Mozambique - Third Rehabilitation Credit Project

Document of The World Bank FOR OFFIClAL USE ONLY Report No. 13866-MOZ PROGRAM COMPLETION REPORT MOZAMBIQUE THIRD REHABILITATION CREDIT (CREDIT 2021-MOZ) January 11, 1995 Country Opearations Division Southern Africa Department Africa Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Metical (pl. Meticais) Appraisal (April 1989): US$1 = 709 Meticais Completion (August 1993): US$1 = 3,521 Meticais ABBREVIATIONS AND ACRONYMS AGRICOM State Enterprise for Agricultural Marketing BCM Banco Commercial de Mocambique BOM Bank of Mozambique ERC Economic Recovery Credit ERP Economic Rehabilitation Program ESAF Enhanced Structural Adjustment Facility GDP Gross Domestic Product IDA International Development Association IMF International Monetary Fund Mt Meticais PRN National Reconstruction Program PTIP Plano Trienal de Investimento Publico (Three-year Public Investment Plan) SAF Structural Adjustment Facility SNAAD System for the Non-Administrative Allocation of Foreign Exchange SRC Second Rehabilitation Credit TRC Third Rehabilitation Credit UTRE Unidade Tecnica de Reestruturacao das Empresas (Enterprise Restructuring Unit) FISCAL YEAR OF THE BORROWER January I - December 31  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation January 11, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Program Completion Report on Mozambique Third Rehabilitation Credit (Credit 2021-MOZ) Attached is the Program Completion Report on Mozambique - Third Rehabilitation Credit (Credit 2021-MOZ) prepared by the Africa Regional Office with Part II contributed by the Borrower. The Third Rehabilitation Credit (TRC) was designed to consolidate the policy reforms initiated in 1987 under the Government's Economic Rehabilitation Program. Its main objectives were to continue support for appropriate fiscal and exchange rate adjustment, and to reform the foreign exchange system, trade tariff structure, public expenditure management, and pricing and distribution policy. T he TRC was implemented over a difficult period marked by several exogenous shocks, including a severe drought in 1991/92, ongoing civil strife (until the signing of a Peace Accord in 1992), and a termination of trade links with the former Soviet Union and Eastern Europe in 1991. Although these shocks inevitably affected economic growth and macroeconomic stability, the policy reform objectives of the TRC were largely met. The project also contributed to the development of an institutional capacity to formulate national investment plans. In addition, through this operation the Bank was able to play an important catalytic role in mobilizing external financial support for Mozambique's adjustment efforts. Overall, Mozambique has implemented a difficult adjustment program in extraordinarily adverse circumstances. Major price distortions have been eliminated; production, marketing and internal trade have been largely liberalized; progress has been made in fiscal, parastatal and financial sector reforms; and a basic framework for private sector development has been put in place. However, considerable challenges lie ahead. Poverty is widespread, institutional capacity remains severely limited, and the country is still heavily dependent on external aid flows and technical assistance. The sustainability of benefits will depend to a large extent on the ability of the policymakers to generate an adequate supply response through further structural adjustments in a peacetime environment when aid flows are likely to decline. The project outcome is rated as satisfactory. Institutional development is rated as modest and sustainability as uncertain. The PCR is of good quality. It provides a comprehensive and candid assessment of the program's performance and draws important lessons of experience. An audit is not planned at this time. Attachrment This document has a restricted distribution and mnay be used by recipients only in the performance of their official duties. Its conteoau mray not otherwise be disclosed without World Bank authorization.   FOR OFFICIAL USE ONLY CONTENTS Page Preface Evaluation Summary i-vi PART I - REVIEW FROM BANK'S PERSPECTIVE A. The Economic Rehabilitation Program 1 Background 1 Macroeconomic and Sectoral Objectives of the ERP 2 B. Role of IDA 3 Justification of IDA Support 3 Program Design 3 Primary Policy Goals 4 Complementarity between the TRC and the IMF Program 4 Complementarity with Other Aid Flows 5 C. Implementation of Adjustment Program 8 Implementation and Results of the Adjustment Program 8 The Reform of the Foreign Exchange System 9 The Reform of the Management of Public Expenditures 12 The Reform of Price and Distribution Policy 15 The Effectiveness of the National Customs System 17 Enterprise Sector Reform 17 Institutional Development 19 The Impact of the Donor Community 20 Progress of Macroeconomic Adjustment 23 The Implementation of Macroeconomic Policy Adjustment 25 Poverty and Recent Social Developments 26 Utilization of the TRC 27 Assessment of Risk 27 Overall Progress in Reform 27 D. Lessons Learned for Subsequent Adjustment Programs 31 The Reform of the Foreign Exchange System 31 The Reform of the Management of Public Expenditures 31 The Reform of Price and Distribution Policy 32 The Enterprise Sector Reform 32 The Impact of the Donor Community 32 E. Borrower's Performance 34 Compliance with Credit Agreement 34 Disbursements 34 Audits 35 Procurement 35 F. Bank Supervision 37 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ANNEX 1: COMPLIANCE WITH COVENANTS 37 PART II - REVIEW FROM BORROWER'S PERSPECTIVE 38 PART III - STATISTICAL INFORMATION 42  PROGRAM COMPLETION REPORT MOZAMBIQUE THIRD REHABILITATION CREDIT (Credit 2021-MOZ) PREFACE This is the Program Completion Report (PCR) for the Third Rehabilitation Credit in Mozambique, for which Credit 2021-MOZ in the original amount of SDR 68.2 million (US$90.0 million equivalent) was approved on May 18, 1989. For disbursement purposes the Credit was closed on August 31, 1993, over two years behind schedule. A further extension of the Credit closing date to April 30, 1994, was approved pending resolution of some of the Credit's audit and accounting issues. An undisbursed credit amount of SDR .770 million (US$1.08 million equivalent) was cancelled on June 6, 1994. The Credit was cofinanced by the United Kingdom (12.8 million pounds, US$21 million equivalent); Norway (75 million Norwegian Kroner, US$12.3 million equivalent); Switzerland (20.1 million Swiss Francs, US$ 14 million equivalent); Finland (40 million Finnish Markkaa, US$10.4 million equivalent), and Denmark (US$545,545, transferred from the Second Rehabilitation Credit). The PCR was jointly prepared by the Borrower (Part II) and the Country Operations Division of the Southern Africa Department (Parts I and III). Parts I and III draft were sent to the Government and Cofinanciers with a request for their comments. The Government submitted Part II of this report, which incorporates their comments on the credit's program and its implementation. The PCR is based on the President's Report, the Development Credit Agreement, theLetter of Development Policy, supervision reports, correspondence between the Bank and the Borrower, internal Bank memoranda, and discussions with the relevant Government officials and Bank staff.' 1The Program Completion Report (Parts I and III) was prepared by Mr. Andrew Goudie (Consultant) and Ms. Carolina Machado (AF6CO). The Task Manager at the time of Appraisal and at start of implementation was Mr. Nils Tcheyan. Task Managers during implementation were Mr. James Biderman, Ms. Jane Armitage, and Ms. Machado. Mr. Praful Patel is the managing Division Chief, and Mr. Stephen Denning is the Department Director.   PROGRAM COMPLETION REPORT MOZAMBIQUE THIRD REHABILITATION CREDIT (Credit 2021-MOZ) EVALUATION SUMMARY Objectives 1. The Third Rehabilitation Credit (TRC) was designed both to consolidate the policy reforms of the first two years of the Economic Rehabilitation Program (ERP) and to maintain the momentum for further reforms in subsequent years. Within this context, the objectives of the TRC were fundamentally unchanged from those of the Second Rehabilitation Program (SRC) - which had supported the reform program of 1987-89 - and, therefore, maintained the focus on the structural adjustment of key aspects of the economic system. 2. The initiation of the Economic Rehabilitation Program (ERP) in January 1987 marked a move towards a comprehensive reform program, based on establishing an increasingly greater reliance on market mechanisms, a substantial reduction in the degree of centralized direction of economic activity and the integration of the national economy within the international economic environment. More specifically, the objectives of the ERP were to (i) reverse the decline in production and sustain a steady growth path in order to restore a minimum level of consumption and income for all the population, particularly in rural areas; (ii) reduce substantially the domestic financial imbalances and strengthen the external accounts and reserves; (iii) enhance efficiency and establish the conditions for a return to higher levels of economic growth once the security situation and other exogenous constraints eased; (iv) integrate official and parallel markets; and (v) restore orderly financial relationships with trading partners and creditors. 3. The TRC was an integral element of the broader international support for the reform program and, in conjunction with the SAF and ESAF programs of the IMF, the TRC played an important catalytic role in the mobilization of other external sources of finance. Indeed, the level of total external assistance (including all grants, credits, debt relief and the effective assistance from the accumulation of arrears) averaged almost four times the value of the export revenues from both goods and services in 1989. Implementation Experience 4. Despite the powerful adverse influence of the insecurity situation until the signing of the Peace Accord in October 1992 - and, indeed, for many years to come as the massive impact is gradually overcome - and the serious repercussions of the 1991/92 drought, the primary objectives of the Third Rehabilitation Credit were attained. Of most importance, the program of policy reform continued across a wide range of macroeconomic and structural policy. Moreover, upon project completion in 1993, it is clear that the impetus for reform is being maintained. The key policy objectives of the TRC were implemented as follows:  - ii - (i) Allocation of foreign exchange. Despite initial difficulties in establishing a system for the non-administrative allocation of foreign exchange, the SNAAD accelerated the progress towards the formation of the Secondary Market in 1990,and the subsequent unification of the official and secondary markets in 1992; (ii) The deployment of public expenditure. With the compilation of the rolling three- year PTIP, there was a major enhancement in the efficiency with which public expenditures were deployed and in their orientation towards the primary objectives of the ERP; (iii) The market-based price mechanism. The establishment of a market-based pricing mechanism for the allocation of goods and services was broadly achieved, with important benefits as an integral element of the incentive framework for economic production and trade; and (iv) The review and reform of the trade tariff structure. A major review of the tariff structure was undertaken in 1989 and 1990, leading to a substantial rationalization of the rate structure and the elimination of most exemptions. Results of the Program 5. It is impossible to isolate the specific impact of the TRC, as it was an integral element of the overall ERP: instead, it is appropriate to assess the global impact to which the TRC contributed. 6. While GDP growth averaged 6.1 percent per annum over the 1989-93 period, falling well short of the 11.4 percent per annum averaged over the life of the SRC from 1987-89, most of the deterioration in performance was attributable to the two constraints: the impact of the insecurity and the drought. Certainly, the deterioration in 1992, when GDP fell by -0.8%, is primarily attributable to the severe impact of the drought, allowing little inference to be drawn from the production indicators about the effectiveness of the policy reform programs supported by the TRC. 7. It is preferable to assess the effectiveness with which the reforms were implemented. In each of the five policy areas targeted under the TRC, progress in implementation was generally successful in meeting the initial objectives. 8. Throughout the first seven years of the ERP, exchange rate policy played a critical role. Following the major readjustment of the exchange rate in 1987, which precipitated the fall in the ratio of the parallel exchange rate to the official exchange rate from 40 to 2.2 during the year, there followed three years of comparatively little adjustment in the real official exchange rate. While the nominal exchange rate was progressively and steadily depreciated over the three year period, 1988-90, this adjustment process was only sufficient to maintain a broadly constant real effective exchange rate: in fact, in the three years, the real effective exchange rate appreciated by a little over one percent. Consequently, the parallel rate premium over the official rate generally showed an upward, if volatile, trend. 9. The most marked progress in policy occurred with the introduction of the secondary market in November 1990, following which the real effective exchange rate recommenced its depreciation. In consequence, the premium on parallel market rates fell sharply from a high  - iii - of 165 percent in 1990 to less than 20 percent in April 1992, before reaching a post- Independence low of 14 percent in August 1992. In the course of 1991-92, the real effective exchange rate depreciated by over 22 percent. The second major policy step was the unification of the official and secondary markets in April 1992. Although the unification was temporarily suspended in September 1992, a unified rate was successfully reinstated and maintained from June 1993. 10. In 1987 and 1988, the fiscal adiustment was equally striking. Bank financing of the budget stood at 12 percent of GDP in 1986, and, having fallen sharply in the first two years of the ERP, the Government was able to reduce its credit outstanding with the banking system to 1.4 percent in 1993. The success of this policy was a major factor in the progress towards sustainability in the monetary aggregates. One of the key underlying reasons was the significant increase in budgetary revenues, from 18.1 percent of GDP in 1986 to 20.7 percent in 1988 and, subsequently, to 21 percent on average in 1992 and 1993. Over the TRC period, government expenditures averaged 47-48 percent of GDP. This level, however, hides the real trend of government expenditures, since there were substantial changes in the budgetary coverage over the period. As is reflected in the trends in bank financing to the budget, the overall deficit after grants showed an encouraging downward trend from a peak of 12.4 percent of GDP in 1990 to 5.2. percent of GDP in 1993. 11. Throughout the life of the Economic Rehabilitation Program, the adjustment framework has embodied a substantial degree of macroeconomic disequilibrium. This, however, was explicitly recognized as an important part of the overall reform program, in order to secure the restoration of sustainable economic growth and, thus, the re-establishment of macroeconomic balance over the medium to long-term. Consequently, there was no expectation that there would be substantial reductions in the macroeconomic imbalances in the early years of the adjustment. This has, indeed, been the case. 12. Progress towards enhancing transparency of the financial system have revealed that financial imbalances in the financial and enterprise sectors are substantial. Explicit budgetary subsidies to state enterprises were reduced to less than one percent of GDP by 1992, but implicit subsidies proved more difficult to eliminate. One source of implicit subsidy -- the non-payment of counterpart funds (or delayed payment) required for the importation of commodities financed by import support funds -- was eliminated in 1992. Stricter explicit credit rules were also imposed. The Government adopted the principle that bank loans would not be granted to cover the operating losses of state enterprises, following its assumption in 1987 of financial responsibility for the bad loans of state enterprises (amounting to 14 percent of GDP). Nevertheless, the publication of Bank of Mozambique's (BOM) and Banco Comercial de Mocambique's (BCM) accounts in mid-1993 revealed that substantial additional credit to state enterprises had in fact been provided in the period 1987-1992 (mainly as a consequence of BCM's continued close association with the Government through BOM), with the accumulation of non-performing loans (eventually assigned to BCM) in the order of 4 percent of GDP. 13. Savings mobilization has been poor. Domestic dis-saving is extreme (- 11 percent of GDP in current prices in 1993), and most of it is from the private rather than the public sector. This has largely been a consequence of severe disruptions to agricultural activity flowing from the civil war. Revitalized economic activity should therefore increase domestic savings -- and it is expected that, with a continuation of peace, the resettlement of rural areas,  - iv - and an increase in agricultural production, savings rates should increase quickly in the near future. Lessons for Subsequent Adjustment Programs 14. The TRC focused attention on several areas of policy reform that required addressing in the subsequent years: The Reform of the Foreign Exchange System 15. Several lessons from the initial attempt to establish a market-based foreign exchange mechanism are apparent: (i) Real equilibrium exchange rate. There was a primary pre-requisite for an appropriate equilibrium exchange rate to be established. Throughout the SNAAD period, this condition was not fulfilled, although there were certainly additional problems to the setting of the rate attributable to the uneven and unpredictable flow of available foreign exchange. The avoidance of an inherent tendency to excess demand and a return to centralized administrative allocation was seen, therefore, to depend on an appropriate exchange rate; (ii) Sources of foreign exchange. The setting of an appropriate equilibrium exchange rate and the maintenance of a market system that is relatively small and selective depends on an even flow of exchange. The lesson is that the adoption of such a limited degree of market allocation is too problematic and a faster move to liberalization would avoid these problems. The more recent experience of the secondary market would tend to support this latter conclusion. There is additionally a need for donors to respond rapidly in the provision of more flexible sources of funds - both with regard to the source of products and the procurement rules that were specified; (iii) Credibility of the system. The integrity of the system decayed rapidly as the publicized regulations and conditions for eligibility were set aside. Maintaining such a system depends fundamentally on a rigorous adherence to the declared regulations in order to maintain confidence; (iv) Dialogue with the Government. Even though the SNAAD may have been unsuccessful in many respects, it played a valuable role in the policy dialogue. In this respect, even a modest policy step was shown to be highly beneficial in highlighting the key priorities that needed to be addressed in order to accelerate the trade reform process. The Reform of the Management of Public Expenditures 16. The experience of reform suggests several important lessons in this regard: (i) The integration of the expenditure program. The proliferation of the sources of budgetary assistance required an accelerated program of coordination and prioritization in order to align better the expenditure program with the objectives of the ERP. A much more tightly defined set of objectives and responsibilities for each expenditure initiative - with all initiatives brought under the fiscal umbrella - would have  v - substantially alleviated the problem of expenditure overlap and potential policy incompatibility; (ii) The orientation of the program. A clear lesson from the Mozambique experience was that Donor Coordination Groups should play a much more central role in the government expenditure process. Specifically, only by an effective and forceful presentation to the donor community on a regular ongoing basis can the government expect to realign the priorities of the donor community to support the sectoral and macroeconomic program. Arguably, such Coordination Groups should be chaired at the highest level by the Minister of Finance, supported, as necessary, by sectoral Ministers; (iii) Macroeconomic Policy. Macroeconomic policy-making was severely hampered by the inaccuracy and under-recording of the true degree of Government expenditure. A comprehensive coverage of all expenditures within the official budgetary framework is an essential pre-requisite for informed fiscal policy formulation. The Reform of Price and Distribution Policy 17. While, in general, the reform process in this regard has been effective, the failure to unite the parallel and official product markets did seriously hamper the development of the incentive structure. There is a clear lesson that unification should be accorded a high priority in four respects: (i) the influx of emergency assistance, of which a large percentage was illegally finding its way to the parallel markets, should be much more tightly controlled; (ii) the flow of illegal imports from neighboring countries should be stemmed; (iii) the competitiveness of domestically produced products should be safeguarded by the imposition of equal tax burdens on domestically and imported products; (iv) the overvaluation of the meticais should have been more rapidly eliminated. 18. In addition, it has now emerged more clearly that the reform process undertaken by the central Government should be complemented by similar policy reform at the provincial and district levels. To the extent that policy is directed at these lower levels, it is important that the same market-based approach reinforces the central reform program. Enterprise Sector Reform 19. Several lessons from the experience of enterprise reform emerge: (i) the commercial and legal framework. In retrospect, the process of enterprise reform would have been greatly accelerated by a more comprehensive re-commercialization of economic activity and, specifically, the enforcement of commercial contracts. Too little attention was paid to the continuing accumulation of bad debt within the productive enterprise sector and between the productive and financial sectors. Moreover, a stronger move towards reducing the dominance of the state in the ownership of both productive and financial enterprises would have provided the incentives to rectify these problems;  - vi - (ii) enterprise restructuring. Policy should have been directed at a more market-based approach: with, firstly, a greater pressure for the transfer of assets to private ownership and, secondly, a more aggressive approach to the establishing of an enabling business environment. More specifically, an accelerated withdrawal of state support, together with an enforcement of contractual debt obligations, would have compelled enterprises -and, notably, state enterprises - to adopt more decisive strategies either for restructuring, securing private sector support (either through joint ventures or privatization) or liquidation; (iii) financial sector. It is arguable that, had the reforms of the financial sector been initiated in parallel with the productive sector reforms - with a more explicit recognition of the crucial interlinkages - then the latter would have proceeded in a more efficient manner within an appropriate market-based structure; (iv) enterprise subsidies. A high priority should be accorded to the termination of ad hoc Government subsidies and to eliminating the continued provision of bank credit to enterprises with non-performing debt; (vi) targeting of enterprise subsidies. In view of the widespread uncreditworthiness in the enterprise sector, the government clearly needed to adopt a more rigorous analysis of the sector in order to determine those enterprises that were most likely to be viable over the long-term and were, therefore, worthy of short-term transitional support. Only through such an approach could the fiscal costs of a more generalized enterprise support and the broader economic ill-effects of a subsidized system be averted. Certainly, any assistance of this nature should be transparent and managed solely through the fiscal system. The Impact of the Donor Conmunuity 20. Several lessons emerge from the experience of coordinating policy reform with the support programs of the donor community: (i) trade reform. One of the contributing factors to the lack of success of the Government's first efforts to pursue trade reform was the inflexibility of donor assistance. The experience highlighted the importance of securing an even and predictable flow of donor aid in order to design appropriate policy, and the importance of eliminating the tying of aid to specific products or product sources or procurement rules; (ii) impact on domestic production incentives. There is an urgent need both to control more effectively the flows of humanitarian assistance - to curb the illegal diversion of aid; to maximize the local sourcing of such products; and to regulate more flexibly the inflow of such aid, with supplies being rapidly cut back as the situation is alleviated; (iii) public expenditure reform. Progress towards a more appropriate expenditure program was severely constrained by the pressures of the donor community and by their preferences rather than those defined by the ERP. As noted above, the Donor Coordination Groups might have played a more dominant role in accelerating the transformation in this respect.  PROGRAM COMPLETION REPORT MOZAMBIOUE THIRD REHABILITATION CREDIT (Credit 2021-MOZ) PART I - REVIEW FROM BANK'S PERSPECTIVE Project Identity Project Name: Third Rehabilitation Credit Credit No.: 2021-MOZ RVP Unit: Africa Regional Office Country: Mozambique Sector: SAL A. THE ECONOMIC REHABILITATION PROGRAM Background 1. Mozambique's economic problems in the post-Independence period have been attributable to a multiplicity of factors of which the most important have been the serious structural weaknesses inherited from the colonial era, the political instability of the Southern African region, the severe deterioration of national security and a series of calamitous natural disasters. Moreover, for many years, these powerful exogenous forces were exacerbated by the pursuance of inappropriate domestic economic policies. In addition to the serious repercussions for domestic production and trade, the attempts rigorously to control both production and marketing activities led to the development of a major parallel market in both goods and foreign exchange. Serious imbalances emerged in both the fiscal account and in the external accounts, and it became apparent that prevailing policies were totally inadequate to reverse the serious trends. 2. In consequence, there was sharp decline in the economy, particularly in the first half of the 1980s, with real GDP falling by 1986 to around two thirds of the 1980 level. By 1987, 60-70 percent of the population was absolutely poor, and Mozambique's social indicators were arnong the worst in the world. Much of the rural infrastructure (electricity transmission lines, roads, bridges, and railroads) had been devastated by more than ten years of civil war, fueled by political developments in Southern Africa. A third of all health units and half of the primary schools had been destroyed. Much of the service networks (marketing, transport, social sectors) operated poorly or was inoperative. Most enterprises had been nationalized or taken over by the state as 'intervened' companies. The industrial sector was paralyzed (output was only one third of the 1973 level), and the agricultural sector was reverting to subsistence levels. The consequence was a sharp fall in Mozambique's import capacity as exports fell by two thirds. Aid dependence was extreme: because of the sharp decline in production and exports, 90 percent of marketed grain in the country had to be provided through emergency assistance. External debt was unmanageable: Mozambique's debt stock was equal to 3.5 times its GDP and 45 times its exports.  3. The initiation of the Economic Rehabilitation Program (ERP) in January 1987 marked a move towards a comprehensive reform program, based on establishing an increasingly greater reliance on market mechanisms, a substantial reduction in the degree of centralized direction of economic activity and the integration of the national economy within the international economic environment. The Secondary Rehabilitation Credit (SRC) was designed to support the first stages of the reform program and the Third Rehabilitation Credit (TRC), which became effective on August 4, 1989, was simnilarly designed both to consolidate the policy reforms of the first two years of the program and to maintain the momentum for further reforms in subsequent years. Within this context, the broad objectives of the TRC were fundamentally unchanged from those of the SRC, and, therefore, maintained the focus on the structural adjustment of key aspects of the economic system. 4. In 1989, as at the start of the ERP in 1987, the primary economic problem was to design an appropriate set of reform policies in the context of an ongoing war situation, which, it was acknowledged, would inevitably dampen to a marked extent the responsiveness to changes in the policy environment. In this context, the ERP was explicitly designed progressively to establish a policy framework that would be most appropriate when peace was restored. The continuation of minimal controls was seen as necessary in a war situation, but, even with the ongoing security problem, it was determined that a more market-orientated approach would provide the greatest potential for recovery in the short term and certainly allow a more rapid recovery with the re-establishment of peace. 5. In addition, the government strategy embedded in the ERP was explicitly gradualist in nature. The government took this approach on the basis of four broad areas of concern: the realization that the potential for a response to the policy changes was weak, due both to the war constraint and to the severe supply-side weaknesses, including the serious infrastructural deficiencies; the perceived costs of a rapid adjustment process, particularly in an environment in which severe poverty was so widespread and so intense; the anticipated political costs of a reversal of economic policy were the pace of reform perceived to be too rapid; and the need to allow time for the firm establishment of an entirely different mode of economic thinking and culture, following a long period of centralized and direct economic management and the difficulties of gaining widespread acceptance of the new decentralized and market-based approach. 6. The reversal of the economic downturn and the establishment of recovery in 1987 and 1988 lent support to the appropriateness of the Economic Rehabilitation Program and its underlying strategy. Thus, the primary objective of the TRC was to build on this encouraging progress through the deepening and broadening of the structural adjustment and through addressing the newly emerging priorities. The TRC was designed to provide the financial support to this ongoing policy program. Macroeconomic and Sectoral Objectives of the ERP 7. The general objectives of the ERP were: (i) to reverse the decline in production and restore a minimum level of consumption and income for all the population, particularly in rural areas; (ii) to reduce substantially the domestic financial imbalances and strengthen the external accounts and reserves;  - 3 - (iii) to enhance efficiency and establish the conditions for a return to higher levels of economic growth once the security situation and other exogenous constraints eased; (iv) to integrate official and parallel markets; and (v) to restore orderly financial relationships with trading partners and creditors. 8. The ERP over the life of the TRC was designed to achieve real GDP growth of between 4% and 5%, with recovery centered on the agricultural sector and the revitalization of the rural areas. This was seen as the most effective strategy for achieving macroeconomic stability over the medium to long term and for restoring incomes and reducing severe and widespread poverty. Within the framework of the Policy Framework Papers, macroeconomic adjustment was to be accelerated in fields of fiscal, monetary and exchange rate policy, while comprehensive institutional changes were to be effected in the key sectors of agricultural, industry, transport and energy. The primary strategy was to re-establish the incentive structure throughout the productive and distributive sectors through market-based incentives. B. ROLE OF IDA Justification of IDA Support 9. Within the first two years of the adjustment process, it became apparent that the reform program would need to be maintained over many years. Even in the absence of war, the nature and scale of the economic distortions within the economy necessitated the formulation of a long-term program of adjustment. Specifically, it became increasingly apparent that, while the macroeconomic stabilization reform program had made substantial progress in many areas, and while significant project assistance was being received from the donor community, there remained widespread weaknesses in the economic structure and in the macroeconomic policy framework that would increasingly need to be addressed. Indeed, the effectiveness of both the macroeconomic program and the project assistance clearly depended on developing the basic policy instruments (fiscal, credit and exchange rate policies) that were needed for carrying further the process of structural adjustment. 10. For these reasons, the TRC particularly addressed the problem of improving the resource allocation processes, specifically with regard to the allocation of foreign exchange and public expenditures, but also with respect to the objective of enhancing the allocation of goods and services through the general price mechanism. 11. In addition to this support for the structural policy reforms, the first two years of the ERP emphasized the importance of maintaining substantial long-term external assistance. Indeed, the fundamental strategy of the government was premised on the fact that substantial macroeconomic imbalances would remain a feature of the Mozambique economy for some time, specifically due to the substantial inflows of foreign assistance to maintain the domestic levels of consumption and investment. In this context, the support of IDA was crucial, both in the direct mobilization of funds to the government and in its catalytic role in mobilizing the resources of the remainder of the donor community. Just as in the 1987-88 period, the programs of the IMF and IDA were seen - to varying degrees - as important prerequisites for bilateral programs of both project, program and debt assistance, and for the multilateral moves towards debt rescheduling and debt relief.  -4 - Program Design 12. The TRC had two principal objectives: (i) to support the consolidation of the progress made in macroeconomic stabilization; and (ii) to initiate reforms in key aspects of resource allocation in order to sustain the recovery process. 13. The TRC was approved by the Board of Executive Directors on 18 April 1989. It included IDA financing of SDR 68.2 million, and co-financing administered by IDA from Switzerland (SwF 20 million), Finland (FMks 40 million), United Kingdom (