Mozambique - Second Poverty Reduction Support Operation Project

Documentof The World Bank FOROFFICIAL USEONLY ReportNo.32890-MZ INTERNATIONAL DEVELOPMENTASSOCIATION PROGRAMDOCUMENT FORA PROPOSEDCREDIT INTHE AMOUNT OF SDR 83.3 MILLION(US$120MILLIONEQUIVALENT) TO THE REPUBLIC OF MOZAMBIQUE FOR A SECOND POVERTYREDUCTIONSUPPORT OPERATION August 4,2005 PovertyReductionand Economic Management - AFTP1 Environmentallyand Socially Sustainable Development-AFTS1 Africa Region This document has arestricteddistribution and may be usedbyrecipients only inthe performance oftheir official duties, Its contents may not otherwise be disclosed without World Bank authorization.  MOZAMBIQUE - GOVERNMENTFISCAL YEAR January, 1-December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as o f May 4,2005) Currency Unit Metical US$1 .oo 21,300 Weights and Measures Metric System ABBREVIATIONAND ACRONYMS BdPES Progress Report on the Economic and Social Plan BIM Bank o f Mozambique CAS Country Assistance Strategy CEM Country Economic Memorandum CFAA Country Financial Accountability Assessment CFMP Country Financial Management Plan CNCS AIDS National Council CPAR Country Procurement Assessment Review C T A Confederation o f Economic Associations o f Mozambique DBS Direct Budget Support EU European Union FSAP Financial Sector Assessment Program GBS General budget support GDP Gross Domestic Product GNP Gross National Product G o M Government o f Mozambique HIPC Heavily Indebted Poor Countries IAS International Accounting Standards IBRD International Bank for Reconstructionand Development I C A InvestmentClimate Assessment ICR Implementation Completion Report IDA International Development Association IFC International Finance Corporation IFRS International Financial Reporting Standards IMF International Monetary Fund INE National Statistics Institute JSA Joint Staff Assessment LDP Letter of Development Policy LFL Bankruptcy Law LICSF Banking Institutions Law MDGs Millennium Development Goals MEC Ministryo fEducationand Culture MIC Ministryo fIndustryandCommerce MINAG MinistryofAgriculture M o F Ministry of Finance M o H Ministryo fHealth  FOROFFICIAL USEONLY M o U Memorandum o f Understanding MOZAL Mozambique AluminiumCompany MPD Ministryo fPlanningand Development MTEF Medium-Term Expenditure Framework MTFF Medium-term Financial Framework MYR MidYear Review OE State Budget PAF Performance Assessment Framework PAP ProgramAid Partners PAPPA Programme Aid Partners' Performance Assessment PARPA Action Plan for the Reductiono f Absolute Poverty PEN National Strategic Plan PER Public Expenditure Review PES Economic and Social Plan PMTCT Prevention of mother-to-child transmission PRGF Poverty Reduction and Growth Facility PRSC Poverty Reduction Support Credit PRSP Poverty Reduction Strategy Plan PSIA Poverty and Social Impact Analysis QAG Quality Assurance Group QUIBB Qualitative Indicators Survey SADC Southern African Development Community SDR Special Drawing Rights SISTAFE Integrated Financial Management System TA Technical Assistance UTRESP Technical Unit for Public Sector Restructuring VAT Value Added Tax Vice President: Gobind Nankani Country Director: Michael Baxter Sector Managers: Emmanuel Akpamichard Scobey Task Team Leaders: Gregor BinkertiJeeva A. Perumalpillai-Essex This document has a restricteddistribution and may be usedby recipientsonlyin the performance of their official duties. Its contents may not be otherwisedisclosed without World Bank authorization.   THEREPUBLICOFMOZAMBIQUE SECONDPOVERTYREDUCTIONSUPPORT CREDIT TABLE OFCONTENTS CREDIT AND PROGRAMSUMMARY.................................................................................... 1 I INTRODUCTION............................................................................................................ . 3 II COUNTRYCONTEXT................................................................................................... . 6 A. RECENTECONOMICDEVELOPMENTSINMOZAMBIQUE ..............6 B. MACROECONOMICOUTLOOKAND DEBT SUSTAINABILITY ....... 10 I11. THE GOVERNMENT PROGRAM................................................................................. 15 A. THE GOVERNMENT'S PARPAIMPLEMENTATION PROGRESS ...... 17 B. DONORHARMONIZATION..................................................................... 27 lv. BANK SUPPORT TO THE GOVERNMENT STRATEGY .......................................... 30 A. CONSISTENCYOF THE PRSC WITH THE CAS .................................... 30 B. COLLABORATION WITH THE IMF........................................................ 30 RELATIONSHIPTO OTHERBANK OPERATIONS ............................... 31 D. C. LESSONSLEARNED................................................................................. 34 E. ANALYTICAL UNDERPIN"G OF THE PRSC .................................... 35 V . THE PROPOSEDPRSC 2............................................................................................... 40 40 B PRIORACTIONS COMPLETED............................................................... A. BACKGROUND.......................................................................................... 42 C..TRIGGERS FOR SECOND TRANCHERELEASE ................................... 46 D. 47 E. MONITORING AND EVALUATION........................................................ CREDITAMOUNT AND TRANCHING................................................... 47 VI. OPERATIONIMPLEMENTATION.............................................................................. 48 A. 48 DISBURSEMENT AND AUDITING.......................................................... SUPERVISION........................................................................................... B. 48 C. 48 D RISKSAND RISKMITIGATION .............................................................. . ENVIRONMENTAL ASPECTS.................................................................. 50 ... 111  LISTOFANNEXESAND ATTACHMENTS Annex 1A: Performance Assessment Framework 2004 (Including data on 2004 on Outturns) ........52 Annex 1B: Performance Assessment Framework 2005 to 2007 ....................................................... 57 Annex 2: Memorandum of Understanding...................................................................................... 64 Attachment A: List of Attachments.......................................................................................................... 73 Attachment B: List of Signatories ............................................................................................................ 74 Attachment C: Performance Assessment Framework (PAF) ................................................................... 75 Attachment D: ReportingRequirements .................................................................................................. 76 Attachment E: Dialogue and Monitoring Process.................................................................................... 78 Attachment F: Split ResponseMechanism............................................................................................... 80 Attachment G: Disbursement ................................................................................................................... 81 Attachment I: Terms of Reference for the Audit of the Financial Records of the Programme Aid....... 82 Attachment H: Auditing ........................................................................................................................... 83 Attachment J: Programme Aid Partners Structure .................................................................................. 86 Attachment K: Exceptions........................................................................................................................ 89 Annex 3: FundPublic InformationNote......................................................................................... 91 Annex 4: Letter of Development Policy.......................................................................................... 100 Annex 5: Programme Aid Calendar ................................................................................................ 108 Annex 6: Monitoringand Evaluation of the PARPA- IssuesNote ............................................... 110 Annex 7: Mozambque PRSC Results Framewok............................................................................ 113 Annex 8: Country at a Glance ......................................................................................................... 115 LISTOFTABLES Table 1: Basic Macroeconomic Indicators (% GDP) .................................................................................. 7 Table 2: Macroeconomic Framework (1997 to 2006) ................................................................................. 8 Table 3: Actual and ProjectedGDP Real Growth Rates by Expenditure Category (%) ........................... 19 Table 4: Actual Expenditure by Functional Classification (% GDP) ....................................................... 20 Table 5: Recent Performance and MediumTerm Targets for Selected MDGs ........................................ Table 6: Balance of PaymenWBudget Support Programme Disbursements and Pledges (2000-2005) ..24 28 Table 7: World Bank Lending Activities inMozambique (US$ million) (August2005) ......................... 33 Table 8: Analytical Underpinningof Structural and Fiduciary Assessments ........................................... 36 Table 9: Status of PRSC 2 Prior Actions for FirstTranche ...................................................................... 43 LIST OFFIGURES Figure 1: Mozambique NPV of Debt-to-Exports Ratio............................................................................. 11 ~~The Credit was preparedby an IDA teamconsistingof Gregor Binkert.AntonioFranco.PeterMoll. MariaBenito.Spinetto. LurdesMalate (AFTP1); PeterNicholas (AFCMZ); LouiseFox (AFTPM); Jeeva Perumalpillai.Essex. Daniel De Sousa. Caroline Forkin. Jacominade Regt. Luisa Matsinhe. CarolineGuazzo(AFTS1); Gilbert0de Barros (AFTPS); Noel Kulemeka. Alexandria Valerio. HumbertoCossa. Jean-Jacques de St.Antoine (AFTH1); Kate Kuper. Lance Morrell. Cathy Revels(AFTU1); Jose Luis Macamo(AFTPR); RaviRuparel(AFTFS); MohamedKhatouri. TariqulKhan (AFKL); Gert Van der Linde(AFTFM); Albert0Ninio (LEGAF); SlaheddineBen-Halima(AFTQK); Ani1Bhandari. Dieter Schelling I (AFTTR). Peer Reviewers: Manuela Ferro(SASPR) andJeni Klugman(AFTP2). iv  THE REPUBLIC OFMOZAMBIQUE SECONDPOVERTY REDUCTION SUPPORTCREDIT CREDIT AND PROGRAMSUMMARY I Republic o f Mozambique Borrower ImplementingAgency MINISTRYOF FINANCE SDR 83.3 million ($120 millionequivalent) Terms Standard IDA terms (40-year maturity, 10-year grace period) Tranching Two tranche operation: FirstTranche - SDR 41.65 million($60 million equivalent); Second Tranche - SDR 41.65 million ($60 million equivalent) The proposed operation i s a two-tranche Poverty Reduction Support Credit (PRSC) that will support the Government of Mozambique's primary objective o f reducing absolute poverty and achieving the Millennium Development Goals (MDGs) through the implementation o f the Government's Action Plan for the Reduction o f Absolute Poverty (PARPA). The operation is designed as an exceptional two tranche PRSC in order to further harmonize with the other donors providing budget-support. This i s the second operation within the framework o f three operations that were designed as part o fthe First PRSC approved inJuly 2004 (29262-MZ). This two-tranche credit completes the support envisaged within the framework o f the first PRSC. The proposed PRSC 2 will continue to support the Government's reform agenda of promoting growth, accelerating human resource development, and strengthening governance and public sector management. The main benefit of the operation is to help the Government of Mozambique make further progress in reducing absolute poverty, improving the delivery o f services and achieving the MDGs. It i s aligned with the direct budget support programs of 16 other donors and ensures a joint focus on the priorities set out by the Government in its comprehensive poverty reduction strategy, and on a common set of indicators to measure progress. The resource flow and improved aid effectiveness should accelerate progress towards the MDGs. Furthermore, the operation will help the Government to maintain macroeconomic stability while pursuing an ambitious reform agenda that cannot be fully financed from domestic sources. 1  The mainrisks associated with the operation are: (i)Macroeconomic instability as a result ofterms oftrade shocks, regional instability, or deteriorating financial sector performance. Some of these risks, such as terms o f trade shocks or regional instability, are exogenous. Considering the highlevel ofreserves, the fourfold increase of exports over the past five years, a flexible exchange rate regime and low external debt vulnerability, the likely impact should be manageable, even though no stabilization mechanism exists at this point. Regarding financial sector performance, the new Financial Institutions Laws - approved in 2004 as a prior action for PRSC 2 - gave the Central Bank much more power to supervise the banking system, and prepared the ground for introducing International Financial Reporting Standards in the banking system. The new legal framework and strengthened supervision have reduced the risk o fbanks accumulating a high share of non-performing loans, as has happened inthe past. (ii)Unpredictability of donor disbursements for budget support. This i s being mitigated by intensive efforts in donor harmonization, and the signing o f a Memorandum of Understanding by all parties. (iii)Political will to carry out the reforms. The new Presidenl and the Government have reaffirmed their commitment to the reform agenda as articulated inthe five-year program tabled ir Parliament in March 2005. The political and social risks are thus considered to besmall. (iv) Weak administrative capacity to implement reforms, suck as inpublic financial management, procurement and improvec service delivery. To mitigate this risk, the Government anc donors agreed duringthe Joint Review to develop an integratec strategy for capacity development in public financt management, and to strengthen the coordination anc management o freforms. PE-PO56201 2  IDA PROGRAMDOCUMENT FOR A PROPOSEDCREDIT TO THE REPUBLIC OFMOZAMBIQUE FOR A SECOND POVERTY REDUCTION SUPPORT CREDIT I. INTRODUCTION 1. This program document proposes a two-tranche Second Poverty Reduction Support Credit (PRSC 2) to the Republic of Mozambique for SDR 83.3 million ($120 million equivalent), on standard I D A terms. The proposed operation i s an integral part o f the Bank's strategy to support the implementation of Mozambique's Action Plan for the Reduction of Absolute Poverty (PARPA), and the Performance Assessment Framework (PAF; Annex 1A) agreed among the seventeen extemal partners (the G-17)' providing direct budget support (DBS). The PRSC framework was to include three annual operations to be delivered over FY04-06. As articulated inthe FirstPoverty Reduction Support Credit (PRSC l), the PRSCs for Mozambique will deepen the Bank's support for the Government's reform agenda of accelerating growth and reducing poverty by: (i)building public sector capacity and accountability through better public financial management, decreasing aid dependency, improving monitoring and evaluation (M&E), accelerating public sector reform and fighting corruption; (ii)improving the investment climate through strengthening the financial sector, easing constraints in the regulatory environment, and expanding infrastructure services to maintain Mozambique's current highgrowth rates; and (iii) enhancing service deliveryinhealth, education, rural water and sanitation. While the PRSC operations will provide financial support for implementing the whole PARPA, they are to disburse against the upfront completion o f a numbero fspecific reform measures identifiedinthe PAF. 2. The PRSCs constitute operations designed to align thepolicy agenda supported by the Bank and other donors with the national priorities. They are generally considered to be single tranche operations - however in order to be more harmonized with the other budget support donors, PRSC 2 has been designed as a two tranche operation. The first tranche i s for national budget year 2005 and the second tranche for budget year 2006, expected to be released in January 2006. This two-tranche approach i s proposed as an exceptional measure in order to adhere to the Paris Declaration on Harmonization; align future PRSCs with the budget cycle; and allow future PRSCs to be based on the findings o f the annual AprilMay Joint Review and the September Mid-Year Review. Furthermore, disbursing the PRSC funds early in the Mozambican budget year would ease the treasury's cash flow difficulties in the first semester arising from the cyclical nature o f tax revenues. 3, The PAF indicators being tracked are a subset of the 250 indicators that the Government is monitoring to measureprogress of the PARPA. Some are output indicators and others are process indicators, the sum total o fwhich would contribute to the reduction o fpoverty outcomes. In some instances, there is a lag in the impact on poverty o f some o f the indicators `The 17 donor are Belgium, Canada, Denmark,EU, Finland,France, Germany, Ireland, Italy, Netherlands,Norway, Portugal, Spain, Sweden, Switzerland,UK,andthe World Bank 3  that are being measured, for instance legal or procurement reforms. However, the partners involved in DBS are confident that the indicators being measured will contribute to overall poverty reduction. They are good proxies for State capacity, governance, the quality o f service delivery, and a better investment climate that fosters growth. The trend in investor confidence, for example, provides evidence that the reform agenda i s on track and will lead to the desired poverty reduction outcomes. 4. The First Poverty Reduction Support Credit was successfully deployed. PRSC 1 was approved as a single-tranche operation by the Board on July 6, 2004 for SDR 40.9 million (US$60 million equivalent) and disbursed on September 23, 2004. PRSCl covered primarily cross-cutting issues: (i)macroeconomic stability; (ii) finance reforms, including the public design and implementation o f a new integrated electronic financial management system (SISTAFE), budget comprehensiveness, improved accounting and accountability, strengthened internal controls, reform o f the procurement process, and improved linkages between budgeting, planning and the delivery o f service; (iii) efficiency o f the delivery o f services through civil the service reforms; and (iv) the investment climate for private sector development. Overall progress o f the reforms has been satisfactory and the Government continues to pursue a far- reachingreform agenda. 5 . Conditions for PRSC 2 are based on the Government's monitoring indicators for its PARPA. The PRSC 2 prior actions and second tranche conditions are drawn from the Government's PAF matrix. The focus o f PRSC 2 i s to continue supporting the reform agenda supported under PRSC 1, i.e. cross-cutting institutional reforms to improve public financial management including public procurement, and begin second generation reforms. A key element is rolling out e-SISTAFE (Integrated Financial Management System) in the Ministries o f Finance and Education and Culture and all their provincial directorates. Additionally, the coverage o f the budget will be extended by including significantly more health expenditures within the budget framework - currently over 30 percent o f health expenditures are off-budget. A new procurement code based on international standards will be introduced, together with a new financial institutions law, a new commercial code, a decree to ease restrictions on hiring foreign labor, and new laws to simplify redtape and strengthen anti-corruptionmeasures. 6. The process of monitoring the PAF takes into account all sectors. In addition, improved service delivery in PARPA priority sectors Le. agriculture,health, education, rural water supply, infrastructure, justice and related governance sectors, is being monitored through the Joint Sector Working Groups. Progress in achieving all the indicators contained in the PAF i s assessed twice a year through the Joint Review in AprilMay and the Mid-Year Review in September. The sector working groups have become over the past year the best mechanism for policy dialogue, donor harmonization, and for reaching agreement between the Government and all the donors involved in a specific sector. Furthermore, a joint Budget Working Group meets on a quarterly basis with the Government to monitor budget execution, particularly in the priority sectors. Even though all priority sectors are being monitored by the Bank in cooperation with the Joint Sector Working Groups, it was decided that no sector- specific triggers would be chosen for PRSC 2, but only cross-cutting ones. 7. The PRSCs are based on extensive analytical work completed over thepast few years. This includes two PERs (FYO1 and FY03), two Country Economic Memoranda (CEM, FYO1, 4  FY06), a Country FinancialAccountability Assessment (CFAA, FY02), a Country Procurement Assessment Review (CPAR, FY03), an Investment Climate Assessment (ICA, FY03), a Financial Sector Assessment (FY03), a Public Financial Management and Fiduciary Risk assessment undertaken with other donors (2004), a Country Health Status Report (FY05), a PSIA on the impact of school fees (FY05), and a poverty profile publishedby the Government (2004). Bank-IMF work on tracking public expenditures in HIPC countries has also played a role inprogram design. 5  11. COUNTRY CONTEXT A. RECENT ECONOMIC DEVELOPMENTS INMOZAMBIQUE a. Recentperformance and outlook 8. Mozambique's economy continued to perform well in 2003 and 2004. Real GDP growth was robust in both years at 7.8 percent in 2003, and an estimated 7.2 percent in 2004 (Table 1). The marginal decline reflected a slow-down inconstruction related to the completion o f a number of private sector mega projects as well as a decline inmarine production. Growth in most o f the other sectors continued to be buoyant. This was fuelled by a number o f factors including: (i) continued good performance in agriculture (8.9 percent), transport services (16.4 percent) and government services (9.4 percent); and (iii) hlloperationoftwo megaprojects- MOZAL Aluminum IIand the gas pipeline (15.4 percent). End-of-period inflation was at 9.1 percent; money supply growth was also within the program at 5.9 percent. The extemal sector recorded notable improvements, with a 24 percent reduction in the trade deficit due to an increase in exports from the mega-projects, as well as an associated rise (30 percent) in net international reserves to 4.8 months o f import cover (of goods and non-factor services including imports for the mega-projects). The performance o f the financial sector was also positive, as commercial non-performing loans fell from 27 percent to 6 percent o f gross loans, indicating a reduction in the risks to macroeconomic stability from the banking sector. Linked with these improvements ineconomic fundamentals and reflecting the weakness o f the dollar, the nominal exchange rate appreciated by 21 percent against the U S dollar and by 4 percent against the Rand in2004. TheIMFestimatedthe realeffective exchange rateto have appreciated by25 percent in 2004. The appreciation had, however, been reversed inApril and M a y 2005. Fiscal performance in2004 was below expectation across most major categories of taxes with government revenues reaching only 12.3 percent o f GDP against the target o f 13.4 percent2. As a result, the government's primary deficit target was exceeded by 0.7 percentage points, reaching 3.8 percent of GDP. The investment to GDP ratio was high in 1999/2000 reflecting mega-project investments. The decline in 2004 has been due to reduced government investments from 11.7 percent of GDP to 9.1 percent o f GDP and private investment fell from 14.2 percent o f GDP to 10.9 percent o f GDP. The fall in private investment in 2004 mainly reflects the partial completion inmega-project construction. The private investment rate is expected to rise again as a new mega-project (Moatize coal mine) will soon start its implementation phase. GDP restatement: a recent development is ME'S(Instiluto Nacional de Estatistica) publication o f final GDP figures up to 2002 and a new estimate for 2003, replacing previous DNPO estimates. While the new GDP figures do not question the high growth rates estimated previously, both the growth rate and the GDP deflator for each year from 2000 have been restated. The result is higher nominal GDP figures, thus modifying the calculation of GDP ratios compared to the ratios mentioned in the PAD for the PRSC 1. 6  Table 1: Basic MacroeconomicIndicators (% GDP) - (excluding grants) I I I Exchange rate (Mt `000: US$) 11.9 12.7 15.7 ! 20.7 , 23.7 1 23.8 22.6 ~ 9. Mozambique held general elections in December 2004, and the new Government reaffirmed its commitment to continue and even accelerate economic and governance reforms. The newly elected President, from the same party as the previous president, was elected with 64 percent o f the votes. The governing party Frelimo gained 160 seats out o f 250 in Parliament, thereby strengthening its Parliamentarymajority. Some o f the results were contested by the opposition parties, but the overall outcome was never in doubt given the wide margin. There was no violence aAer the elections, as some observers had feared, and the opposition members o f Parliament took up their seats when Parliament reconvened. The new Government was formed in February, 2005. It submitted its Five Year Program to Parliament in March, where it outlined an ambitious reform program to reduce absolute poverty. The Program emphasizes the need to: strengthen the market economy; develop a crash program for vocational training; accelerate legal andjudiciary reforms; promote entrepreneurship for small and medium businesses; and accelerate rural development by empowering district administration and communities. 10. A new PRGF was approved by the IMF'sBoard in June, 2004, and the second review was completed in June, 2005. The main conclusion o f the review was that the performance under the PRGFprogram during October 2004-March 2005 was mixed. The slippages primarily reflected a weakening o f tax collection, and delays in the implementation o f the reform agenda caused by the political transition. The review recommended that a second wave o f reforms should focus on increasing tax revenues, strengthening public sector operations, reducing the costs o f doing business, promoting labor-intensive sectors, and developing rural development. The review concluded that the prospects for 2005 remained favorable, including for strong growth, a firther deceleration ininflation, andmaintenance o f a sustainable external position, as the Government i s committed to take the necessary fiscal measures, pursue a monetary program consistent with a fbrther reduction o f inflation, take measures to strengthen the banking system, foster private sector development and revive the public sector reform. 11. The medium-term macroeconomic outlook for 2005 and 2006 continues to be good. Average GDP growth for 2005 and 2006 is projected to be about 7 percent per year. Monetary policy is expected to maintain inflation at single digit levels (7.5 percent average for 2005-2006, Table 2). Fiscal policy i s expected to move towards a more sustainable deficit, and increasingly 7  to channel resources to priority areas in line with the government's poverty reduction strategy. The overall fiscal balance before grants is expected to be around 10.3 percent by 2006, and the domestic primary deficit around 2.8 percent o f GDP. The trade balance will continue to be greatly affected by the developments in the mega-projects (Mozal, Pande Gas and Areias Pesadas-Heavy Sands). Also, a concession contract for another potential mega-project, the Moatize coal mine, was awarded to an international firm3in November 2004. The current account balance for 2005 and 2006 i s expected to widen in relation to 2004 due to higher imports as the second phase o f the gas pipeline comes into construction, and due to higher international oil prices, but still will be narrower than the average o f the last few years. Terms of trade are expected to deteriorate slightly, about 4 and 3 percent in 2005 and 2006 respectively, due to higher oil price projections o fUS$42 per barrelin2005 andUS$38 per barrel in2006. Table 2: MacroeconomicFramework(1997 to 2006) i. Outputandprices Inflation (period average) i 6.4 I 0.6 1 2.9 ' 12.7 1 9.0 I 16.8 13.4 1 12.6 1 8.0 7.3 ~ ~ 1 ' 'ooo/us$) II I II I I I - --1 L-- 1 Total revenue ____---___- 11.3 11.4 ~ 1 2 . 13.2 I 314.0 T o t a l exp. And net lending 23.5 21.6 I124.7 27.3 I 34.6 I 3 4 . 1 T 2 6 . 5 2 3 . 7 25.6 24.4 ~ , - , Interest - _ _ _ ~ - 1.3 1.0 0.6 1.2 ! 1.0 ! 0.8 1 0.9 Non-interest expenditure 22.2 20.6 ! 24.1 $ k k % * 6 2 5 . 4 , 1-19.7 1 '122.8 , 24.8 23.5 ~ ~ ~ ~ Overall balance before grants -12.2 -10.3 I 1 , -12.7 -13.7 -17.5 1 -14.0 -11.7 -12.4 ' Primary balance after grants -1.6 1 -1.2 1 -0.4 , -5.6 ' -5.4 -5.9 -3.3 -3.4 -5.2 m-10.2 1 Financing (% GDP) F Privatization Domestic financing , -3.1 -2.2 , -0.3 , 1.7 1 1.9 , 0.9 , 0.1 , -0.5 , 1.1 , 0.1 I Transfer of HIPC assistance 1 .. 1 .. 1 0 . 8 1 0 . 7 1 0 . 6 ' 0 . 2 / 0 . 3 1 0 . 2! 0 . 2 1 b. Impact of growth and reforms onpoverty reduction 12. The results of the Second National Household Survey of 2002/03 indicate that the proportion of the population living below the poverty line declined by about 15 percentage points since 1996197 (First Household Survey), from 69 to 54percent. A decline was apparent in both monetary and non-monetary measures. Progress in reducing monetary poverty was substantial, as reflected in the headcount as well as measures o f depth and severity, but it showed regional unevenness. The most progress was recorded in the Central Region, which in 1996 had been the poorest region, with less progress in the North, bringing the numbers in the Brazilianminingcompany CVRD-CompanhiaVale do Rio Doce. This will be oneof the largest investment in Mozambique (US$1-2 billion dependingon thevarious componentsconsidered). Incomparison, the largestinvestmentthus far hasbeen the constructionof the aluminum smelter Mozalphase Iand I1with an investment o f approximately$2 billion. The Sasol gaspipelinewas a$1.2 billion investment, of which $800million were spenton the Mozambicanpart. 8  region closer to the national average. According to the poverty analysis, all groups in society, including the poorest, benefited from economic growth. In addition inequality in real consumption between provinces and regions has diminished. However, the gains recorded hide the complexity and diversity o f the way in which poverty affects different groups in society, gender, geographical and other disparities persist. For example some key groups, including female-headed households, orphans and vulnerable children, have not benefited hlly from the gains inpoverty reduction. The levels o f chronic malnutrition (stunting) are also very high, with 41 percent recorded in2003 among children 6 to 59 months old. To improve the understanding of these issues, further work, especially qualitative analysis still needs to be done, especially in the context o f the PARPA11preparation. 13. Non-monetary measures also showed improvement. The share of food in total expenditures fell for all quintiles, and there were improvements in the quality o f houses and possession o f radios and bicycles (which are good proxies for household income). Access to a safe water sources, a latrine or other sanitation facility improved. Access to health care also improved. Enrollments increased inall quintiles, although amongst the poorest there was still a lag. With respect to distance to services (health and education), a gap exists between the top quintile and the other quintiles, with the exception o f distance to a primary school, which appears to be equal in all quintiles. Notwithstanding this, primary schools are still on average quite a distance away, which has a disproportionatelynegative effect on disadvantaged groups in rural areas, and contributes to late entry and high drop-out. According to the recent Poverty and Social Impact Analysis (PSIA), the most important factor affecting school retention i s distance to school. This was even more important than registration fees, levies for school related expenses and school materials. Access to upper primary education and beyond i s also severely constrained. 14. One key reason for the good poverty performance is that inequality did not change much, so aggregate growth in consumption reached poor households. Overall, household consumption per adult equivalent increased by 4.6 percent p.a., and the lowest quintile in rural areas seems to have had the fastest growth rate. This was also confirmed by the data from the agricultural income survey. Inall the regions the strong growth o f consumption in agricultural households helped decrease poverty. There was also a shift in the composition o f income in households in the rural areas, with the non-farm sector increasing its share. However, an important unknown i s the inequality within the quintiles (as opposed to between groups such as rural-urban and the provinces) which means that there could be significant variation within quintiles. 15. Mozambican households have diverse sources of income. In rural areas subsistence agriculture provides about half o f total income, with the rest coming from sales o f agricultural products, and from employment income. In urban areas the majority o f income i s from employment, followed by self-employment. The fastest growing sectors o f employment seem to be trade and private services from the agriculture sector. Men are three times more likely as women to be in wage employment, and 1.5 times as likely to be in self employment. Only 16 percent of the total labor force receives a wage. 9  B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 16. Mozambique's good macroeconomic performance has been crucial to its excellent growth record in the past decade, but needs to be well managed. Nevertheless there are two interrelated areas o f concern - price stability and fiscal control. Without continued improvements inthese areas, the country's highgrowth rate could be put at risk. Additionally, the impact of HIV/AIDS and malaria on the population has serious consequences ifnot controlled. 17. Price stability is essential because the immediate losers from rapid inflation are the poor, as it acts as a regressive tax. Inthe medium term the poor lose further, because investors are driven away and growth and employment opportunities decline. Despite the country's good growth record and progress on the macroeconomic front, there i s still a potential for price instability. Reorganization of the banking system in the mid-1990sYtogether with tight money, resulted insingle-digit inflation up to 1999. But there have been two phases of inflation brought on by lax monetary policy in the wake o f banking crises, one starting in 2000 (exacerbated by the response to the massive floods), with inflation o f 17 percent in2002, and another in 2003/4, with inflation rising again to 17 percent in early 2004, subsequently falling to 8 percent by January and 4.5 percent inApril 2005. Inthese instances, monetary policy hadto be tightened by increasing reserve requirements, raising the bank rate and/or accelerating the sale o f foreign exchange reserves to the public. The authorities' present program i s to have inflation fall to 8 percent in2005 and 7.3 percent in2006, so as to reinforce the expectationo f low inflation. 18. The second source of concern lies in uncertain domestic revenue mobilization. Mozambique has maintained an exemplary record o f fiscal discipline inthat it has only on a few occasions resorted to borrowing from the banking system. However, revenue performance was weak across all tax segments in2004. Thus, insteado frevenues reaching 13.6 percent o f GDP as stated inthe Performance Assessment Framework, they reached only 12.3 percent4. The PARPA envisages raising revenues to 16.7 percent by 2010. Hence, there will need to be greater efforts to rake domestic revenues by strengthening tax administration. Inthe short term this will require actions, such as conducting audits o f large taxpayers. Inthe medium term, actions envisaged include the creation o f the Central Revenue Authority, the integration o f domestic tax and customs operations, and harmonizing computer data systems to improve VAT collections. Some further actions could also be taken to broaden the tax base (e.g. fwther extensions o f VAT to a wider range o fbusinesses), but since the base has already been considerably extended inthe past five years with the introduction o f the VAT and the extension o f income tax to civil servants, the scope i s limited. Therefore, the main instrument for increasing domestic revenues i s a stronger implementation o fthe existing set o f tax arrangements. 19. Thepublic external debt has been considerably reduced through twoHIPC operations. Combined with the country's excellent prospects for exports, the net present value o f foreign debt service i s projected to fall from its 2005 level o f 89 percent o f exports to 65 percent by 2010, and 49 percent by 2020. Values o f 125-150 percent are considered inthe HIPC context to indicate a debt overhang problem. Hence by this standard, Mozambique i s well clear o f a growth-reducing debt overhang, at least on the external side. 4As o f 2005, new GDP estimatesprovidedbythe national statistics institute are used; see footnote 2. 10  Figure 1: Mozambique NPV of Debt-to-Exports Ratio Figure 1 Mozambique NPV o f debt-to-exports ratio 160 140 &CAS ba5r OBSC -+-CAS huse case ( l o n u ~ranls) -120 e100 SO 60 40 2000 2005 2010 2015 2020 20. Mozambique's exchange rate system is a managedfloat. The real effective exchange rate slightly depreciated between 1999 and 2003. In2004, however, the real effective exchange rate, as calculated by the IMF, appreciated by 25 percent. This was due to three main factors -- a recent increase inforeign investment, an improvement inthe ability o f the country to export, and the depreciation o f the U S dollar in the international market. In early 2005, the Central Bank introduced an auction system to sell foreign exchange. As the financial markets had to get used to this new instrument, the exchange rate has been rather volatile since then. By April 2005, the appreciation trend was reversed. In general, even though aid has amounted to 11-19 percent o f GDP, this has not caused a significant appreciationo fthe currency. As the forthcoming Country Economic Memorandum shows, calculations based on a general equilibrium model indicate that the increase in productivity generated by the aid flows (e.g. roads, education) has compensated for the aid-driven upward pressure on the prices o f nontradables, thereby sparing the country from "Dutch disease." 21. Greater efficiency of public expenditures will be crucial for growth and poverty reduction in thefuture. Domestic revenues are projected to increase as a percentage o f GDP over the coming years. But foreign aid, currently about 11percent-19 percent o f GDP, is likely to remain stable in dollar terms in the next 5-10 years. As a result o f the fast GDP growth, its share i s projected to decline. At the same time there is a need for increased effort and efficiency inservice delivery ifthe Millennium Development Goals areto be achieved. For example, inthe case o f the education sector, the Education for All Fast Track Initiative (EFAFTI) estimates that inorder to achieve universal completion of primary education (up to grade 7),the Government will need to increase substantially public expenditures on primary education alone, while at the same time addressing structural issues related to teacher management, deployment and compensation structures to increase the efficiency and improve the quality o f the system. Mozambique's fiduciary accountability i s weak, although the Government i s taking measures to improve it. The weakest areas are accounting, auditing and procurement. Mozambique scored 6 out o f 15 by one assessment5, and 5 out o f 30 by another - less than the sub-Saharan African The HIPC AAP rating, Highly IndebtedPoor CountriesInitiative: Activity andAction Planfor Expenditure Reform, compiledby the WorldBank andthe IMF annually. 11  average.6 It will be critical to improve the accountability and effectiveness o f public financial management for sustained broad-based growth and further human development in the next decade. 22. Government has started modernizing its public financial management system. The Government has embarked on a reform program in this area, and has followed the right sequencing, starting with a new financial management law in 2001 (known by its Portuguese acronym as SISTAFE) and accompanying regulations in 2002, which set the basis both for modem budgeting and financial management procedures and for procurement reform. The integrated electronic financial management system - e-SISTAFE - was introduced in the Ministry of Finance in 2004. Currently all fund releases from the Central Treasury Bank Account to bank accounts of spending units are processed through e-SISTAFE, providing the means to control the receipt o f accounting retums from spending units against their next fund release. Accounting returns from spending units are further supported by the submission o fbank reconciliation statements, which are also monitored. The data captured in e-SISTAFE and the accounting retums from spending units enable the compilation o f financial statements by the Ministry o f Finance. Roll-out o f e-SISTAFE to the Ministry o f Education and Culture will be piloted in2005. During this phase the pilot ministry will be connectedto e-SISTAFE to directly execute and account for its revenues and expenditures, against the budget controls o f the Ministry of Finance and through the Single Treasury Bank Account. Next will be a rollout to other key sectoral ministries during 2006 and 2007. This will soon enable more accuracy in accounting andpermit greater timeliness inauditing, thereby facilitating parliamentary oversight. Subsequently, improvement of the classifiers (program, functional, regional) should follow so as to provide detail sufficient to permit analysis o f poverty impacts. Budget comprehensiveness is another goal which will be facilitated by the e-SISTAFE rollout, though further work will be needed to get proper accounting of donor-funded spending. In parallel, the regulations and institutions goveming procurement are being revised according to international standards to promote competition, transparency, value for money, and reduce the opportunities for corruption. 23. A variety of measures are called for to improve Mozambique's competitiveness and raise employment. Further reductions in import duty rates will be implemented, in accordance with the SADC protocol, and in particular the top import tax rate will be lowered from 25 percent to 20 percent in 2006. Although important progress was made with taxation o f foreign investors through the recently passed Code o f Fiscal Incentives, the tax law inrespect of mining enterprises needs to be modified further to allow for specific features o f miningbusinesses (in particular the need for accumulation and carry-over, and to accommodate the cyclicality o f mining).Greatly increased efforts are needed to improve andbroadenthe coverage and improve the quality and reliability o f electricity services, and lower the cost. The costs o f bank finance need to be reduced by further strengthening banking supervision, establishing commercial courts, simplifjang the relevant judicial procedures, and improving the credit register. Mozambique has a notoriously difficult set o f procedures for registering new firms, and so the Government i s working to reduce the time and cost involved inregistration. Inthe future it may be necessary to consolidate the three Government entities dealing with this work, and introduce computerization. ~ ~~ The combined World Bank/EU/DflD assessment framework executed by Scanteam in2004. 12  24. I t is now easier to hire skilled foreign workers. The Government has undertaken to revise the labor law to make employment arrangements more flexible - which was raised as a priority in the Investment Climate Assessment (ICA). More flexibility in hiring expatriate workers is especially important to attract foreign direct investment. It was possible to achieve this objective by adoptinganew decreewithout havingto wait for the reform o fthe overall labor law (currently scheduled for 2006). The adoption of this new decree (57/03) -which revoked the decree 25/99 - was considered as a prior action. There i s also a need to increase the relevance and quality o f the Technical and Vocational Education and Training (TVET) system to ensure it responds to the existing and emerging needs o f the labor market, whether in formal or informal sector employment. In time, a better skilled workforce will help to decrease the reliance on foreign or imported labor, particularly at semi-qualified and qualified technician levels. The Government i s working with external partners and the World Bank to transform the fragmented, supply-driven training delivery system into a demand-driven one that would function under a unifylngtraining policyandthat wouldbebased on labor specific occupational standards for key sectors o f the economy. 25. The Impact of HIV/AIDS on economicgrowth is serious. Current projections indicate that in2010 the Mozambican economy will be 14-20 percent smaller than it would otherwise be due to the impact of HIVIAIDS. Per capita GDP growth will be between 0.3 percent and 1.0 percent lower per annum due to reduced productivity growth, humancapital accumulation, and reduced physical accumulation. In addition, population growth will be reduced. By 2000, approximately 100,000 Mozambicans had died from AIDS since the beginning o f the pandemic. However, projections o f the number o f accumulated AIDS deaths over the coming decade show that this figure may climb as high as 1.2 million deaths by 2010, and the projected population growth between 2000 and 2010 i s estimated to be about 1.6 percent per annum, as opposed to the 2.5 percent it would be in the absence o f the pandemic. Life expectancy projections show that by 2010, average life expectancy may be 36.5 years, as opposed to a projected 50.3 years in the absence of the pandemic. Inaddition, the impact on the productivity o f the public sector is serious, particularly for sectors that are heavily dependent on human resources such as education. Teacher absenteeism is very high in some provinces, which disrupts the normal daily routine o f students and affects their learning as many teachers are not temporarily replaced during periods o f illness. Serious thought needs to be given to providing for a national public sector workplace policy, backed by high level Government support, that addresses the needs o f specific sectors. 26. Critical impact on labor and vulnerable groups. HIV/AIDS primarily affects individuals in the 20-45 year age group - prime years both in terms o f work and family responsibilities. Another strikingly vulnerable group is young children who are at risk o f infection through mother to child transmission (MTCT). The probability o f transmission o f infection o f a child from a pregnant HIV positive woman, either during pregnancy, childbirth or through breast feeding, is approximately 30 percent. Given a M T C T transmission rate o f 30 percent, and prevalence rates at antenatal clinics in the range o f 15 percent to 30 percent, between one and two children in'20 become HIV positive through MTCT. Also, by 2010, about one child in four will have lost at least one parent. Since children represent a large share o f the population, orphans are projected to account for about 10 percent o f the population in 2010. Additionally, since the primary school age group has one o f the lowest prevalence rates (also considered the `window o f hope'), the Ministryof Education and Culture is launching a national 13  school health initiative in all primary schools that will include HIV/AIDS prevention messages and activities. The impact o f the slowly increasing availability o f Antiretroviral treatment (ART) needs to be taken into consideration for future growth projections, and research is now planned to look at the impact o f comprehensive care and treatment on the current demographic projections (which were concluded prior to the initiation o f an affordable care and treatment program by the Ministry o f Health). This new five year M o H Strategic Plan (PEN Saude) and the National Strategic Plan (PEN 11) have both now factored in the need to scale-up access to care and treatment, together with maintaining a sound focus on prevention, advocacy, stigma reduction, and impact mitigation as the pillars to a broad-based encompassing strategy, mainstreamed across all sectors. 27. Malaria is a serious public health problem and the number one "killer" disease. Malaria accounts for 35 percent o f deaths among children below five years o f age, 60 percent o f admissions in pediatric wards, and 40 percent o f overall outpatient consultations. Among pregnant women, the disease i s associated with poor pregnancy outcomes, and is a contributing factor to at least 30 percent o f maternal deaths. Inaddition, malaria causes significant morbidity in children and adults resulting in high levels of school and work absenteeism. It has been estimated that in Sub Saharan Africa, malaria reduces GDP growth by an estimated average o f 1.3 percent per year. For Mozambique this may be even higher given the transmission pattern o f the disease during all seasons, and constraints in access to preventive and curative health services, particularly in rural areas. The poor suffer the most from malaria infection. The govemment o f Mozambique has a Malaria Control Program focused on three strategies: (i) health promotion and education; (ii) control (use o fbednets, larvae control, etc.); and (iii) vector early diagnosis and adequate treatment, including the Intermittent Prophylaxis Treatment (IPT) for pregnant women. This program, however, has been under funded and needs significant improvements in its coverage. The Global Fund approved a small US$12 million package, and program implementation has begun. The government is committed to scale up malaria prevention and control inline with the Abuja targets and its Plan of Action to Reduce Absolute Poverty (PARPA). 14  111. THE GOVERNMENTPROGRAM 28. ThePARPA is the Government's strategy to reduce absolutepoverty. InApril 2001 the Council o f Ministers approved the PARPA for 2001-2005, later endorsed by the Bank and Fund Boards as Mozambique's first full PRSP. The PARPA's public action strategy emphasizes economic growth, public investment in human capital and productive infrastructure, and institutional reform to improve the environment for private investment. Growth is expected to come from large-scale capital-intensive projects financed by private foreign capital, productivity and value-added gains in agriculture and manufacturing, and a general expansion in intemal trade, transport and services. To implement this strategy, the PARPA, in line with its poverty diagnosis, identifies six priority areas for action: health, education, infrastructure, agriculture and rural development, govemance, and macroeconomic and financial policies. The PARPA also identifies actionable measures within each priority area and establishes targets and milestones in an operational matrix. A new PARPA for the period 2006-2010 will be elaborated inthe coming months, based on the newly elected Government's Five Year Program and a consultation process. The Government expects the revised PARPA to be ready by early 2006. 29. The PARPA's goals, objectives and strategies were established in a context of post- conflict economic recovery and poverty reduction, and continue to be appropriate to Mozambique's circumstances today. A sound program of economic reform and management - based on privatization, financial sector reform, investment promotion, trade and price liberalization, prudent macroeconomic management and substantial public investment - has underpinnedMozambique's ongoing economic transformation and growth record. The PARPA has improved on the Government's previous poverty reduction strategies.' Inparticular, there is: increased country ownership; improved prioritization; better monitorable targets; and improvement in the integration o f macroeconomic policies, institutional reforms and sector programs. There is need for further development o f the poverty analysis (regarding gender, HIV/AIDS and vulnerability to exogenous shocks), and o f the prioritization, sequencing and implementation o f the policy actions identified, which tend to focus on access to the relative exclusion o f quality and efficiency. It also identified a need to deepen and institutionalize the participatory process, which the Government has begun through the Poverty Observatory. Recently the Government and its partners also agreed that the PARPA progress indicators need to bereduced innumber andrevised to reflect the MDGs. 30. Government is developing an institutional mechanism to monitor the PARPA. Since April 2003 the Government has reoriented implementation to achieve three major goals: (i) improving the effectiveness o f Government systems; (ii) increasing extemal assistance in the form o f budget support; and (iii) improving the reliability o f budget execution. Since the end o f the conflict period extemal resources have been mainly transferred through direct project financing channels from the donors to the beneficiaries, resulting in parallel structures. About 60% o f all extemal aid was not reported in the budget in 2004 - being so-called off-budget expenditures. In addition, unpredictability of donor aid has resulted in delayed and untimely budget allocations from the Ministry o f Finance (MoF) to the line ministries. A key step inthis process occurred when the Government worked with the extemal partners to develop a single The Government preparedits first poverty reduction strategy in 1994 andits second strategy in 1999. 15  plan o f actions for the entire partnership, with a tighter prioritization o f actions and indicators than i s given in the PARPA itself. This action plan is known as the Performance Assessment Framework (PAF) matrix, which i s now part o f the PES, the Economic and Social Plan submitted to Parliament. 31. The PARPA is managed through the public planning system. This i s the five-year government program (2000-2004), and i s subordinated by two main bands o f instruments: (i) medium-term planning instruments- which include the sectoral and provincial strategic plans and the medium-term financial framework (MTFF); and (ii) annual operation instruments, the Economic and Social Plan (PES) and the State Budget (OE). Each year the PES determines the targets and actions in line with the MTFF and the State Budget in line with the prevailing restrictions on resource availabilities. It thereby determines the level of funded activity to be executed. The PES is the critical link inrelation to which measures to achieve the following are required: (i) improvement in the interaction among Government institutions resulting in a more consistent and detailed annual planning, hence reflecting the targets and actions to be carried out in the year; (ii) improvement in the implementation management o f PES and OE; And (iii) improvement inmonitoring and review processes of PES andrelated reports, eliminating ad-hoc reports not provided inthe planningprocess. The monitoring instruments o f the PES and OE are the Balango do Programa Econbmico e Social (BdPES), and the quarterly budget execution reports. The BdPES is a semesterly progress report submitted to Parliament. Its annual version also serves as the annual PARPAprogress report. 32. The Government works with the donors to refine the PAF matrix and to monitor implementation. The Government and the G-17 have agreed to hold biannual meetings, in April/May (Joint Review) and September (Mid-Year review) to review progress on the PAF matrix, which forms the basis o f direct financial support to the budget. The most recent review meeting took place inApril/May, 2005. This review assessedthe implementation o f the PARPA and PAF in 2004. The main documents used for the assessment were the Government's annual report on PARPA implementation (BdPES) for 2004, the budget execution report for 2004, the Government's annual plan (PES), the Government's medium-term financial framework (MTFF), and the State Budget (OE). The conclusions were formulated in an Aide Memoire agreed between direct budget support donors and the Government in the context o f the Joint Review which was completed on 12-13 May 2005. This review consisted o f a backward looking exercise that assessed performance in 2004, and a forward looking exercise that articulated the need to achieve the targets for the next two years. Joint government-donor working groups completed detailed reviews invarious focal areas', and subsequently a supra technical group, co-chaired by the Ministries of Plan and Development and Finance, reviewed the group outputs, and articulated key overall actions which the Government agreed to implement over the period 2005- 2006. 33. The PARPA implementation process is aligned with the MTFF, PES, and the OE. The Government has encouraged donors, and particularly those providing budget support, to * Technical working groups focused on: (i) and macroeconomic stability; (ii) ;(iii) growth poverty monitoring and evaluationsystems; (iv) taxation; (v) budget formulation, execution and reporting; (vi) procurement; (vii) SISTAFE; (viii) public sector reform, decentralizationandcorruption; (ix) legalandjudicial reform; (x) financial sector; (xi) investment climate; ( xii) agriculture; (xiii) telecommunications, air andrail transportation; (xiv) energy; (xv) HIVIAIDS; (xvi) health; (xvii) education; and (xviii) water and sanitation. 16  align their own annual review and decision-making processes with the Government's calendar. Key features include the following: 0 PARPA implementation is aligned with the Government's financial year (January to December). The measurement o f outcome and output targets i s aligned with the measurement o f fiscal outtums and reported in MoF's annual report on PES implementationto the parliament (FebruaryMarch). 0 The sequence and timing o f existing SWAP and sector review processes i s aligned with the annual PARPA andPES review process, which would occur about three-four months after the end o f the fiscal year (i.e. in April/May), thus allowing fiscal results from the previous fiscal year (January to December) to inform these reviews. 0 The PARPA and PES review allows all parties to review past progress and make indicative commitments on the basis o f actual outcomes inthe previous fiscal year. 34. The Public Expenditure Review (PER) process will be annualized and integrated into the cycle by being split into twoparts - a review of the outtums of the previous fiscal year to be undertaken in time for the annual PARPA and PES review, and in addition a review of the next fiscal year's budget inAugust, before the Council o f Ministers finalizes and submits the budget to Parliament inSeptember. A. THE GOVERNMENT'S PARPAIMPLEMENTATIONPROGRESS 35. PARPA implementation progress has been considered to be satisfactory since its inception. Spending inthe priority sectors o f education, health, roads, water and agriculture has produced good results and has helped reduce poverty directly and indirectly. Increased education spending has raisedthe gross enrolment rate inlower primary schools from 56 percent in 1995 to 100 percent by 2001. The completion rate for the primary level (EP1) rose from 20 percent in 1990 to 40 percent in 2003. Health spending increased access to health facilities and services (e.g. vaccinations). Road rehabilitation and maintenance has also increased with the number o f roads ingood or fair conditions rising from 57 percent in2000 to 70 percent in2003. Lncreased spending on water resulted in greater access to safe water in the period 1996/97 to 2002/3 from 12 percent to 27 percent in rural areas and 54 percent to 64 percent inurban areas. About 20 percent of farmers received extension services in2003 compared to about 7 percent in 2000. 36. The Joint Review of May 2005 confirmed the continued good progress in implementing the PARPA in 2004. The Mozambican economy continued to grow strongly. Real GDP growth was 7.8 percent in 2003, and is estimated at 7.2 percent in 2004, primarily reflecting a slow down in construction related to the completion o f two private sector mega projects. Growth in most o f the sectors continued to be buoyant, including agriculture (8.9 percent), transport (16.4 percent), government services (9.4 percent) and mega-projects (15.4 percent). The end-of-period inflation rate declined to 9.1 percent (from 13.8 percent at end- December 2003), despite a sharp rise in petroleum prices. The composition of growth indicates that its base continues to be broad, and should have contributed to a further reduction in the poverty level; but this can only be confirmed when a new household survey i s undertaken (Table 17  3). The banking system has reduced its vulnerability as the share o f non-performing loans has decreased. Mega project-led exports have contributed to a significant decrease in the trade deficit, which coupled with higher-than-projected donor support and private capital inflows, boostedreserve accumulationto 4.8 months o f imports (including imports for mega projects), 37. There was uneven progress in achieving the 2004 PAF targets due to political economy factors. A major factor contributing to the mixed performance in 2004 was the preparation and holding o f the presidential and parliamentary elections in December 2004. Subsequently it took some time for the new Government to be formed, and Parliament passed the budget for the year 2005 only in May 2005. Nevertheless, most PAF targets in service delivery were broadly met, while several targets inthe areas o f public financial management and governance reforms were only partly met. In particular, approvals o f the procurement and commercial codes have been delayed and fiscal performance was below expectations, with the collection o f revenues lower by about one percentage point o f GDP than programmed, which contributed to the domestic primary deficit target being missed by 0.7 percent o f GDP. The budget-support partners agree that the incoming Government has a unique opportunity to drive forward on second-generation reforms, and to use the revision of the PARPA to further embed these processes in Government policy across the board. The new Government has shown its commitment to reform by making up after the Joint Review for the delays that have been experienced in late 2004 and early 2005. After an extensive consultation process with all stakeholders, the new procurement code is almost ready, and the first actions for its implementation are already prepared. The Commercial Code is scheduled to be approved during the next session o f Parliament in October. An equally important law to simplify the business environment, the Commercial Registration Code, i s also ready to be approved at the same time, and the Government has already signed a contract in June 2005 to computerize the entire commercial registry. The latter action alone will reduce the time required to register a business or a brand name by 30-50 days. 38. Programme Aid Partners (PAPs) have madeprogress in improving the effectiveness of their funding. There is improved donor harmonization, but there remains a need to continue improving alignment and predictability. External consultants evaluated the performance o f the PAPs against a PAP performance matrix (PAPPA) agreed to in 2004 as part o f the MoU. They concluded that the donors made progress regarding harmonization, but still have a mixed record inimplementing thebest-practice principles for directbudget su~port.~ 39. The new Government's Five Year Program indicates that PARPA 2 will focus on accelerating shared growth. The focus will be on improving the business environment especially in rural areas. This would include simplifying red-tape for the private sector to flourish; reform of the judiciary system; ensuring a corruption-free society; improved agricultural services; and infrastructure investments, particularly in rural roads and electricity. The new Government is committed to a major push invocational and technical training to raise labor productivity. The share o f social sector expenditures will be maintained, but the quality and timely delivery will be monitored more carefully at the district and community level. The fight against HIV/AIDSandmalaria is also a top priority. Perfect Partners? ThePerformance of ProgrammeAid Partners in Mozambique, 2004 by Tony Killick, Carlos Castel-Branco and Richard Gerster. Mimeo, May 2005 18  Table 3: Actual andProjectedGDPRealGrowthRatesbyExpenditureCategory(%) Category 1997 , 1998 I 1999 j 2000 II 2001 ! 2002 2003 I '1 I I , IOverall GDP(mktprices) I 11.1 12.6 ' 7.5 ' 1.5 13.0 I 7.4 7.8 7.2 7.7 , 7.4 ' Agriculture I 9.5 9.5 6.5 -10.8 1 13.0 1 8.5 7.5 8.4 7.0 7.0 ' Fisheries 1 2.1 -11.0 -2.1 9.5 1 9.0 -4.3 13.4 1 3.9 11 3.0 1I 3.0 Mining ' 21.1 20.6 -6.5 52.8 12.4 5.2 31.6 1119.2 5.0 7.0 1 ~ Manufacturing 1 31.8 14.4 14.7 1 20.3 I1 27.2 4.0I 12.8 1 28.4 10.0 I 10.0 Electricity and water 1 37.9 279.0 78.3 -6.1 13.9 , I 6.2 ' -14.0 9.3 1.7 ' 5.0 5.0 ~ ~ ~ Construction 18.1 26.1 1 3.4 j 4.7 1 9.7 40.3 10.5 10.0 10.0 8.2 12.1 I 2.5 2.4 5.7 'Commerce 5.4 6.0 ' 6.0 6.0 1 6.0J Restaurants and hotels 35.5 -2.1 5.4 6.4 , 19.1 2.8 8.6 5.2 6.0 1 6.0 Finance and insurance i 29.9 -17.4 1 -26.9 41.9 ' 9.2 9.4 0.9 1.0 4.0 1 4.0 1 iReal estate ' 2.3 9.1 I 3.0 -1.9 5.7 ! 2.5 ' 2.4 2.5 4.0 4.0 Public administration -0.9 2.8 18.1 4.1 12.9 ' 3.7 1 10.0 , 1 ' I ' 6.0 1 6.0 ~ 10.2 , Trans., communication 17.3 4.8 9.0 1.2 21.6 I -13.4 8.6 13.6 8.0 7.0 i 8.0 j LEducation services 7.2 7.4 9.5 9.8 21.7 , 9.5 1 5.1 1 13.2 , 7.0 Health services 5.1 9.5 17.1 , 12.1 11.9 1 5.3 4.9 I 5.9 7.0 7.0 1 Lother services 9.2 9.7 10.0 1 10.5 I 10.3 6.6 I 9.0 18.5 -5.0 I 5.0 1 40. Monitoring of PARPA Implementation has improved, but challenges remain. There was limited progress against the PESPAF indicators relating to the integration o f PES, OE and Medium-Term Financial Framework (MTFF), using the single process methodology, and strengthening the BdPES. However, the 2004 PES and OE are a good representation of improved linkages between core actions, outputs and outcomes to be achieved towards the implementation o f the PARPA. The MTFF defines the base framework for 2004, and gives a perspective for the period 2005-2008, but its dissemination to the line ministries i s still weak. The Government has included the MTFF inthe 2005 budget. The BdPES is a better reflection o f the PES implementation, but still needs to provide more information on main policy developments and issues. Inaddition, the sector and provincial monitoring systems are not yet fully harmonized with the BdPES preparation. Although the relationship between the PES and OE has improved, it still needs to be strengthened in the areas o f identifylng costs, improving budget comprehensiveness with inclusion o f off-budget items and the beginning o f budget programming. A.l Building Public Sector Capacity &e. strengthening public financial management, decreasing aid dependency, and accelerating public sector reform) 41. Performance in public financial management has been mixed. In the area o f budget execution, spending in priority areas continues to be the main focus o f fiscal policy, Based on preliminaryfigures, spending in priority sectors remained below the 65 percent target at 63.3 percent o f total expenditure, o f which 50.4 percent was in education and health. This shortfall i s explained by low reported rate o f externally financed projects. Progress in improving the comprehensiveness o f the budget is slow, with some own revenues and many off-budget activities not being captured. Execution o f the externally financed investment expenditures remains low at 52 percent, probably reflecting weak reporting rather than execution. The flow o f funds, from the perspective o f sectors and provinces, remains irregular and unpredictable. The reports from the key sectors (e.g. water, health, education, agriculture) show that consistency o f 19  information between different sources and stakeholders remains unsatisfactory. To ensure efficiency o f public expenditures in the education sector issues o f teacher management, deployment and compensation inthe expanded system needs to be monitored (Table 4). Table 4: Actual Expenditure by Functional Classification (% GDP) net lending Generaladministration 3.9 1I 1.9 2.0 ` 1.8 1.9 1 Education 5.5 6.9 ' 4.9 5.0 14.8 Health 3.6 2.9 3.5 2.6 !2.5 'Agriculture 1.1 1.7 1.o 1.2 11.0 Roads 1.6 2.6 2.0 2.7 I2.0 Sanitation and publicworks 2.5 1i 2.3 0.7 0.5 ~ Residual, plusall sectors 8.4 12.6 ' 14.4 12.1 1 ~ ~ 10.3 42. e-SISTAFE was rolled-out in the Ministry of Finance on November 1, 2004 allowing financial execution of the State budget. This is significant as it will make budget execution more efficient and transparent over the short to medium term. The indicator for progress in rolling out the system was that general budget execution o f the 2004 State Budget, as well as direct budget execution in the Ministries o f Finance and Education and Culture through e- SISTAFE, would have been initiated. However, this has not been accomplished for the Ministry o f Education and Culture (MEC) for a number o f reasons, and hence the 2004 PES/PAF indicator i s considered to be partially met. 43. Therehas been progress in the review of the internal and external auditfunctions. The MinistryofFinance (MoF) completed the diagnostic study on the internal control institutions at national level, the strategic plan 2005-2009, and a 2005 activity plan. A value-for-money audit in the road sector, due to be conducted in 2004, was actually carried out at the beginning of 2005, and a draft report has been released. Concerning external audit, neither the assessment o f the progress towards the 2004 PESPAF target, nor the discussion on the indicators and targets for 2005-2007, took place. However, there was improvement in 2004 on the external audit by the Auditor General ("Tribunal Administrativo") o f the General State Accounts, in terms o f timeliness, quality and scope o f the audit report, which was debated inthe National Assembly in April 2005. 44. The 2004 PES/PAF indicator to approve a new procurement regulation was not met. This was partly due to delays inconsultations with the different stakeholders. A well functioning Public Procurement System has four pillars: (i) a legal procurement framework, (ii) modemized procurement procedures, (iii) the institutional capacity, and (iv) independent control and appeal mechanisms to ensure the integrity o f the system as well as to have Anti-Corruption measures incorporated. The Government has prepared its action plan to bring the procurement system up to international standards. 45. Performance in the tax system was mixed. The target to submit the draft legislation on the creation o f a Central Revenue Authority to parliament was achieved, as the draft law was submitted to Parliament in August 2004. Revenue collection was 12.3 percent o f GDP, about 20  one percentage point less than the target.8 Weak performance was observed across all categories o f taxes. Greater efforts to improve tax administration are essential to maintain fiscal stability and accelerate progress towards achieving the MDG's. 46. Progress has been made on anti-corruption, but much remains to be done. The national study on good governance, corruption and service provision was completed in the first semester of 2005. It i s under consideration by the Council o f Ministers, and will serve as the basis for the formulation o f an anti-corruption strategy. The study, however, has not yet been officially published. The Anti-Corruption Law was approved in2004, and the HighAuthority for Combat o f Corruption has recently been formally created and two regional delegations have been established. Many alleged corruption cases were reported to the Gabinete Central de Combate 6 Corrupcio (Anti-Corruption Unit), but the number o f completed investigations and convictions has been very low. The Government has signed, but has not yet ratified the UN convention and the SADC protocol on corruption. An institutionally comprehensive anti- corruption strategy needs to be prepared, with strong political backing and clout. 47. Overall progress in the area of public sector reform was slow. In the area o f public sector reform the three targets agreed for 2004 have been partially met, with limited impact on service delivery. The PESEAF target for completion and approval o f functional analyses (FAs) o f Ministerial staffing was only partially met; out o f the six FAs only two have been formally approved i.e. MINAG andMIC, and presentation o f the remaining four has been rescheduled for 2005. Preparatory work was undertakenfor the Medium-Term Pay Policy. 48. There has been notable progress in decentralizatioddeconcentration against the PESPAF targets, but a number of challenges remain. The targets for the introduction o f participative district planninghave been achieved, and in some cases have exceeded the output target. The regulations o f the Local Government Law were approved in April 2005. Improvement inbudget execution and fiscal decentralisation needs to take place so that the local authorities have greater autonomy. There i s some concem that the Government has focused more on consolidation o f the municipalities rather than on their efficiency, and resources need to be targeted to areas with greater poverty. Other concems are the quality of budget allocation, execution and accountability mechanisms at the sub-national level. The percentage share o f the budget going to provinces and districts has to some extent stagnated. 49. Littleprogress was noted in the area of thejustice sector reforms and administration; stronger Government commitment is essential. Progress was made in legislative reform and training programs and an integrity study o f the judiciary was completed. However, the long-term vision document, an essential part o f the reform program, was not completed. With regard to the judiciary, a review o f the 2004 targets shows little progress, Despite an increase in the productivity o f case disposition meeting the 2004 PAF target, the backlog and the total volume o f judicial cases continues to increase. Slow processing o f civil cases, and highjudicial costs, constitute barriers to contract enforcement. The target for decreasing the number of detainees awaiting accusation and trial was not met. The ratio between investigated and sentenced cases in the area o f corruption and economic crime continues to be low, and communication with the public onthe resolution o f certain highprofile cases is still outstanding. Ifthe constraints are not * This ratio isbased on the new GDP figures calculatedby the National Statistics Institute. It should be noted that the ratios contained inthe PAF use the old GDP estimates. 21  overcome, they will continue to affect the appropriate functioning o f the administration o f justice services, and the sector's capacity to contribute to poverty reduction. Henceforth, the challenges continue to be enforcement o f human rights, access to justice, including both formal and informal justice delivery and contribute to the promotion of social justice and a favorable business and investment climate. A.2 Improving the Investment climate (strengthening the financial sector, regulatory environment, and expanding infrastructure) 50. The overall performance of the enabling environment for private sector growth and participation has been mixed. Generally there has been a slow down in the reform process which could impact on growth inthe coming years. Key areas where a greater focus i s required include banking efficiency, tradability o f land-use titles, labor law reform and energy availability and efficiency for private sector growth. 51, Overall progress in the financial sector was satisfactory. There was progress in four main areas: (i) the strategy for International Financial Reporting Standards (IFRS) has been presented; (ii) the regulations related to the Banking Institutions law (LICSF) were approved; (iii) withdrawalofGovernmentparticipationinBancoAustralwas completed; and(iv) a the chart o f accounts for the insurance sector was published. Areas where progress has been slower include the forensic audit o f Banco Austral, where it took a long time to find an international reputable company willing to carry out such an audit, and the strategy for the Government's withdrawal from Banco International de Mogambique (BIM), which is still under development. The Government is committed to establishing a Financial Investigations Unit and have it operational byDecember 2006. 52. Progress against the PES/PAF indicators for business environment is mixed, with optimismfor future improvement. Of the four PESPAF 2004 targets under the Ad Hoc Legal Reforms section: (i) Amendment o f the Labor Law is in progress; (ii)Commercial Code i s delayed but progressing; (iii) regulations for licensing commercial and industrial activities are in place, as are (iv) inspections o f commercial and industrial activities. Much remains to be done at the level o f the PESPAF's Strategic Objective for 2004 which states "Creation o f favorable environment for private sector action". The approval o f the commercial code would be a step in this direction. 53. Growth in the agriculture sector remains strong. The growth inthe sector continues to be through expansion inlanduse and productivity gains inthe northern belt o f the country. The growth in output o f 9 percent was due to the increase in basic food crops (6 percent), and in export products (10.5 percent). Within basic food crops, grains contributed around 10.7 percent, with the maize contributing around 16 percent, while cassava maintained the growth same as in the previous year, around 4.3 percent. Amongst the cash crops cotton (69.9 percent), tobacco (33.7 percent) andtea leaf (19.2 percent) achieved significant outputs increases. 54. Some progress in agriculture service delivey, although the institutional reforms required to sustain this growth are slow. Most services indicators exceeded their targets, except for livestock vaccinations, which were below target by 50 percent. Some advances were recorded inthe institutional reform of the Ministryo f Agriculture (MINAG), namely the revision 22  and approval o f its statues and functions, and the ones for newlycreated or restructuredresearch institutions; however, less then expected progress was made in drafting the plan for staff resource development and deployment to the districts. The Ministry finalized the preparation o f its strategy document for PROAGRI 2 (the agriculture strategy document). Delayed disburse- ment continued to hamper the normal implementation o f the Ministry's work plan and budget, resulting in only 62 percent o f the planned 2004 budget being executed. Specific budget execution concerns include: (i) lack o f a uniform mechanism for the flow o f information on execution for projects outside o f PROAGRI' system; (ii) information regarding execution o f the external investment budget at the provincial level not being sent to central level; and (iii) the lack o f information on MINAGs procurement account. 55. The energy sector shows progress in the majority of the indicators set in the sector policy and strategy. Most notably the Ministry implemented the goals for connecting new consumers, the Master Plan (2005-20) for grid extension has been completed, and distribution networks for low-cost technologies andintermediate energy types are being established. The first large-scale gas project has been implemented, and future areas for exploration and investment have been identified. New sources of funding for FUNAE (National Energy Fund) have been identified, but yet to be approved. Significant progress has been achieved in drafiing new regulations for natural gas distribution and for the electricity sector. 56. Overall the trend in the road sector is positive. The indicators o f progress were largely achieved which included: the routine maintenance target was accomplished (103 percent); the rehabilitation indicator was significantly exceeded (184 percent), largely by rehabilitating the tertiary roads using the Road Fund(RF) budget; and funds for periodic maintenance were about 80 percent o f the planned amount. The RF transferred funds from periodic maintenance to emergency and rehabilitation works (in breach o f its policy o f giving priority to routine and periodic maintenance over rehabilitation and new construction) largely in response to urgent repair works needed on priority roads. Progress in institutional reforms has been satisfactory with the separation o f the RF from the Road Agency, namely Administraqio Nacional de Estradas (ANE). Both have an independent oversight Board with private sector and user representation. Other reforms include: the technical and financial audits o f road sector expenditure programs which are regularly performed by the RF; the gradual phasing out o f force account operations which have been replaced by increased private sector participation; introduction o f improved financial management systems and transparent procurement methods; and direct transfers to the Provincial Authorities for routine maintenance. However, further improvements need to be made in: instituting better reporting systems with separate accounts for routine, periodic and rehabilitation works; monitoring and evaluating performance and outcomes; increased funding for periodic maintenance and adequate provision o f counterpart funds; and the organizational structure and institutional capacity o f ANE. Institutional capacity o f ANE for implementation o f projects and supervision services is limited. Additionally, the flow o f timely investment funds from the Ministry o f Finances are matters o f major concern. Another area o f major concern is the bureaucratic and lengthy process o f contractor and consultant payments. This has resulted in significant RF debts related to late payment, interest and claims (approximately $10 million in 2004), and has a detrimental impact on private sector development, especially o f smaller companies. 9 PROAGRIis the agriculture strategy being financially supported by about 11donors under a sector-wide approach. 23  A.3 Enhancingservice delivery(health, education, rural water andsanitation) 57. Delivery of key services showed good overall progress. Ineducation progress seems to be satisfactory in terms o f enrolment levels. Despite promising progress in girls' enrolment, regional and gender inequalities continue. Close attention is required to monitor primary school completion rates, with a particular focus on regional and gender dimensions. As mentioned previously, there i s a further need to address structural issues related to teacher education, management, deployment and compensation, at all levels. The proportion o f unqualified teachers continues to increase, particularly in disadvantaged provinces. Another important issue to be addressed i s that o f monitoring leaming outcomes. Currently there i s no student leaming assessment in place. Finally, the preparation o f the investment framework for the Second Education Sector Strategic Program (ESSPII) has yet to be finalized. Inhealth there was positive overall progress, both in MDG indicators measured by the demographic and health survey o f 2003 and in the PESPAF indicators, although DPT coverage rates stagnated in 2004. In HIV/AIDS the targets for 2004 were satisfactorily met, but implementation of an equitable multi-sectoral HIV response remains a major challenge. Inwater sector the coverage target was partially achieved, but the government i s still facing significant challenges in improving sanitation services. (Table 5) Table 5: RecentPerformanceandMediumTermTargets for SelectedMDGs 1 1 I 1990or I Most ' Historic I Tarfet 1 TrR Target I AGR I I for for I , year 2006 1 2006 1 2015 1 2015 '- Malaria rate d a 18 nla n/a I n/a 1 4 8 Access to safe water nla , 57 i d a 1 63 2.4 78 ! 2.4 ~ 58. Overall performance against the three H I V A I D S PAF/PES indicators in 2004 was satisfactory. The target for the prevention of mother-to-child transmission (PMTCT) was 81 percent met. Although this target was not fully achieved, overall progress is positive, as 2004 was the first year o f implementation o f the program PEN Sa~de,and there were significant challenges in scaling-up access to care and treatment. The target for antiretroviral (ARV) treatment was exceeded. The HIV prevalence rate still shows an upward trend consistent with the projected HIV prevalence done earlier for the period 1998-2010. There was significant progress in the application o f the "Three Ones"- namely the establishment o f one national strategic plan; one coordinating mechanism; and one national monitoring and evaluation system. Political leadership at all levels and across all sectors i s crucial to an effective national response - yet the Aids Council (CNCS) Board (which should spearhead this effort) didnot meet in2004, compounding the fact that political leadership has been sub-optimal. HIV/AIDS is inextricably linked to gender inequality and poverty, and must be tackled through a coordinated multi-sector 24  response, yet few sectors have mainstreamed HIV/AIDS programs. The M E C has made progress on mainstreaming HIV/AIDS and education and launching school level activities with the support o f various partners, including the World Bank. The upsurge in the number o f orphans and vulnerable children has stretched coping mechanisms beyond their limits. Civil society engagement at all stages o f strategy development and implementation i s key to the achievement ofPAF/PES, PEN11and PENSaitde targets, but has yet to be adequately recognized. Significant delays inthe development o f a workable Grant Management System have detracted CNCS from focusing on its core business o f coordinating, leading andmonitoring the national response. 59. I n the education sector, the net enrollment indicator from the PES/PAF matrix was achieved. The performance o f the education sector has on the whole been positive over the period 2003 and 2004. Gross Enrolment Rates (GER) has continued to improve from 110.4 percent in2003 to 121.2 percent in2004 at EP1 level (primary). EP2 level (secondary) has also shown some improvement where the GER has increased from 35.5 percent in 2003 to 42.7 percent in 2004. Net Enrollment Rates (NER) has shown some positive trends, with EP1 schools registering an increase from 67.9 percent in2003 to 75.6 percent (73.2 percent for girls) in2004. It is important to note that the PAF target for NERwas set at 72 percent total for EP1, where girls would have attained 69 percent. Similarly, EP2 schools have also seen the NER increase from 4.3 percent in 2003 to 5.6 percent in 2004. These rates reflect serious constraints in access beyond EP1and a highproportion o f over-age pupils inthe system. Greater attention needs to be made to ensure that quality o f education is not compromised during the necessary expansion of the system. Repetition rates at EP1 have dropped from 21.9 percent to 20.8 percent over the same period; with less than satisfactory result for EP2, where the repetition rate has actually increased from 19.5 percent in2003 to 20.3 percent in2004.9 60. The education sector continues to progress, but a focus on quality is critical. The Government abolished the payment o f compulsory fees that were being made inprimary schools. While this is an important step forward, the desired impact interms o f additional enrollment and retention through the primary cycle remains to be seen: the G o M did not provide additional resources to offset the loss o f revenue from school-based fees and levies which for most primary schools i s the only source of revenue to cover day to day expenses. The implementation o f the New Curriculum for Basic Education and literacy and non-formal education, as well as the HIV/AIDS Strategy, constituted areas o f progress. Important changes were seen at the post- secondary education level. The revision o f the secondary School curriculum is in process to improve the quality and relevance o f this sub-sector. A reform o f Technical-Professional Education i s also in progress with the participation o f the private sector, national, and international partners. 61. Nevertheless, the Ministry of Education and Culture faces serious challenges. The Education Sector Strategic Program (ESSP) 11has not been finalized as foreseen inthe PES/PAF because o f some weaknesses in the planning capacity at MEC. The difficulties observed in the area o f financial management led to low budget execution, hindered the disbursements o f education (FASE) funds, and caused delays in salary payments for teachers and subsidies for literacy trainers, thereby compromisingMEC's programs. Teacher training, includingin-service training, and distribution o f text books still do not respond to needs inthe sector. Similarly, in This might be the result o f the new curriculumwhich effectively has removed the exambarrier between grades 6 and 7, only for students to sit for the exam at grade 7. 25  the area ensuring greater gender balance progress was weak. Additionally the major issue with expansion i s that the Government has been hiring new teachers without the requisite qualifications. Recent statistics indicate that over the years the proportion of unqualified teachers has been increasing and the recent spurt o f hiring nearly 5000 new teachers is likely to exacerbate this situation." 62. The Health sector performed positively in 2004. In addition to the 2.1 percent increase in the global volume of activities, two out o f three targets set in the PES/PAF were achieved. Only the coverage o f DPTHeB (3rd dose) remained unchanged compared to 2003, a weakness which can be attributed to problems with the management o f the vaccination programme (PAV), particularly in logistics (vaccine supply and the regular operation o f the cold chain in the health units) and the poor performance o f the outreach teams. Expansion o f basic and essential obstetric services and interventions within the network also contributed to the overall positive performance, resulting in a reduction o f infant and under-five mortality rates per 1,000 live births from 147 to 124, and from 219 to 178, respectively, based on Demographic and Health Surveys o f 1997 and 2003. Provision o fHIV/AIDS prevention and treatment services improved, with the entry into operationo f 113 voluntary counseling and testing sites and 25 Day-Hospitals. Access to ARV treatment remains limited and a systematic analysis o f how men andwomen are affected differently by HIV/AIDS, i s still being institutionalized inthe sector. The share o f total budget allocated to the health sector has fallen, from 14 percent in 2002 to 11percent in 2004, although its execution has shown some improvements. 63. I n water and sanitation, the PES/PAF indicator for access to safe water is for 41 percent coverage, with the sector achieving 39.8 percent in 2004, implying an overall satisfactory performance*1. Sanitation coverage figures for rural and urban areas are based on various surveys, but these do not allow the monitoring o f the indicator on an annual basis. The government i s still facing challenges in the improvement o f sanitation services. First steps in improving the monitoring system for which the National Department o f Water (DNA) is responsible were made, with some provinces and cities having updated sector databases. Budget execution figures are still not finalized as the budget execution report do not coincide with either DNA or DPOPH (Provincial Directorate o f Public Works and Housing) financial figures. The final figures will only be available once the General State Accounts are completed. Internal investment spending at central level has improved to 55.5 percent, but this is still too low. Treasury difficulties continued to hamper budget execution in the sector. Execution o f the external component o f the investment budget at the central level, however, i s alarmingly low at 22.8 percent, due to slow disbursement o f funds. The majority o f the provinces (Tete, Sofala, Maputo, Gaza, Nampula, Inhambane andNiassa) have reported investment execution rates o f at least 70 percent, and some report on-time disbursements from Ministryo f Finance (MoF), while others report execution rates below 60 percent due to late disbursement from MoF. Progress has also been registered in international river management, in the elaboration o f National Water Resources Strategy, and inthe revision o fthe National Water Policy and Water Act. loPercentage o f unqualified teachers: EP 1: 1992: 27% & 2003: 37%. EP 2 : 1992: 6% & 2003: 35%; ESG 1: 1997: 5% & 2003: 37%. ESG2: 1997: 5% & 2003: 17% l1The IAF indicates that access to water from improved sources was 27% inrural areas and 64% inurban in 200213. 26  B. DONORHARMONIZATION 64. Intensive efforts towards donor harmonization have taken place in thepast two years. Good progress has been made inharmonizing donor programs", and improving their alignment with government policy, with agreements andmechanisms developed to handle donor-donor and donor-government relationships. Considerable effort has been invested in this, both interms of discussions and evaluations. This section will review the progress made. 65. The proportion of external funds subject to the budget process, and the level of discretionay expenditure in the budget, have increased. The volume andproportion o f aid that i s channeled through the budgetary process has increased consistently over the last five years. While the first harmonization moves by donors were to pool funding in sub-sector and sector arrangements outside the nationalbudget, inthe last two years sector-wide approaches have been increasingly channeled through treasury accounts as earmarked funding. More hndamentally, the level of funds allocated as general budget support has increased from around $100 million in 2000 to $154 million in 2003, and around $250m pledged for 2004 (Table 6). Part o f 2004's growth in general budget support (GBS) i s due to the fact that some significant donors (EC, DFID) have increased the overall level o f aid and the proportion allocated to GBS; and part to the fact that other donors havejoined the club. 66. Policy dialogue has become morefocused on key publicpolicy and public expenditure issues and processes. The main vehicles for this have been the Framework Agreement on Joint Donor Programme for Macro-Financial Support in the year 2000 and the Memorandum o f Understanding o f 2004 (Annex 2). The latter was also signed by the Bank. The negotiation process and the agreements themselves have established the key principles, conditions and working arrangements amongst donors, and between donors and the Government. Inparticular, the M o U established the commitments o f donors interms o f disbursements, and o f Government in terms o f the priority to pro-poor expenditure and improved financial management. This was further strengthened by the establishment o f ajoint donor-government Performance Assessment Framework (PAF), setting targets for government achievement. In order to ensure mutual accountability, donor performance is also assessed each year by independent consultants through the Programme Aid Partners Performance Assessment (PAPPA). 67. There are many challenges ahead. Late donor disbursements remain one o f the factors contributing to low budget execution rates. In2004 donors set up their own monitoring system. There has been relatively little attention so far to broader issues o f domestic accountability, and to cross-cutting issues andreforms that go beyond particular sectors. The national authorities are perceived by donors as claiming increased ownership throughthe dialogue over the principles o f GBS collaboration. There remain questions about whether the practice has over-burdened government with heavy joint review processes, and assertion by donors o f their own policy priorities inthe PAF. loEvaluation of General Budget Support: the Case of Mozambique, byBatley, Certan, Cumbi, de Groot and Harvey, December 2004. And Perfect Partners? ThePerformance of Programme Aid Partners in Mozambique, 2004, by Killick, Castel-Brancoand Gerster, May 2005 27  Table 6: Balanceof PaymentdBudgetSupport ProgrammeDisbursementsandPledges (2000-2005, $m) Belgium 2.7 Denmark 14.6 9.6 8.8 10 10 EU 52.2 61 35 71 77.7 58 Spain Sweden 10.9 9.8 10.6 13.6 14.9 Switzerland 4.7 5 4.5 5.3 7.7 7.4 UK 15.2 14.4 14.2 15.6 27.4 58 WorldBank 60 60 Total 98.4 126.8 100.7 142 243.5 273.9 68. Technical assistance andlor capacity-building has become morefocused on key public policy and public expenditure issues and processes. While systems have been established to harmonize objectives and strengthen joint planning between government and donors, weaknesses remain in the government's capacity to plan and execute budgets. There is a program for the reform and computerization o f the public financial management system (SISTAFE), but many bilateral donors see this as being too focused on financial reporting and accounting, and not enough on prioritization and budgetary allocation. There i s also a cross- governmental program o f public sector reform led by a technical unit for public sector restructuring (UTRESP). Nonetheless, donors and government are focusing more on the more urgent need to build the capacity o f Ministries o f Planning and Development and Finance. Current technical assistance within the ministry i s managed on a project basis by diverse donors; there i s now a recognition o f the need to systematize this. 69. Donors have aligned more of their aid with national goals and systems. While the PARPA is the formal basis o f alignment, all the largest donors and many o f the smaller ones have now aligned themselves through the government's own planningprocesses: the economic and social plan (PES) and a shared matrix o f performance targets (the PAF). This is seen by government and donors as a major advance towards alignment and national ownership. Moreover, by setting indicators the PAF `concretizes' shared objectives which were otherwise only qualitatively stated (ifat all) inthe PARPA. The PAF and the joint review process have the effect o f aligning goals both inthe annual setting o f targets and intheir monitoring. 28  70. Donor activities in Mozambique have become more harmonized. There are now carefully worked out procedures for harmonization between the GBS donors, and these arrangements also involve a wider range o f associated observers. The importance o f GBS as a proportion o f aid i s growing. The main donors not being a member o f the G17 are the USA and Japan. They have an observer status inthe G17, and they participate inthe Joint Sector Working Groups. The latter is also tme for the UNsystem. UNDP and the specialized agencies participate fully inthe Joint Sector Working Groups; some ofthem are chairedby staff from the UNfamily. I However, all the donors that contribute to GBS also provide other forms o f aid that i s less harmonized; for most of them, other forms o f aid are more important. Even so, sector working groups and the PAF discussions influence priorities not only o f GBS expenditure but also o f project aid. 71. Nevertheless, there are issues about the gap between plan and reality. Disbursement have sometimes not been made according to plan. Also the Bank found the constraints o f the MoUand o fthe slimmed down 50 PAFindicators too restrictive. Therefore, the Bank's PRSC 1 contained a Program Matrix that was different from the PAF, even though it had signed the MoU earlier. Starting with the proposed PRSC 2, the Bank will now adhere fully to the PAF and no longer elaborate a separate Program Matrix. 29  IV. BANKSUPPORTTO THE GOVERNMENT STRATEGY A. CONSISTENCYOFTHE PRSCWITH THE CAS 72. The PRSC is consistent with the CAS. Bank support to the PARPA i s through the FY04-07 Country Assistance Strategy (CAS) (Report No. 26747-Moz). The base case scenario o f the CAS envisages programmatic support through four consecutive PRSCs to support Mozambique's efforts in building public-sector capacity and accountability, improving the investment climate, and expanding service delivery. The PRSCs would systematically address the issues o f poverty reduction across sectors identified in the PARPA. It would continue to support the maintenance o f macroeconomic stability, but the focus would increasingly shift to cross-cutting public sector management and sector-level issues, with the key challenge being to replicate a strong macroeconomic policy and implementation record at the sector level to facilitate economic transformation and permanent poverty reduction. One o f the key CAS objectives is to achieve a full alignment o f Bank instruments with the principles o f local ownership and leadership. Because Government policies and the Government budget are the key instruments for implementing the PARPA, the Bank is committed to supporting and aligning with the budget process. B. COLLABORATION WITH THE IMF 73. The IMF approved a PRGF in 2004 which complements Bank support. InJuly 2004 the IMF approved a new arrangement under the PovertyReduction and Growth Facility (PRGF) to support the Government's economic program for the period 2004-2006. The structural reforms supported by the PRGF aim to consolidate macroeconomic stability and sustain strong broad-based growth, consistent with the PARPA. The Bank and the IMF cooperate closely within their respective mandates in assisting the government implement the PARPA. The IMF leads the policy dialogue on macroeconomic policy (including fiscal, monetary, and exchange rate policies), the integrated financial management information system (SISTAFE) and tax and customs reforms. The Bank leads the policy dialogue on public expenditure management, sector structural reforms, reforms o f the civil service, and poverty and social impact analysis. Areas of close collaboration include banking supervision, financial sector issues, trade issues, the PARPA, and external debt sustainability (Annex 3). 74. The required progress for the PRGF in 2005 is evident. The program for 2005 envisages growth o f 7.3 percent, and a further decline in inflation to 8.5 percent by year's end. The fiscal program seeks to increase revenues through improvements in tax administration and the expiration o f some tax benefits, and to reduce the domestic primary deficit to 3.3 percent o f GDP, with the view of providing appropriate room for credit to the private sector. The overall deficit after grants i s projected to widen in 2005, owing to a substantial increase in capital outlays financed with concessional project loans, and with a part o f the proceeds from a signing fee paid in 2004 by a Brazilian company for coal prospecting and exploratian inMoatize. (This signingfee was treated as a "below the line" financing item.) Several steps are envisaged toward establishing a Central Revenue Authority by 2006, and strengthening public expenditure management and fiscal transparency. 30  75. The PRGF program includes additional measures to improve liquidity sterilization. Further steps will also be taken to strengthen the balance sheet o f the Bank o f Mozambique, improve banking supervision, and move towards International Financial Reporting Standards (IFRS) in the banking system. The enhanced supervisory regime for the largest bank was discontinued following the approval o f the bank's financial statements for 2004, and a feasibility study on the divestment o f the government's participation inthe bank will be completed by end- September 2005. C. RELATIONSHIP TO OTHER BANK OPERATIONS 76. I t is envisaged that programmatic lending will be complemented by investment support. PRSC support will coexist with investment support to well-articulated sector programs, and with technical assistance to the development o f government systems and capacities necessary for an increased reliance on those systems and capacities to channel external support. The share o f programmatic financing in overall financing inFY04 and FY05 was approximately 30 percent (or $60 million out o f $207 million o f new financing over the two years taken together). PRSC 1 covered primarily cross-cutting issues, policy dialogue, and other Govern- ment actions with no specific conditions related to service delivery. PRSC 2 would continue to strengthen the capacity built under PRSC 1. Future PRSCs would increasingly embrace sector progress and support the new Government's focus on development at the district level, thus enabling both Bank and Government to learn and continuously evaluate the appropriateness o f this approach. The PRSC process recognizes that conditionality in itself is ineffective in improving economic policy, and that domestic considerations, which are relatively immune to donor pressures, are the prime factor in achieving and sustaining economic and institutional reform. The PRSC's will continue to draw conditions exclusively from the PAF matrix, as revised each year duringthe Mid-YearReview inSeptember. 77. The primary aim of the PRSC is to help achieve and monitor progress towards a strategic subset of objectives defined in the PAF matrix. Given that the proposed operation is part o f the first cycle o f a PRSC multisectoral program, a strong focus on PARPA implementation is required. Disbursements will be contingent on progress towards a subset o f the PARPA's medium-term objectives as set out in the PAF matrix. Emphasis is placed on establishing an adequate M&E system for prior actions and triggers included inthe PRSC series, taking care to ensure that this system also strengthens the Government's poverty monitoring system, including the Poverty Observatory. The resources provided through the PRSC will complement Government and other resources. 78. ThePRSC series serves as a vehicleforpolicy dialogue. The policy dialogue focuses on public sector capacity and accountability with a strong focus on strengthening financial management, improving the investment climate and expanding service delivery. Technical assistance i s beingprovided through separate projects for public sector reform program, judicial reform, and regulatory reform in selected infrastructure sectors, private sector development, and decentralization to municipalities and local governments. A financial sector technical assistance operation will soon be presented to the Board. The PRSC series i s also complementary to parallel efforts to reduce poverty supported through a large portfolio o f investment projects in HIV/AIDS, education, strengthening local governments, water supply and sanitation, roads, railways, and other infrastructure. 31  79. As of March 2005, total Bank commitments were $945 million. Details of the investment programs are in the attached Table 7. The investment portfolio of 19 projects is diverse and supports the three pillars o f the CAS. Inthe agriculture and environment sector support has been provided to a sector-wide assistance program (SWAP) that seeks to improve the impact o f public expenditures and provide an enabling environment for sustainable and equitable growth in the rural areas. The Coastal and Marine Biodiversity Management Project pilots an integrated approach to sustainable development in two coastal areas. Inthe education there are two programs strengthening the capacity o f public institutions. The Education Sector Strategic Program supports the implementation of the National Education Strategy and the Higher Education project supports the entire higher education system. In transport and infrastructure there are four investment programs supporting rehabilitation and maintenance of roads, railways and ports and improved communications. The water sector programs aim to improve delivery of water supply systems in both urban and rural areas. Strengthening the investment climate and encouraging private sector participation has been supported through projects in the communications and minerals sector, and through the private enterprise development project. 32  Table 7: World BankLendingActivitiesinMozambique(US$ million) (August 2005) and care for orphans and people living with HIViAIDS Treatment The primary goal of the Treatment Acceleration Program (TAP) i s to pilot 20.8 17.2 30109107 Acceleration Program strategiesfor strengthening each country's capacity to scale up comprehensive (TAP) I program providingcare and treatment, which is effective, affordable, and equitable. Total Human Development 206.8 112.1 Public Sector Reform To transform public administration so that the citizens receivebetter services. 25.6 (grant) 23.7 30/06/06 Decentralized IITo improve performance of district authorities to plan and manage demand- 42.0 (grant) 34.3 30/06/08 To boost competitiveness ofprivate firms by expandingaccess to support 33  D. LESSONSLEARNED 80. There is evidence of greater country ownership of the PARPA process. As donors support programmatic lending with direct budget support and its alignment and harmonization with the PARPA, PES, OE, BdPES and the quarterly budget execution reports, there is greater government ownership. The harmonization process i s predicated on using Government documents rather than independentassessments as the basis for planning and monitoring. While some o f the documents and data still need to be improved, and the various planning instruments integrated into a single process, the new approach launched with the M o U has increased Government's ownership of the process, and it has enhanced domestic accountability, as Parliament analyzes the same documents as the development partners. It i s clear that donors need to be sensitive to limited government capacity. But it is better to work with documents that have full domestic ownership even if they do not (yet) measure up to best practice planning and monitoring standards. This process has resulted in an increased work-load for the central ministries, and has strengthened the role o f the Council o f Ministers. The Ministries o f Finance and o f Planning have to engage in substantive discussions on priority allocation o f resources, targets and indicators with the line Ministries. Previously this was done by the line ministries together with the key donors, but now the focus has changed and made this a more internal process. The bottom line for Government: ownership means more coordination work, more dialogue inter- and intra- ministries andmaking tough choices on allocating resources. 81. Donor harmonization is taking root. The signing o fthe Memorandum o f Understanding with the Government and 17 donors providing direct budget support, and the agreement on the Performance Assessment Framework in April 2004, opened a new era in policy dialogue, partnership, and donor harmonization. For the first time, the Bank participated in this harmonization mechanism with its first series o f PRSCs. Two Joint Reviews were held inApril 2004 and May 2005 and a Mid-Year Review in September 2004. In-between, regular meetings took place according to the structure described inAnnex 2. Canada and Spain started to provide direct budget support and signed the M o U in 2005, thereby turning the G15 into the G17. A bilateral agency chairs the G I 7 group for a year on a rotating basis. The Chair for 2004-05 (April-April) was held by Switzerland. Sweden is chairing in 2005-06 and the Netherlands in 2006-07. The harmonizationprocess has been evaluated by independent consultants working on behalfo f the G17, and by a Development Assistance Committee (DAC) expert group. 82. Transaction costs are still significant as theprocess is new. Duringthe year, the burden on the government has somewhat diminished, but it i s high during the period o f the Joint Reviews. On the donor side, the numerous working groups, sub-groups, and coordination meetings imply a significant and almost permanent time commitment. But coordination among donors has become more effective and meaningful, and the consensus between the government and the donors has been strengthened. As hrther experience i s gained, simplification o f the harmonization structure will have to be contemplated to reduce transaction costs for both the Government and the donors. 83. Monitoring indicators have changed to reflect realities. As the Government and the donors become familiar with the PRSC process and changes occur inthe economy, the technical review teams have focused on indicators that will reflect in a more appropriate manner progress inthe implementationof the PARPA. It was agreed that at the time of the midyear review in 34  September, changes to the indicators for year n+l could be made. Hence inSeptember 2004, the 2005-2007 indicators were defined. In September 2005, the indicators for 2006-2008 will be agreedupon. 84. Monitoring the PAF indicators has been a positive experience. The self-imposed limit o f monitoring not more than 50 indicators has forced a healthy discipline in setting priorities. However, there are instances where sector and thematic working groups continue to analyze many issues, rather than focusing on a few to judge whether progress has been satisfactory or not. Monitoring indicators were given little importance inthe past, but now they play a key role as nearly $300 million worth o f direct budget support are dependent on indicator-measured progress. Experience has shown that the choice o f the indicators and activities to be monitored still requires more analytical work, policy dialogue, and better quality data. This will be addressedduringthe revision o f the PARPA. 85. Processesand approach within the Country Team change. On the Bank side, preparing and supervising the PRSC has encouraged the country team to find new ways to work inmulti- sector teams, and to find new and innovative ways to carry out policy dialogue through the various lending instruments. During the first phase o f the PRSC series, when attention was focused on cross-cutting issues o f public financial management, accountability and investment climate, some o f the sector specialists felt marginalized. As the team has moved into preparing PRSC 2, and as more experience has been gained in working with the budget support harmonization structure and the sector working groups, the synergies o f a multi-sector team are starting to bear h i t s and allow for a much more effective method o f policy dialogue with both the Government andthe other donors. 86. With regard to the reform efforts supported by the PRSC, significant progress has been made, while still much remains to be done. Introducing e-SISTAFE has started an irreversible change process in the public administration and the investment climate is beginning to improve as a result o f a stronger financial sector and new legislation simplifying procedures. On the other hand, some o f the other items on the public sector reform and governance agenda have not moved decisively - an experience shared by other African countries, as recent Bank research has shown." The PRSC and DBS harmonization experience has also shown that many sector ministries are not interacting effectively with the central ministries o f Planning and Development and Finance. They are still more used to talking to donors about projects. As direct budget support becomes an ever more important instrument, this is bound to change, which will reinforce local ownership and accountability. E. ANALYTICAL UNDERPINNING OFTHE PRSC 87. As Table 8 shows, the first PRSC series is built on analyticalwork that was completed in implementingthe PARPA, and that informs the PRSC with respect to the adequacy of policies and institutions inareas relating to fiduciary and environmental safeguards. BuildingState Capacity inAfrica; 2004. Ed. S. KpundehandB.Levy, Sept. 2004, WBIDevelopmentSeries. 35  Table 8: AnalyticalUnderpinningof StructuralandFiduciaryAssessments Product Done Poverty assessment FY04 A second national household welfare survey was completed in 2002-03 and reported inMarch 2004; trend data, drawing on a first national survey completed in 1998, are being analyzed. CEM FYO1 Mozambique's growth prospects and reform agenda were thoroughly reviewed inFebruary 2001, and a new CEM is currently under preparation. PER FY03 This was the secondvolume ofa PER started inFYO1;they will henceforth be completed annually to track improvements inthe fiduciary framework. CFAA FYOl CFAA action plan endorsedby G o M andunder implementation. CPAR FY04 CPAR action plan endorsed by G o M and new legislation submitted to Parliament for approval. Financial sector FYO1- The PRSC supports the implementation o f key recommendations o f a joint analysis FY03 Bank-Fund financial sector assessment completed in May 2003 and complements a proposedFinancial Sector Technical Assistance project. ~ Legal andjudicial FY03 This assessment found that corruption, a lack of skilled human resources, sector assessment poor accountability for results, and numerous administrative weaknesses are the key sectoral challenges. Investment Climate FY03 An assessment of Mozambique's industrial performance and investment Assessment climate was completed in July 2003; implementation o f recommendations is supported by the PRSC series. PSIA on Primary FY05 The analyses conclude that school fees are not the major constraint to school fees enrollment and retention. I t is rather the distance to primary schools in rural areas, and the existence o f other direct costs (school materials) that have the most impact. OED reviews FY02 The review stressed the importance of understanding Mozambique's o f adjustment political economy at the micro level as well as o f sequencing financial operations sector reforms, including privatizations, inan appropriate manner. Health Sector FY05 A comprehensive report onthe health sector inMozambique. Status Report Impact o f Exten- FY06 Survey results reflect positive impact o f public and private extension sion Services in services. Public extension services have beenpro-poor rural Mozambique 88. Poverty Assessment. Usingthe nationally representative household surveys o f 1996-07 and 2002-03, the poverty headcount i s estimated to have fallen from 69 percent to 54 percent in the intervening period. Thus, the goal set inthe PARPA of a poverty rate o f 60 percent by 2005 has already been achieved, with the reductions slightly swifter in rural areas. These findings, which indicate that the Government's overall poverty program i s on the right track and achieving results, broadly agree with results from other data sources: (i) MINAG data indicate that the per capita growth rate o f cereal crop production was 14 percent in the six-year period 1996-2003 (i.e. a little over 2 percent annually), and mean household income increased by 61 percent; (ii) a qualitative indicators survey (QUIBB) in 2000/01 found that poverty had decreased by nine percentage points, using an econometric technique to link the (purely qualitative) QUJBBwith the household survey o f 1996; (iii) the household and agricultural surveys, dramatic increases in were found in the numbers o f bicycles, radios and other assets over 1996-2003; and finally (iv) education and health indicator surveys found strong improvements, particularly in the areas of primary school attendance, vaccination coverage, and attended births, over 1996-2003. 36  89. Country Economic Memorandum. A new Country Economic Memorandum12 reviews the economic performance inrecent years, provides a thorough analysis o f the poverty profile in Mozambique based on the new household survey data, and analyzes the linkages between economic growth, macroeconomic policies, and poverty inMozambique. It suggestspolicies for the optimal use o f Mozambique's natural resources - land, forestry, fisheries, mining and water -and for integratingtheir management into the overall growth strategy. Analytical work on rural development andtourism, supported bythe Bank, has contributed to this exercise. Some o f the findings o f these inquiries are expected to be incorporated into the new PARPA for the period 2006-2010. 90. Public Expenditure Reviews. PERs were completed in FY02 (in conjunction with the CFAA) and in FY04, in a participatory process that brought together central and sectoral government institutions, local and international academic and research institutes, the private sector, and a variety o f donors. The recommendations o f these PERs focused on improving budget formulation, execution and reporting to enable better tracking and informed decision- making conceming poverty-related expenditures. As the Bank and other donors provide larger proportions o f their assistance inthe form o f budget support, the PERprocess will be annualized and closely integrated with the Government's budget cycle to support specific reforms in the budget process. To improve results-based M&E, some public expenditure analysis and review will be progressively integrated into the cycle o f financial management (e.g. through analyzing several sectors each year). 91. Public Financial Management. A Country Financial Accountability Assessment (CFAA) was completed in 2001 in collaboration with several donors and the Government, an IMF Review o f Standards and Codes (ROSC), and a joint Bank-IMF assessment o f the Government's capacity to track poverty-reducing expenditures, have also been completed. All noted recent improvements and continuing challenges in Mozambique's public financial management and fiduciary systems. They also identified specific action plans for dealing with weaknesses in coordinating support and policy dialogue on these issues. Government actions being supported by the PRSC series play a central role in helping to implement these action plans. 92. Procurement. A Country Procurement Assessment Review (CPAR) was prepared in 2001, but it was only in 2004 that the Government agreed to take action. In line with these recommendations, and with the support o f this PRSC, a new procurement decree following international best practice will be submitted to the Council o f Ministers for approval following extensive consultations with main stakeholders including development partners. 93. Financial Sector Analyses. Since 2000, the Bank has completed a study o f the financial sector, AAA on Mozambique's compliance with the Base1 Principles, and a formal financial sector assessmentjointly with the IMF (FSAP). The May 2003 FSAP assessment found that the potential vulnerabilities of the banking system lie mostly in its loan portfolio; that banks are exposed to high credit risk due to high and volatile lending rates (themselves due to volatile inflation, high interest rate spreads and a poor lending environment); that high interest rate spreads result from large provisioning requirements, high overheads, and (for smaller well-run banks) high profit margins; and that the poor lending environment results from high corporate ~ ~~ l2CEM expectedto be completedby September 2005. 37  leverage, a low number of bankable projects, a weak repayment culture, and various legal and institutional impediments to credit selection and recovery. It also found that the volatility o f the Metical threatens financial sector stability and development by promoting dollarization and raising the cost o f domestic public debt. The PRSCs address a number o f these issues by supporting Government action to strengthen banking supervision; improving market oversight through transitioning the banks to international financial reporting standards (IFRS); completing the Government's divestiture from the banking system; and improving the lending environment through needed legal reforms (including the adoption of a new Commercial Code). Inaddition, a proposed Financial Sector Technical Assistance investment project will facilitate the implementation o f the mainFSAP recommendations. 94. Legal and Judicial Sector Assessment. This Bank assessment, which i s under Government review, found that: (i) Mozambique's legal andjudicial sector institutions have not kept pace with economic growth in the 1990s, with the result that public confidence in them i s low, and they are now perceived to be a deterrent to investment and a hindrance to growth; (ii) the sector's key problem is a relative lack o f skilled human resources; (iii) sector needs to the develop results-focused management practices and a culture o f accountability for results; (iv) while some laws (e.g. regardingland and labor) are ahindranceto growth and should be revised, the main effort should focus not on legislative but on administrative reform; (v) sector institutions must fight and be seen to fight corruption, or their reform efforts overall will become irrelevant. The PRSC series has responded to these findings by including conditionality linkedto corruption; helping to institute a results-focused management process within Government; and benchmarking Government actions intended to improve the administration o fjustice (also to be supported through a proposed legal capacity strengthening project). 95. Investment Climate Assessment. The Bank, together with the Investment Promotion Center and the Confederation o f Economic Associations o f Mozambique, completed an I C A in 2003. From an analysis o f 193 firms surveyed in 2002, the I C A found that the most severe constraints to doing business in Mozambique included: (i) lack o f access to and the high cost o f finance (cited by 78 percent o f the sample); (ii) Mozambique's uncertain policy environment; (iii)the costs imposed byregulatory and administrative procedures; and (iv) inadequate infrastructure. The PRSC series i s helping the Government to complete actions designed to ease some o f these key constraints, including the time and cost involved in registering a business; labor regulations governing short-term hires, expatriate hires andretrenchment benefits; the time involved in clearing imports and exports; as well as the cost and reliability o f electricity and telecommunications services. Policy dialogue will also address emerging issues, such as delays inthe Government paymentofVAT refunds. 96. Education PSIA. A Poverty and Social Impact Analysis (PSIA, FY05) has studied the impact o f school fees on primary school enrollment and retention. It was undertaken to fill the information gap on the impact o f direct costs (formal and informal school fees and related schooling expenses), and opportunity costs on enrollment and pupil retention in primary education. The main recommendations were for the Government to: (i) the current policy revise on school fees, to clarify the type (if any), purpose, frequency o f fee contributions, payment mechanisms and accountability o f funds; (ii) initiate public information campaigns to educate communities on the right o f children to attend primary school; (iii) increase resources that are channeled directly to the schools, mainly through the Direct Support for Schools program, to 38  ease the burden on households, especially when it comes to purchasingpupil's school materials; (iv) ensure better deployment o f teachers so as to distribute qualified teachers, especially inrural areas; and (v) build schools closer to the communities, so as to reduce the travel time to school, and consolidate lower and upper primary schools into one physical place to increase the likelihood o f continuation from one level to the next. 97. Better Public Health Spending to Reach the MDGs. The main sector issues identified are: the lack of adequate human resources (in 2003, Mozambique had one doctor per 40,000 inhabitants compared to one for 22,000 in Sub-Saharan Africa) and low pay; uneven geographic access and utilization o f health services; weaknesses in quality o f services; irregular application o f user charges that are a disincentive to receiving care, and low budget execution. Key recommendations include the need to focus on strengthening management and improving the coverage and skill levels o f paramedical staff. There i s a need for Mozambique's budget to be more strategically designed so as to allocate funds for operations and investment in areas where they would have the strongest impact in achieving better health outputs and outcomes. To that effect, the government would need to focus on: (i) increasing the staffing o f health facilities in the most rural areas; (ii) increasing the ratio o f health personnel to population in the Northem provinces; (iii) introducing contracts with appropriate incentives to encourage health personnel to practice inrural and difficult areas; and (iv) preparing and implementing a medium-termplan to reach the appropriate mix o fhuman resources for the health sector. 98. OED review of aa'justment lending in Mozambique: During FY02, OED reviewed eight IDA projects, including four adjustment operations, in Mozambique during FY90-FYO1. The adjustment operations aimed to help stabilize the post-war economy, improve public sector management, transform the economy from a centrally-planned to a market-oriented one, reallocate public spending to poverty-reducing activities, and begin to create the conditions for private sector-led growth. While querying the adjustment operations for having failed to achieve poverty reduction through private sector-led growth-a doubt that the recently completed poverty assessment indicates may be misplaced-the OED review also identified several key lessons. First, Government ownership and successful implementation o f an adjustment program may not suffice to achieve its objectives. Inaddition the operation needs to be developed in full appreciation of Mozambique's political economy at the micro level, and complemented by projects that could ameliorate some o f the weaknesses. This i s particularly true regarding the ability of Mozambicans to participate effectively in the privatization program. Second, sequencing financial sector reforms is critical to both financial and private sector development. In particular, weak state-owned banks should be privatized before they are restructured or recapitalized; state-owned banks should be privatized before large numbers o f other enterprises are privatized, or else inappropriate resource allocation may occur; state-owned banks should be privatized without permitting a sizeable residual government ownership, as this ownership could result in continued connected lending, insolvency and budget obligations; and the absence of world-class prudential regulations and supervision as well as a functioning legal system when the private sector enter the financial sector may invite moral hazard problems. The PRSC series has taken these lessons into account. 39  V. THE PROPOSEDPRSC2 A. BACKGROUND 99. PRSC 1 and theproposed PRSC 2 constitutea series of operations designedtoprovide budget support over threeyears based on thepolicy agenda andpriorities of the PARPA. The PRSCs concentrate on the issues considered to be binding constraints to growth and poverty reduction. They are: (i) improving the management o f public finances to enhance the efficiency and efficacy of expenditures and improve govemance; (ii) enabling private sector development, and (iii)improving the delivery o f services. While recognizing the importance o f each o f the sectoral areas in the PAF, the PRSC series has focused the policy dialogue initially on cross- cutting issues, particularly govemance, public financial management, and the investment climate before including prior actions in other PAF priority areas, such as education, health, water and rural development. Within this general framework, there were four key considerations: 0 A focus on the Government's PAF and PARPA implementation processes is highly appropriate. 0 A focus on planning, budgeting and managingpublic service delivery, including through government restructuring and the introduction o f e-SISTAFE, will have an important medium- and long-term benefit for service delivery. 0 As indicated in the ICA and the upcoming CEM, Mozambique's growth opportunities can be further enhanced through second-generation reforms that address constraints to businesses, including the high cost o f banking, labor law inflexibilities, and the high costs involved inbusiness registration. The recent C E M points to possible improvements for agricultural productivity and rural development through a better management o f the country's abundant natural resources, and the link between secondary and tertiary education and poverty reduction. Hence the areas o f focus correspond to the govern- ment's agenda o f sustainedprivate sector-led growth for poverty reduction. e While the Bank continues to support sector development programs through investment projects, the policy dialogue in these sectors will be complemented and enhanced by the general budget support. The donor harmonization mechanism allows for the Bank to be involved effectively inpolicy dialogue also insectors where it has no specific investment project, since all priority sectors are being monitored closely through the PAF. 100. Theproposed PRSC 2 will support the national policy priorities defirzed in the PAF, which is based on the PARPA. The financing needs and levels are based on the medium-term financing plan contained in the Government's Medium-Term Financial Framework (MTFF). The Letter o f Development Policy (Annex 4) confirms Government's commitment to implementing the reform program and PARPA. All o f the expected results are based on the PARPA's objectives, and on the results framework for the CAS for FY04-07. 40  101. The proposed PRSC 2 is concentrating on completing actions in three key building blocks of the PAF that arefundamental to sustaining growth: a) Building public sector capacity and accountability. This component focuses on maintaining macroeconomic stability, improving public financial management, and enhancing governance. The govemment has started to implement the new integrated electronic financial management system, e-SISTAFE; improve procurement practices in line with international practice; restructure key ministries to improve the delivery o f services; proceed with decentralization; and strengthen the fight against corruption. b) Improving the investment climate. Actions are intended to: (a) strengthen the financial sector by enhancing supervision by the central bank, proceed with divestiture o f government interests in the banking system, and transition the banking sector to international financial reporting standards, (b) improve the regulatory framework by reducing impedimentsto entry and exit; (c) improve the labor market environment; and (d) expandinfrastructureservices, thereby reducing costs o fproduction andmarketing. c) Expansion of Service Delivery. The govemment continues channeling at least 65 percent (excluding interest payments) o f its expenditures to the priority sectors o f the PARPA (agriculture, health, education, rural water supply, infrastructure, justice and related governance sectors), with the objective o f achieving basic outcome and output indicators established inthe PAF and PARPA. 102. I t is proposed that the PRSC 2 be designed as an exceptional two tranche operation to allow for the transition to afully harmonized approach. The first tranche of the PRSC 2 would provide financing for the 2005 Mozambican budget year, and the second tranche for the 2006 budget cycle. The Bank signed the M o Uwith the G o M and the other Programmatic Aid Partners in 2004, but the modality of PRSC 1 still required several exceptions that prevented the Bank from full harmonization. The first tranche o f PRSC 2 is already more aligned with the MoU, as the prior actions are exclusively taken from the PAF, which serves as the Program Matrix. (PRSC1 had a separate Program Matrix that was different from the PAF.) The second tranche o f the proposed PRSC 2 would already follow the M o U rule that budget support for year n+l be firmly committed inthe year n. Given the exceptional transitional character o f PRSC 2, budget support for 2006 i s based on a set o f triggers, rather than prior actions. Starting with PRSC 3 (tentatively scheduled for Board presentation in December 2006), the Bank's budget support would be fully harmonized, and again inthe form o f single tranche operations with a set o fprior actions. 103. The PRSC 2 would deepen the harmonization process. The programmatic policy dialogue - outside of investment operations - between the Bank and G o M is now taking place through the sector working groups and the PAP structures. This new approach by the Bank of seeking consensus among partners andwith the Government -rather than carrying out a separate policy dialogue - i s inline with the Rome andParis Declarations on Donor Harmonization. As a result o f the Bank's new OPBP 8.60, the PRSC 2 would disburse into the common account at the Central Bank set up for direct budget support contributions from the other members of the G17, rather than through a dedicated account, as was the case with PRSC 1, and the audit will be donejointly. This is another move toward harmonizing procedures. 41  104. Aligning the PRSC with the budget cycle of the Government of Mozambique and the procedures of the other DBSpartners. The Rome and Paris Declarations strongly recommend that budgetary support be predictable. Predictability based on past performance has been one of the guiding principles of the M o U signed inApril 2004 and reconfirmed after the Joint Review o f May 2005. Under the MoU, the normal procedures are as follows: donors make a firm commitment about the amount and timing o f their budget support for year n+l four weeks after the Joint Review inyear nis concluded. The Joint Review, which normally takes place inApril'3 assesses performance in year `n-1'. Therefore, the amount o f budget support in year `n+l' i s determined by the performance o f the government in year `n-1'. Performance in year `n' only affects the amount o f DBS in year `n+2'. As a safeguard against any slippages, the M o U stipulates that budget support can be suspended, and consultations undertaken, if underlying principles are violated, such as serious breaches regarding democracy, human rights, or loss o f macroeconomic stability. A Mid-Year Review takes place in September o f each year, when the performance inthe first semester i s reviewed, and the PAF indicators are updated and agreed for the Government's performance inyear `n+1' (Annex 5). 105. Thefirst tranche of PRSC 2 would be disbursed based on the achievements reached in Calendar Year 2004 and early 2005. All the PAF indicators are jointly monitored by all development partners through the respective sector working groups. A formal assessment was made during the Joint Review in May 2005. The second tranche would be disbursed after the completion o f a set o f triggers specified below. All o f the triggers are taken exclusively from the PAF for 2005. They represent important reform actions inthe area o f improving public financial management and the investment climate. B. PRIORACTIONS COMPLETED 106. The overall assessment of performance by the Government in 2004 wasjudged to be satisfactory by the Joint Review concluded on May 14, 2005, even though some benchmarks were not fully met, and not all the indicators could be achieved. Table 9 shows the status o f the prior actions for PRSC 2. They correspond to the triggers defined inthe PAD o fthe PRSC 1. Each prior action i s discussed in the subsequent paragraphs. The PRSC 1 PAD mentioned maintaining macro-economic stability as a trigger, but this is considered to be a pre-condition for the purpose o f PRSC 2. It has been hlly met, as inflation (9.1 percent) was contained below target levels, and growth was strong at 7.2 percent. l32005 was an exception. The delay was caused by the elections inDecember 2004. 42  Table 9: Status of PRSC2 Prior Actionsfor First Tranche I PRSC2 Prior Actions I Status I Component 1: Public Sector Capacity and Accountability 1. Ministryof Finance will implement e-SISTAFE Ministry of Finance has rolled out e-SISTAFE in the inthe Ministryandits provincialdirectorates Ministryand inall itsprovincial directorates onNovember 1,2004. 2, The Council o f Ministers will approve a new There have been delays due to an intensive consultation procurement decree that brings public procurement process with the private sector and the development processesinline with internationalpractice. partners. An acceptable draft procurement code is expected by October, 2005, Component2: Improvingthe Investment Climate 1. The Government will present a new Financial The Financial Institutions Law was approved and Institutions Law to the NationalAssembly. promulgated in2004 and implementation regulations have beenissued. 2. Making the hiring o f foreign labor more flexible The new decree 57/03 was published in 2004, and it by adopting Decree 57103. revoked Decree 25/99. 3. The Government will present a new Commercial There have been delays, but the new Commercial Code is Code to the National Assembly. expected to be approved by the next session of Parliament inOctober 2005. The draft code hasbeenapprovedat the technical levels o f the Government, Parliamentary subcommittee, andDonors. Component 3: Expansionof Service Delivery The Government will formulate its 2005 budget 65 percent o f expenditures were allocated to the priority with agreed allocations to P A W A priority areas sectors in the approved budget. Execution rate was 63.3 and execute its 2004 consistent with agreed percent, o f which 50.4 percent were spent on education allocations; inparticular it will spend 65 percent o f and health. its 2004 budget on the priority areas. B 1. Component1 :BuildingPublicsector capacityand accountability 107. E-SISTAFE has been rolled out in the Ministry of Finance at the central level and in the provinces. Since November 1, 2004, e-SISTAFE has been deployed in the Ministry o f Finance. Currently all fund releases from the Treasury Single Account to bank accounts of spendingunits are processed through e-SISTAFE, providing the means to control the receipt o f accounting returns from spending units against their next fund release. Accounting returns from spending units are further supported by the submission o f bank reconciliation statements, which are also monitored. The data captured in e-SISTAFE, and the accounting returns from spending units enable the compilation o f financial statements bythe Ministry o fFinance. This has started 43  to profoundly transfom budget management and reporting. e-SISTAFE will be extended to all the line ministries inthe coming two years, starting with the Ministry o f Education and Culture inOctober 2005. Duringthisphasethepilotministrywillbeconnected to e-SISTAFE to directly execute and account for its revenues and expenditures, against the budget controls o f the Ministry o f Finance and through the Treasury Single Account. Switching from a manual expenditure management and accounting system to a computerized one has been resisted for a long time by civil servants who were experts in the old system, and were afraid of not being capable o f adapting to the computerized one. Furthermore, it i s accompanied by the unification o f thousands of public bank accounts into a single treasury account and other changes in the rules o f expenditure management. e-SISTAFE will allow for expenditures to be properly classified and tracked. Without it, it would also be very difficult to get all the donor-funded projects on-budget. Government i s fully aware o f the risks. An extensive national training program was designed, and a "change management" component was included in the design o f the program inpreparation o f the introduction o f e-SISTAFE. Training and change management will continue to be provided in the coming years to all the sector ministries at the central, provincial, and district levels. The design o f the software, the hardware configuration, the training program, and the implementation o f e-SISTAFE are being accompanied by a Quality Assurance Group made up of international expert that reports every six months to the Government and the donors supporting the new system. The Bank is an observer in the e- SISTAFE Quality Assurance Group. 108. The delay in procurement reform is due to the process required to ensure an efficient system. The donors were to some extent overly optimistic as to the time required to ensure that a proper procurement system is inplace. The benefits from a modem public procurement system are clear, as it will enable the Government to achieve better results from the expenditure o f public funds, discourage corrupt practices, and promote private entrepreneurial initiative in the country. Moreover, having procurement in line with international standards will ensure its acceptability by Development Partners, which will facilitate the harmonization o f procedures with the country systems and lower transaction costs. The steps to be taken to proceed with the implementation o f the procurement reform, and achieve its objectives, are the following: (a) Legal Procurement Framework: (i)Have the lawhegulations finalized in accordance with international standards and approved by the authorities; (ii) establish the institutions as provided for in the regulations, including the supervisory and recourse functions, and provide the necessary means for them to become functioning and carry out their responsibilities - i.e. oversight, policy and audit; (b) Procurement procedures, to be modernized based on (i) clear guidelines and standard bidding documents to ensure transparent bidding, bid-evaluation and award procedures, and trinsparent and accountable contract management. In addition, (ii) procurement processing should become part and parcel o f the public expenditure chain management; (c) Institutional Capacity should be achieved through: (i) establishment in each contracting entity of procurement management units, (ii) staff in place trained to become procurement proficient, capable to apply the regulations and procedures efficiently and transparently; (iii)monitoring o f standards o f the Public Procurement system and keeping them up to date (modemized), and (iv) make available initial and on the job training and technical support; and(d) independent control systems and appeals mechanisms are inplace 44  B 2. Improvingthe InvestmentClimate 109. A new Financial Institutions law was approved by Parliament and promulgated in 2004, and the relevant regulations were issued. The new law creates a modem regulatory framework and increases dramatically the supervision powers o f the Central Bank in parallel with the transitioning o f the banking system to the International Financial Reporting System (IFRS). It also sets new standards for non-banking financial institutions and for the micro- finance sub-sector. Positive signs reflecting some stabilization are the large drop in the ratio o f non-performing loans, and the fall in interest rates on lending (prime rate) from 28 percent at end-2003 to 24.5 percent in October 2004 and 18 percent in May 2005. However, interest rate spreads continue to be large. There continue to be structural problems inthe financial sector that need to be addressed to improve access to modem financial instruments and expanding the sector to the rural areas. A strategy is currently being developedto expand micro-finance. 110. Important actions have been taken with respect to improving the regulatory framework to reduce impediments to entry and exit and improve labor market flexibility. A new industrial registry process was established simplifying entry and exit. In addition, the land registry timing was reduced to a maximum o f 90 days under a new ministerial decree. With respect to the labor markets, the government published a decree that improved firms' flexibility inhiring expatriates. This was identified by the Investment Climate Survey carried out in2003 as an important constraint to doing business inMozambique. Inparallel the country is also now issuing entry visas at the main border points, and additionally the visa requirement for citizens from South Africa to Mozambique has been completely abolished for short visits since April 2005. 111, Modernizing the Commercial Code is an essential precondition to allow for further private sector growth, particularly of SMEs as they do not have a special status. The current Code i s over a century old, dating as far back as 1888. A new Code has been elaborated inclose consultations with the private sector, and the legal expertise has been financed by a Bank technical assistance project. The draft Code was submitted to Parliament three years ago, and has since been analyzed in detail by the technical commission. The revised version has the agreement o f public officials, the private sector, the development partners and the relevant sub- committee o f Parliament. Parliament is expected to approve the new Commercial Code during the next session in October. Equally important for the private sector i s a new Commercial Registry Code to simplify the procedures and cut red tape. This new Code is also ready, and should be approved together with the Commercial Code in 2005. The Government has contracted an international consulting firm inJune to computerize the commercial registry. This will reduce the time required to register a company or a brand name by 30-50 days andwill be a major step forward to facilitate the entry o f newbusinesses. B 3. ExpansioninService delivery 112. As agreed in the PES/PAF, 65percent of the budget was to be targeted to the PARPA priority sectors, of which 50 percent was for the education and health sectors. Budget execution for the priority sectors was slightly below the target at 63.3 percent. This shortfall is largely explained by a low "reported" execution rate o f externally financed investment projects. (Actual expenditures on externally financed projects are likely to be higher, as there are still 45  shortcomings in reporting project expenditures to the Ministry o f Finance.) About 30 percent o f total government expenditures are invested in the health and education sectors. The concentration of resources in the two priority sectors have meant that important outcomes have been reached, despite the extremely low levels o f US dollars per capita expenditures that they represent. However, continued focus on efficiency o f expenditures i s required and must be closely monitored. C. TRIGGERSFOR SECONDTRANCHE RELEASE 113. The second tranche of the proposed PRSC 2 would focus on two pillars: (i) cross- cutting actions to strengthen public sector performance by enhancing efficiency and effectiveness in the use of public resources, and (ii) enhancing the investment climate. The triggers were chosen as important indicators that the second generation reforms to improve the quality o f public financial management and enhance the institutional environment for accelerated growth and poverty reduction are on track. They are evidence o f the new Government's strong commitment to the reform agenda. The specific set o f triggers for the release o f the second tranche, scheduled to be inJanuary for the budget year 2006 are: PublicSector Capacity and Accountability Adoption o f a modem procurement system in accordance with the best international practices, and a start on its implementationbased on the new procurement regulation and in connection with the e-SISTAFE. For 2005, the Government is committed to start operationalizing the new procurement system by approving a revised implementation action plan; carrying out procurement audits in a sample o f ministries; preparing a training program for civil servants and suppliers; and preparing the TOR'Sto elaborate standard biddingdocuments. (Trigger # 34 o fthe 2005-07 PAF inAnnex 1B) Rollout o f e-SISTAFE to the Ministry o f Education and Culture. This means that the Government's computerized financial and accounting system (e-SISTAFE) will be fully operational in the Ministry o f Education and Culture; financial and budget execution, accounting and reporting will be done on-line, and all financial transactions will be carried out through the Treasury Single Account. (Trigger # 31 o f the 2005-07 PAF in Annex 1B) Increase the coverage of the budget: conclude the study on off-budget expenditures in the health sector, and initiate the implementation o f the recommendations. For the 2006 state budget cycle, the Government is committed to include in the budget for the health sector the revenues and expenditures resulting from the "special clinic" o f the central hospital, and a larger portion o f the revenues and expenditures from the extemal common finds compared to the 2005 budget. (Trigger # 28 o fthe 2005-07 PAF inAnnex 1B) Combat corruption: The Government is committed to increase, in real terms, the resources allocated in its 2006 budgetary proposal for the anti-corruption unit. The planned increase of budget resources would allow the anti-comption unit to hire more qualified staff in the capital and for its two regional delegations, and have the means to carry out its work (Trigger #46 ofthe 2005-2007 PAFinAnnex 1B). 46  ImprovinPthe InvestmentClimate e) Revision o f the 1888 Commercial Code through the adoption o f a new Commercial Code. (Trigger # 21 o fthe 2005-07 PAF inAnnex 1B) f) Legal reforms:submit the following bills to Parliament: (1) the organic law ofjudicial courts including commercial sections; (2) Revision of the Notary Code (Trigger # 49 b) andc) o fthe 2005-07 PAF inAnnex 1B) Preparingthe Next Series of PRSC's 114. The next PRSC is expected to be presented to the Board around December 2006. The next series o f PRSCs would provide budget support in 2007-09. The focus would continue to be on the three pillars as in the current series: (a) The improvement o f public financial management, such as the rollout o f e-SISTAFE to all the sector ministries at the central, provincial, and eventually the district levels. The Government i s also expected to enhance governance by adopting and implementing an anti-corruption strategy. (b) The improvement o f the investment climate by reforming its labor legislation, reducing red tape further, and improving the regulatory framework where necessary. (c) It is expected that the third pillar - service delivery - would become a more important focus o f future PRSCs. Inparticular, prior actions would be chosen to support rural development, which i s a top priority for the new government and essential inthe fight against poverty, as 70 percent o f the population still live in rural areas. D. MONITORINGAND EVALUATION 115. The establishment of a sound M&E system remains a challenge. The First PRSC appraisal document discussed the many problems in the existing system ,and there have since been improvements. The Joint Review in May 2005 found that there was some improvement in consolidation o f the various reports, but adequate systems still need to be operational inmany o f the Ministries. A more extensive discussion of the M&E system to monitor the implementation o f the PARPA and the PAF i s contained in Annex 6. The recommendations contained therein have been discussed with the relevantjoint Working Group for Poverty Analysis and Monitoring Systems and the Government. 116. The donor working group is working to improve harmonization and alignment in planning the monitoring systems/support. Technical assistance is being provided to Government for the monitoring systems (including PARPA preparation) and to engage with civil society (Annex 6). E. CREDIT AMOUNT AND TRANCHING The Credit is a two tranche operation o f a $120 millionequivalent. 47  VI. OPERATION IMPLEMENTATION A. SUPERVISION 117. The Bank's supervision of the PRSCs is aligned with the supervision of the joint Direct Budget Support program of the G17. In order to reduce the transaction costs for the Government, the Bank carries out all supervisionjointly with the other donors. It participates in the Troika Plus (consisting o f three donors/a chair/co-chair and outgoing chair, forming the troika chairmanship -- EC and WB are permanent members, thus forming the Troika Plus), the overall coordination mechanism set up by the G-17, and all the relevant coordination meetings (see Attachment J on Structure o f PAP). All Bank sector missions working for the PRSC team liaise closely with and through the respective joint sector working groups to assure maximum coordination with all other sector partners. Additionally, the Bank missions will utilize the Results Framework -Annex 7 - to monitor progress. 118. The M o U defines two key review eventsper year. A Joint Review takes place each year in April/May (Year n). It assesses the Performance of the government inthe previous budget year, which corresponds to the calendar year (Year n-1). The review focuses on evaluating progress with regardto the 50 indicators defined inthe Performance Assessment Framework and makes an overall assessment o f progress. The second event i s the Mid-Year Review in September. This review i s mainly forward-looking and formalizes the agreement on the performance indicators for the following year (Year n+l). Both the Joint and the Mid-Year Review are a multi-sector exercise, and Bank staffparticipate inall relevant sectors. The reviews are prepared at the technical level by the variousjoint sector working groups. 119. I n addition, the supervision of the PRSC is done on a continuous basis in harmonization with the other direct budget support donors. The Task Team Leader for the operation i s based inthe field, andparticipates inall relevant coordination andjoint government- donor steering committee meetings. Progress in each sector i s monitored byjoint govemment- donor sector working groups. Bank staff actively participates inthese meetings through its staff inthe fieldoffices andWashington (through missionsor byvideoconference). 120. Furthermore, the Bank participates in joint IMF-Bank missions to monitor progress in the macroeconomicframework. The joint staff assessment mission to evaluate progress of the PARPA was carried out at the same time as the Joint Review. B. DISBURSEMENT AND AUDITING 121. Theproposed credit will follow disbursing and auditing procedures of per the MoU. Details o f the disbursement and auditing arrangements as agreed and signed by the Program Aid Partners (PAPS) are provided in Attachments G-H. The Bank's Credit will be disbursed and audited accordingly. C. ENVIRONMENTAL ASPECTS 122. The Program is a development policy lending operation that supports Government's poverty reduction strategy, and is likely to have impact on the environment. The PRSC will 48  support the PARPA based on a review o f key multi-sector output/outcome indicators measuring physical outputs e.g. kilometers o f road rehabilitated, irrigation systems rehabilitated etc and process indicators. There can be bothpositive and negative impacts on the environment o f some o f the budget support operations. However, many o f the sectors supported under the operation have specific environmental safeguards in place such as in health, education and agriculture, through other investment operations. Additionally there are other activities supported through the budget e.g. revision o f the commercial code, where it i s difficult to assess the impact on the environment. 123. Analysis has recently been carried out of the sustainability of natural resources (land, water, fisheries, forestry and mining). Natural resources are critical for growth and poverty reduction in Mozambique. The basic conclusion o f the recent analyses, also reflected in the upcoming CEM, is that the legal and administrative frameworks for exploiting these resources are designed to protect the poor, but inpractice the actual outcome is the opposite. There i s also a gap between regulations enacted and implementation - primarily due to lack o f capacity, interferences and rent seeking behavior. This includes clarifying regulations that create uncertainty, introducing transparency, and improving monitoring capacity. An institutional capacity assessment will be carried out as part o f the CSNCEA (see below) - based on which technical assistance maybe provided to develop capacity. 124. Additionally, there is a significant knowledge gap concerning the links between poverty and communities' access and use of natural resources. Inparticular, very few studies have attempted to understand communities' perspectives. Key questions include how dependent communities are on natural resources, what access do they have to land, water, forests, fisheries, mines, etc.; how do government policies impact on their livelihoods and the environment; and the extent to which they are capable o f influencing government policies affecting natural resources and their immediate environment. Mozambique has been chosen as a pilot country to carry out a joint Country Social and Environmental Assessment (CSNCEA) analysis with the use o f BNPP Trust Funds (Dutch). The work is expected to be carried out inthe next eighteen months. The analysis will be based on the premisethat the environmental and social aspects are linked in three major ways; (i) reduction programs should not damage the resource base poverty and the environment on which the poor depend for their livelihoods; (ii) improving the social and environmental conditions can help reduce poverty and promote pro-poor growth and (iii) mitigating measures, as needed should be identified as part o f the policy dialogue. 125. A Report Card survey will be carried out. The survey will gather quantitative and qualitative information from communities on their utilization o f natural resources, their perceptions o f public management o f these natural resources, and the public support they would like from government to manage and exploit these resources effectively and sustainably. Linked to the Report Card will be efforts to empower communities to utilize the information gathered in the Report Cards to pressure effectively for changes in public policy in this area. The second part will look at the government's capacity to respond effectively by providing services and regulation in this area. The work will involve a detailed review o f existing environmental legislation, policies and legal framework. This will involve both literature review and country interviews. Analyses of comparable fi-ameworks in similadneighboring countries will be carried out, together with an assessment o f institutional capacity. 49  D. R I S K S AND RISKMITIGATION 126. One set of risks concerns the potential for macroeconomic instability as a result of terms of trade shocks, regional instability, or deteriorating financial sector performance. Some of these risks, such as terms o f trade shocks or regional instability, are exogenous. Considering the highlevel o freserves, the fourfold increase o f exports over the past five years, a flexible exchange rate regime and low external debt vulnerability, the likely impact should be manageable, even though no stabilization mechanism exists at this point. However, if oil prices remain at their current high level in international markets, then the fiscal position would need some adjustment. Regardingfinancial sector performance, the new Financial Institutions Laws - approved in 2004 as a prior action for PRSC 2 - gave the Central Bank much more power to supervise the banking system, and prepared the ground to introduce Intemational Financial Reporting Standards in the banking system. The new legal framework and strengthened supervision has reduced the risk o f banks accumulating a highshare o f non-performing loans, as has happened inthe past. Furthermore, a Financial Sector Technical Assistance Project has been appraised and will soon be presented to the Board. This project should help reduce the vulnerability o f Mozambique's financial sector. 127. A second set of risks concerns the unpredictability of donor disbursementsfor budget support. This i s being mitigatedby intensive efforts indonor harmonization and the signingo f a Memorandum o f Understanding by all parties. The M o U was signed by 15 donor agencies in 2004; inthe meantime, two more partner countries - Canada and Spain -have signed the MoU. The Government has also assumed strong ownership o f the Joint Review process in AprilMay 2005, which has consolidated mutual trust inthe process. 128. A third set of risks concerns the political will to carry out the reforms. The new President and the Government have reaffirmed their hll commitment to the reform agenda as articulated in the five-year program tabled in Parliament in March 2005, thus the political and social risks are considered to be small. The new Government has shown leadership and started to address complex institutional reforms, such as legal, judiciary and other govemance reforms. It i s also aggressively undertaking legal and organizational reforms to improve the investment climate. 129. Afourth set of risks concerns weak administrative capacity to implement reforms such as public financial management, procurement, and improved service delivery. To mitigate this risk, the Government and donors agreed during the Joint Review to develop an integrated strategy for capacity development in public finance management, and to strengthen the coordination and management o f reforms. 50  ANNEXES 51  I . $ 0 0 * 2 0 i a c1 E * Q) $ 0 c 0 e b 0 i 5O 8 2 0L I S L. 3 P b a %i - 2 3 L k0  -1  ij E YA * 8 0 % z3 -t, 5 .-E ....*M * 6 .I 0 I B 8 ....5i 0 e, 0 E E rs n .-v1 0 9 13 .... & n 2  G E I3 aEm I  6 1 . m - ? -a x * a m n i -B f /I .I B0 4Y - M > .I gY uW  l- 0 s n 0 v l N - n 3 s \o 0 d 0 -s N n s m zd $1 /Aid 2 SI N m d 9 t i! a aL d S 0 c-l E g iT1 PI  3 3 N 2 d c-a 3 T- - m ~ VI  R? 14:. N 3 N * C I -.- m  l- I I IC) N w N N b 00 N I  -l- l- 0 0 - N B>0 rg 0 0 N 2k P In $a 0 0 - n! N 2. z d 00 m I I  Ux --r I C) m W 9 1 0 i i 9 19 d 0 d In  l- 0 - 0 N W - 0 0 N v) 0 - 0 N 5 L t  ANNEX 2: MEMORANDUMOFUNDERSTANDING BetweenGovernmentofthe Republicof Mozambique andthe ProgrammeAid Partners for the provisionof DirectBudgetand BalanceofPaymentsSupport Preamble 1. This Memorandum o f Understanding (MoU) sets out principles and terms for the partnership between the Republic o f Mozambique, represented by the Government o f Mozambique (GoM), and the signatory Programme Aid Partners (PAPs) listed in Attachment B. Its annexes give operational expression to these principles and terms. Programme Aid refers in this M o U only to Direct Budget Support and Balance of Payments Support. This M o Ureplaces the `Joint Donor Programme for Macro Financial Support to the Government o f Mozambique' that came into force in2000. 2. This M o U will be attached as an annex to each o f the PAPS'bilateral agreements on Programme Aid with the GoM. Bilateral agreements, which will be distributed to all signatories o f this MoU, have precedence over this MoU. However, to the extent possible, given existing contractual and statutory provisions, PAPs will not include in their bilateral agreements any additional conditions or administrative and reporting requirements to those agreed upon in this MoU. Where PAPs have existing bilateral agreements, these will be amended in line with the MoU. In the exceptional cases where PAPs do have different or additional conditions or administrative or reporting requirements intheir bilateral agreements, these are shown inAttachment K. Introductoryprovisions 3. GoM and PAPs hereby declare their commitment to create an effective development partnership based on mutual commitment, trust, respect and confidence. They do so in the interests o f the people o f Mozambique, aiming to reduce poverty, and sustain development gains. GoM and PAPs contributing Direct Budget Support are also aiming to promote peace and deepen democracy. G o M and PAPs are determined to work inthe spirit o f the principles o f NEPAD, Monterrey and Rome in a process o f open dialogue and mutual accountability. In this context, GoM and PAPs declare their commitment to the modality o f Programme Aid, given the potential to improve aid effectiveness and country ownership o f the development process through increasing donor harmonization, increasing recipients' institutional capacities in planning, implementing, monitoring and evaluating their programmes, strengthening domestic accountability, reducing transaction costs, allowing allocative efficiency in public spendingand increasingpredictability of aid flows. 64  4. G o M and PAPswish to develop a partnership based on frank and open dialogue on the content and progress of Mozambique's Poverty Reduction Strategy (PARPA), Medium Term Fiscal Framework (MTFF), Economic and Social Plan (PES), and the State Budget (OE). G o M and PAPs will focus their dialogue particularly on the GoM's Performance Assessment Framework (PAF), which i s a multi-annual matrix o f priority targets and indicators based on the PARPA, updated on an annual basis through the PES process and agreed through cross- governmental dialogue. Each year the signatories will attach the agreed PAF to this M o U as a substitute and updated annex. GoM and PAPs believe that the PARPA, MTFF, PES and OE are instruments o f good govemance, on which G o M is accountable to the Mozambican citizens through the National Assembly. The PARPA should be developed through interactive and consultative processes with Mozambican political and economic stakeholders, includingthe private sector and civil society. The Balanqo do PES for year n-1and the PES for year nwill be submitted to these stakeholders for discussion. GoM and PAPs declare their intention to conduct dialogue and monitoring and ensure delivery and use o f Programme Aid inaway that workswith andstrengthens theseprocesses. 5. Inthis spirit of development, partnership and commitment to poverty reduction, the G o M andPAPs thus decide and agree as follows: Section 1: Overall objective 6. The overall objective o f Programme Aid is to contribute to poverty reduction inall its dimensions by supporting the evolution, implementation andmonitoring o f the PARPA. Section 2: Intermediate objectives 7. The intermediate objective o f Programme Aid is to support poverty reduction in Mozambique by: i) Building a partnership based on frank and open dialogue on the content and progress o f Mozambique's poverty reduction strategy as set out inthe PARPA and made operational through the MTFF, the PES (including priority indicators and targets as defined inthe PAF) and OE. ii) Providing financing to the public sector for poverty reduction, clearly and transparently linked to performance, in a way which improves aid effectiveness and country ownership o f the development process, reduces transaction costs, allows allocative efficiency in public spending, predictability o f aid flows, increases the effectiveness o f the state and public administration, improves monitoring and evaluation and strengthens domestic accountability. Section 3: Underlyingprinciples 8. GoM and those PAPs supplying Direct Budget Support consider the GoM's. commitments to peace and to promoting free, credible and democratic political processes, independence o f the judiciary, rule o f law, human rights, good govemance and probity in public life, including the fight against corruption, (with reference to commitments in the 65  constitution, NEPAD and international agreements) to be underlying principles of govemance for the provision o fbudget support. 9. In addition, the following are considered by GoM and all PAPs to be underlying principles for the provision o f ProgrammeAid: 0 GoM's commitment to fight poverty (with reference to the Millennium Development Goals and PARPA), including through a pattern of public expenditure consistent with PARPApriorities; 0 GoM's commitments to pursuing sound macro-economic policies (with reference to IMFprogramme `on-track' status or anequivalentjudgment). 10. Concems regarding violation o f these underlying principles will be dealt with through consultation and dialogue between PAPs and G o M at the appropriate level for decision- making, at any moment one of the signatories thinks this to be appropriate. The violation of an underlyingprinciple is understood as being above and beyond concerns raised about under- performance against indicators andtargets expressed inthe PESPAF. Section 4: Commitments 11. G o M is, inaddition to the commitments included as underlying principles inSection 3, committed to: 0 Implementingits PAFcommitments; 0 Improving Public FinanceManagement, commitment to which will be reflected inand assessed annually through the PAF. 12. GoM and PAPs are committedto improving the quality o fdevelopment cooperation in Mozambique through: 0 Strengthening dialogue on the PARPA, PES (particularly the PES priorities identified inthe PAF), MTFFand OE; 0 Guaranteeing the timely availability o f all documentation necessary for this dialogue (as outlined in Section 5); 0 Establishing an agreed disbursement schedule, in order to assist G o M in implementingits PESPAF commitments. 13. Inaddition, PAPs are committedto providing ProgrammeAid inaway that: 0 I s aligned with Mozambican instruments, processes and systems o f financial management, including: o Providing assistance for and undertaking dialogue around the PARPA, PES, priority aspects o f the PES set out inthe PAF, the CFMP and the OE. o Usinggovernmentprocesses anddocumentation. o Following the government cycle for planning, implementation, monitoring, reporting and funding. 0 Increases the predictability o f the flow of donor funds, including bymakingmulti-year agreements on Programme Aid, providing GoM with information on Programme Aid 66  commitments in time for the information to be used in policy and budget planning, linking response mechanisms to agreed, realistic targets and indicators, disbursing according to the agreed disbursement schedule and not interrupting in-year disbursement, unless underlyingprinciples are violated; Ensures transparency of conditions and funding; Improves harmonization by eliminating bilateral conditions and bilateral administrative and reporting requirements (as far as possible given existing legal and statutory requirements, which should also be reduced over time); Lessens the administrative burden o f their assistance on G o M by increasingly mounting joint missions, undertaking joint analysis, using joint procedures and by reducing the number o f visits and overlapping activities; Enhances the capacity o f the G o M to meet its commitments by providing appropriate technical assistance and capacity building. Section 5: Reporting 14. This section refers to reporting on G o M poverty reduction plans and performance and PAP commitments and performance. Timing o f provision and content o f documents is shown inAttachment D. 15. G o M commits to provide PAPswith the following: a Planning documents including the PARPA, PES (and PAF), MTFF and OE, as well as other information, reports and documentation relevant to these programmes and budgets, especially on macroeconomic and poverty reduction developments; a Monitoring documents including Balanqo do PES (half year and year), Budget Execution Reports, the General State Account and annual audit reports (as indicated in Section 10, including the Administrative Tribunal Report on the General State Account and the quarterly reports on the flow o f counterpart funds ); a An annual report on fiduciary risk assessment within public financial management done by or with GoM; a Other reports agreed upon by G o M andPAPs. 16. PAPscommit to provide GoMwith the following: e Information on multi-year commitments, indicative commitments, final commitments and disbursement schedules at a time that GoM can use it in policy and budget preparations. PAPs will provide G o M quarterly with updated information on the disbursement o ftheir Programme Aid; e A report on performance against the PAP commitments, including on harmonization andalignment, on harmonization andalignment, outlined inSection 4, paragraph 13. Section 6: Monitoring and dialogueprocess 17. This section refers to monitoring o f and dialogue around GoM plans and performance and PAP performance. Monitoring and dialogue processes will follow an annual review process aligned with GoM's planning, budgeting and monitoring cycle. Monitoring and 67  dialogue processes will use reports outlined in Section 5, focusing on the documents submitted by GoM to Parliament. All formal performance assessments will be undertaken jointly by G o M andPAPs and not bilaterally (except when PAP legislation requires a national or institutional audit authority to undertake their own assessment o f PAP operations, inwhich case the PAP will inform other PAPs and GoM, undertake a joint process where possible, share results andpursue any concerns through the mechanisms o f this MoU). 18. There will be two joint GoM-PAP reviews on Programme Aid: the annual review (following the production o f the Balanqo de PES) and a mid-year review (prior to submission o f the PES and OE to Parliament). The annual review i s focused on coming to ajoint view on performance, which serves as the basis for commitments. The mid-year review focuses on dialogue on forward planning and budgetingand agreement on the PAF. The joint view on performance may include divergent opinions, where these are acceptable to all signatories. In the exceptional case where ajoint view cannot be reached, following increasingly higher-level dialogue, views will be reported separately. 19. Inthe annualreview: e GoM and PAPswill assess performance against the PES, PAF and OE inyear n-1and inyear nup to the point ofthe review, basedonthe informationinthe Balanqo do PES and Budget Execution Report and other available information (including information inthe PES, PAFandOEinyear nas context for performanceassessment). e G o M and PAPswill come to ajoint view on performance inyear n-1by the end o f the review. The most important factor indefiningperformance will be results as measured against indicators and targets committed to in the PAF. This will be seen inthe wider context of a holistic analysis o f performance against the PES and OE. It will focus on trends and the direction o f change. It will take into account the extent to which performance difficulties are being addressed, as shown in the PES, PAF and OE commitments for year n GoM and PAPs will assess PAP performance against commitments outlined in Section 4, Paragraph 13, based on the report mentioned above inSection 5, paragraph 16. 20: Inthemid-yearreview: e G o M and PAPs will discuss performance in year n until the moment o f the review, based on the last budget execution report, the half year PES-report and other available information; e G o M and PAPs will discuss G o M plans for year n+l on the basis o f the PARPA (when relevant), MTFFand headline information on the PES and OE; e G o M andPAPs will agree the PAF outlined for year n+l, based on a G o M proposal o f priorities identified, through cross-governmental dialogue, duringthe PES process; e G o M andPAPs will discuss PAP commitments for improvingaid effectiveness; 0 Incasedatawere notprovidedintimefor assessmentofvariableportionsofthe PAP response mechanism at the annual review, G o M andPAPs will make an assessment o f performance against specified selected indicators for variable portions o f PAP response mechanisms (see Section 7); 68  Details are given in Attachment E. G o M and all PAPs will come to a joint view on this assessmentbythe end o fthe review. 21. There will be a follow up meeting twice a year (in June and December) to discuss progress on issues raised duringthe reviews. 22. Budget Working Group (BWG) meetings will take place four times a year, always in combination with a review (April and August) or a follow-up meeting to a review (June and December). At these BWG meetings GoM and PAPs will discuss budget execution up to the end o f the previous quarter, based on budget execution reports. PAPs and G o M will agree on the detailed disbursement schedule at the December meeting. 23. The reviews will be linked to other dialogue processes, including the Poverty Observatory. They will be complemented by and build on on-going dialogue throughout the year. Ad hoc meetings will be arranged as required and agreed by the signatories to this MoU. G o M will manage the process, including organizing and chairing all meetings and being responsible for drawing up minutes. Attachment E shows the timing, participants and activities o f the above reviews and Annex 5 shows the calendar o f the dialogue and monitoring processes. Section 7: Response mechanism 24. This section describes the response mechanism, which is the link between GoM performance and PAP commitments and disbursements o f Programme Aid for the coming year (the World Bank has its own response mechanism as described in Attachment K).PAPs may choose between making a single response based on the joint view o f performance or a split response, with one part (fixed portion) being based on the joint view o f performance and the other part (variable portion) beinglinkedto specific, transparent commitments drawn from the PAF and agreed with G o M (see Attachment F). PAPs will define their financial contributions intheir bilateral agreements with the GoM. 25. The process o f commitment on funding will work as follows (see Attachment K for exceptions) : PAPswith a single response: 0 Will use the annual review joint view o f Performance in year n-1to make bilateral decisions on the implications for their provision o f Programme Aid inyear n+l; 0 PAPs will make commitments within four weeks after the end o f the annual review and confirmed commitments by 31 August. The commitment can only change between commitment and confirmed commitment if an underlying principle is violated. PAPs with a split response: 0 Will commit the fixed portion as above; 0 Will make indicative commitments for year n+l for the variable portion within four weeks after the end o f the annual review and confirmed commitments not later than 31 August, subject to timely reporting. These commitments may change between indicative and confirmed commitments on the basis o f further information about G o M 69  performance on specific indicators in year n-1 and/or performance on specific indicators inyear nuntilthe moment o f the mid-term review. 26. Once commitments are confirmed they cannot be changed and committed funds will be disbursed, except when PAPs believe that there has been a violation o f an underlying principle (see Section 3), or as a consequence o f a PAP parliamentary decision or when one of the specific conditions for individual PAPs applies, as described inAnnex 10. Section 8: Dispute settlement 27. Ifany dispute arises betweenthe signatories (GoM andPAPs) as to the interpretation, application or performance o f this MoU, signatories will engage in increasingly higher-level dialogue inorder to reach an agreed and amicable solution. Section 9: Disbursement process 28. A disbursement schedule will be agreeduponbetween GoM andPAPsbefore the start of the fiscal year at the December Budget Working Group meeting. It will take into account the needs o f the budget, as identified in central Treasury planning. It may only be revised at one o f the Budget Working Group meetings, if GoM and PAPs agree to do so. Details o f disbursementprocedures are showninAttachment G. Section 10: Auditing 29. There will be annual audits 1) o f the financial records o f Programme Aid; 2) o fbudget execution and 3) o f expenditure performance in relation to results (value for money). The details are shown inAttachment H. 30. Where independent auditors are used, GoM will be responsible for contracting the auditors, who will be selected incollaboration with PAPs. The audit reports will be presented on time (as set out inAttachment H), discussed and followed up within the framework o f the reviews. Section 11: Procurement 31. Government procurement will be done on the basis o f Mozambican legislation on procurement.GoM will as soon as possible reform and bring up to internationally acceptable standards, its legislation and system o f govemment procurement. GoM and PAPs will agree on a mechanism to follow up on the process and practice o f improving the procurement system. Any concerns regarding procurement will be dealt with through the mechanisms o f this MoU. Section 12: Corruption 32. Inthe context of GoM's commitments to combating and reducing corruption, as set out in Section 3, GoM and PAPs will require that all staff and consultants dealing with the provision and the use of Programme Aid will not offer to third parties or seek, accept or be promised from or by third parties, for themselves or for any other party, any gift, 70  remuneration, compensation or profit o f any kind whatsoever that could be interpreted as an illegal, fraudulent or corrupt practice. Any concerns regarding corruption with respect to Programme Aid will be dealt with through the mechanisms o f this MoU. In the case o f serious deviation or misuse o f state budget funds or acts o f large-scale corruption by members or structures of GoM, GoM commits to make all due efforts to recover funds thus misusedor misappropriated and take appropriate measures. PAPs reserve the right to unilaterally or jointly withhold disbursements or claim repayment in full or in part o f funds in the case o f misuse or fraud. Section 13: Evaluation 33. PAPs will decreasingly undertake bilateral evaluations o f the effectiveness o f Programme Aid as an aid modality. PAPs will undertake a single harmonized evaluation by 2006. Section 14: Responsibilities and structure 34. GoM will determine (a) focal point(s) for Programme Aid and will define how it will engage with PAPs for the activities provided inthis M o U(see Attachment J). 35. PAP signatories will have a structure for the implementation and follow-up o f the provisions of this MoU. The responsibilities and composition o f this structure will be agreed upon by PAPs, inconsultation with GoM (see Attachment J). The PAPs will nominate one o f themselves to act as chair o f the group. Section 15: Admission and termination 36. GoM will decide on each request for admission to the M o U and inform the PAP chair inwriting of its decision. The inclusion of a new PAP to the MoU shall be effected by an addendum in writing to the list o f signatories. PAPs that sign this M o U are entitled upon signature to become full participants inthe PAP structure. 37. PAPsnot having a valid agreement with the GoM, will not be considered to beparty to this MoU. Individual PAPs may withdraw from thejoint mechanisms and from this M o Uby a notice o f withdrawal. GoM may also rescind its bilateral agreement with any one o f the PAPs, upon which the PAP shall cease to be a signatory o f the MoU. GoM, or the PAPs acting in consensus, may terminate this M o U by a notice o f termination to the other party. The signatories will endeavor to provide as much notice o f termination as possible, not being less than three months written notice. In timing its notification o f withdrawal, a PAP will take account of the GoM budget cycle and the effects o f its withdrawal on the year incourse. Inthe case o f an individual PAP withdrawal, disbursements previously made will not be reimbursed by GoM, unless withdrawal accompanies events as provided for under Section 12 above. In the case of rescission or termination by GoM, funds still held in account (to be determined at the date o f termination by extemal audit) shall be reimbursedby GoM. 38. Agencies that have not signed the M o U or withdraw from it may request to become observers. 71  Section 16: Effective data, duration and amendments 39. The MoU enters into effect for each PAP on the date o f signature by G o M and the relevant PAP, given that the PAP has a valid bilateral agreement. See paragraph 2 above for the relationship between this M o U and bilateral agreements. The Joint Donor Programme for Macro Financial Support to the Government o f Mozambique expires for each PAP on the date o f entry o f this new MoU. 40. Amendments to the M o Uwill be valid only if agreed inwriting between the G o M and all signatory PAPs on the basis o f unanimity. Amendments to its Annexes have to be agreed upon by G o M and a majority o f PAPS.The MoU will terminate five years after it enters into effect, unless specifically renewed by agreement of the signatories. 72  ATTACHMENT A: LIST OFATTACHMENTS 1. List o f Signatories 2. Performance Asessment Framework (PAF) 3. Reporting Requirements 4. Dialogue and MonitoringProcess 5. Split Response Mechanism 6. Disbursement 7. Auditing 8. Draft terms o fReference for the Audit of Financial Records o f the Programme Aid 9. ProgrammeAid Partners Structure 10. Exceptions 73  ATTACHMENT B: LIST OF SIGNATORIES The Republic o fMozambique, representedbythe Government o f Mozambique Programme Aid Partners providing Direct Budget Support: Belgium Canada Denmark European Commission Finland France Germany Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland UnitedKingdom World Bank ProgrammeAid Partners providing Balance o f Payments Support: International Development Association (World Bank) Non-signatory observers: African Development Bank InternationalMonetary Fund Japan UnitedNations United States of America 74  ATTACHMENT C: PERFORMANCE ASSESSMENT FRAMEWORK (PAF) While drafting the PES for the coming year (year n+l), G o M will each year identify from among its goals and targets a concise list o f the highest priority indicators and targets in the areas o f governance, system reform, and the priority poverty reduction sectors. This will be done through a process o f cross-governmental dialogue. This short list, the Performance Assessment Framework (PAF), will orient the dialogue on priorities andperformance between G o M and PAPs. The PAFwill also include, as far as possible, indicative targets and indicators in these areas for the succeeding two years (year n+2 and n+3), based on medium term commitments made inthe PARPA andMTFF. At the annualreview meeting, the agenda and focus o f discussion on GoMperformance inthe previous year (year n-1)will be oriented around performance against indicators and targets o f the PAF (see Section 6). In the context o f this joint assessment o f performance in year n-1, PAPs and G o M will discuss potential priorities for the PAF for year n+l.The PAF proposal will thereafter be defined during the annual process o f cross-governmental dialogue on the PES. The PAF for year n+l will then be agreed in essence between G o M and PAPs at the mid-year review meeting in August each year (see Section 6 and Attachment E). The PAF will be submitted to Parliament as part o f the PES andbe formally agreed between GoM and PAPs and annexed inits final version to this M o U at the year-end meeting inDecember. G o M will ensure particularly that its annual Balanqo do PES report addresses the results achieved in the past year on all the items in the PAF. Performance against the PAF will be assessedinthe context o f performance against the wider PES, as described inthe Balanqo do PES. The annual review in2004 will be a transition year to take account for the fact that the 2003 PAF is not fully integratedwith the PES. Since the 2003 PES does not klly reflect the targets and indicators for governance, system reform and priority poverty reduction sectors, information in the Balanqo do PES about performance against the 2003 PES cannot provide adequate context for assessing performance against the PAF. In the 2004 annual review, information from the Balanqo do PES will therefore be supplemented in PAF priority areas with information from recent GoM-donor sector, governance and system reform reviews. A decision will be made at the end o f the 2004 annual review as to whether this transition approach will also be necessary for the annual review in2005. 75  ATTACHMENT D: REPORTINGREQUIREMENTS 1. GoMwillprovide PAPswithplanning documents including: 0 PARPA, with anyrevisionmade available for consultationprior to conclusion; 0 MTFFmade available indraft inApril andduringhpon revision; 0 PES made available after sending to Parliament (with headlines presented inAugust); 0 PAF matrix (limited set o f prioritized targets and indicators for n+l to n+4, developed byGoM and drawn from the PES), made available inAugust; 0 OE made available after sending to Parliament (andheadlines presented inAugust). 2. G o M will provide PAPs with monitoring documents including: 0 Balanqo do PES (made available not later than 15 March for the year report and not later than 15 August for the half year report), reflecting performance against PES targets and indicators, including those identified as PAF priority targets. In 2004, the lack o f full integration o f the PES and PAF means that the Balanqo do PES will include reporting against the 2003 PAF commitments in addition to reporting against the 2003 PES. From 2005, PAF reporting will be integrated with PES reporting. 0 Budget Execution Reports, as stipulated in SISTAFE Law 9/2002, (made available within 2 months o fthe end o f each quarter, coveringperiods 1January to 31 March, 1 January to 30 June, 1January to 30 Sept, 1January to 31 December). 0 The final annual state account (Conta Geral do Estado) and the Administrative Tribunal report on the annual state account according to the deadlines set in legislation. 0 Quarterly financial execution reports on the Programme Aid (Quarterly Report on the Flow o f Counterpart Funds), made available not later than two months after the end o f each quarter, providing documentary evidence of: o The cash flow inand out o fthe B o Mforeign exchange account(s); o The inflow o ffunds to the Transitory specific Account (Metical equivalent) andthe foreign exchange equivalent (with the exchange rate used) supported by copies o f bank statements; o The flow o f funds from the Transitory Account(s) into the Central Treasury Account; o Annual audit reports as described inAttachment H; o Annual report on developments in fiduciary risk within public financial management and other reporting on this issue done by or with G o M or with the agreement (and building the capacity) o f GoM, including SISTAFE and Public Sector Reform reporting, Public Expenditure Review (PER), Country Financial Accountability Assessment (CFAA), Country Procurement Assessment Report (CPAR), Report on Observance o f Standards and Codes (ROSC) and other World Bank and IMF diagnostic studies and other donor supported exercises; 76  o Medium term evaluation reports, as defined in the PARPA Monitoring and Evaluation strategy, including survey results and analysis and other relevant reporting on poverty. 3. PAPSwill provide G o M with the following: Where relevant, information on multi-year commitments by 31August each year; 0 Information on commitments (single response mechanism and fixed portion o f split response) and on indicative commitments (variable portion of split response) for year n+lwithin four weeks ofthe endofthe annual review; 0 Information on confirmed commitments for year n+l by 31August (see Attachment K for exceptions); 0 Information on disbursement schedules (timing and amounts) for year n+l by 31 December o f year n; e A three monthly report on the release o f their Programme Aid (made available within 2 weeks o f the end o f each quarter, covering periods 1January to 31March, 1January to 30 June, 1January to 30 Sept, 1January to 31 December); 0 A report on performance against the PAP commitments outlined in Section 4, paragraph 13 within 75 days of.the end o f the year (timing to be in line with provision o fBalanqo do PES). 77  ATTACHMENT E: DIALOGUE AND MONITORINGPROCESS Annualreview on ProgrammeAid Timing: April Participants: GOM and PAP representatives; observers. Activities: 0 Assess PES, PAF and OE performance for year n-1, based on the Balanqo de PES and Budget Execution Report, and other available information (including information in the PES, PAF and OE for year n as context for performance assessment), taking account o f information from GoM-PAP sector reviews in the last year (and medium term evaluations when available); 0 Assess development in fiduciary risk issues (initially based on fiduciary risk report undertakenjointly by PAPs and G o M but moving as soon as possible to being assessed on the basis o f information inthe Balanqo do PES); 0 Assess the results o f the financial audit, the value for money audits and the Audit o f the State Accounts; 0 Discuss any issues arising inimplementation PES, PAF andbudget execution; 0 Discuss budget plans for year n+l on the basis o fMTFFandbudget ceilings; 0 Assess performance o f PAPs in n-1 against commitments set out in Section 4, Paragraph 13; 0 Discuss the follow-up to the previous Annual Review based on the agreed minutes o f that review. Outcomes 0 Joint GoM-PAP assessment o f G o M performance against PES, PAF and OE inyear n- 1; 0 PAP commitments for fixed portion o f Programme Aid and indicative commitments for variable portion inyear n+l within 4 weeks from the end o f the annual review; 0 GoMassessment o fPAPperformance inn-1against M o Ucommitments . Mid-year review Timing:August Participants: GOM and PAPrepresentatives; observers. Activities: 0 G o M and PAPs will discuss performance in year n until the moment o f the review, based on the last budget execution report andother available information; 0 G o M and PAPs will discuss G o M plans for year n+l on the basis o f the PARPA (when relevant), CFMP, headline information on the PES and OE and the PAF; 0 G o M andPAP will discuss PAP commitments for improvingaid effectiveness; 78  GoM and PAPs will assess performance against specified conditions for variable portions o f PAP response mechanisms (see Section 7) based on existing and any hrther information on performance in year n-1, as well as on completion or non- completion, during year n up to the time o f the mid-term review, o f outstanding commitments from year n-1. Outcomes 0 Agreement o fPAF for year n+l; Commitment o f variable part for year n+lbyPAPswith a split response; 0 Confirmation o f all PAP commitments for year n+l. Follow-upmeetings Timing: June and December Participants: GoM and PAP representatives; observers Activities: 0 GoMandPAPs discuss progress inareas raisedat previous annual or mid-year review; 0 GoMandPAPsdiscuss progress inGoMpreparationo fplans for the coming year; 0 GoMandPAPs discuss progress inPAP improvements inaid effectiveness. BudgetWorking Group Timing: April (integrated with annualreview), August (integrated withmidyear review) and June and December (integrated with follow-up meetings) Participants: GoM and PAP representatives; observers, Activities: 0 Discuss budget execution, accumulative up to the end of the previous quarter (including explanations from GoM about any shortfalls inexecution, developments in sectoral allocations and total domestic revenue, including and specifying donor funds); 0 Undertake adjustment to the agreed disbursement schedule Outcomes: 0 Joint PAP view on performance against budget up to the end o f the previous quarter; 0 Agreed adjustment to the agreed disbursement schedule. 79  ATTACHMENT F: SPLIT RESPONSEMECHANISM European Commission (EC), Sweden and Switzerland will use a split response mechanism. These PAPSwill have a fixed and variable portions. Variable portions will be linked to the following targets and indicators selected from the PAF andagreed with GoM: EC: The decision to disburse will be based only on performance in year n-1. In case not enough information i s available at the annual review to make a commitment, an initial commitment will be made, to be confirmed after the mid-year review on the basis o f further information about G o M performance on specific indicators inyear n-1. Variable portion will bebased on: 0 Outcome indicators for the social sectors: 50 percent, out o f which Education indicators (20 percent) andHealth indicators (30 percent); 0 Budget execution indicators: (50 percent), out o f which ratio global budget executionhudget plan at central and provinces levels (20 percent), and same ratio in health, education and other PARPA priority sectors (30 percent) at central and province levels. Sweden: The variable portion will be linked to financial sector and governance targetshndicators selected from the PAF for year n+l agreed at the time o f the August mid-year review in year n. These targets will be linked to 30 percent o f Sweden's total Direct Budget Support (see also Sweden's procedures inAttachment K). Switzerland: In making its assessment for preliminary confirmation o f commitments at the mid-year review, Switzerland will also look at performance inyear n-1and inyear n, up to the time o fthe mid-year review (see Attachment K for final confirmation o f commitments). For the fixed portion (50 percent o f total Direct Budget Support), the assessment will be based on the general performance against commitments in the PESPAF, including in particular macroeconomic performance. This assessment will also take into account the discussions on headline information of PES and OE for year n+l Thevariable portionwill be basedonthe following PAF targetshndicators: 0 Public Financial Management (linked to 20 percent o f total Direct Budget Support); 0 Revenue mobilization (linked to 15 percent o f total Direct Budget Support); 0 Private sector development including the financial sector (linked to 15 percent o ftotal Direct Budget Support). 80  ATTACHMENT G: DISBURSEMENT 1. Disbursementof DirectBudgetSupport Installments will be requested in writing by the Ministry of Planning and Finance (MPF) directly or via the Ministryo f Foreign Affairs from the PAP inquestion, copied to the Bank o f Mozambique for information. Installments shall be deposited inthe Forex account designated by the GoM for that purpose and heldbyBanco de Mozambique inFrankfurt. Within 48 hours (2 working days) o f receipt o f the SWIFT, the Bank o f Mozambique will credit the Metical equivalent counterpart funds to a specific MPF Transitory Account, specific to the Programme Aid. The Metical equivalent will be calculated on the basis o f the Central Bank (buying) exchange rate on the 'data valor' o f the receipt o f the funds. The Metical equivalent will be transferred from the specific Transitory Account to the Central Treasury Account in accordance with the treasury plan and will be used as state budget revenue and recorded in the state account as such. All interest earned, if any, will be added to the State Budget. PAP fknds covered by this M o Uwill not be subject to payment o f any commission to the Bank o f Mozambique, with any transaction costs incurred being deducted from the account itself. The Bank o f Mozambique will immediately (within 3 working days) acknowledge receipt o f the foreign exchange funds, inwriting, to therespective PAP andthe Ministry ofPlanningandFinance. 2. Disbursementof Balanceof PaymentSupport Disbursement o f the credit will follow IDA'S simplified disbursement procedures for adjustment operations. Accordingly, the credit proceeds will be disbursed incompliance with the stipulated single tranche release conditions. Disbursement will not be linked to any specific purchases and no procurement requirements will be needed. Once the credit i s approved by the Board, the Borrower will open and maintain a dedicated deposit account in U S Dollars for the Borrower's use. As the single tranche is released on credit effectiveness, IDA will disburse the proceeds o f the credit into the deposit account. IDA reserves the right to require an audit o f the deposit account. 81  ATTACHMENT H: AUDITING 1. Audit of the financial records o f Pronamme Aid: A legally registered, private and independent audit company meeting international standards on auditing and the qualification of the auditors assigned will perform annual audits based on the quarterly financial reports. The audit costs will be met by G o M from the OE. The Terms o f Reference for the audit is shown inAttachment Io fthis MOU. The final audit report will be submitted annually to GoM as well as to PAPs no later than three months after the year's end. The PAPs reserve the right to review the audit. The auditor concerned should assist this review and should supply the reviewer with all relevant documents relating to the audit. 2. Audit of State Account: In accordance with prevailing legislation, the Administrative Court audits the General State Account (CGE) annually. Once the report i s submitted to the Assembly of the Republic and published G o M undertakes to discuss the Administrative Court's opinion with PAPs. 3. Value for money audit: Annual value for money audits will be carried out, on a sample o f activities relevant for poverty reduction and financed through the OE, by the General Inspectorate of Finance (IGF), where considered necessary by the signatories in close collaboration with independent, qualified and recognized auditors, acceptable to all signatories. Areas to be audited and Terms of Reference will be agreed upon between the signatories to this MoU. Financing will be agreed upon between G o M and the PAPs upon presentation of a detailed budget for the audit by the IGF. One VFM audit will take place yearly until the capacity o f IGF has made it possible to undertake further value for money audits. These audits will also contribute to the capacity building in increasing the proportion of audit reports that come from normal auditing by the competent Mozambican audit authorities. 82  ATTACHMENT I:TERMS OFREFERENCEFORTHE AUDIT OF THE FINANCIALRECORDSOFTHE PROGRAMME AID Preamble The M o U for Programme Aid Partners for the provision o f Budget and Balance o f Payment Support was signed between the Government o f the Republic o f Mozambique and the Programme Aid Partners, namely Belgium, Denmark, European Commission, Finland, France, Germany, Ireland, Italy, Netherlands, Norway, Portugal, Sweden, Switzerland, and UnitedKingdom (hereafter designated as PAPs), inwhich they agree to provide funds through a common disbursement mechanism. Objective The objective o f the audit i s to verify that disbursements made available by the PAPs to the Government o f Mozambique under the "common mechanism" were accounted for in accordance with the agreed procedures (MoU Q 29e Attachments G and H) and good management practice. Inthis context, the audit will verify the flow o f funds: a. From the point where the funds are credited to the Forex account designated bythe G o M for that purpose andheldbyBanco de Mozambique (BM) inFrankfurt; b. Through the conversion ofthe counterpart funds andtheir transfer to the transitory account o f the Ministry o f Finance (MPF), created specifically for the PAP; c. Through to their final deposit inthe State budget (OE) account inthe Central Treasury, based inBM, with a numberto be indicatedwhen the audit is actually performed. Scope of work The presentaudit includes the following tasks: 1. Verify the information in the financial records presented by MPF. The financial record should identify the contribution by each PAP to the Forex account, the date o f the bank transfer, the amount disbursed in both domestic currency and dollars, the countervalue in Meticais and respective exchange rates; 2. Verify if the financial record includes bank accounts with earned interest and if any commission related to the transactions were previously agreed and presented in a transparent manner; 3. Deliver the documents and confirm that the amounts presented in the financial record above mentioned correspond and ensure the existence o f a basis for auditing; 4. Assess whether accounting principles were used or were in line with the State's financial management regulations; 5. Confirm the initial and final balance inboththe Forex and Specific Transitory accounts; 83  6. Verify which Central Bank (buying) exchange rate was used in the countervalues transactions to the specific Transitory account ofMPF (Attachment G); 7. Confirm that all disbursements made by PAPs, except the World Bank (Attachment G), entered into the Forex account and that this account was exclusively used for transactions relatedto the PAPs'mechanism o f disbursements; 8. Confirm and reconcile with BM the amounts transferred from the Forex account to the specific MPF Transitory account, including comments about whether the agreed schedule was respected. The bank transfers should take place within two working days after the receipt of the SWIFT from the Forex account by BM; 9. Confirm and reconcile with MPF, through the credit slip from the account o f the Central Treasury and the legally defined certified models for bank transfers, whether the amounts transferred from the MPF Specific Transitory Account were paid into the Central Treasury account and were recorded in the public accounting system and reflected in the budget executionreports; 10. Follow up o f recommendations done inthe previous financial audit report. Results 1. Regardingthe presentation o fthe results, the Auditor shouldprepare: i Anauditreport,includingtheopinionoftheauditor;and .. 11 A "management letter" The "management letter" should include comments andrecommendations about: a) Appropriateness of MPF's accounting and monitoring procedures as well as the financial management system; b) Disbursements from the Forex account to the Specific Transitory Account and from thence to the Central Treasury; c) The report should include information provided by MPF and BM as well as information from PAPs; d) Adherence to the existing accountingprocedures; e) Strengths, deficiencies and weaknesses, if any, inMPF's monitoring system; f) Bring to attention any matters pertinent to Program Aid transactions that arose duringthe audit. These may include suggestions for clarification on MoUcontents andimprovements inbanking andforeign exchange operations; g) Suggest realistic conclusions and recommendations for improvements to programme implementation and MPF's financial management, accounting and control processes. 2. MPF, BM and PAPs will assess and make the relevant comments on both draft reports mentioned inpoint 1(i) above, and (ii) after which the auditor will present the final versions; 3. Bothreports should be delivered to MPF, BMand PAPsboth inPortuguese and English; 84  4. The auditor should respect the following calendar: 0 Draft o f the financial audit report mustbe provided to GOM and PAPs end February; 0 Final version o f the financial audit report must be provided to GOM and PAPs by mid March (or at the beginning of the Joint Review) so as to enable G o M and PAPs to assess the results o f the financial audit. Maputo,..... de 200- 85  ATTACHMENT J: PROGRAMMEAID PARTNERSSTRUCTURE ProgrammeAid Partners(PAPs) OrganizationStructure andTerms ofReference DRAFT BACKGROUND 1. The introduction of the PRS approach, donor and partner country commitments at Monterrey and donor commitments at Rome all demanded new ways o f working between donors and partner governments and among donors. The PRS approach required donors to step back and for partner governments to take stronger ownership o f the development process. Commitments at Monterrey and Rome demand that donors align behind partner government plans and processes and harmonize among themselves. 2. In Mozambique most donors are committed to supporting the Government's poverty reduction strategy, the PARPA. Since 2000, one o f the most important donor groupings for promoting government ownership, alignment andharmonizationhas been the group o f donors providing budget support. Over that time the group has grown considerably in size and has sought to develop ways o f working that allow it to effectively support GoM's poverty reduction strategy. In 2003-04 this led to the development o f a new Memorandum o f Understanding (MoU) for Programme Aid (Direct Budget Support and Balance o f Payment Support). The M o U was signed by 13 bilaterals, the European Commission and World Bank (together known as Programme Aid Partners or PAPs). The MoU includes a common performance assessment framework (PAF) in which G o M identifies its priorities andjointly with PAPsassessesperformance on an annual basis. 3. The new M o U (section 4) defines commitments to improving the quality o f development cooperation and provision of Programme Aid, that imply certain changes in the PAP- governmentrelationship. For donor behavior, this leads to: 0 Need to align with government's instruments, processes and systems o f financial management, shifiing accountability from donors to the Mozambican citizens through the NationalAssembly; 0 More strategic, on-going dialogue with G o M on those instruments and systems; 0 Need to discuss and form a joint view on the range o f government policy and performance, including sector and cross-cutting issues relatedwork; 0 Commitment to greater transparency, predictability and harmonization; 0 Commitment to reduce administrative burden. 4. These changes in turn imply the need for a clearer organizational structure among PAPs, and for terms o f reference which define the different levels o f PAPs' work and roles and responsibilities for dialogue with the government and amongst PAPs. This will include sectors and cross-cutting issues related groups. This paper sets out the objectives o f the PAPs structure, operatingprinciples and TORSfor each o f the groups. 86  1. OBJECTIVES OF THE PAP STRUCTURE 1. The objectives o fthe structure areto: 8 Increase transparency between GoM and PAPs and within PAPs; 0 Reduce transaction costs (for GoM and later for PAPs); 8 Ensuremembershave a clear and adequatemandate; 8 Improve communication among PAPs andbetweenPAPs and Government; 0 Increase coherence across areas o fdonor and government operations; 8 LinkPAPs effectively to other donor structures and groupings, inparticular the DPGand the CG. 2. OPERATING PRINCIPLES 1. The operatingprinciples are that: 8 All PAPsthat are signatories to the M o Ushouldbepart o fthe structure. Observers may be invitedto all levels and groups; 8 All groups will normallyhave a,commonchair andco-chair, which rotate annually (the chair, co-chair andoutgoing chair forming the troika chairmanship). Additionally, E C and WE3 will bepermanent members, forming the troika plus; 0 Groups should be `slagvaardig' (strategic, lean, mean, decisive, non-bureaucratic, responsive to need, adding value); 8 Transparency and openness between PAPs and within PAP agencies. 3. STRUCTURE 1. The PAPs structure for dialogue comprises the Heads o f Mission group (HoMs), the Heads o f Cooperation group (HoCs) and the Economists Working group (EWG). Additionally, there will be PAF coordination group, chaired by the troika HOCs and formed by the representatives o f Sector Working groups (SWG) and cross-cutting reform groups relevant for assessing PAFperformance. 2. The Troika plus, at HoCs level, has the mandate delegated by the HOMs group to represent the group as necessary, prepare and facilitate the PAPs decision making process associated to the MOUimplementation. 3. The secretariat assists the PAPs inthe dialogue between them and with the government through provision o f supporting services and facilitating information sharing. 4. The PAPs structure i s summarized as follows: 87  Summary Table Group OBJECTIVE MANDATEFunctions MEET HoMs Oversightand Political Political dialogue, Quarterly discussion Govemance including l i n l t o EU and as underlying HoMs (e.g. on required principles demarches) HoCs Steer work o f Overview o f Define PAP strategy Monthly PAF performance and annual work Coordination against PAF and programmes Key Group and PAP development EWGto commitments partner for G o M _--_--___-__-__---. deliver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assist the Facilitation o fthe Fortnightly HOCgroup decision making functions andpreparation o f key meetings EWG Dialogue Analytical work Report and advice Fortnightly with GoM for the M o U the HoCs group on and implementation progress within the performance and government EWG's areas o f assessment at Performance responsibilities technical assessment level The PAF Coordination Group and SWGs below are coordination and consultative forum and groups directly involved in the PAF process but not hierarchic dependen from the PAPSand may involve other non-PAP donors. PAF Operational Assessment Discuss and assess Monthly Coordination and jointly with problem issues o f Group coordinating G o M o f relevance across donor forum performance sectors PAF Share knowledge commitments SWGs Coordinate Dialogue with G o M Weekly or donor-GoM counterpart as defined engagement byeach at sector level r o u p Sector Working Groups (SWG) are included in this table because they are a keyhmportant component in the PAF process, discussion and assessment, therefore members o f the coordination group, but not dependent in hierarchy line from the above PAP structure and chairmanship. 88  ATTACHMENT K: EXCEPTIONS The following are exceptions to this MoU. PAPSundertake to reduce the number o f exceptions to the M o Uover time (particularly those that are not caused by statutory or legal requirements). WorldBank: The M o Uwill be referred to inthe World Bank bilateral agreement, rather than appearing as an annex. The World Bank will follow the same dialogue and monitoring process but will have its own response mechanism and disbursement arrangements. The World Bank will make a multi-year indicative commitment o f Balance o f Payment Support under its Country Assistance Strategy (CAS). The actual amount o f Balance o f Payments Support for any given year will be more specifically determined duringthe appraisal and negotiations o f an operation under a series o f Poverty Reduction Support Credits (PRSCs), and definitively determined after the operation i s presented to the IDA Board o f ExecutiveDirectors for their approval. At present, appraisal and negotiations are expected to occur annually inApril-May, and Board presentation in June o f the year n. IDA will use the joint GoM and PAP assessment o f performance inyear n-1,particularly against prior actions selected from the PAF and agreed with the G o M for inclusion inthe relevant PRSC operation, to appraise and negotiation the credit for year n. The credit for year n will also identify triggers, also selected from the PAF and agreed with the GoM, that will become prior actions for the proposed credit for year n+l. IDA will normally disburse within one to eight weeks from the date o f Board approval. Switzerland: Switzerland will only give final confirmation on commitment for year n+l after approval o f OE and PES for year n+l by Mozambican Parliament that are consistent with PARPA priorities. Sweden: Sweden will make commitments in May and August as provided in this MoU, but due to Swedish government procedures, final commitments for the fixed portion for year n+l can only be legally confirmed in year n+l (usually March). The variable portion for year n+l i s based on performance on selected indicators in the PAF for year n (See Attachment F), and will be confirmed only after a performance assessment has been made at the Annual Review inyear n+l A transitional arrangement onthe variable portion will be applied in2004 on the . basis on PAF 2003. Germany: Germany retains the right to interrupt disbursements if the Government of Mozambique fails to perform its payment obligations to KfW (German Development Bank). Germany will confirm its commitment as soon as possible depending on approval o f the German Parliament and/or release bythe German Ministryo f Finance. 89  France: France retains the right to interrupt disbursements if the Government o f Mozambique fails to perform its financial obligations to the Agence Franqaise de DCveloppement (AFD - French Development Agency), as agreed in `Contract0 de Reduqgo da Divida de Desenvolvimento', signed by the Governments o f France andMozambique. EuropeanCommission(EC): The EC will follow the same dialogue and monitoring process, response mechanism and disbursement arrangements. This M o Uwill be referredto inthe E C bilateral agreement. However, This M o U remains subject to the provisions of the Cotonou Agreement or any subsequent framework for the European Commission-Mozambique cooperation; and to the actual andprospective availability o f funds under the relevant framework; The provisions inthe Financial Regulation o f the European Development Fundremain applicable to the EC programme o fbudget support; The EC's confirmed commitments and disbursements remain formally subject to final decision by the EuropeanCommission; With reference to Section 3, concerning the Underlying Principles presented in Articles 8 and decisions linked to an eventual breach, mentioned inArticle 10, the E C will follow the appropriate consultationprocedures and measures foreseen inthe Final Provisions o f the Cotonou Agreement, particularly under Articles 9, 96 and 97; Incase the assessment ofthe variable portionof its ProgrammeAid can only be made at the mid-year review, or even after, due to late availability o f the relevant data, the EC will not be able to confirm its commitment on the variable portion by 31 August, butwill strive to do it for December (yearn); For variable portions relating to data for years prior to the signature o f this MoU, the conditions o f the existing Financing Agreement will continue to apply; For the year 2004, disbursement o f one portion will be linked to specific conditions on the electoralprocess. BelgiumandNorway: Finalcommitments can only be legallymade when specific bilateral agreements are signed. Multi-annualplans: The following donors cannot make multi-annual plans for ProgrammeAid: Sweden 90  ANNEX 3: FUNDPUBLIC INFORMATION~NOTE Public InformationNotice(PIN) No. FOR lMMEDlATE.RELEASE . InternationalMonetaryFund 700 lghStreet, N N Washington,D.C. 20431USA I IMF Executivewith Boa'rdConcludes 2005 Article IV Consultation the Republicof Mozambique OnJune 22,2005 the ExecutiveBoardof the lntemationalMonetaryFund(IMF) concluded the Article IV consultationwith the Republicof Mozambique.' Background Duringthe lastdecade, Mozambique'sstrongcommitmentto sound macroeconomicpolicies andstructuralrefoimhasledto a remarkableimprovementineconomicperformance, supportedby substantialdonor assistance. RealGDPgrowthaveraged8 percentayear (the highestinAfrica), end-periodinflationwas reducedto singledigits, publicexternaldebt shrank, the internationalreservespositionstrengthened,.and the shareof the populationlivingin absolute povertydeclinedsubstantially. Theseachievementswere facilitatedby a stable UnderArticle'IVof the IMF`sArticles ofAgreement,the IMFholds bilateraldiscussionswith members, usuallyeveryyear. A staffteam visits the country, collects economicandfinancial information,anddiscusseswith officialsthe country'seconomicdevelopmentsandpolicies.On returnto headquariers,the staff preparesa report,whichformsthe basisfor discussionbythe ExecutiveBoard.Atthe conclusionof the discussion,the ManagingDirector,as Chairmanof the Board, summarizestheviews of ExecutiveDirectors,andthis summary is transmittedto the country's authorities.This PINsummarizesthe viewsof the ExecutiveBoardasexpressed duringthe June22,2005 ExecutiveBoarddiscussionbasedonthe staff report. 91 -  - 2 - .I politicalsituationaid the consolidationof the democraticsystem, as illustratedbythe rbcent ', general electionsthat took placepeacefully. The economy continuedto performwell in2004. RealGDPgrowth decelerated slightlyto'an estimated7.2percent. Inflationdeclined morethan expectedto 9.1 percentat end-December 2004 andto 4.5 percentat end-April2005 driven by lowerfood pricesand despite a shad increaseinpetroleumprices.The easingof inflationexpectationsalso contributedto a reductionin interestrates. Stronggrowth intraditionalexports,the completionoftwo megaprojects, and improvedterms of trade helpednarrowthe extemalcurrent account deficit, excludinggrants, by onethirdto 13.8percentof GDP in2004.This togetherwith greater-than anticipateddonor supportand largeprivate capital inflows,contributedto boostnet intemationalreserves,well aboveprogram, to about6 monthsof imports.This ledto a strong . appreciationof the Meticalin realeffectiveterms in2004. Performanceunderthe Fund-supportedprogramwas mixed.All quantitativeperformance criteria, except the one pertainingto the govemmentdomesticprimarydeficit, were met. The envisagedfiscal consolidationwas notachieved.The revenueto GDP ratio decreasedfrom . . 12.9percentof GDPin2003to 12.3 percentin 2004andfell short by 1.Ipercentof GDPof the programindica<:ive floorfor end-December2004 (usingthe new GSP series).Collectionof mosttaxes turnedout lowerthan envisaged.The revenueshortfallwas mainlydue to higher- than-projectedVAT reimbursementsrelatedto megaprojects,delays incurredby corporations incomplyingwith the paymentscalendarunderthe newcorporateincome tax code, andthe impactof the appreciationofthe metical.Anotherimportantfactorwas the weakening of tax collectionduringthe transitionperiod leadingthe nominationof a new govemment.The 92  - 3 - revenue shortfall was partialiy compensatedby cuts incurrentexpenditures.However,the . . share of priority expendituresto totalexpenditure (about63percent)was slightly lowerthan programmed.As result,the domesticdeficit fell shortof the programtarget by0.7 of GDP EI . , and the overallfiscal deficit,aftergrants,was slightly higherthanenvisaged. Broadmoney growth sloweddownSignificantly in2004, reflectinginpartthe impactof the appreciationof the meticalan theforeigncurrencydeposits. Inthe midstof the commercial banksrestructuration,the increaseindomestic credit to the privatesectorremainedrelatively modestwhile netcreditto thegovemmentwas slightly exceeded. However,the end-December indicativestock of wewe moneywas exceededby a smallmargin, owingmainly to a larger- than-expecteddemandfor domesticcurrency. In2004 andearly2005, the Bank of Mozambique (BM) took severalstepsto strengthenmonetarymanagementincludinga more judiciousmix of its monetary instrumentsinthe context of a managedfloating exchangerate system.Sincethe isecondhalfof 2004, ithas reliedmoreonforeign exchangesaleto control ' liquidity,following the heavy relianceondomesticmonetaryinstruments. Progressinimplementing structuralreformshas beenslowerthan envisaged. Inparticular,five out of eight benchciatkswere missedwhile one of the two structuralperformancecriteriawas not observed,includingin the monetaryandfiscal areas. Implementationof liscaf reformshavecontinuedbutwith somedelays. A draftgeneraltax law and a law creating the CentralRevenueAuthority (CRA)were submittedto theAssembly in mid-2004but have not yet been adopted. Progresshas beenmadeto facilitatethe mergerof the General Directcratesof DomesticTaxes (DGI) and Customs (DGA) into the CRA by end- 2005. Onthe expenditureside, at the beginningof 2005, the new electronicfinancial 93  - 4 - I administration system (e-SISTAFE) beganto recordand classify alldisbursementsto lii\e 1 ministries. Inaddiiion, work is progressingto strengthenthe functioning of theTreasury Single Account (TSA). Inthis context,the transactionsbetweenthe BMandcommercialbanksare now reconciledon a daily basis. Keystructuralmeasuresinthe bankingsystem are also beingimplemented. Nonperformhg loanshavedeclinedsharply. The BM hasfinalized a timetableto adopt lntemationalFinancial ReportingStandards(IFRS)inthe bankingsystem and bringloanclassificationand provisioningin line with best internationalpractices.The reviews afthe four largestban'ks, finalized inFebruary2005,showthat they are readyto moveto IFRS.The regulationsof the newly adopted FinancialInstitutionsLawwere approvedby the Councilof Ministersinlate 2004, andthe revisionof the regulatoryframeworkfor microfinanceactivitieswas completed. 'Reformsinother ssctors haveencounteredsome difficulties. Reformsinthejudicial system were hampered by capacity constraintsanddelays inapprovingrelevantlegislation. The creationof a financial investigationunitwas delayeddue to the pendingamendmentof the current anti-money taundering law.Progresson landtenure reformwas hinderedbythe * . difficulty of gatheringconsensuson sucha sensitive issue. The new procurem6ntlegislation was notapprovedclue to delays relatedto the consultationprocess. ExecutiveBoardAssessment ExecutiveDirectorsnotedthat Mozambiqueis at a criticaljuncture initsdevelopment.After its impressiveperformanceof the pastdecade,a secondwave of reformsis neededto deepen andacceleratestructuralchangesto sustain high and broad-basedgrowth. The authorities' 94  - 5 - strongcommitmert to followthroughwith the neededreformswill help ensurethat the . . remarkableresults the counlry has achievedso far are not ieversed.Inthat context,Directors emphasizedthat efforts should aim at (i) increasingtax revenues; (ii) strengthenin public 9 sector operations;(iii)reducingthe costsof doingbusin&; (iv) promotinglabor-idtensive sectors; and (v) implementinga ruraldevelopmentstrategy. I. Directorswelcomedthe substantial reductioninpovertyrealizedoverthe pastdecade.At the sametime, they stressed that stepped-upeffo'rtsare neededto further reducepoverty and, , with the necessaryfinancialassistanceof the internationalcmxm"ty, reachthe Millennium DevelopmentGoals. Inparticular,they lookedforward tothe newpovertyreductionstrategy . paperfor 2006-1 0, Directorsnotedthat performanceunderthe PRGF-suppbrtedprogramhas been mixed.They welcomedthe contihuedstrong growth,decelerationin'inflationto single digits, and strengthened exterial positionin2004. Directors, however, regrettedimportantslippages during the periodClctober2004-March2005, which coincidedwith the electionsandthe installmentof the n3w administration, in particularthe weakeningof tax collectionand delays * . inthe implementationof the structural reformagenda.They welcomed the authorities' commitmentto bringthe fiscal stance backontrack in2005, by strengtheningtax collection, andimplementingexpenditurecontingencymeasuresto preserve priority outlays. Directorsconcurredwith the authorities' medium-termfiscal consolidationstrategy,which rests appropriatelyon increasingrevenuemobilization,moderatingthe growthof the wage bill, and enhancingpublicexpendituremanagement. Inthis regard, Directorsencouragedthe Mozambicanauthoritiesto further improvetax administrationprocedures,notingthat a 95  c significantpartof potentialtaxes are not beingrealized,andto makethe budgeta moa effectiveinstrumentof fiscal reportingand management,throughthe timely rolloutof the new electtonicfinancial administrationsystem (e-SISTAFE).The newbudget managementsystem should, with the assistance of the donorcommunity,includeall project-relatedexpenditures. Directors'alsoencmragedthe authoritiesto increasethe share of pro-poorexpenditures. Directorscommendedthe authoritiesfor the stepsthey hadalready taken onthe revenueside. They notedthe progressmadeinestablishingthe CentralRevenueAuthority. They also welcomedthe recentapprovalof the new regulationsfor tax auditing and inspection. Onthe expenditureside, Clirectorsexpressedconcematfurther delays inimplementingthe e- SISTAFE.However,they welcomed itsrolloutin the Ministryof Financeinlate2004, its useto recordandclassify all disbursementsto line ministries,andthe authorities' commitmentto foil I it outto the Ministryof EducationandCulture in2005,They also noted progressin strengtheningthefiinctioningof tho Treasury SingleAccount. Directorscommendedthe authoritieson keepinga prudentmonetary policy stance and increasingthe flexitiilityof the exchangefate. Directorsnotedthat theflexible exchangerate . . regimehas helped wshionthe impact of exogenousshocks.They encouragedthe authorities to continuepursuinga balancedmix of foreign exchangesales and issuanceof treasury bills to sterilizeexcess liquidity. Interventionintheforeignexchange market should belimitedto achievingthe internationalreservetarget and preventingshort-term volatility. Directors welcomedthe introcluctionof foreign exchangeauctions.They also notedthat therewas no evidenceof a realeffectiveexchangerate misalignment. 96  - 7 - Directorsnotedthe recentimpfovementinthe performanceof the bankingsector, Includingthe . . sharpfall innonpwformingloans. They welcomedthe authorities'commitmentto strengthen the supervisory regimeandthe reportingpracticesof the bankingsystem. They enfouraged the authoritiesto continueto divestits ownershipinthe bankingSystem and urgedlthe authoritiesto continue their effort3to deepen the financialsystemby developing microcredit institutionsand reforminglandtqnuretitles to facilitate the provisionof financialservices to ruraland urban households.Directorsalso welcomedthe authorities'commitmentto strengthen the baliancesheet of the centralbank. Directorssupportedthe authorities'renewedefforts to reducethe cost of doing businessin Mozambique,expand and diversifythe exportbase,andimproveinternational competitiveness.They welcomedthe authorities' planto,furtherremovethe remaining restrictionson the inakingof paymentsand transfersfor intemationalcurrenttransactions.In addition, Directors encouraged@eauthoritiesto continuestreamliningcommerciallicensing proceduresand reforminglabormarketregulation,andthejudicialsystem. Directorsstrongly encouragedthe authoritiesto reachagreementwith bilateralnon-ParisClub creditorsthat have notyet provideddebt relief underthe enhancedHlPCInitiative.At the same time, creditors' readinessand support inthis'regardarefundamental. They also encouragedthe authoritiesto secure highly concessionalforeignassistance. This, together with increasingtax -evenueandthe strengtheningof the debt-managementcapacity, should , contributeto keepirgextemaland publicdebts sustainable. Directorswelcomec the authorities' commitmentto revivethe publicsector reformwith the helpof theWorid Brmk and other donors. They stressedthatthe reformsof the civilservice 97  - 8 - and procurementlegislationare necessaryto improvethe efficiencyol government Spending, , combatwrruption and ensure apprOpriatewagesfor publicemployees. Directorsappreciatedthe authorities'renewedefforts to improvegovemance,whichcontinue to cloudthe investmentclimate. They welcomedthe authorities'commitmentto amendthe anti-money launderinglaw andcreatea financial investigationunit. They also praisedthe ' authoritiesfar their commitmentto publishanddisseminatethe resultsof the NationalSurvey I on Govemance an3 Corruption. Whilewelcoming rment improvementsinthe statisticalsystem,especiallyinthe national accountsseries, Directorsurgedthe authoritiesto continueto strengthenthe statistical ' system, which still has deficienciesthat hinderthe monitoringof economicdevelopment. 1 1 Public informationNotices(PINS)form part ofthe IMF`seffortsto promotetransparencyofthe IMPS views and analysis of economicdevelopmentsand policies.With the consent of the country (or countries) concened, PINSare issuedafter ExecutiveBoarddiscussionsof Article IV consultations with membercountries, of its surveillance of developments at the regional level,of post-program monitoring, and of ex post assessmentsof membercountn'eswith longer-term programengagements. PINSare also issuec after Executive Boarddiscussionsof generalpolicy matters, unlessathewise decided by the Executive Boardin a particularcase.. 98  - 9 - Mozambique:'SelectedEconomic andFinancialIndicators, 200346 2003 2004 2005 2006 1 , Ad. Rev. Rev. (Annual&centak- change, unlessotberwis~s a dRoj. Proj. ) National incomeandprices ~ominalGDP(iibillionsofmeticais) 113,811 137,425 1591912 184,289 RealGDPgrowth a 7.8 7.2 7.7 7.4 c~nsumerpriceindex (end Bf period) 13.8 9.1 18.0 7.0 Externalsector Merchandise exports 28.9 44.1 13.9 1.9' Merchandiseimports ' . I 12.8 * 16.9 15.6 2.8 Termsoftrade -1.4 13.4 2.2 ' -7.3 Realeffective exchangerate (end ofperiod) 1/ -2.7 . 24.8 ... ... (Anrmalchangesinpercentof begimhg-of-period stockof money,unlessotherwise indicated) Money andcredit Net foreignassets 8.6 30.0 0.8 ' 2.6 Net domestic assets2/ 10.1 -24.O 13.7 11.6 Broadmoney(343) 18.7 5.9 14.5 14.2 Interestratefor 9O-daytreasuy bills(inpercent;endofperiod) 12.1 10.5 ... ... (Inpercentof GDP) Investmentand saving Gross domestic investment 2519 20.1 21.3 21.3 Oross domestic savings(exc:.. grants) * 6.0 6.2 ' 7.4 8.4 Currentaccaunt, before pmts -19.9 -13.8 43.9 -12.9 Governmentbudge! TotaIrevenue 12.9 12.3 13.2 14.0 Totalexpenditureandnetlending{hcl residual) 26.5 23.7 25.6 24.2 Overallbalance, after grants -4.5 -4.4 4.0 -4.4 Domestic primarybalance (Inpercentofexportsofgoodsandnonfacorservices)-1.6 -3.7 -3.7 -2.8 Net presentvalue oftotal putilic extemd debt outstanding 105.4 83.8 83.6 89.5 Externaldebtservice(nonfmmcial publicsector) Scheduled,after enhancedH1PCInitiative 6.I 4.5 5.1 5.3 andadditional bilateral ?&stance (InmillionsofU.S.dollars, uuIessotherwisespecified) Overall balanceofpayments 122 212 -84 -30 Grossinternationalreserves(2nd ofperiod) 947 1,159 1,076 1,045 Inmonthsofimportsofg d s& nonfactorservices 5.4 5.8 4.7 4.4 Sources: Mozambicanauthorties; andIMFstaffesthmes andprojections. 11A minussignindicatesdepreciation. 2/ The percentage changefor Net DomaticAssets inthe revisedprojection for 2004 hasbeenadjustedto rakeacoountofthe W i n gofthe extemal liabilitiesofthe BMto the government. 99  ANNEX 4: LETTER OF DEVELOPMENTPOLICY REPUBLICADE MOCAMBIQUE MlNlSTERIODA PLANlFlCAC&OE DESE NVOLVIMENTO 'CABfNETEDO MINISTRO 100  101  102  103  104  105  ...^ . . . 106  -....., Cottclirsion 107  00 0 4   ANNEX 6: MONITORINGAND EVALUATIONOFTHE PARPA-ISSUES NOTE Monitoring and Evaluation PARPAM&E System 1. The M&E strategy of the PARPA relied on the exiting sectoral M&E systems. The PARPA guided the GOM in defining the state's medium-term and annualbudgets, programs and policies from 2001 to 2005 with a focus on those sectors that play an important role in terms o f the impact they have on poverty reduction and socio-economic development. Those sectors included education, health, infrastructure (roads, energy, and water), agriculture, governance, justice, and macro-economic and financial policies. The Monitoring and Evaluation (M&E) strategy o f the PARPA relied mainly on the existing government mechanisms for monitoring progress in implementing sectoral strategies, assessing changes in the welfare level o f populations through periodic focused surveys, and ensuring flow o f information to all stakeholders through periodic reporting. 2. Significant improvementsof the PARPA M&E system have been introduced. The GOM introduced new monitoring and reporting mechanisms o f the PARPA since the beginning of its implementation to ensure better coordination and integration o f planning, monitoring, and reporting. They included: (i) the development o f the Performance Assessment Framework (PAF), which focuses on a subset o f the PARPA priority actions and indicators supported by its development partners, (ii)the production of the PARPA implementation review reports called "Balanqo de PES", which provides an assessment o f all government activities reflected in the annual Economic and Social Plan (PES), and (iii) the poverty observatory consultative forum, through which the Balanqo de PES and other qualitative studies are presented two times a year to civil societies andpartners at the national level. Inaddition, the budget execution o f the priority programs is reportedperiodically inthe budget quarterly reports. 3. Sector M&E systems are at different levels of development. The PARPA monitoring system relies heavily on the existing sector administrative data which are at varying degrees o f development and reliability. This situation creates inconsistency and discrepancies in data quality and delay inthe time o f reporting. Tracking progress towards the PARPA outcomes is uneven due to the fact that some sectors do not have an appropriate M&E system to collect accurate and reliable information o f their sector indicators and therefore can't adequately determine whether or not they are on track to achieve the targeted results. For example, Education and Health sectors have relatively good statistical units which compile consistent administrative data about the performance of their sectors. The Ministry o f Agriculture has just finalized a plan for operationalizing its Management Information System (MIS), which includes tracking outputs, outcomes and impacts for monitoring and evaluating the performance o f the sector. The infrastructure sectors (energy, water, and roads) performance monitoring systems still need further improvement, both at central and provinciaVdistrict levels to provide reliable data on the PARPAPAF indicators. 4. Inadequate PARPA M&E implementation plan. The initial strategy for monitoring PARPA implementation was not to create a new system for PARPA, but to rely on the existing sector M&E systems. On the other hand, because of the diversity and complexity o f 110  the flow o f information in each sector, this approach may only work well when a clear M&E plan i s developed that clearly defines all institutional arrangements, responsibilities, tools and methodologies for data collection, analysis, and reporting on each indicator. The existing M&E systems were developed to monitor the performance o f the implementation o f the sectoral strategies and plan and therefore vary by sector. The Health sector, for example, went through several iterations o f defining indicators and monitoring arrangements. The Agriculture sector has just finalized a performance M&E plan with a series o f output, outcome, and impact indicators to be tracked by the agriculture management information system. The data reported by such systems includes information which is not well structured, to address specifically the need for reporting on the key PARPA results. Only a subset o f that information may be needed for PARPAreporting needs. 5. A lack of improvedM&E capacity continues to be a challenge for implementingthe PARPA M&E system. Inadequate skill in M&E still exists at the national, sectoral, and provincial levels. It relates to the design o f results frameworks, methodologies for data collection, analysis and interpretation, and approaches for the use and dissemination o f M&E information to improve linkage between monitoring, planning, and budgeting. Lack o f capacity in M&E in one level o f the information flow chain would have a negative effect on the quality and reliability o f the whole M&E system. It is necessary to enhance M&E capacity at the central and sectoral ministries to ensure reliability and sustainability o f the M&E systems. Statistical units/departments o f line ministries are very important to the establishment o f a good and sustainable monitoring system, Technical assistance and enhancement o f data collection and analysis i s needed for staff working with the existing sectoral management information, especially at the provincial and district levels. Coordination o f inter-sectoral planning and monitoring processes to achieve PARPA outcome results still needs improvement. To fulfill its role o f planning and coordination o f PARPA integrated M&E systems, the Ministry o f Planning needs to develop capacity in (i) coordinating the design and implementation o f monitoring and evaluation systems to enable acquisition and production o f data necessary for reporting on overall progress in PARPA implementation to different users including government, donors, and the general public, and (ii) analyzing policy andbudget allocationto facilitate the development o f annualized actionplans o f activities and policies that will contribute to the achievement o ftargeted outcome and impacts. M&ESystemfor PARPARevision The government has already started the process o f revising the PARPA and the plan is for the first draft o f revised PARPA to be finalized by the end o f September 2005. It i s important to use this process to achieve the development o fbetter M&E system for PARPA, which include the implementation o f the following recommendations. 6. The revision of the PARPA should use the outcome-oriented approach. Most o f the key challenges facing the GoM in achieving better results in fighting poverty and increasing economic growth are multidimensional and can be addressed only by adopting an outcome- oriented or program-based approach to planning and budgeting. Therefore, it i s important to adopt a new integrated approach in revising the new PARPA by first defining the outcomes and results to achieve, second, identify programs intheir entirety as well as the relationships between different sector interventions that would contribute to the achievement o f such 111  outcomes and results, and third, align the existing sector development strategies and plans with the PARPA outcomes and link them to budget allocation. The recently developed five- year government plan should be used as the base for the development o f PARPA IIto ensure linkage and alignment o f objectives. 7. For the PARPA revision, develop a simplified results and policy framework. Based on the lessons learned from the implementation of the previous PARPA, it i s necessary to develop a simplified PARPA results and policy framework that clarifies the outcomes to be achieved, indicators to measure for each outcome, and general policy actions to be implemented to achieve each outcome. The development o f the new PARPA results framework should be carried out using a participatory approach and discussed as openly as possible to develop wide ownership and commitment. The results framework defined this way, would lead to greater clarity on how various policy actions and outputs contribute to the achievement o f the PARPA outcomes. This, in turn, will serve in facilitating the design and development o f an integrated M&E system for PARPA andwill play a role inthe allocation of funds to sector programs contributing directly to the achievement o f targeted outcomes. Likewise, the framework would provide a basis for harmonizing donor's programs and developing PAF annual actions and performance reviews so they better align with the PARPA outcomes. The results framework should focus on using a short list o f key outcome and impact indicators for monitoring the implementationo f PARPA. However, clear linkage to all other monitoring level indicators o f the entire results chains (input and outputs) should be defined. Input and output indicators could be tracked by management information systems in each sector for monitoring the implementation o f sector strategies and programs. Important process and intermediate indicators that are linked to the achievement o f key results indicators, for which annual data is not possible to track and analyze, could be added to the annual performance tracking systems such as the PAF. 8. For the revised PARPA, develop an integrated M&E implementationplan. In order to establish a regular flow o f reliable information from the sectors into a monitoring and reporting system on PARPA indicators, it i s necessary to develop a comprehensive and integrated M&E system for PARPA. The development o f such a system should start with the review o f the existing M&E systems, including systems at the provincial levels, to identify systematic weaknesses surrounding data collection, analysis, and reporting on PARPA key outcome indicators and implementation processes. This assessment i s required to streamline information on the indicators that are to be reported within the framework o f monitoring PARPA and provide input to the development of the PARPA M&E plan. The aim is to create a framework for harmonizing and streamlining the existing systems to enhance timeliness, quality o f data generated, and actual use o f M&E information for planning and policy development. The resultant M&E plan would clarify institutional roles and responsibilities within the integrated system, methodologies for data collection, analysis, and reporting for each outcome indicator. This plan should be developed in the beginning o f the implementation o f the revised PARPA, with close consultation with data providers and users in each sector, to definehedefine indicators and other institutional arrangements, and especially to address any gaps that may slow down the M&E process. The institutional arrangements for monitoring should build upon existing capacity with a plan for further capacity strengthening at all levels to ensure proper implementation o f the monitoring plan. 112  vi 2 s P VI 2 m 2 n 10  5 5 m a vi s 0 xm N a x m N xB  ANNEX 8: COUNTRY AT A GLANCE Sub- POVERTY and SOCIAL Saharan Low- Mozambique Africa income 1 Developmentdiamond' 2003 Population,mid-year(millions) 18.8 703 2,310 Life expectancy GNI per capita (Atlas method, US$) 210 490 450 i GNI (Atlas method, US$ billions) 3.9 347 1,038 Average annual growth, 199743 Population (%) 2.0 2.3 1.9 , ~ Laborforce (%) 2.1 2.4 2.3 GNI per - Most recent estimate (latest year available, 1997-03) capita Poverty (% ofpopulation below nationalpovertyline) 54 Urban population (% of totalpopulation) 36 36 30 Life expectancyat birth (years) 41 46 58 I I Infant mortality(per 1,000live births) 101 103 82 j Child malnutrition (% of children under 5) 24 44 I Access to improvedwater source Access to an improvedwater source (% ofpopulation) 57 58 75 lliiteracy @ ofpopulation age 15+) 60 35 39 Gross primary enrollment (% of school-agepopulation) 106 87 92 Male 107 94 99 I Low-incomegroup Female 95 80 85 KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1983 1993 2002 2003 , Economic ratios* GDP (US$ billions) 3.2 2.0 3.6 4.3 Gross domestic investmenVGDP 11.6 25.5 30.3 27.9 Exportsof goods and services/GDP 6.1 13.2 23.5 22.8 Trade ~ Gross domestic savings1GDP -5.0 -9.6 15.6 11.3 Gross national savings1GDP -3.9 -3.2 15.8 12.8 T Current account balancelGDP -13.5 -25.8 -18.8 -12.2 Interestpayments1GDP 0.0 3.8 4.9 3.8 Total debUGDP I1 13.0 227.8 132.2 116.3 Total debt servicelexports I1 0.0 19.0 26.1 8.0 Presentvalue of debtiGDPli2 24.8 23.2 Presentvalue of debtiexports 1/2/3/ 96.0 91.2 Indebtedness 1983-93 1993-03 2002 2003 2003-07 (average annual growth) GDP 3.6 8.1 7.4 7.1 7.6 1 -"Mozambique GDP per capita 2.6 5.7 5.3 5.1 5.8 Low-incomegroup ~ Exportsof goods and services 5.0 17.6 14.1 16.2 17.0 I STRUCTUREof the ECONOMY 1983 1993 2002 2003 1 Growth of investment and GDP (%) Is',of GDP) Agriculture 37.6 29.5 26.6 26.1 ' looT Industry 27.5 20.7 28.9 Manufacturing 7.3 14.9 Services 34.9 49.8 44.6 Private consumption 84.3 95.4 73.4 Generalgovernmentconsumption 20.8 14.3 11.0 11.5 1 Importsof goods and services 22.8 48.4 38.2 39.4 -GDI ' D I G D P I 1983-93 1993-03 2002 2003 (average annual growth) ~ Growth of exports and imports (%) Agriculture 2.9 6.1 7.2 8.0 - Industry -3.5 17.7 7.5 Manufacturing 18.1 4.0 Services 7.7 3.1 6.2 Private consumption 2.8 1.9 10.4 Generalgovernmentconsumption 1.7 6.2 5.8 Gross domestic investment -0.3 14.4 2.5 0.5 "-Exports - O l l m p o r t s Importsof goods and services 0.0 4.0 13.9 5.8 ,1 Note: 2003 data are preliminaryestimates. * The diamondsshow four key indicators inthe countfy (in bold) comparedwith its income-groupaverage. If data are missing, the diamondwiil be incomplete. I / Public and Publicly Guaranteeddebt. Excludes private non-guaranteed debt. 21Data include impact of total debt relief underthe enhancedHlPC initiative,additional bilateral assistance,and new borrowing. 31As percent of 3-year moving average of exports of goods and non-factorservices. 115  PRICES and GOVERNMENT FINANCE 1983 1993 2002 2003 Inflation(%) Domestic prlces I ("Achange) 2o T Consumer prices 28.2 42.3 16.8 13.5 Implicit GDP deflator 13.0 51.4 11.5 12.6 Government flnance I (% of GDP, includes current grants) Current revenue 18.0 18.5 18.0 18.4 98 99 00 01 02 Current budget balance -2.1 -11.o 3.6 2.2 2.5 1 -GDPdeflator ' - c c C P I Overall surplusldeficit after currentgrants -17.8 -15.8 -11.4 O3 Overall surplusldeficit after ail grants -16.0 -3.6 -7.9 -4.9 TRADE 1983 1993 2002 2003 (US$ mi//ions) Export and import levels (US$mill.) Total exports (fob) 132 132 679 880 2,000 - Cashew nuts and raw cashew 16 20 17 17 1500 - Prawn 31 69 64 64 Aluminum 361 519 Manufactures 7 13 15 Total imports (cif) 830 1,351 1,445 97 98 99 00 01 02 03 Export price index (1995=700) 96 90 74 78 Import price index (7995=100) 99 89 82 83 Exports .Imports Terms of trade (1995=700) 7/ 97 101 90 94 BALANCE of PAYMENTS 1983 1993 2002 2003 ' (US$ m1Lons) Current account balanceto GDP ( O h ) I Exports of goods and services 222 312 1,058 1,230 Imports of goods and services 694 958 1,745 1,820 Resource balance -472 -646 -687 -590 Net income -33 -179 -189 -213 Current account balance beforegrants -437 -511 -678 -527 Financing items (net) 393 465 772 699 Changes in net reserves 43 46 -94 -172 Memo: Reserves including gold (US$ miBons) 15 187 825 1,007 Conversion rate (DEC, local/US$) 40.2 3,951 23,678 23,782 EXTERNAL DEBTand RESOURCE FLOWS 1983 1993 2002 2003 (US$ millions) Composition of 2002 debt (US$ mill.) Total debt outstanding and disbursed2/ 422 4,514 4,756 5,024 iBRD 0 0 0 0 IDA 0 512 985 1,232 Total debt service 21 0 71 286 102 IBRD 0 0 0 0 IDA 0 3 7 9 Composition of net resourceflows 2/ Official grants 90 503 420 536 Official creditors 202 134 179 Private creditors 0 0 0 0 Foreigndirect investment 0 32 380 342 E. 1.029 World Bank program Commitments 0 123 0 81 A iBRD E -Bilateral Disbursements 0 93 149 156 B IDA D -Other multilateral F Private - Principai repayments 0 0 3 2 C IMF --- G - Short-term Net fiows 0 93 146 154 Interestpayments 0 3 4 6 Net transfers 0 90 142 147 ~~ The World Bank Group:This table was preparedby country unit staff;figures may differ from other World Bank published data. 9/16/04 I / includes aluminum price. 21Public and PubiiclyGuaranteed. Datafor 2001 includesimplementationof November 2001 Paris Club underthe Enhanced HlPC Initiative. Data for 2002 includesall signed agreementsunder the EnhancedHlPC Initiativesigned by end 2002. Excludes private non-guaranteeddebt estimatedat US$ 1.6 billion in 2001 and 2002. 116