pl. Meticais US$1 = MT 2,2131 US$1 = MT 11,4622 ABBREVIATIONS AND ACRONYMS ADB - African Development Bank AGRICOM - State Enterprise for Agricultural Marketing BM - Banco de Mocambique BCM Banco Comercial de Mo,cambique BPD - Banco Popular de Desenvolvimento CG - Consultative Group CNP - Comissao Nacional do Plano (National Commission of Planning) ERC - Economic Recovery Credit ERP - Economic Rehabilitation Program ESAF - Enhanced Structural Adjustment Facility GCPI - Gabinete de Coordenacao dos Programas de Importa,co (Department for the Coordination of Import Programs) GDP - Gross Domestic Product IDA - International Development Association IMF - International Monetary Fund MOH - Ministry of Health NGO - Non-Governmental Organization OECD - Organization for Economic and Cooperation and Development PFP - Policy Framework Paper SNAAD - Sistema de Alocacao Nao-Administrativa de Divisas (System for Non-Administrative Allocation of Foreign Exchange) UTRE - Enterprise Restructuring Unit FISCAL YEAR January I - December 31 Vice President : Callisto Madavo Director Phyl I's Pomerantz Technical Manager Ataman Aksoy Staff Member . Rene Bonnel, Principal Economist Secondary Market exchange rate as of April 1992 (Source: President's Report of 5/18/192) . 2October, 1996.  FOR OFFICIAL USE ONLY Table of Contents Page No. Preface Evaluation Summary ........................................................... i - iv Part I: Program Implementation Assessment ..........................................1........ A. Statement and Evaluation of Objectives .....................................1........ B. Achievement of Program Objectives .................................................. 5 C. Bank Performance .................................................... 10 D. Borrower Performance ....................... .............................. 10 E. Assessment and Conclusion .................................................... 11 Part II: Statistical Tables . .......................................................... 14 Table 1: Summary of Assessments .15 Table 2: Related Bank Operations .16 Table 3: Project Timetable. 1 7 Table 4: Disbursements .17 Table 5: Key Indicators: Actuals and Projected, 1992-96 18 Table 6: Studies Included in the Credit .20 Table 7: Status of Legal Covenants .21 Table 8: Bank Resources - Actual Staff Inputs. 22 Table 9: Bank Resources - Missions. 23 Appendices: A. Mission's Aide Memoire B. Assessment of Privatization Program C. Map This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  IMPLEMENTATION COMPLETION REPORT MOZAMBIQUE ECONOMIC RECOVERY CREDIT (CREDIT 2384-MOZ) Preface This is the Implementation Completion Report (ICR) for the Economic Recovery program in Mozambique, for which Credit 2384-MOZ in the amount of SDR 132.0 million (US$180.0 million equivalent) was approved on June 11, 1992 and made effective on August 3, 1992. The Credit closed on June 30, 1996, one year after the original closing date. The first tranche was released upon effectiveness. The second tranche was released on September 1993. Final disbursement took place on November 22, 1996 and the remaining balance of SDR21,038 was cancelled. Cofinancing for the credit was provided by Switzerland (7.0 million Swiss Francs, US$5.7 million equivalent), Norway (36.6 Norwegian Kroner, US$5.1 million equivalent), Denmark (40.0 million Danish Kroner, US$6.3 million equivalent, transferred from the Third Rehabilitation Credit), and ODA (0.846 million, British Pounds, US$1.3 million equivalent, transferred from the Third Rehabilitation Credit). The ICR was prepared by Rene Bonnel, Sr. Economist and Task Manager, AFTM1 and Carolina Machado, Operations Analyst, AFTM1. This report was reviewed by Phyllis Pomerantz, Country Director for Mozambique and Ataman Aksoy, Technical Manager, Macroeconomics 1, Southern Africa. The ICR was reviewed and approved by the Borrower. Comments were also received from co-financiers. Preparation of this ICR was begun during the Bank's final supervision/completion mission in March 1996. It is based on discussions with Bank staff, on findings of the completion mission, and on the President's Report, the Loan Agreement, and other materials in the project files.   ECONOMIC RECOVERY CREDIT (Credit 2384-MOZ) Mozambique Evaluation Summary i. The early 1990s marked a turning point for Mozambique. First, the long-lasting military conflict between Renamo and government forces was replaced by peace negotiations in 1992. Second, the economy was faced by substantial external shocks. Aid from the Former Soviet Union stopped in 1991, and Mozambique lost key markets in Eastern Europe. Then in 1992, the agricultural sector was devastated by the most severe drought of the century. Third, the devastation caused by the civil war and the resulting displacement of over one-third of Mozambique's population was accompanied by a rapid increase in donors' assistance. To enhance the efficiency of the extraordinary level of assistance provided by donors, significant institutional and policy changes were required. Program Design and Objectives ii. These broad changes shaped the objectives of the Economic Recovery Credit (ERC), which was approved in June 1992. The primary objective was to establish a policy and institutional framework that would be more appropriate when peace was restored. Provided peace would be sustained, economic growth was expected to increase sharply mainly because of the envisaged resumption of agricultural activities throughout the country. This implied that a market-led development, favoring private enterprises, would offer the greatest potential for economic recovery over the medium-term. However, it was realized that the potential for a rapid supply response to policy changes would be weak during the transition to peace, while there could be increased social costs resulting from the expected adjustment. To alleviate these costs, the ERC was designed to protect the living conditions of the poor by reversing the previous decline in budgetary allocations for the social sectors and establishing a limited safety net for poor urban households. iii. The ERC supported policy reforms aimed at: (i) improving the foreign exchange allocation and the management of foreign aid; (ii) strengthening export incentives; (iii) developing a commercially-oriented financial sector; (iv) privatizing state enterprises in commercially-oriented sectors; and (v) redeploying public expenditures towards the social sectors and the establishment of a targeted social safety net for the urban poor. The implementation of these reforms required substantial technical assistance, which was provided through existing IDA projects or bilateral assistance.  ii iv. In conjunction with the ESAF programs of the IMF, the ERC played a substantial role in the mobilization of other forms of external aid, particularly import support funds. Joint Bank/donor assessments in the context of annual Consultative Group meetings as well as the 1993 SPA Joint Bank/Donor Evaluation Mission contributed to a better understanding of Mozambique's exceptional need for financial assistance, and in particular for untied import support funds. The substantial levels of project and balance of payment support received by Mozambique were accompanied by significant debt relief in the context of successive rescheduling with the Paris Club. Implementation Experience and Results v. Because the ERC was an integral part of a broad international financial support, the specific impact of the ERC cannot be isolated. However, it is appropriate to assess the global impact of the Government's reform program to which the ERC contributed. Overall the outcome of the ERC is positive. The strong support the ERC has received from donors and the continuation of the reforms since the Credit closed bode well for the sustainability of the reform program. The main results are the following. GDP growth has averaged 6 percent p.a. in real terms from 1991 to 1995 as a result of peace and sustained adjustment. The administratively-managed allocation of foreign exchange has been replaced by market-based allocation with the official exchange rate been determined by market forces. Privatization has been quite successful. Some 32 large enterprises were privatized. Including small and medium enterprises, about 700 firms out of approximately 1,000 have been privatized. The private sector now commands well over two-thirds of industrial output compared with less than one-third in 1990. The banking sector was transformed from a state-dominated banking sector into a diversified set of commercially-oriented financial institutions, consisting of private domestic and foreign banks, including a credit cooperative bank and a leasing company. vi. Peace, the restoration of growth and the strong expansion of internal trade have dramatically improved food security and the living conditions of the poor. especially in rural areas. The number of families in need of food assistance declined from over one million in 1994 to only 90,000 in 1996. Particularly noticeable has been the restructuring of budgetary expenditures towards the social sectors and the increase in the provision of social services: the volume of health services is estimated to have increased by 12 percent between 1993 and 1995, particularly in rural areas, while primary school enrollment rates among 6-10 years old in rural areas increased from 24 percent in 1991 to 45 percent in 1994. At the national level, the previous decline was stopped, with the primary enrollment rate rising from 54 percent in 1993 to 57 percent in 1995. vii. These are extremely encouraging results, but this assessment needs to be qualified in three important aspects. First, to a large extent the economic record reflects recovery from extremely depressed levels rather than progress along a firmly established growth path. In addition, most of the increase in growth was due to the resettlement of about five million refugees in rural areas and the successful transition to sustained peace and political stability. Second, a difficult reform agenda still lies ahead. Although the  iii condition of the poor has improved, poverty indicators are quite low by even the standards of Sub-Saharan Africa. Sustainable poverty reduction requires a lasting improvement to the overall food situation, and this in turn implies the transformation from subsistence to a more market oriented agriculture sector with increased linkages to urban markets and agroindustries. In all these areas, complex institutional reforms are needed to develop markets, particularly in rural areas, establish a modern financial sector, and stimulate the creation of a competitive private sector. Third, with an external debt amounting to 3.6 times GDP and 13 times exports, Mozambique faces an unsustainable debt burden over the medium-term. Reducing it requires the combined implementation of policies aimed at' reducing the financial burden of the debt as well as the country's dependence on external financing. viii. Overall, progress towards macroeconomic stabilization has been elusive. Key factors were the difficulties involved in coordinating large inflows of external aid, the decline in fiscal revenues (as a percentage of GDP), and the country's limited institutional capacity to accelerate the reform of the enterprise and financial sector. Because some of the monetary and fiscal benchmarks were not met, the IMF was not able to complete its mid-term review for 1995. However, the Bank and the Fund completed a new Policy Framework Paper for 1996-98 and a new ESAF program was approved by the Fund Board in June 1996. Progress since then has been good. Monetary control has been tightened and the cumulated rate of inflation fell to 16 percent in 1996. ix. A key feature accounting for the overall positive outcome of the ERC was the Government's commitment to the implementation of the reform program as well as the strong financial support provided by donors. The Borrower was actively involved in the design and implementation of the Credit, and clearly demonstrated ownership of the program. Of particular importance, the Government's commitment to reform was sustained and the implementation of the reform program since the Credit closed continues to move ahead. Throughout the implementation of the ERC, donors maintained or increased their financial commitment to the implementation of the reform program. Substantial resources were made available to the government budget, which allowed the Government to finance the exceptional expenditures resulting from the 1992 drought and the Peace Agreement. Coordination between donors and Government was gradually strengthened in the form of Government/donors working groups, which proved effective in ensuring complementarity among donor assistance. x. An important constraint that affected the pace of reform was the need to strengthen the country's institutional capacity. For various historical reasons, the country found itself with a critical shortage of skilled human resources at a time when the need for such resources was immense. While the country's commitment to the reform program was quite strong, the time required for building the institutional capacity of the Government constrained the reform program and prevented a rapid restructuring of institutions and policies.  iv xi. The summary ratings (Table 1) are: * Achievement of objectives: substantial * Program sustainability: likely * Bank performance: satisfactory * Borrower outcome: satisfactory; and, * Assessment of outcome: satisfactory xii. The main conclusions and lessons are: * Borrower ownership of the adjustment program is essential. Because of the Government's strong commitment to the reforms supported by the ERC, the implementation of the program proceeded despite the political uncertainty that prevailed during the implementation of the Peace Agreement in 1992-94. a A phased reform program allows for continued ownership of the reform program by Government when the initial institutional capacity is limited. A phased strategy allows the reform program to be designed so that it can be implemented by the Government without excessive recourse to foreign technical assistance. This makes it easier for the Government to maintain ownership of its program, and to put the reform program back on track when slippages occur. - Uneven progress in implementing the enterprise andfinancial sector reforms creates substantial macroeconomic instability. Because macroeconomic stabilization cannot be achieved unless leakages from financial institutions and enterprises are brought under control, simultaneous reform of the financial and enterprise sector is required to bring under control the accumulation of non-performing loans. The delays in carrying out such reforms account for much of Mozambique's continued macroeconomic instability. * Slow progress in reducing macroeconomic imbalances increases the social costs of adjustment. Difficulties experienced in rationalizing budgetary expenditures made it more difficult to redirect expenditures towards the poor and increase social expenditures on health and education. In addition, the slow process in controlling inflation worsened the burden of adjustment for the urban poor as well for the households that were net purchasers, of food products. * The reforms must be part of a broad program offiscal reform to increase the efficiency of international aid. Because Mozambique is so dependent on international aid, coordination and prioritization of donor aid is essential. Moreover, the disbursement procedures for import support funds must be as simple as possible if the objective is to finance the internal or the external deficit. In particular, less restrictions on the use of funds for petroleum imports would have resulted in much faster disbursement.  PART I: PROGRAM IMPLEMENTATION ASSESSMENT 1. After independence in 1975, Mozambique's economic development was stunted by a variety of factors of which the most important ones were a centralized planning system, a fifteen-year civil war and the exodus of most skilled labor at independence in 1975. By the mid-1980s, much of the economic and social infrastructure inherited from the colonial period had been destroyed, GDP was only two-thirds and exports one-third their post-independence peak (1980). Mozambique's debt had reached unsustainable levels and poverty affected most of its population. 2. In 1986, the Government decided to embark upon a reform program aimed at reversing the decline in output and restoring orderly financial relationships with trading partners and creditors. The Second Rehabilitation Credit (FY87) supported the first steps towards reducing massive distortions (in prices and the exchange rate), decreasing administrative controls, rehabilitating state enterprises, and mobilizing domestic resources. The Third Rehabilitation Credit (FY89) continued the process by focusing on improving the sectoral allocation of expenditures, tightening credit policy and initiating a restructuring of public enterprises. It also contained trade reform measures. A. STATEMENT AND EVALUATION OF OBJECTIVES 3. The overall impact of the Economic Rehabilitation Program implemented since 1987 was positive. It led to a reversal of the economic decline of the earlier 1980s with GDP growing at 6.6 percent in 1986-90, which lent support to the appropriateness for Mozambique of pursuing its reform program. The Economic Recovery Credit (ERC) aimed to build upon these encouraging results as well as to address newly emerging priorities. 4. In 1991, when the ERC was prepared, domestic insecurity was widespread throughout the country, but there were indications that a peace agreement could soon be reached with RENAMO. The ERC was designed to establish a policy framework and an institutional basis that would be most appropriate when peace would be restored. The development of fiscal and credit policy instruments was seen as crucial for macroeconomic stabilization, but it was determined that a more market-orientated approach would provide the greatest potential for rapid economic recovery. This implied: (i) establishing a transparent institutional process for privatizing state enterprises; and (ii) adopting the legal and regulatory framework needed for the development of a modern banking sector. Because of the perceived social costs of a rapid adjustment process, the ERC was also designed to protect key social activities in health and education and establish a targeted safety net in urban areas. This safety net would complement the existing annual Emergency Appeal which provided humanitarian assistance in rural areas.  2 5. The following policy reform areas were supported by the ERC: (i) Foreign exchange allocation and management of external aid. Actions under the ERC included: (i) replacing the administrative management of foreign exchange by a market-based system; (ii) contracting consultant services to improve the accounting and reporting procedures applied to import support funds; and (iii) maintaining the official exchange rate at a market-related level. (ii) Pricing and marketing. The focus of the ERC was to: (i) reduce the taxation of exports; (ii) simplify the regulations applying to rural traders to promote domestic marketing; (iii) abolish the system of ex-post price control for industrial products; and (iv) review the role of AGRICOM (state marketing agency) in agricultural marketing and the role of minimum prices. (iii) Financial sector. Prior to Board presentation, the Government prepared a comprehensive outline for the reform of the financial sector. The first phase to be supported under the ERC included: (i) the establishment of the Bank of Mozambique (BM) and the Commercial Bank of Mozambique (BCM) as separate entities; (ii) the preparation of an action plan to restructure the Commercial Bank of Mozambique; (iii) the publication of BM's and BCM's accounts; (iv) finalizing the regulations and procedures for the licensing of new banks; and (v) liberalizing lending interest rates. (iv) State enterprises. The program contained two components. The first one called for the establishment of a privatization process and the privatization of at least five enterprises the first year. The second component consisted of the formulation of a plan for transforming those enterprises that would continue to remain state enterprises into commercially-oriented public enterprises. (v) Budgetary Policies. The Government was to: (i) prepare a three-year investment plan (1992-94) satisfactory to IDA; (ii) introduce an harmonized system for the collection of counterpart funds; (iii) increase expenditures from domestic sources on agriculture, health and education by respectively 1.5%, 4.5% and 1% in 1993; (iv) increase expenditures on drugs and medical supplies (procured by Medimoc) for the National Health System to at least US$ 1 per capita by 1993; and (v) carry out an inventory of donor and NGOs -supported health activities. (vi) Poverty. The Government was to: (i) establish a coordinating body for policy formulation; (ii) reform the food ration scheme and replace food subsidies by targeted income transfers in urban areas; and (iii) prepare a report on land distribution.  3 Evaluation of Credit Objectives 6. The importance of structural reforms for attaining macroeconomic stabilization was a central theme underlying the ERC. Mozambique faced large fiscal imbalances which reflected a weak revenue base, insufficient recurrent funds for priority sectors, lack of expenditure controls, as well as leakages from financial and non-financial public enterprises. Because of the links with structural reforms, exchange rate, fiscal and monetary policies focused on: (i) reforming the foreign exchange market to reduce the fluctuations in the official exchange rate induced by shortages of foreign exchange; (ii) controlling monetary expansion by restructuring the state banks and strengthening monetary control by the central bank; (iii) increasing budgetary revenues by improving the mobilization of import support funds generated by import support funds; and (iv) imposing a harder budget constraint on enterprises by limiting budgetary subsidies. 7. While there was a clear consensus on the need to deepen the reform program, the strategy supported by the ERC was explicitly gradual. The Government took this approach on the basis of three broad areas of concern. First, it was acknowledged that the required adjustment was such that it required complex institutional changes that could only be implemented in successive phases. This was particularly the case of the financial sector reform where the issue was how to create a commercial banking sector given the predominance of two state banks in credit allocation. The emphasis was, therefore, placed on defining a medium-term action plan that would be supported first by the ERC and then by a follow-up financial sector adjustment credit. Second, there was a concern that a rapid adjustment would entail high costs that would not be politically sustainable, especially given the already high level of poverty and the political uncertainty surrounding the on-going negotiations with Renamo forces. Third, it was felt that the widespread acceptance of the new decentralized and market-based approach would take time. 8. Foreign Exchange Management. The central theme of the reform was to unify all the existing mechanisms for foreign exchange allocation and to create a market-based system for the allocation of foreign exchange. The decision to allocate foreign exchange through a market-based system was motivated by the experience gained under the Third Rehabilitation Credit (FY89). This experience indicated that: (i) foreign exchange would be allocated administratively unless the official exchange rate was at a market-related level; (ii) a market for foreign exchange would not function satisfactorily unless import support funds are untied and exporters can sell all their export earnings through that market; and (iii) the payment of counterpart funds generated by import support funds could not be monitored adequately unless import support funds were disbursed through the banking sector. 9. Policy reforms in marketing and price controls were necessary to allow for the economic integration of the country to take place. Inter-provincial trade in agricultural goods had been liberalized in June 1991, but several constraints prevented traders from selling and buying crops throughout the country. In addition, the system of minimum  4 prices for agricultural goods was found ineffective as prices were nearly always set at the minimum by state enterprises. Reforrns were, therefore, focused on removing the policy constraints preventing traders from operating in rural areas, reviewing the role of AGRICOM (the state marketing agency), and privatizing Caju de Mozambique (the largest state-owned processing enterprise in the cashew sector). 10. Financial Sector Reform. In 1991, Mozambique's financial sector was quite rudimentary, consisting mainly of two state banks --the Bank of Mozambique, which performed both central bank and commercial bank functions, and the Banco Popular de Desenvolvimento-- and one small private bank. This structure, similar to the one typically found in centrally planned economies, was viewed as inappropriate for supporting the development of Mozambique's private sector once peace would be restored. This implied separating the Bank of Mozambique into a Central Bank (Bank of Mozambique) and a commercial bank (the Commercial Bank of Mozambique), establishing a legal framework for the entry of new banks, and separating and clarifying the accounts of BM and BCM. The reform agenda was appropriate as it reflected the priorities of the Government and the conclusions of a recent study of the financial sector. 11. Enterprise Reform. The reform of the enterprise sector was a key requirement for reducing the financial imbalances that were adversely affecting the banking sector. However, privatization could not proceed rapidly because of the need to clarify the legal situation of the so-called "intervened" enterprises. These enterprises had been taken over by Government, but legally they still belonged to their initial owners. Technical assistance to prepare the enterprises for sale was provided by a separate IDA Enterprise Restructuring Credit (Cr. No. 20810). The specification of policy actions was realistic. The appraisal mission had discussed with Government what targets should be achieved, and what privatization meant from the point of view of the second tranche conditionalities. 12. Budgetary Expenditures. The reforms in the area of public expenditures were basically a continuation of the work started under the previous adjustment credit. By 1991, important progress had been made in terms of recording the great majority of investment projects and aligning actual expenditures with the country's stated objectives. However, there were indications that: (i) budgetary allocations for the social sectors were declining in real terms; (ii) the institutional capacity of the Government was adversely affected by the erosion of salaries; and (iii) the implementation of projects was hindered by the lack of counterpart funds. 13. The ERC supported the reallocation of expenditures towards the social sectors (health and education) and the replacement of food subsidies by a social safety net targeted to the urban poor. These measures, while modest, proved to be realistic. The setting up of a social safety net was supported by an extensive analysis of various options for targeting households on the basis of the data generated by the Ministry of Health and combining that information with other income data.  5 B. ACHIEVEMENT OF PROGRAM OBJECTIVES 14. The overall structural objectives of the Credit were achieved. Growth accelerated; the system of administered allocation of foreign exchange has been replaced by a market- based system; the banking sector has been modernized and privatized; the state enterprise sector has been largely privatized (two-thirds of output); and the social conditions of the poor have greatly improved. These achievements have been made partly possible by the 1992 Peace Agreement signed by the Frelimo Government and the Renamo forces. Following the demobilization of about 80,000 soldiers, Mozambique's first multi-party elections were held in October 1994, returning Frelimo to power. A small army, combining the previously adversary forces of Frelimo and Renamo, was formed, and opposition parties participate fully in the political debate. The following paragraphs highlight the main accomplishments and issues concerning the outcome of the program. 15. Economic growth accelerated noticeably in 1992-95. Real GDP growth reached 6 percent p.a. on average in 1991-1995 compared to 5.1 percent p.a. in 1987-91. However, this performance masked different sectoral developments. Agriculture output recovered quickly from the severe 1992 drought, while industrial output continued to decline in 1992-94. In 1995, however, manufacturing output rose by 18.5 percent as the privatization of large industrial companies led to substantial increases in output. Throughout the period the transport and commercial sector also expanded rapidly. During the first six months of 1996, GDP is estimated to have increased by 7.4 percent relative to the same period in 1995. The most significant developments have been the rapid increase in agricultural output reflecting the highest grain harvest in twenty years and the doubling of marketed cashew due to the elimination of quantitative restrictions and the reduction in export tax, resulting in a 29 percent increase in producer prices. 16. Overall, the main factors accounting for the acceleration of growth were the restoration of peace, which allowed over one-third of the population to resettle in rural areas, substantial donor assistance and policy reforms. Growth came mainly from small- scale agriculture and the informal sector, but also to an increasing degree from an emerging private sector that is gradually taking over the activities of the previously state- controlled economy. The rapid emergence of these new activities indicates that the growth recorded in 1991-95 would have been much more modest if reforms had not been implemented continuously since the initiation of the ERP in 1987. 17. Reform of the Foreign Exchange System. The focus of the reform was to combine trade liberalization with the development of a market for foreign exchange. Both objectives were achieved. In 1992, the administrative involvement of the Ministry of Commerce in the management of import support funds was dismantled. This was accompanied by a strengthening of the institutional capacity of the Bank of Mozambique to monitor and manage the new system of foreign exchange allocation. Compared to the ultimate goal of creating a market system for the allocation of foreign exchange, the new system was somewhat of an hybrid as it mixed earnings from exporters with import support funds, but it represented a significant step forward.  6 18. What made the import liberalization sustainable was the drastic change in exchange rate policy. Until 1991, the official exchange rate was substantially overvalued as shown by the premium of the secondary market exchange rate (over 100 percent on average in 1987-90). In April 1992, the country adopted a floating exchange rate policy with the official exchange rate being set on the basis of the parallel market exchange rate. The spread between the official exchange rate and the parallel market exchange rate was kept within a 15-20 percent band during the first years of the program. It fell to less than less than 10 percent on average in 1994-95 and to less than 2 percent by mid-1996. 19. Pricing and Marketing. The objectives of the ERC were met, but after some delays. As expected, private sector participation in the domestic marketing of agricultural products increased sharply with the relaxation of the licensing requirements on retailers and wholesaleis. Prices of agricultural commodities rose above the minimum prices, which rendered obsolete the envisaged review of minimum prices and AGRICOM, the state marketing board, whose share in the procurement of maize declined drastically. The remaining price controls on industrial products were lifted in 1993 and the restrictions affecting informal traders were relaxed. Export taxes were reduced in 1991, but export restrictions affecting unprocessed agricultural crops (particularly raw cashew nuts) remained in place until 1995. The reason for the slow progress in liberalizing exports of agricultural products was the strong resistance of the processing industry. 20. The main domestic effects of the policy measures were to increase agricultural marketing, particularly for maize, and to reverse the worsening of the terms of trade between agriculture and industry in those regions where small private traders were active. Externally, the policy measures led to increased exports. The rate of growth of exports of goods and services rose continuously from 2.7 percent in 1993 to 20.8 percent in 1995 (in current US$). During the first half of 1996, merchandise exports increased by 42 percent compared to the same period in 1995. In particular, raw cashew exports reached US$25 million compared with US$1 million the previous year, and processed cotton and cashew increased by 23 percent and 33 percent, respectively. 21. Financial Sector. The specific objectives of the ERC were met. The Bank of Mozambique was separated into two institutions -- the Bank of Mozambique (central bank) and the Commercial Bank of Mozambique (BCM); new regulations were enacted to allow for the entry of new banks; and accounts were established for BCM. These revealed large losses (equivalent to 12 percent of GDP) in BCM's balance sheet. Immediate privatization was ruled out at the time because of BCM's extremely poor financial situation and the fact that BCM represented virtually the entire banking system. Instead, the Government opted for a restructuring strategy which included transferring losses from BCM's balance sheet to internal collection units and write-offs, the cessation of lending to non-performing borrowers, appointing external management advisers, and privatizing and restructuring the largest non-performing borrowers. In March 1995, faced with limited progress in transforming BCM into a dynamic commercial bank, the Government decided to privatize BCM. BCM was privatized in July 1996, and the process to privatize BPD, the second largest state-owned bank, is currently underway.  7 22. While the reform of the financial sector is far from complete, recent trends indicate that the initial objective of creating a dynamic and commercially-oriented financial sector is being attained. Shareholdings have changed in some of the existing banks to include South African interests; a new Portuguese has entered the market; a credit cooperative bank has been established by Mozambican entrepreneurs; and a leasing company started operations in 1996. 23. Privatization and Enterprise Reform. After a slow initial start, the privatization program accelerated quickly. The medium-term objective of the Credit of privatizing some 25 enterprises was exceeded with some 32 large enterprises sold in 1992-96. Including small and medium enterprises, over 700 enterprises, out of approximately 1,000, have been privatized. The private sector now commands well over two-thirds of industrial output compared with less than a third in 1990, and industrial recovery is taking place. A joint review with Government of the impact of privatization revealed a five-fold increase in the output of the firms that were recently privatized under the responsibility of UTRE (government agency which oversees the sale of large enterprises) (see Appendix B). However, it also indicates that some of the privatized firms did not perform well and closed down. 24. Particular emphasis has been placed on those public sector companies that are the largest debtors to the banking system. Of the 14 largest non-performing enterprises identified in mid-1994 under the Second Economic Recovery Credit (SERC), five have been sold, three are at the point of sale, and three are in the process of being privatized. With respect to the remaining three, LAM (the national airline) is in the process of being privatized and bid documents are been prepared for private/public joint ventures, with a majority private sector share for CFM (the national railways). As to AGRICOM, the state marketing board, its debt has been written-off and its role in agricultural marketing drastically reduced. The Government plans to complete the privatization program by the end of 1997, including the sale of another 30 large enterprises. 25. Compared to privatization, the restructuring of public utilities has proceeded slower than expected. It was initially envisaged in 1991 that large state companies, primarily transport and utilities, would be restructured as public enterprises rather than immediately privatized. While the legal modification did take place, the effective transformation of these enterprises into commercially-oriented public enterprises has been slower than envisaged. However, initiatives are now underway to remove barriers to entry and increase private sector participation, particularly in the transport (railways, aviation, coastal shipping, port handling), petroleum distribution and water sectors. 26. Macroeconomic Framework. When the ERC was prepared, it was explicitly recognized that macroeconomic disequilibrium would remain substantial over the medium-term. This was viewed as reflecting the economy's severe supply side weaknesses and the country's dependence on emergency assistance over the short-term, both of which could only be gradually addressed over time. However, it was envisaged that macroeconomic stabilization could be achieved through better control of monetary  8 expansion. This objective proved to be elusive with broad money growing at an average rate of 63 percent p.a. in 1992-95, which exceeded the programmed levels in every year during the ERC program. 27. A key factor was the difficulties encountered in reforming the two state banks, BCM (Banco Comercial de Mocambique) and BPD (Banco Popular de Desenvolvimento), which together accounted for 90 percent of banking activities. While progress was achieved in improving the transparency of the accounts of the banks, the establishment of bank accounts for the two state banks in 1992-93 revealed substantial financial imbalances within the state banks. Although monetary growth declined from 79 percent in 1993 to 58 percent in 1994 and 55 percent in 1995, monetary targets proved difficult to meet due to a marked financial deterioration of the two state banks and excessive overdrafts with the central bank. Because of the difficulties encountered in restructuring BCM and ensuring that its lending operations remain with agreed credit ceilings, the Government decided to accelerate the privatization of BCM and BPD. BCM was privatized in mid-1996 and the privatization process of BPD --initiated in mid-1996-- is expected to be concluded by early 1997. Because of the improved credit control, money supply growth declined sharply and the inflation rate fell to 16 percent in 1996. 28. Budget. Throughout the program the attainment of the fiscal macroeconomic goals proved elusive. The fiscal adjustment relied mainly on expenditure reduction, but the main unexpected development was the fall in revenues. Expenditures were reduced from 47.4 percent of GDP in 1992 to 39.1 percent of GDP in 1995, but budgetary revenues declined from 21.1 percent of GDP to 18.3 percent of GDP during the same period. Because of substantial donor assistance, the budget deficit after grants remained small (5.2 percent of GDP on average, excluding the impact of the peace agreement in 1994) and was not a key factor behind the rapid monetary expansion of the 1992-95 period. 29. Substantial budgetary reallocation took place during the period. Sustained peace allowed the Government to cut the defense budget and to use the "peace dividend" to increase social expenditures. Expenditures on health and education increased in real terms by 15 percent and 21 percent, respectively. Nevertheless, total budgetary current expenditures fell from 21.4 percent of GDP in 1993 to 16.6 percent in 1995. These reductions adversely affected the implementation of the investment budget because of the shortages of local contributions needed for externally-financed projects. 30. A key factor was that the envisaged development of a more systematic approach to the management of public expenditures proceeded more unevenly than expected. As agreed under the ERC, a three-year investment plan was prepared, but it did not fully play its intended role because throughout the implementation of the Peace Agreement in 1992-94, many distinct expenditure initiatives emerged. Some were the direct consequence of the Peace Agreement while others reflected short-term humanitarian objectives or the country's medium-term development objectives. As a consequence, there were substantive problems of unresolved issues of expenditure prioritization. A  9 much more tightly defined set of objectives as well as a substantial reduction of the fragmentation of external assistance would have greatly improved the scope for macroeconomic stabilization. To integrate more fully donor-financed projects in the budget cycle, the Government launched in 1996 a fiscal management review with the assistance of the Bank and bilateral donors. 31. The achievement of peace has enabled Government to carry out a substantial reallocation of budgetary expenditures towards the social sectors. As agreed under the ERC, expenditures for health, agriculture and education were increased in real terms in 1992 and 1993. A significant step was reached in 1995 when the Government decided to reduce military expenditures by 37 percent and to increase social expenditures by 44 percent, both in real terms. The goal was to offset the decline in budgetary expenditures in real terms that took place in 1994 because of the higher than expected inflation. Overall, there was a noticeable improvement in health and education services. The volume of health services rose by 12 percent between 1993 and 1995, principally in rural areas, while primary school enrollment rates among 6-10 year olds in rural areas rose from 24 percent in 1991 to 45 percent in 1994. At the national level, the previous decline was stopped with the primary enrollment rate rising from 54 percent in 1993 to 57 percent in 1995 (see Table 5 in annex). 32. Poverty. The social objective of the ERC to improve the living conditions of the poor was achieved. While poverty indicators still indicate widespread poverty, the living conditions of the poor have improved substantially, mainly as a result of peace and the ensuing agricultural growth. Because poverty was so pervasive as a result of the war, the restoration of economic growth and the attainment of peace were the main vehicles for reducing poverty. Peace allowed for the resettlement of over one-third of Mozambique's population in rural areas, which generated a dramatic turn-around in food insecurity with the number of families in need of food assistance declining from over one million in 1994 to an estimated 90,000 in 1996. A key factor was the unexpected large role that small traders, mainly women, came to play in the marketing of maize throughout Mozambique. 33. The evolution of poverty in urban areas is more difficult to assess due to the lack of indicators. On one hand, the delay in reducing inflation had probably a high social cost because it increased the burden of adjustment for the urban poor and the households that were net purchasers of food. On the other hand, the Government established a coordinating poverty unit for policy formulation and a targeted income safety net for poor households in urban areas. In recent years, over 80,000 households were covered under the scheme. Other factors contributing to increased income in urban areas were the increased economic activity recorded in the informal sector (including transport and trade) and the resettlement of households in rural areas which reduced the downward pressure on wages in urban areas. The privatization of state enterprises was accompanied by a reduction in the excess labor that these companies had previously kept, but it allowed those enterprises to increase wages subsequently. One indicator of the overall effect of these different trends is the minimum wage rate, which declined in real terms in 1990-94, but rose by 15 percent in 1995.  10 C. BANK'S PERFORMANCE 34. The Bank's performance in the identification, appraisal and negotiation of the credit was satisfactory. Supervision of the reform program was monitored in the context of annual PFPs, Consultative Group Meetings, and IDA investment projects. A useful vehicle for supervision was the Joint Bank/Donor Evaluation Mission (1993). It helped create a consensus on the achievements and shortcomings of the foreign exchange market. The implementation of the privatization program was carried out with technical assistance provided under the IDA Industrial Enterprise Restructuring Credit (Cr. No 20810), while the accounts for BCM were established with technical assistance financed by the IDA Small and Medium Scale Enterprise Credit (Cr. No. 20820). Supervision of the banking reform was carried out mainly through the Resident Mission, and the on- going Second Economic Recovery Credit (Cr. No. 26280) focused on the financial sector. 35. Implementation of the program was substantially enhanced by the Government/donors sectoral coordination groups that were established. The role of cofinanciers was particularly important for petroleum, health and transport sectors. Regular coordination helped set up common procurement procedures for petroleum and avoid financing crisis. It also ensured continuous monitoring of sectoral developments. In recent years, other sectoral coordination groups were created, particularly as concerns macroeconomic policies. These institutional developments provided the backdrop for the development of key sector investment programs in the health and transport sectors. D. BORROWER'S PERFORMANCE 36. Borrower's performance in the identification stage was satisfactory as it took ownership of the program. The Government carried out an analysis of the cost of the various system of foreign exchange allocation, which proved instrumental in creating a consensus on the need to implement a market-based system for the allocation of foreign exchange. The Government also played an active role in formulating a program for the privatization of state enterprises that could be implemented taking into account the complex legal institutional issues that needed to be addressed. The design of the banking reform was developed in coordination with Government, who played an important role in defining a phased-approach for the reform of the sector. Similarly, the program for the redeployment of public expenditures was defined by the sectoral ministries in coordination with the Ministry of Finance. 37. The main issue that delayed the release of the second tranche of the Credit by about four months was the Financial Management Action Plan (FMAP). The purpose of the FMAP was to address shortcomings in the management of import support funds, which had been revealed by the audits of the Second and Third Rehabilitation Credits. However, the implementation of the FMAP turned out to be more complicated than expected. After some delays, a comprehensive review of all missing documentation was carried out by an independent consulting firm and remedies were agreed with IDA.  11 Measures were taken to improve accounting and technical assistance (financed under bilateral assistance from ODA) was provided. 38. Most measures agreed under the Credit were implemented and all covenants were complied with. However, disbursement of the Credit was slower than anticipated. This was partly due to the procedures required for accessing funds which, from the point of view of commercial banks, were quite complicated and costly. A second factor was the need to open Letters of Credit. This process took often from three to six months. As funds were drawn against the special accounts, funds were tied up for a long period of time. This issue arose especially at the end of the Credit when funds were committed, but remained undisbursed. To allow full disbursement of the Credit, the ERC was extended for another year. E. ASSESSMENT AND CONCLUSION 39. Program Sustainability. The sustainability of the reform program is highly likely. The Government has continued to deepen the reform program to address the shortcomings of the reform program, particularly as concerns macroeconomic stabilization. In this regard, the key decisions taken by Government to privatize BPD (Banco Popular de Desenvolvimento), to reform customs and trade taxes, and to improve budget management are indicative of the continuing government commitment to reform. 40. Overall Assessment. Because the ERC was part of a broad program of financial support from the donor community, the specific impact of the ERC cannot be isolated. O)ne can only assess the global results to which the ERC contributed. In each of the policy areas targeted by the ERC, the outcomes have generally been satisfactory. Significant economic liberalization has taken place and a basic framework for private sector development has been established. Growth has been strong, though uneven and the living conditions for most households, particularly in terms of food security, have improved substantially. It is to the credit of the Government that this difficult adjustment program was carried out in extraordinarily adverse circumstances stemming from the powerful adverse impact of the insecurity situation in 1992-93, the severe 1992 drought and the political uncertainty that surrounded the transition to a democratically-elected Government. 41. Because of the country's dependence on foreign aid, the implementation of the program implied strong donor involvement to simplify and harmonize procurement procedures and maintain a substantial inflow of import support funds. In this context, progress turned out to be slower than expected. A fundamental difficulty was that from the point of view of firms, the access to import support funds remained complicated and costly. In retrospect, the disbursement of funds would have proceeded much faster if there had not been a 20 percent limit on the use of ERC funds for financing petroleum or food imports (each) for which the existing procurement regulations result in substantial savings. In Mozambique's case, there was a shortage of funds for financing petroleum imports and the country ended up buying petroleum products on an emergency basis at a  12 higher cost than otherwise. In 1995, however, the ERC legal agreement was modified to remove the restrictions on petroleum imports. 42. While there were some implementation delays and policy slippages, the key objective of the Credit to enhance private-sector based economic growth was achieved. The program helped establish the institutional changes required for moving from administrative management to market-led economic development. It contributed to the development of a strong privatization program, and it provided the institutional basis for a commercial banking sector as well as the expansion of agricultural marketing by private traders. Secondly, it helped to protect key activities in health and education and establish a safety net for the urban poor. Lastly, it contributed to reducing macroeconomic instability by providing resources to close the financing gap. 43. These are extremely encouraging results, but this assessment needs to be qualified in several important respects. First, the rapid economic growth recorded the last few years reflects a recovery from extremely low levels as well as the resettlement of over five million people in rural areas. Transforming this short-term recovery into long-term growth requires the implementation of complex institutional changes, including the development of the state capacity to manage economic changes. Second, the improvement in the situation of the poor was made possible by the restoration of peace, the resumption of productive activities in rural areas and the reorientation of government expenditures towards health and education. Third, the macroeconomic framework is still fragile, while weak institutional and human capacity constrains the pace of structural reform needed for ensuring an appropriate balance between macroeconomic stabilization, economic development and poverty reduction. With peace, emergency assistance is being phased out, but Mozambique remains highly dependent on external aid, both to finance imports and budgetary expenditures. In addition, with an external debt amounting to 3.7 times GDP and 13 times exports, Mozambique faces an unsustainable debt burden over the medium-term, which can only be reduced through a combination of debt relief measures and further adjustment. Taken all together, the implication is that a difficult adjustment agenda still lies ahead. 44. Lessons Learned. The main conclusions and lessons learned are: * Borrower ownership of the adiustment program is essential. Because of the Government's strong commitment to the reforms supported by the ERC, the implementation of the program proceeded despite the political uncertainty that prevailed during the implementation of the Peace Agreement in 1992-94. While slippages did occur, they were corrected by Government and the program was put back on track. * A phased reform program allows for continued ownership of the reform program by Government when the initial institutional capacity is limited. As adjustment moves from outright liberalization to reforms requiring increased institutional capacity, the pace of reform is constrained by Mozambique's  13 weak human resource base. A phased strategy allows the reform program to be implemented by the Government with its own resources. * Uneven progress in implementing the enterprise andfinancial sector reforms creates substantial macroeconomic instability. Because macroeconomic stabilization cannot be achieved unless leakages from financial institutions and enterprises are brought under control, simultaneous reform of the financial and enterprise sector is required. Delays in carrying out such reforms result in macroeconomic instability. * Slow progress in reducing macroeconomic imbalances increases the social costs of adjustment. The difficulties involved in meeting fiscal targets limited the scope for reorienting budgetary expenditures towards health and education and financing the safety net for the urban poor. In addition, the slow reduction of financial imbalances led to high inflation, which increases the cost of adjustment for the poor, and particularly for those households that are net purchasers of food. * The reforms must be part of a broad program offiscal reform to increase the efficiency of international aid. Because Mozambique is so dependent on international aid, coordination and prioritization of donor aid is essential in order to better align budgetary expenditures with the overall priorities. A much more tightly defined set of objectives and responsibilities for each expenditure initiative, and with all initiatives brought under the government budget, would have substantially alleviated the problem of expenditure incompatibility given the budgetary resource envelope. However, the disbursement rules for import support funds must be as simple as possible if the objective is to transfer funds quickly to finance the internal or external deficit.  14 PART II - STATISTICAL TABLES Table 1: Summary of Assessments A. Achievement of Objectives B. Program Sustainability C. Bank Performance D. Borrower Performance E. Assessment of Outcome Table 2: Related Bank Operations Table 3: Project Timetable Table 4: Disbursements Table 5: Key Indicators, Actuals and Projected, 1992-96 Table 6: Studies Included in the Credit Table 7: Status of Legal Covenants Table 8: Bank Resources - Actual Staff Inputs Table 9: Bank Resources - Missions  15 Table 1: Summary of Assessments A. Achievement of Objectives Substantial Partial Negligible NIA Macroeconomic Policies V Sector Policies Financial Objectives v Institutional Development V Physical Objectives V Poverty Reduction Gender Concerns V Other Social Objectives V Environmental Objectives V/ Public Sector Management V Private Sector Development V B. Program Sustainability Likely Unlikely Uncertain C. Bank Performance Highly Satisfactory] Satisfactory Deficient Identification Preparation Assistance V Appraisal V Supervision V/ D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation V/ Implementation Covenant Compliance V E. Assessment of Highly Satisfactory Satisfactory Unsatisfactory Highly Outcome Unsatisfactory [f~~ V  16 Table 2: Related Bank Operations Credit Title Purpose Fiscal Status (As it relates to the ERC) Year Precedig Operatins ;:;;; ;; ;I Rehabilitation Program To rehabilitate and maintain investments and 1985 Completed economic services expected to generate an immediate production response. Second Rehabilitation To support policy and institutional reforms; to 1988 Completed Credit provide foreign exchange to finance essential imports; and to assist the Government develop an agenda for longer-term policy changes. Third Rehabilitation To improve the allocation of foreign exchange 1989 Completed Credit system, budgetary policy, and price policy, and to review and reform the trade tariff structure. (Pararllel Ofperations :::f : ;;l Economic/Financial To strengthen the key economic and financial 1990 Under Management Technical management functions of the Ministry of implementation Assistance Finance and Bank of Mozambique. Small and Medium Scale To provide medium and long-term financing 1990 Under Enterprise Credit implementation Industrial Enterprise To restructure and rehabilitate the industrial 1990 Under Restructuring Credit sector through the privatization of state-owned implementation enterprises and financing for plant and equipment rehabilitation. Following Operations; Financial Sector To develop and strengthen the financial sector 1994 Under Capacity Building institutions, including training of central and implementation commercial banks staff and legal professionals at BOM and MOF. Second Economic To strengthen key elements of fiscal and 1994 Under Recovery (SERC) monetary policy while supporting an interlinked implementation program of enterprise and financial sector reform. Third Economic To support measures to improve 1997 Under appraisal Recovery (TERC) macroeconomic management through financial and fiscal refonn, and to stimulate the supply response. l  17 Table 3: Project Timetable Steps in Project Cycle Date Planned Date Actual Identification March 1991 Preparation April 1991 July 1991 Appraisal October 1991 November 1991 Negotiations January 1992 April 1992 Letter of Development Policy January 1992 April 1992 Board Presentation June 1992 June 1992 Signing June 1992 June 1992 Effectiveness October 1992 August 1992 First Tranche Release October 1992 August 1992 Second Tranche Release May 1993 September 1993 Closing Date June 1995 June 1996 Table 4: Disbursements (in US$ million equivalent) FY93 FY94 FY95 FY96 FY97 Appraisal Estimate 90.0 80.0 10.0 Appraisal Estimate Cumulative 90.0 170.0 180.0 Actual 80.0 65.6 21.0 20.8 0.9 Actual Cumulative 80.0 145.6 166.6 187.4 188.3  18 Table 5: Key Indicators, Actuals And Projected, 1992-95 (% unless otherwise indicated) Actual Bank Proiections3 1992 1993 1994 1995 1992 1993 1994 GDP Growth -0.8 19.3 5.0 1.5 3.0 5.0 5.5 Total Investment/GDP 48.8 54.4 52.2 50.8 41.9 39.9 38.6 Gross Domestic Savings/GDP -3.0 1.9 -3.5 13.5 -11.5 -13.2 -13.3 Export Growth (GNFS) (US$) -0.2 2.7 9.2 20.8 10.3 13.8 11.7 Import Growth (GNFS) (US$) -3.1 11.7 6.7 -16.5 -1.3 7.3 5.7 Current Account Balance (US$ Mn4) 738 825 894 684 750 822 855 Current account deficit (% of GDP) Before grants 57.5 56.2 61.2 44.9 60.3 60.1 57.3 After grants 18.6 21.9 19.4 22.6 17.6 20.1 19.6 Total Revenues/GDP5 21.1 20.0 17.6 18.3 25.9 26.0 25.0 Total Expenditures/GDP 47.4 42.2 47.3 39.1 57.2 56.6 53.0 Fiscal deficit before grants/GDP 26.3 22.2 29.7 20.9 31.3 30.6 28.0 Fiscal deficit after grants/GDP 5.5 5.1 8.3 5.0 4.8 4.3 4.0 ConsumerPriceIndexGrowthRate 45.1 42.3 63.1 54.4 25.0 14.0 100 Note: Due to inadequacies in the national accounts, the ratios to GDP are distorted. In addition, investment figures include a significant proportion of recurrent expenditures. The national accounts are being revised. Projections are from the ERC President's Report (P-5775-MOZ) dated May 18, 1992. 4 Excluding foreign grants. Excluding capital grants. 6 Including net lending.  19 Table 5: Social Indicators, 1993-95 (continued) Health Indicators 1993 1994 1995 Indicators of Access Number of visits per people 0.36 0.37 0.40 Facility-based deliveries per people 26% 29% 27% Ante-natal coverage 57% 63% 64% Coverage 0-l1 months 75% 83% 92% DPT third dose coverage 45% 55% 57% Measles vaccination 60% 65% 69% Health Services Hospital days 1,992,862 2,045,570 2.,093,377 Facility-based deliveries 145,250 166,802 164,117 Vaccinations 3,624,491 4,665,690 4,617,684 Number of visits 4,698,906 4,797,791 5,390,985 Units of health services 1/ 29,068,316 31,026,951 32,578,111 Source: "Situa,do, Problemas e Perpectivas, o Servi,o Nacional de Saude ", Ministry of Health, April 1996 Note. 1/ Units of health services are weighted average of the above categories Education Indicators (%) 1991 1994 1995 Enrollment ratio in rural areas 6-10 years 23.8 45.4 n.a 11-12 years 43.3 63.7 n.a. 13-15 years 42.2 51.8 n.a. Gross enrollment ratios (primary) National level 62.9 54.2 57 Source: "Rural Poverty Profile ", Poverty Alleviation Unit, Ministry of Planning and Finance, April 1996  20 Table 6: Studies Included in the Credit Studies Purpose Status Review the methodology Improve price incentives for Study was done, but was for setting floor prices of and cotton and cashew obsolete as decision was cashew and cotton on the taken to move to market basis of border prices determined prices Prepare action plan to Identify policy options for Plan was prepared. In 1996, restructure BCM dealing with bank's losses BCM was privatized. Formulate plan for Improve performance of Explicit plan was not transforming public utilities public enterprises by prepared, but decree to into commercially-oriented restructuring along "commercialize" state public utilities commercial lines those enterprises was issued and enterprises that would the strategy shifted towards remain in the state sector (i) promoting increased competition; (ii) tightening the budget constraint; and (iii) increasing private sector participation in the public enterprises. Carry out inventory of Improve coordination of Inventory of projects was donor and NGOs supported donor-supported activities carried out with an estimate health activities and improve budgeting of recurrent costs. Review income transfer Assist in developing Review of income transfer schemes efficient transfer scheme was done. mechanisms Conclusion was that the scheme reached poor households. Prepare progress report on Increase transparency in Condition of Second land distribution and land allocation Tranche. Report was done, transfer but its intended purpose was not achieved.  21 Table 7: STATUS OF LEGAL COVENANTS Loan Agreement Description of Covenant Comments Section Schedule 3 1 The Borrower has operated the revised consolidated Condition met. market-based system for the allocation of foreign exchange. 2(a) The Borrower has completed the separation of the BOM was separated accounts of Banco de Mocambique (BOM) and Banco into BOM and BCM. Comercial de Mo,ambique (BCM); and 2(b) finalized a balance sheet for BOM for 1991. Condition met. 3(a) The Borrower has adopted regulations satisfactory to Completed. the Association for licensing new banks; and 3(b) implemented procedures satisfactory to the Association Procedures for for the assessment and approval of applications for licensing of banks banking licenses submitted to Banco de Mo,ambique adopted. by new banking institutions. 4 Satisfactory progress has been achieved in the Condition met. implementation of the Borrower's privatization program in accordance with the terms of reference and targets set forth in the Program (of action). 5(a) The Borrower has prepared a three-year investment Completed. plan (FY92-94) and a financial plan (FY92-94) satisfactory to the Association; and 5(b) increased its budgetary allocations from domestic Condition met. sources in real terms from FY92 to FY93 by at least 1% for education, 1.5% for agriculture, and 4.5% for health. 6 The Borrower has completed and submitted to the Report was submitted Association a progress report on land distribution and to IDA. transfer of land rights to smallholders and private enterprises through September 30, 1992. 7 The Borrower has completed and submitted to the Completed with some Association a progress report on its financial delays. management action plan, in accordance with terms and conditions agreed between the Borrower and the Association.  22 Table 8: Bank Resources - Actual Staff Inputs7 Stage of Project Cycle Staff Weeks Us$'009 l Preparation to Appraisal 52 155 Appraisal 21 66 Negotiations through Board Approval 8 24 Supervision 42 131 Completion 9 35 TOTAL 132 411 Source: MIS Report (COSR2) - Staff Time Use and Schedule, in Staff Weeks and Dollars. 8 Includes travel and labor costs.  23 Table 9: Bank Resources - Missions Stage of the Project Month/Year Number of Days in Field Cycle persons Identification March 1991 1 10 Preappraisal July 1991 5 15 Appraisal November 1991 5 15 Supervision March 1993 2 15 August 1993 1 15 October 1993 1 5 November 1995 4 5 Completion March 1996 2 15 Note: Supervision of the credit in 1994-95 was carried out through the PFPs mission and the supervision missions of the Second Economic Recovery Credit.   Appendix A Page 1 of 5 AIDE-MEMOIRE IMPLEMENTATION COMPLETION MISSION (Credit 2384-MOZ) 1. A World Bank Mission visited Mozambique from March 25 to April 10, 1996 to prepare the Implementation Completion Report (ICR) for the Economic Recovery Credit (ERC). The ERC is scheduled to close on June 30, 1996. The Mission consisted of Messrs. Rene Bonnel (World Bank) and included the participation of Mr. David Wilton (World Bank). This aide-memoire summarizes the main conclusions of the mission. Overall Conclusion 2. The good news is that a new pattern of economic development is taking place based on rapid agricultural growth and new exports (most of them not reflected in official trade). What is causing these changes are increased domestic and external trade resulting from the resettlement of households in rural areas, on-going liberalization of internal trade and balance of payments and economic recovery in Southern Africa. The issue is that government policy is still aimed at rebuilding the economy as it was before independence and preserving the existing industrial structure. The result is a set of inconsistent policies that are slowing down economic recovery. 3. This is particularly the case for the financial sector reform. For the last four years the Government has been trying to maintain the two state banks alive because they were the main source of credit for the economy. The problem is that as loans are not being repaid9, the state banks are suffering from a liquidity crisis, which is alleviated through increased overdraft by the Central Bank. The state banks have generally exceeded their net domestic asset credit ceilings, have not observed their loan concentration limits and have extremely weak accounting systems. As a result, they have not been restrained by credit controls or prudential controls. Only the private banks have been. The consequence is a serious macroeconomic risk as shown by the experience of countries which failed to successfully address financial sector issues.'