Mozambique - Poverty Reduction Support Operation Project

Documentof The World Bank FOR OFFICIAL USEONLY ReportNo. 29262MZ INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAMDOCUMENT FOR A PROPOSEDCREDIT INTHE AMOUNT OF SDR40.9 MILLION ($60 MILLIONEQUIVALENT) TO THE REPUBLICOF MOZAMBIQUE FOR A FIRSTPOVERTY REDUCTIONSUPPORT OPERATION June 9,2004 AFTPllAFC02 Africa Region This documenthasa restricteddistributionand may be usedby recipientsonly in the performanceof I their official duties. Its contentsmay not otherwisebe disclosedwithout World Bank authorization.  The last Country Assistance Strategy was dated October 20,2003 Currency Equivalents US$1 =23,240 Metical(as ofJuly 2003) Abbreviations and Acronyms AAA Analytic and Advisory Activities M&E Monitoring and Evaluation APL Adjustable Program Loan MADER MinistryofAgriculture andRural BAu Banco Austral Development B C M Banco Commercial de Mogambique M D G MillenniumDevelopment Goal BIM Banco Intemacional de Mogambique M I C Ministry ofIndustryandTrade CAS Country Assistance Strategy MMR Maternal Mortality Rate CASCR CAS Completion Report M o H Ministry o f Health CDF Comprehensive Development MoJ Ministry ofJustice Framework MPF Ministry o f Planning and Finance CEM Country Economic Memorandum MTFF Medium-Term Financial Framework CFAA Country Financial Accountability NGO Non-Govemmental Organization Assessment NPV Net Present Value CPAR Country Procurement Assessment N W D National Water Development Review OED Operations Evaluation Department CPI InvestmentPromotion Center PAF Performance Assessment Framework CPPR Country Portfolio Performance PARPA Action Plan for the Reduction o f Review Absolute Poverty CWIQ Core Welfare Indicators PER Public Expenditure Review Questionnaire PODE EnterpriseDevelopment Program DPFP Decentralized Planning and Finance PRGF Poverty Reduction and Growth Project Facility EFA-FTI Education for All Fast-Track PROAGRI National Program for Agricultural Initiative Development EMPSO Economic Management and Private PRSP Poverty Reduction Strategy Paper Sector Operation PSIA Poverty and Social Impact ESSP Education Sector Strategic Program Assessment ESW Economic and Sector Work PSR Public Sector Reform Project FDI Foreign Direct Investment RENAMO Mozambique National Resistance FIAS Foreign Investment Advisory Service WED Regional Program for Enterprise FRELIMO Mozambique Liberation Front Development FY Fiscal Year SADC Southern African Development G11 Group o fElevenDonors Community GDP Gross Domestic Product SAPP Southern Africa Power Pool GEF Global Environment Facility SISTAFE IntegratedFinancial Management HIPC Highly Indebted Poor Country System IAS Intemational Accounting Standards SME Small- and Medium-sized Enterprises IFPRI Intemational FoodPolicy Research SWAP Sector Wide Approach Institute TA Technical Assistance IMF International Monetary Fund USMR Under Five Mortality Rate IMR Infant Mortality Rate UN UnitedNations JSA Joint Staff Assessment UNCDF UnitedNations Capital Development JPMFS Joint Program for Macro-Financial Fund support UNDP UnitedNations Development LAM Mozambique Airlines Programme Vice President: Callisto Madavo Country Director: Darius Mans Sector Manager: Emmanuel Akpa Task TeamLeaders: Antonio Franco and Johannes Zutt  FOROFFICIAL USEONLY THE REPUBLICOF MOZAMBIQUE FIRST POVERTYREDUCTIONSUPPORT CREDIT TABLE OFCONTENTS I. INTRODUCTION ...................................................................................................... 1 I1. ECONOMICDEVELOPMENTS AND POVERTYREDUCTION ....................................... 2 . B. Policies,GrowthandPovertyReductioninMozambique........................... A. Context ofthe PARPA................................................................................. 2 3 D. ExternalAssistanceto Mozambique............................................................ C. Medium-TermProspects.............................................................................. 6 7 I11. THEACTION PLANFORTHE REDUCTION ABSOLUTEPOVERTY OF ........................ 8 B. FinancingNeedsfor the PARPAandMDGs............................................. A. The Strategyof the PARPA......................................................................... 8 9 C. PARPA ImplementationProcesses............................................................ 12 D. Credibilityof the Budget Process ............................................................... 14 IV. THEWORLDBANKGROUP STRATEGY ................................................................ 22 A. Consistencyof the PRSCwith the CAS ..................................................... 22 B. SupportingPARPA Implementationthroughthe PRSC............................ 23 C. Alignment Betweenthe Bank andthe other Donorsin Support ofthe PARPA .............................................................................. 24 D. Analytic Underpinningsofthe PRSC......................................................... 26 V. THEPROPOSED PRSCl REFORM PROGRAM......................................................... 30 A. OverviewandObjectives of the PRSC Series ............................................ 30 B. The ProposedCredit ................................................................................... 31 C. BuildingPublic Sector Capacity andAccountability ................................. 32 D. Improvingthe InvestmentClimate............................................................. 43 E. ExpandingServiceDelivery....................................................................... 57 F. ReformMeasures andActions TakenPrior to Board.................................. 62 G. CreditAdministration................................................................................. 65 H. EnvironmentalAssessmentandRating...................................................... 65 VI.Benefits andRisks............................................................................................... 66 V. Conclusions.......................................................................................................... 68 Annexes Annex 1: ProgramMatrix................................................................................. .......69 Annex 2: ReducedPAFMatrix andPriorityActions.............................................. 76 Annex 3 Public FinancialManagement.................................................................. 79 Annex 4: Letterof Development Policy ................................................................. 88 - This document has a restricted distribution and may beused by recipients only in the performance of their official duties I t s contents may not be otherwise disclosed without World Bank authorization . . _-  Annex 5: Mozambique . a Glance...................................................................... At 96 Annex 6: Mozambique . Social Indicators.............................................................. 98 Annex 7: Mozambique . Economic Indicators................................................ Key 99 Annex 8: Mozambique . o f Bank Group Operations ................................... Status 101 Annex 9: Relations with the IMF............................................................................. 102 Boxes Box 1: Conclusions and Recommendations of the First 2004 Joint Review............13 Box 2: Selection Criteria o f Components o f PRSC1-3............................................. 31 Figures Figure 1: GDP Growthand Inflation ...................................................................... 5 Figure 2: N P V of Debt-to-Exports Ratio.................................................................. . 8 Figure3: Selected Sectorial Current Expenditures................................................... 10 Figure4: Prospects for Achieving the MDGs: Two Scenarios................................ 11 Figure 5: Financial Calendar .................................................................................... 15 Figure 6: The Mozambique PRSC Program............................................................. 16 Figure7: Percentage of FirmsinMozambique RankingIssues ............................... 48 Table 1: Selected Poverty Indicators ......................................................................... Tables 3 Table 2: Selected Economic Indicators...................................................................... 4 Table 3: Actual and ProjectedGDP Growth Rates by Expenditure Category .......... 6 Table 4: External Financing Requirements and Sources of Financing...................... 7 Table 5: Actual Recurrent Expenditures .................................................................... 9 Table 6: Recent Performance and Medium-TermTargets for Selected MDGs ........10 Table 7: HIPC Expenditure Tracking Assessment .................................................... 17 Table 8: Basic Macroeconomic Indicators ................................................................ 18 18 Table 10: Macroeconomic Framework...................................................................... Table 9: Government Finances inPercentage o f GDP .............................................. 19 Table 11: World Bank LendingActivities inMozambique....................................... Table 12: Analytical Underpinnings o f Structural andFiduciary Assessments ........25 Table 13: Days taken to Resolve Business Disputes inthe Court System ................27 Table 14: Firms' Perceptions o f Specific Labor Regulatory Requirements ..............41 50 TheBanktask team includes: Antonio Franco.Peter Moll. MariaT Benito-Spinetto (AFTP1); Gilbert0 de Barros . (AFTPS); NoelKulemeka. Alexandra Valerio (AFTHl); Jean-Jacquesde St .Antoine (AFTHl); KateKuper. Lance Morrell. Cathy Revels. (AFTU1); JosephNarkovic(EWDAF) ;Daniel Liborio de Sousa. Jacominade Reg. Jeeva Perumalpillai-Essex(AFTS1); CarolineForkin(AFTS4); HarryGarnett. Jose LuisMacamo(AFTPR); Louise Fox (AFTPM); MichaelFuchs(AFTFS); AbdelmoulaGhzala(AFTTR); ReynoldDuncan(AFTEG); JuanNavas-Sabater (CITPO); DianaMasone. Jody Kusak(AFKL); Gertvan der Linde (AFTFM); Alberto Ninio (LEGAF); Slaheddine Ben.Halima. ManuelSumbana. Jean-JacquesVerdeaux (AFTQK); MartaMadeira.LurdesMalate. Aniceto Bila (AFC02); MichelleMcCue.PaolaRidolfi. JohannesZutt (AFCMZ) Peer reviewersare: JeniKlugman(AFTP2); BennoNdulu(DECRS); and Gaiv Tata (AFTPS) . .  THE REPUBLIC OF MOZAMBIQUE FIRST POVERTY REDUCTIONSUPPORT CREDIT CREDIT AND PROGRAMSUMMARY Borrower: Republic of Mozambique Amount: SDR40.9 million ($60 million equivalent) Terms: StandardIDA terms (40-year maturity, 10-year graceperiod) Description: The proposedoperation i s a single-tranche Poverty Reduction Support Credit (PRSC) that will buildon recent reforms completed by the Government of Mozambique and support implementation of the Government's Action Plan for the Reduction of Absolute Poverty (PARPA). The proposed PRSCl will support the policies and reforms aiming to improve the livingconditions ofthe populationbypromoting growth and employment and also strengthening governance and public sector management. PRSCl will also consolidatethe basis for helping the Government to attack poverty ina comprehensive manner. Furthersingle-tranche operations (PRSC2 and PRSC3) are expectedto follow inFY05 and FY06. Benefits: Themainandultimate benefit ofthe operation is expectedto be acceleratedprogresstowards the MillenniumDevelopment Goals (MDGs) as a result of higher growth and improved service delivery achievedthrough implementation of the program supportedby the credit. Inaddition, the operation will helpthe Government to maintain macroeconomic stability by helping to close an external financing gap as well as generate the domestic funds requiredto execute the policies and programs included inthe PARPA. Risks: Theprogram faces severalrisks: (i) macroeconomic or financial sector instability as a result of terms oftrade shocks, regional instability, or deteriorating financial sector performance; (ii) capacity limitations constraining program implementation; (iii) social or politicalpressures, possibly resulting from weaker Government commitment to reform undermining sustainability; and (iv) residual fiduciary risks to resource flows. Estimated SDR 40.9 million ($60 millionequivalent) will be disbursedon disbursements: effectiveness ProjectID Number: PE-PO75805   IDA PROGRAMDOCUMENT FOR A PROPOSED CREDIT TO THE REPUBLIC OF MOZAMBIQUE FORA FIRSTPOVERTY REDUCTION SUPPORT CREDIT I. INTRODUCTION 1. Thisprogram documentproposes a single-tranche Poverty Reduction Support Credit (PRSCl) to the Republic of Mozambiquefor SDR40.9 million ($60 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 o f Mozambique's Action Plan for the Reduction o f Absolute Poverty (PARPA), as updated inApril 2004 through Government revision o f a rolling three-year matrix o f priority actions and indicators agreed with its external partners. A key feature o f the PRSC framework, which is proposed to include three operations to be deliveredover FY04-06, is its focus on cross-cutting and institutional issues. Besides providing financial support to PARPA implementation, the PRSC will help close Government financing gaps which have fiscal and balance-of-payments origins. 2. Bilateral and multilateral donor assistance will be needed to implement the PARPA, as the country's own resourcesfall short of the levels required to achieve the PARPA's objectives, including the MDGs. The Government o fMozambique has made significant progress inraising revenues and improving public financial management, including completion o f a medium-term financial framework (MTFF) and two recent Public Expenditure Reviews (PERs), progressive implementationo f an integrated public financial management system (SISTAFE), and actionto fight corruption. Nonetheless, Government-generated resources fall short o f financing Mozambique's modest medium-term development goals by about $750 million per annum. Encouraged by the Government's track record since 1992, a group o f donors (now numbering 15 and known as the Group o f 15 (G15)) have agreed to provide general budget or balance-of-payments support to the Government under a formally-agreed joint program. Over 2003-04, this group o f donors improvedharmonizationby agreeing to commit and disburse budgetor balance-of-payments support against Government progress inimplementing a results- orientedmatrix o f agreed actions and indicators that updates the PARPA. This matrix provides a framework for policy dialogue and decisions linked to PARPA implementation, and the proposed PRSC i s fully aligned with it. 3. ThePRSC is consistentwith the Bank's Country AssistanceStrategy (CAS), which the Board considered on November 20,2003, and also provides continuing support to the reforms supported by the recently-completed Economic Management and Private Sector Operation (EMPSO), which aimed to improve public financial management andcreate a better environment for private sector-led growth. EMPSO supported: (i) actions identified by the PARPA inthe areas o f public financial management and financial sector supervision to reduce the risk o f financial crisis; (ii) improving macroeconomic stability as a prerequisite for sustaining growth over the medium-term; (iii) improving the investment climate for the private sector; and (iv) laying the foundation for legal andjudicial reform, bothto sustain growth and also to enable the sector to address key legal challenges o fmodemsocieties.  4. Thisfirst PRSCseriesfor Mozambique will deepen Bank support to the Government's reform agenda by: (i) buildingpublic sector capacity and accountability through strengtheningpublicfinancial management, decreasingaid dependency,improving monitoring and evaluation (M&E), and acceleratingpublic sector reform; (ii) improvingthe investment climate throughstrengtheningthefinancial sector, easingconstraintsin the regulatory environment,and expandinginfrastructure services; and (iii) enhancingservice delivery in health, education,and water and sanitation, While the PRSC operations will provide financial support for implementing the whole of the PARPA, they are proposedto disburseagainstthe upfront completion of a small numberof specific reformmeasures (prior actions) identified inthe program matrix (see Annex 1). For PRSCl, these prior actions will focus on ensuring that spending allocations are inline with agreedpriorities, that risks inthe fiduciary environment are reducedthrough progressiveimplementation of SISTAFE, that revenue-raising measurescontinue to be deployed, that public sector reform (including decentralization to localauthorities) leadsto improved service delivery, andthat efforts to combat corruption proceedwith due speed. They will also beginto focus on the completion of reforms that improve the investment climate and promote pro-poor growth. Inaddition, as Bank project-basedfinancing insupport of sector-wide approaches(SWAps) inagriculture, health and education comesto a close, PRSC2 and 3-thought not PRSCl-will continue to support the SWAps inthese sectorswith a view to optimizing their impact on poverty. Inparticular, Bank staff will continue to participate inSWAP reviews andprovide technical assistance as needed, while the PRSC series will provide financial support to the SWAps. 5. ThePRSC is based on extensiveanalytical work completedover thepastfew years, includingtwo PERs (FYOI and FY03), a Poverty Assessment (FY04), a Country Economic Memorandum (CEM, FYOl), a Country Financial Accountability Assessment (CFAA, FY02), a Country ProcurementAssessment Review (CPAR, FY03), an Investment Climate Assessment (ICA, FY03), and a Financial Sector Assessment (FY03). Bank-Fund work on tracking public expendituresinHIPC countries has also played a major role inprogram design. 6. TheBank's strategy, as stated in the CAS, and consistentlywith the strategy of most major donorsin Mozambique, isprogressively to increasethe share of the assistanceprogram deliveredin programmaticform. The PRSC begins this processfor IDA. Continuing weaknesses inMozambique's fiduciary framework indicate that there are risks inproviding increasing levels of programmatic support, but PRSCl helpsto mitigate those risks, andthe residual risks are worth taking as the Bank's PRSC will helpto sustainnational interest in implementing the PARPA, promote greater harmonization among the donors, and improve the accountability of the Government to Parliament andto the people of Mozambique. 11. ECONOMIC DEVELOPMENTS AND POVERTY REDUCTION A. CONTEXTOFTHE PARPA 7. Though Mozambique remains one of the world'spoorest countries, with a GDPper capita of $210, it experiencedstrongpoverty reduction over 1997-2003. The 1996-97national poverty assessment found that the poverty headcountwas 69% (71% mral and 62% urban) and the poverty gap 29%. The 2002-03 poverty assessment found substantialimprovement inboth measures, with the poverty headcountfalling to 54%-well belowthe PARPA target of 60% by 2005-and the poverty gap to 21%. Thus, not only i s a smaller share of the population below the poverty line, but the average consumption levels ofthose remaining below the poverty line has 2  increased inreal terms (from 58% o f the poverty line in 1996-97 to 62% in2002-03). While the poverty headcount is still higher inrural areas (55.3%) than inurbanareas (51.5%), inrelative terms poverty fell more rapidly inrural areas (by 16 percentage points) than inurban areas (I 1 percentage points). Inaddition, access to basic services and asset ownership bothimproved strongly over the reportedperiod. (Table 1shows progress against selected indicators.) Even so, poverty remains deep inthe rural areas, where 70% o f Mozambicans live. Rural per capitaincomes are still believedto be about $100per annum, or halfthe national average, andhealth and educational services, safer water and electricity, are still hardto obtain (see the October 2003 CAS). Most Mozambican farmers live on fewer than three hectares o f landand only about one inten i s able to sell surplus produce, chiefly due to poor infrastructure. 8. Studies are now under way to evaluate the linkages between economicgrowth and poverty reduction in Mozambique. Preliminary indications are that the linkages betweenrapid growth and poverty reduction are strong. Sectors experiencing significant growth have been construction, food and beverages, services, andtourism, most of which are labor-intensive. In addition, the agricultural sector, which accounts for 26% of GDP, grew by 6 4 % a year over 1996-2002, which helps explain the sharp reductiono f poverty inrural areas. Recent surveys show that poverty varies considerably across provinces andwithin communities, limiting the effectiveness of geographical targeting and community-based development initiatives. Further analytical work i s plannedto help determine what has been drivingthese results and why the decline inurbanpoverty has been smaller thanexpected. B. Policies,GrowthandPovertyReductioninMozambique 9. Structural reforms were initiated in Mozambique in the 1990s, even before war ended. Since 1992,the Government has restructured or privatized over 850 companies. It has reformed the financial sector by creating a central bank; adopting regulations on licensing, capital adequacy, and exposure limits; and privatizing the two state-owned banks. The Government also established a progressive investmentregime, promoted free trade zones for manufactured exports, transformed the Investment Promotion Center from a regulatory to a promotion agency, and reduced administrative redtape for investors. Mozambique today has one o f the most open trade regimesinsouthern Africa. Prices have beenliberalized, except for a few consumer goods; import licenses have been abolished; andthe exchange rate i s fully flexible. Mozambique has also made progress intrade policy: the top tariff rate i s now 25%; rates on capital goods and intermediates are between 5% and 10%; further reductions will follow as the SADC trade protocol i s implemented; and collection increases resulting from improved customs management more thancompensated for the decline inrates duringthe 1990s. New tax legislation has also beenprepared. With a view to long-term fiscal sustainability, a value-added tax (VAT) was introducedin 1999;a large taxpayer unit was established in2001;and a new income tax law was passed in2002, rationalizing corporate andpersonal income taxes, reducing the corporate tax 3  from 35% to 32%, andbroadeningthe tax base. Inaddition, anew code of fiscal incentives was passed, establishing standardconcessionsandtransparent rules for foreign investors. 10. Gradualfiscal adjustment in a context of improved revenues and sustained aid has enabled Mozambique to increasespending on roads, health and education. Today 55% of the 27,000 kmroad network is ingood or fair condition, and only 10% sometimes impassable, comparedto 10% and 30% respectively in 1992. From 1994to 1998, the Government nearly doubledits share of current expenditureon health (from 10% to 18%) and education (from 5% to 10%). Health care has improved as over 300 first-level facilities were rehabilitated or constructed, often inremote ruralareas, and about nineinten reliably carry essentialdrugs and medical supplies. Inaddition, over 3,000 lower primary schools have beenrehabilitated or constructedover the 1 9 9 0 ~ ~doubling the numberthat existed at the end of the war. 11. Prudent monetary andfiscal policies have been maintained in spite of shocks. Very high inflationinthe early 1990swas brought downto single digits by 1996 and, except for flood- related rises in2000 and 2002, it has remainedmanageable. For 2003, inflationwas 13.5%, due _. ___ - - Table 2: Selectedeconomic indicators - mainly to exogenous factors Indicator I I 1990-93 1994-01 2003 includinga stronger rand, highoil -1 -(avg.) (avg.) (est.) import prices, andincreasedfood prices due to the regional drought. ~ i. Population (million) 14.7 , 17.1 1 18.8 Population growth (%) 2.1 2.2 i 1.9 At the same time, tax reformand GDP (US$ billion) 2.3 3.3 4.3 improved tax administration have GNI per capita (US$) 155 186 210 increasedGovernment revenuesto GDP growth (%) 1.6 8.1 7.1 i14.3% of GDP in2003, exceeding Fiscal deficit (%) 15.5 14.7 15.5 expectations. The fiscal deficit after Inflation (CPI avg., YO) 40 18.4 13a5 grants i s high (7.9% of GDP in Export growth (%) 15.4 19.8 I 16*2 2002, includingthe cost o f Source: IMFandWorldBank 12. Thepartial privatization of two large state-owned banks in 1995-96 helped to lower inflation, but the banking system requiresfurther strengthening. Liquidity crises at Banco Austral (BAu) and Banco Commercial de Moqambique (BCM) necessitatedGovernment contributions to recapitalizations inboth2001 and2002, amounting to 4% of GDP. The Government is no longer apartner inBAu, which was reprivatized inDecember2OOl-though7 as requiredby law, it still holds 20% of the bank's equity intrust for the bank's employees-and itintendsto withdraw from the Banco Internacional de Mopnbique (BIM, the successor to BCM), while also strengthening supervision capacities at the central bank. InMarch2004, the commercial bank lending rate was 26% (comparedto 35% at end-2002), but spreads were still 15-16%. 13. Sustained structural reforms and macroeconomicstability raised averagegrowth to 9% per annumfrom 1997 to 2002, despite flood emergenciesinboth2000 and 2001. The main drivers ofthis growthwere foreign investment, strong agricultural performance, and large-scale project construction andproduction. Economic growth was 7.1% in2003 and i s projected at 7- 8% annually until2006, with fluctuations mostly due to megaproject construction. Agricultural 4  production grew at 6% per annumsince 1992, as aresult of liberalization, macroeconomic stabilization, infrastructure rehabilitation, input expansion, andthe absence (until 2000) of weather-relatedshocks to production. Inaddition, Mozambique has attractedlarge-scaleforeign direct investment (FDI), suchas the Mozal aluminumsmelter and the Sasol gas developments, which helpedto boost economic activity, raisemanufacturing outputs, improve the trade balance, and increasegovernment revenues. Partly as aconsequence ofthis FDI, the construction industry has grown strongly, increasing Figure 1: GDP growth and inflation its share of GDP from 6.6% in 1996to 11.7% in2002. Therewas also a strongpostwar rebound inmanufactur- ing, which resultedfrom firms 15.0 -- bringingidleproduction facilities back online: the averagerate of capacity utilizationrose from 20% in 1989to 48% in 1998. GDP growth in2003 was sourcedinagriculture (7.5%), trade (6.O%), extractive industry 1997 1998 1999 2000 2001 2002 2003 (31.6%), manufacturing (l2.8%), and transport and communications (8.6%), indicating a widening base. 14. Thisgrowth has reducedpoverty, but sustainability, which is critical to reach Mozambique's poverty-reduction targets, is an increasing concern. Sustainability will require significantly higher levels of broad-basedprivate-sector investment. Newprivate investmenthas beenmodest even during the highgrowth period of the 1990s, when it accountedfor merely2- 3% of GDP. Inaddition, large-scale projects will not createthejobs neededto reduce poverty on the scale that the PARPA envisages. Current and plannedlarge-scale project investmentsof about $10 billion will employ only about 20,000 people, or less than 1%of the 3.7 million new workers projectedto enter the job market by 2010. For the same investment, the average Mozambican firm cancreate about 100times the jobs of a large-scale project. 15. Due to the limited size of the domestic market, greater penetration of international export markets represents the best long-term growth prospectfor theprivate sector. As a result of low wages, richnatural resources, a liberaltrade regime, andprudentmacroeconomic and exchangerate management, Mozambique has potential for expanding a broadrange of exports (including tourism) and attracting more FDI. To date there has beenlimitedrealization ofthis potential beyondthe few large-scale projects, andmost exports remain primarily resource-based andagricultural. Increasing manufacturing sales to export markets (only 6% of total sales in 2001) will be a large challenge: manufacturing remains highly concentrated; capacity utilization inthe sectorremains low, at about 50%; and subsectorsthat haveserved many developing countries as a platform for exports have struggled inthe face of international competition. 16. Making signijkantprogress towards thepoverty reduction goals will require increasing labor-intensive manufactured exports and developing more linkages between the large-scale projects and localproducers. To tap this potential, the cost of doing business needs to be reduced. Despiterecent progress, regulations remain burdensome,with the consequence that local producersof simple consumer goods, such as garments and many food products (which enjoy tariff protection of about 25% andnatural protection from hightransport costs), are often unable to compete with similar imports. Labor inflexibility, highbusiness registration costs, and 5  difficult access to land and capital are key factors inhibitingentry and the efficient allocation o f resources as well as contributing to low productivity and competitiveness. C. Medium-TermProspects 17. Prospects are goodfor maintaining annual GDPgrowth rates at 74% and bringing inflation below 10% over the medium-term. Inthe base case economic scenario, small-holder agriculture, large-scale commercial agriculture, and manufacturing across all sectors and innon- traditional areas are expected to continue to grow andcreate jobs, while deeper regulatory reform should encourage investment ininfrastructure (see Table 3). Assuming no adverse exogenous shocks and satisfactory implementationo f the reform program, large-scale project construction (Mozal2 and the gas and titanium sand developments) will drive growth inthe near term and also explainits main fluctuations. As these projects begin their productive activities, they will help further to expandand diversify the export base, bring growth to local enterprises through upstream and downstream linkages, and create significant spin-off effects, such as employee training, connected infrastructure developments, andhigher Government tax revenues that can support pro-poor spending. Hydroelectric power exports will also contribute to growth, and current prospectingsuggests that coal, petroleum andmineral resources may contribute inthe long term. Ifsustainably managed, Mozambique's agro-ecological resources will remain a good basis for economic expansion. Agricultural growth i s expected to remain strong, at 7% per annum or more, with rapid expansion intobacco and sugar (the latter behind protective barriers), as only a fifth o f arable land i s now cultivated and there i s ample scope for yield improvements, including through irrigation. With a 2,700 kmcoast that has manyunique habitats, tourism i s expected to remain one o f Mozambique's fastest growing industriesand to continue expanding vigorously (luxuryhotel rooms inMaputo increased from 730 in 1999 to 1,370 in2003). Services, stemming inpart from government expenditure, will also continue to expand inthe medium term, particularly intransportation, accommodation, and food. 18. Sustaining growth will require a secondgeneration of reforms designedto improve agriculturalproductivity,expand labor-intensivemanufacturing and services, and increase the efficiency and eflectiveness of public spending in thepoverty-reducing sectors. It is especially important that Mozambican firms become more competitive inworld markets. As 6  shown inthe 2001 CEM, for Mozambique to take full advantage o f identified sources o f growth, the Government should act decisively infive areas: Strengthening the macroeconomic environment: Mozambique needs to reduce its fiscal deficit, improve public expenditure management, reform the financial sector, and strengthen its external balance by expanding the export base and raising manufacturing and cash-crop exports back to pre-independence levels. Unleashing agriculture'spoverty-redwing potential: Itneeds to improve landtenure, expand access to key inputs, and facilitate rural trade by expanding roadtransportation. Removing the impediments toprivate sector growth: The investment climate, particularly for high-potential sectors such as transport, tourism, and labor-intensive manufacturing, needs to be improvedthrough removing administrative barriers and increasingprivate- sector-participation ininfrastructure. Improvinghuman capital: Improving health services, expanding access to education, and controlling HIV and malaria are key to improving skills and productivity levels. Protectingnatural resources: To maximize returns from natural resource extraction, Mozambique needs to strengthen its environmental institutions and policies inways that promote growth and protect the environment. D. ExternalAssistanceto Mozambique 19. Mozambique has benefited enormouslyfrom foreign aid, which amounts to about 15% o f GDP today, compared to 64% for the rest o f sub-Saharan Africa (excluding South Africa), and covers half o f public expenditures. Evenincluding this aid, the Government's overall resource envelope remains far short o fthe requirements for meeting the MDGs. Butthe biggest challenge lies ahead. Aid flows to Mozambique are moving down inreal terms toward the regional average, and this trend i s expected to continue. Coping with this decline will require a substantial fiscal effort inthe next few years. To protect macroeconomicbalances, public spendingwill needto fall instep withthe decline inaid, except to the extent that domestic resources can be mobilized. Since 1998, spending has risen sharply, while revenues have grown more modestly. Although much o f the recent rise inspending i s attributable to flood relief and banking recapitalization, such events cannot be ruled out inthe next few years. Over the long term, increased revenue collection demands sustained growth, and here improving private sector performance is critical. Ofwhich: IMF 35 34 ' 29 60 1 11 1 11 12 5 5~ 5 1 Commercial 90 81 ! 360 322 52 1 543 160 105 265 , 245 Debt relief 4174 224 '1044 449 1 426 I 0 0 0 0 1 0 ' 7  20. Continuedand stablesupport in theform of bilateral and multilateral grants and credits will be needed to enableMozambiqueto meet its development objectives. Excluding large-scaleprojects, Mozambique requires about $750 millionper annuminexternal assistance (see Table 4). At the October 2003 Consultative Group meeting, Mozambique's external partnerspledged$790 million inexternal assistance for 2004 (75% ingrants, and 40% inbudget support), which is more thanenough to meet the country's financing requirementsfor this year. Reliance on aid flows i s projected to decline gradually over the next decade, as strong growth and increasedprivate sector financing reduce aid's share of GDP and of the budget. 21. Mozambique'sdebt is high but has been reducedto sustainablelevels. In2002 the Government paid$52 million indebt service, of which $39 million were domestic interest payments. Public debt of $2.7 billion (57% of total external debt) is mostly long-term debt owed to governments and multilateral institutions. The Bank i s Mozambique's largest creditor, holding $1.O billion. Total public Figure2: Mozambique NPV of debt-to-exports ratio external debt is about 75% of 160 - GDP (end-2002), comparedto UpdatedCP projections 170% in 1997, or two times 2002 140 +CAS basecase exports of goods and services. +CAS basecase (lower grants) ......CAShighcase Although domestic debt is much 120 smaller than external debt, it c entails three times the interest -g 5 100 obligations as a result of high a domestic interest rates. Under 80 the HIPC initiative, Mozambique received debt reliefamountingto 60 about $2 billion innet present value (NPV) terms, with IDA 40 relief amounting to $875 million 2000 2005 2010 2015 2020 ($444 million inNPV terms). 111. THE ACTION PLANFOR THE REDUCTION OF ABSOLUTE POVERTY A. The Strategy of the PARPA 22. ThePARPA is the Government'smain instrumentfor harmonizing international support around a locally-owned developmentprogram. InApril 2001the Council of Ministers approvedthe PARPA for 2001-2005, and inAugust 2001 the Bank and FundBoards endorsed it as Mozambique's first full PRSP. The PARPA'Spublic action strategy emphasizeseconomic growth, public investment inhuman capital andproductive infrastructure, and institutional reform to improve the environment for private investment. Growthi s expected to come from large-scale capital-intensive projects financed by private foreign capital; productivity andvalue- addedgains inagriculture and manufacturing; and a general expansion ininternal trade, transport andservices. To implementthis strategy, the PARPA identifies six priority areas for action: health, education, infrastructure, agriculture andrural development, governance, and macroeconomic and financial policies. 23, ThePARPA's goals, objectives and strategies are appropriatetoMozambique's circumstancestoday. A soundprogram of economic reformandmanagement-based on 8  privatization, financial sector reform, investment promotion, trade andprice liberalization, prudentmacroeconomic management and substantial public investment-has underpinned Mozambique's ongoing economic transformation and growth record. InMarch2004 the MPF reported on PARPA implementation inits annual Balanqo do Plano Econdmico and Social (BdPES), which reports on budget execution inthe previous fiscal year to the National Assembly. The Joint Staff Assessment (JSA) o fthe BdPES, which i s before the Boardtoday withthis operation, concludedthat Mozambique's efforts to implement the PARPAare sufficient evidence o f its commitment to poverty reduction, and that the strategy continues to provide a credible poverty reduction framework and a sound basis for concessional assistance. B. FinancingNeedsfor the PARPA and MDGs 24. Despitestrenuous efforts in the 1990s,Mozambique did notprogress at apacefast enough to reach the MDGs. The PARPA's targeted 8% growth rate would reduce the poverty rate to 50% by 2010 and double the consumptionlevel o fpoor households in 12 years. Inline withthis projection, allocations to poverty-orientedexpenditures have (appropriately) risen. In particular, current budget allocations to health and education rose from 4.1% o f GDP in 1998to 7.5% in2003 (see Table 5), on top o f cumulative GDP growth o f 35% inreal terms inthe period. Moreover (as shown inthe PER 2003), with the exception o f upper secondary school andtertiary health services, education and healthbenefits have been distributed progressively compared to the distribution o fconsumption. Sustainedpriority spending (education andhealth) is anticipated inthe PARPA and this i s likely to ensure progress towards the PARPA goals and the MDGs, butprogress will not be fast enough. 25. Moreover,pro-poor expenditures continueto depend heavily on external assistance. The split between recurrentand investment expenditures can only be examinedfor 2000, as full information on donor funding i s available for that year only (see Table 5). In2000, donor fundingaccounted for 46% o f all spending on education, 70% inhealth, and75% inroads and water-much on the recurrent account (for example, drugs andperiodic road maintenance). projectededucation, health, water and roads expendituresare subtractedfrom ceiling recurrent expenditures. It also includes all sectors other than general administration, education, health, agriculture, roadsand water. Boldedfigures includemost externalfinancing, while non-bolded exclude it. Differenceis more evident in the investmentbudget thaninthe recurrentone. 26. A 2003 analysisof Mozambique's developmentprospects concludedthat, with current policies and aidflows, the MDGs that are likely to be met include only incomepoverty, hunger andprimary enrolment. The PER2003 found that: 9  0 Inhealth, reallocations withinthe sector will not suffice to provide modest assistanceto HIV/AIDS patients, much less meet the health and HIV/AIDS MDGs; 0 Ineducation, in-sector reallocations andefficiency improvementswould suffice to achieve the key reforms, but the goal o f universal primary school completion i s unlikely to be attained by 2015; Figure 3: Selected SectorialCurrent Expenditures 0 Inroads, the desiredprogramis adequately funded, except that as % of GDP, 1998-2003 the Government will need to fundperiodic maintenance fully by making an appropriate budgetary allocation; 0 Inwater, reallocations are needed but they will not suffice to achieve the goals inurban water or sanitation; and finally 0 Incivil service reform, which will include salary decompres- sion, goals can be attained I withinthe projectedbudget 0 1 envelope o f 7% of GDP. 1998 1999 2000 2001 2002 2003 27. ThePER 2003 alsofound that thereis some scopefor pro-poor spending reallocations within the Government'soverallbudget. Among the PARPA non-priority sectors (35% of the budget), the PARPAidentifiedactivities that are "complementary" to the priority sectors, including policies for sustainable growth (transport and communications, technology, environ- mental management), social welfare programs, sectoral policies that contribute to income generation (business development, fisheries, mining, industry, tourism), and programs to reduce vulnerability to natural disasters. The 2003 PER suggested that consideration be given to reducing spending on these activities by holding their allocations constant inreal terms or applying a modest percentage decrease throughout as they are not the key priorities. 28. Analytical work hasshown that absorptive capacity is an issue in all PARPApriority sectors, and especially inhealth, with its weak links betweeninputsand outputs, and inwater, where substantial under-executiono f the budget has beenthe norm. As a result, makingfaster 10  progress towards the MDGswould require significant policy and institutional reform as well as substantial additional resources that are explicitly targeted on, and succeed in, raising absorptive capacity. With this combination, by 2015 the MDGscould also be met with regard to primary completion, HIV/AIDS and access to water, though the gender as well as the child and maternal mortality goals likely will not be met even inthis scenario (see Figure3). Figure 4: Prospectsfor meetingthe MDGs: two scenarios I With Current Policies, Institutionsand External Resources 1 With Better Policies, Institutionsand Additional External Resources Hunger Enrolment Completion Gender ~~~~1~ Maternal Water EnvironmentI Mortality Other Note: Shadingindicatesthat MDGwill be met; shadingwith + indicates that MDGwill be met by a large margin. 29. Given Mozambique's needfor official development assistance to reach the MDGs, even with very high levels of growth, direct budget support is the best way to absorb such a large increase. As donors have attempted to "ringfence" their projects using technical assistance, foreign experts, and quasi-independent project implementationunits (PIUs), Government systems for service delivery have not improved. Instead, transaction costs have risen; spending has been inefficient; Government capacity and accountability has been eroded by parallel structures; and budgetary resources have been highly unpredictable. A shift to programmatic lending would help to redress these deficiencies by aligning donor financing fully with the principleso f Government ownership and leadership, as established inthe PARPA, andby using Government policies and the budget as the key instruments for implementingthe PARPA. 30. The Government of Mozambique has managed levels of external assistance to GDPin the range of 12-15% of GDPper annumforfive years or so, without ill effect. To be able to absorb these levels o f assistance, Mozambique has appropriately focused on measures to increase its absorptive capacity. Decentralization, capacity-building, andpublic sector reform are central inthis respect. Dutchdisease effectsassociatedwith increased aidrevenues are unlikely to have a negative impact on the tradable goods sector or overall economic growth. Macroeconomic models indicatethat about US$400 million or so that Mozambique receives annually inexternal grant assistanceaccounts for about five percentage points o f annual growth, but much o f that assistance consists inimports o f goods and services and capacity building, which raise the productivity o f Mozambican residents and businesses. Budgetsupport, o f which part is spent on nontradables, tends to strengthen the exchange rate, butthere is little evidence o f undue strengthening to date, as agricultural products remain competitive on world markets. 11  C. PARPA ImplementationProcesses 31. SinceApril 2003, the Governmenthas reoriented PARPA implementation to achieving three major goals: (i) improving the effectiveness of government systems; (ii) increasing external assistancein theform of budget support; and (iii) improving budget certainty, both for the MPF andfor the line ministries. InMozambique's post-conflict period, resources for service delivery have beentransferred through the Government's fiscal transfer system as well as through direct financing channels from the donors, resultinginparallel structures, off-budget expenditures, and special staffing structures as well as the hightransaction costs that these arrangements entail. Inaddition, unpredictability indonor flows has repeatedly resulted in delayed budget allocations from the MPF to spending authorities, particularly at the beginningo f the fiscal year. The Governmentwants and needsto improve performance inthis area andhas sought assistance from its partners, who have committed to providing a larger proportion o ftheir aid inthe form o f budget support and according to a predictable calendar linked to the Government's budget timetable. As a key step inthis process, the Government worked with its external partners, including the Bank and the IMF, to formulate a single plan o f action for the entire partnership,with a tighter prioritizationo f actions andindicators than i s given inthe PARPA itself. This action plan, known as the Performance Assessment Framework (PAF) matrix, aims to ensure that all groups financing the Government's development program act ina coordinated manner and that redundancy and procedural duplication are minimized. 32. The Government will continue to work with its developmentpartners to refine the sub- set of priority actions and indicators included in the PAF matrix and to monitor implementation. The partnership has agreed to holdbiennial meetings to do so, inMarch-April andAugust-September of eachyear, andthe Governmenthas agreedto be heldaccountable for completing the actions thus defined while inreturn its partners have agreed to provide financial support on a more predictable basis and increasingly inthe form of programmatic support. The most recent review meeting took place inMarch-April 2004, and was based on Government plans (as reflected inthe PARPA, the PES, andthe PAF matrices) and achievements (as described inits BdPES, budget execution reports, and various monitoring reports completed in the recent past) over 2003. This review consisted ina backward-looking exercise that assessed Government performance over 2003, and a forward-looking exercise that articulatedmore fully the partners' priorities for 2004 and beyond, through agreement on a revised core PAF matrix. Twenty working groups completed detailed reviews inassigned areas,' and subsequently a supra-technical steering group, chaired by the MPF, reviewed the group outputs and, in consultation with line ministries and the G15 donorsY2articulated a revised PAFmatrix o f key overall actions and indicators against which the Government agreed to be held accountable over the mediumterm (2003-06) (see Annex 2). The overall conclusions and recommendations o f this Joint Review are presentedinBox 1(on page 13). The technicalworking groups focusedon: (i)growth andmacroeconomicstability; (ii) poverty; (iii) monitoring and evaluation(M&E) systems; (v) taxation; (v) budget formulation, execution andreporting; (vi) procurement; (vii) SISTAFE; (viii) public sector reform, decentralizationand corruption; (ix) legal andjudicial reform; (x) financial sector; (xi) the investment climate; (xii) agriculture andrural development; (xiii) the environment; (xiv) telecommunications;air andrailtransportation; (xv) road transportation; (xvi) energy; (xvii) HIV/AIDS; (xviii) healthcare; (xix) education; and (xx) water and sanitation. Participating partnersincludedBelgium, Denmark, the EuropeanCommission, Finland, France, Germany, Ireland, Italy, Netherlands,Norway, Portugal, Sweden, Switzerland, the UnitedKingdom and the WorldBank (the G1S), which inApril 2004 signeda Memorandum ofUnderstandingwith the Government. Observing partnersincluded: Canada, Japan, Spain, the UnitedStates, the UnitedNations, the IMF, andthe African Development Bank 12  Box 1: Overall conclusionsand recommendations of the March-April 2004 Joint Review Implementation in 2003: The Joint Review found that PARPA implementation in2003 was broadly positive. Data from the 2002-03 householdsurvey show that the poverty headcountand poverty gap fell sharply, while growth was strong. PAF outcometargets inPARPA priority sectors (education, health, agriculture and infrastructure) were largely met. Interms of cross-cuttingreforms, notable achievements in 2003 were the revision of the labor decree, the financial audit of BIM,the rise intax revenues, integration of PARPA implementation reporting into the BdPES, passingofthe decentralizationlaw and introduction of districtplanning in21 districts, functional analyses inkey sectors, the launching of a corruption survey, approval ofthe legal andjustice sector strategic plan, and good progress with implementing SISTAFE. Nonetheless, the Review found some shortfalls inmeetingPAF outcometargets and fulfilling PAF priority actions. EP1 completion rates fell short oftarget and are off-track for meetingthe MDG goal. Progress in roadsrehabilitation andperiodic maintenancewas slow due inpart to appreciationofthe Randand concerns within the VAT refundsystem. Pro-poor spendingin2003 was below the 67% PARPA target. The new procurement decree was not yet adopted, and legal andjudicial reform was slow, with a continuedpoor record inprosecutingcorruption cases and arise incaseload backlog. Itwas also notedthat Government operationswere hamperedby the fact that donors' disbursements didnot arrive inatimely manner. Priorities for 2004: The Review confirmedthe importanceof implementingpriorities outlined inthe 2004 PAF and wider commitmentsidentified inthe 2004 PES. Emphasiswas placed on acceleratingthe implementation ofthe national HIVIAIDS responseprogram and on initiating a forensic audit of BAu. Plans to improve planning andbudgetingby streamlining and clarifying the M&Esystemand improving budget execution and transparency (by fully reflectingthe functional classification) were welcomed. The Review stressed the importanceofthe Government's good governance priorities for 2004 to adopt anew procurement code and movethe legal andjudicial reformprogram from planningto action. Actions proposedon aVAT taskforce, customs clearances, labor regulationsandbusiness registration were confirmed as important for improving the investmentclimate, and partners urged action to implement commitments inthe areas ofexternalaudit and procurement. Inthe macroeconomic area, strongsupport was given to Government's commitmentsto controllinginflation, by limitingliquidity andrecourseto banking-sectorfinancing for the budgetand by donors disbursingfunds more evenly andpredictably over the financial year; and to helping reduceinterestrates, by implementing acareful and sustainedfinancial sector reformprogram that increasesbanking-sectorcompetition. Reflecting the country's changing priorities, ina few cases, actions from the 2004 PES were addedto or chosento replace actions previously identified inthe PAF matrix. These included submittingthe revised commercial code to parliament, divesting public equities inthe banking sector, reforming the insurancesector, increasingresources allocatedto anti-corruption units, and reforming and unifying the prison system. Moreover, it was agreed that some PAF indicators inthe health and educationsectors shouldbe exchanged for others from the PES, since they would give a better indication ofperformance. A limitednumber of2004 PES actions were also highlighted as being very important for PARPA implementation in2004. These included accelerating procurementreform, achieving budget execution accordingto PARPA priority sectors, and ensuringa smooth flow of funds during the year by establishingsounddisbursementtargets. Isyues to be considered for 2005 PESE'AF and budget. It was agreedthat the key issues to be consideredduring the 2005 PES and OE process would largely relate to continuing and strengtheningsector strategies andthe cross-cuttingreforms underway. Inthe latter area, these would include completion ofthe forensic audit of BAuand implementation of IAS inthe financial sector, submissionof anew and less restrictive labor law to parliament, considerationof setting quarterly disbursementtargets, implementing programbudgeting, extending SISTAFE implementation, achieving progresson procurementreform, strengtheningaudit functions, hrtherintroducing participatory district planning, implementingrestructuring plans inthe key Governmentministries, approving an affordable medium-termpay policy, approving and implementing of a responsiveanti-corruption action plan, andsimplifying key codes and laws. Inconclusion, the Joint Review foundthat goodprogresshadbeenachievedinanumber ofareas, giving areliable basis for the G14 donors andthe World Bank to continueto provide budgetor balance-of- payments support to Mozambique. 33. TheJoint Review's PAF matrix, of which thepolicy actions and triggers to be completed with the support of the PRSC are a subset, has clarified the relationship between inputs, outputs,and expected outcomes in the PARPA. Outcome indicators specified inthe matrix are being usedto measure the achievement of development goals, butbecause these indicators are subject to external risks or assumptions about the behaviors of stakeholders outside 13  the Government's control, the Government andmost ofits partners agreed that output indicators would be utilized to measure Government performance annually as the basis for release of budget support. A subset o fthese output indicators will consist o f policy actions and constitute prior actions and triggers to be completed before the approval o f eachPRSC. 34. SincePARPA implementation is occurringthrough Governmentsystems, the Governmenthas begun to align thePARPA with its MTFF,PES, and annual budget. It has also encouraged donors to align their annual review anddecision-making processes with the Government calendar. Figure4 describes the ideal sequencing to be reached ina "steady state", towards which there i s necessarily a transition, andFigure 5 how the PRSC i s embedded inthe PAF M&E structure and developed over its three-year life. Specific changes include that: PARPA implementationwill be aligned with the Government's financial year (January to December). The measuremento f output andoutcome targets would be aligned with the measurement of fiscal outturns and reported inMPF's annual report on PES implementation to the parliament, the BdPES, inlate February or early March. The sequence and timing of existing SWAP review processes will be aligned with the annual PARPA and PES review process, which would occur about two months after the end o fthe fiscal year (i.e. inlate February or early March), thus allowing fiscal results from the previous fiscal year (January to December) to inform these reviews. The PARPA andPES review would precede Government-G15 agreement on an updated PAF matrix. This would allow all parties to review past progress andmake indicative commitments on the basis o f actual outcomes inthe previous fiscal year. The PER process will be annualized andintegrated into the cycle by being split into two parts-a review ofthe outturnso fthe previous fiscal year will be undertakenintime for the annual PARPA and PES review, and inaddition evaluation o f the budget for the next fiscal year's budget will occur separately inAugust/September, before MPF finalizes and submits the budget to parliament. D. Credibilityof the BudgetProcess 35. The Governmentof Mozambique has madeprogress in improvingmacroeconomic management and budgetformulation, execution,and reporting, thoughfurther work remains to be done. During200I,the IMFand the Bank engaged the Government, inthe context of the HIPC initiative, inan overall plan for public expenditure management reform which draws on different elements, including the 2001 PER, SISTAFE, and items inthe Fund's last Poverty Reduction and Growth Facility (PRGF) arrangement. This exercise developed 15 benchmarks o f the quality ofpublic expenditure management. As of January 2004, Mozambique (inline with many HIPC countries) metonly five (see Table 7). The actionplans developedinthe context o f the PERs o f 2001 and2003, the CFAA and the CPAR, reportedinAnnex 3, summarize the key problemsinpublic expendituremanagement as well as the status ofthe actions which the Government is takingto improve the situation. (a) Macroeconomicmanagement 36. Following a period of swift monetary growth and inflation inthe late 1990s, Mozambique completed an adjustment through demand restriction. The effects of this adjustment are likely to 14  4 I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I ~- 6 8 - - - I 1- em2 II o 2 I x I I .-a0m Y -8E C a E .I M 2  A L I I 3 -b , N 0 Q) m3 4 vi 0 0 I N ._ * 0 C 'i I 0 2 -0 I 0 I I + vi 0 I . N 0 u c, a I I vi 9 0 0 c.l 5 E +1 E A I I I I * 0 0 c.l ' 0  - Table 7: HIPC expendituretracking assessment - . - ~. Budget management Benchmark description _ _ - Mozambique status - definition of general government 2. Limited off-budget transactions Off-budgets not substantial Initiated, but still substantial; some receitus proprius in March 2003 ~ budget execution report 3. Reliability ofbudget transactions 1 Level/compositionof outtum close Met; 95% of total budget executed to budget ' in 2002, but wide sector variability 4. Dataon donor financing Both capital andcurrent donor Initiated; donor financing through 1 expenditures included central government by June 2003 Classification 5. Classification of budget Functionaland/or program Initiated; expected by 2005 transactions 71information provided- 6. Identification ofpoverty- Identifiedthrough use of Initiated; functional classification reducingexpenditures classification system implemented at aggregate level, not 140-odd detailed level (to be done I through SISTAFE, on ministry-by- ministry basis. over 2003-04) 9. Quality of internal audit Internal audit function (whether I Met,butnot effective (see details effective or not) inPER) 11. Quality of fiscal/bankingdata Reconciliationof fiscal and Initiated, but not routinely done reconciliation monetary data routinely done I reports providedwithin 4 weeks provided within 8 weeks 1yearend reduEedto 2 months in2003 I 15. Timeliness of final audited Audited accounts presentedto 1 Not met; audited accounts can take accounts legislature within one year 1 up to 2 years to be presented affect the economy for some time. Onthe fiscal side, the late 1990s saw a large expansionin spending, whichis now expectedto be contained to 26% of GDP by 2006. Growth averaged 8.6% from 1997 to 2003 (Table 8), but there is no room for complacency. Over the medium term, highgrowth rates, inparticular inagriculture, will dependon increasingproductivity, which inturndepends on satisfactorily addressingkey constraints such as landuse rights, transportation costs and volatile international prices. Mozambique is also experiencing the consequences of easy money inthe late 1990s. Inthe mid 1990s,reorganization of the banking systemandtight moneyresultedinsingle-digit inflation, but loose monetary policy in 1999 (M2 growth was 35%) brought inflationto 13% in2000 and, as the exchange rate weakenedpari passu, it roseto 17% in2002. Inresponse, monetary policy during 2002 was steadily tightened by increasingreserve requirementsand raisingthe bank rate. Inflation finally fell back to 9% by the endof2002, at the cost of extremely highinterest rates (35% at end-2002). Partly as aresult of these high interest rates, it is believed that Mozambique's small and medium-sized enterprise 17  sector i s experiencing very weak growth, with large firms that are not dependent on Mozambican financial markets explaining most o f the strong growth recently. I (excluding grants) Exchange rate (Mt000: US$) NPV external debtlexports (% ~ I Sources: GoM, IMF and Bank sta HIPC initiative. As the GoMwas not servicingmost of its debt in the mid-l990s, the reductionis mainly a book entry. l The actual impact was areductionin externaldebt service from about $100million to $50million ayear. I 37. Deficits after grants were less than 3% until 2000, when they began to rangefrom 6% to 8%(see Table 9). A prudentfiscal and monetary stance, accompanied by substantial external assistanceand structural reforms based mainly on privatization, tax and customs reform and trade liberalization, resultedinlow inflation, highprivate investment andhighgrowth rates. At the same time, since 1998 there has been a shift inresources infavor ofhealth, education and agriculture, reflecting an increasing anti-poverty focus. Education, health and agriculture increased their combined share intotal budgetary allocations from 29% in 1998 to 39% in2001. ' Nonproject 1 4.3 4.1 6.3 4.3 4.9 3.9 4.1 ~ Overall balance after grants 1 -2.6 1 -2.4 -1.5 -6.0 1 -6.6 -7.9 -4.9 I ' Net external borrowing , 5.7 , 4.6 1.8 3.5 3.9 6.3 4.6 Net domestic financing -3.1 , -2.3 -0.3 I 1.7 ,i 1.9 0.9 0.1 Transfer of HIPC assistance ' O 0 ' 0 ' 0 . 8 1 0.7 1 0.6 0.2 1 Memorandum item: I 825 1! 856 I 1010 1 992 I 1187 1 1227 1265 18  38. Since 2000,fiscalpolicy has resulted in high deficits before grants, rising to about 20% in2001 and2002. These results were dueto asubstantialincrease inspending, whichgrew at 17% annually inreal terms from 1997to 2002, andwhich was not matched by higher revenue (though revenue growth was also high). The major factors behindthis sharp increasein 1999- 2002 were: (i) the Government's paymentof capital contributions into BAuandBCM/BIM, pari passu with its shareholdings inthese loss-making banks; (ii) increase inthe civil service an wage billof 46% inreal terms (growth of 13%per year); and (iii) social spending made higher possible by debt relief granted under the HIPC initiative. 39. Thefiscalposition of 2000-02 cannot be maintained and will be correctedby increasing revenues and constraining expenditures. The Government's deficit levels to date have been possible only due to high levels of foreign grants. While external assistance is likely to remain high inthe short run, inthe longrunit i s likely to converge towards the 6-8% average for sub-SaharanAfrica. Therefore, fiscal adjustment, involvinga relatively demanding revenue effort with measures to restrain expenditures, has become apriority of Government policy. Although there is no IMF-monitoredprogram at present(the previous PRGF arrangement expired inJune 2003 and anew arrangementwill be presentedto the IMF's Board inJune 2004), the IMFandthe Government have agreeda fiscal framework (see Table 10) under which the overall deficit is programmedto fall to -3.2% of GDP in2006. Output and prices Real GDP growth rate I 11.1 112.6 7.5 i 1.5 113.0 17.4 ' 7.1 ' I8.4 1 6.8 1 6.5 1 ' Ii ' 1 Inflation (periodaverage) 6.4 ' 0.6 1I 2.9 12.7 I 9.0 16.8 13.5 i I 12.9 ' 7.8 7.3 ~ Exchange rate-avg 1i11.5 I 11.9 1 12.7 '1 15.7 1 20.7 23.7 1 23.8 .. .. , I Note: Unallocated revenues and expenditures included in overall balance. 40. The macroeconomicframework envisages important changes on the revenue and spendingsides. The macroeconomic scenario presented inTable 10 i s basedon reasonable assumptionsof economic growth, revenuecapability, anddonor contributions. The fluctuations ingrowth reflect the large-scaleprojects (withtheir contributions risingduringconstruction) as well as other direct foreign investment, continued donor support, and agricultural expansion. Budget revenueshave beengrowing fast andsteadily, increasing by 10% per annum inreal terms between1998and2003 from $450 millionequivalent in 1998to about $610million in2003. For sustainability, revenue should reach 16% to 17%percent by 2010, and this target is 19  achievable. O nthe expenditure side, spendingi s programmedto fall, inline with the medium- term perspective o f the PAWA, from 34.1% o f GDP in2002 to 25.8% in2006. This represents a considerable reduction (two percentage points per year) but inreal terms expenditures are still growingat 4% per year between 2002 and 2010, so it is not politically unrealistic. Inaddition, this effort shouldbe accompanied by re-focusing public expendituresonpriority areaswhile improvingthe efficiency and poverty incidence of public spending. 4I. I n 2003, the Governmentreceived $655 million either throughpolicy-based lending or budget support, and in FY04 the Government's budgetprojects receipts of $710 million. Projected receipts include the credit that i s before the Boardtoday. Ifthis credit were not made available to the Government, Mozambique law requires that the budgetwould need to be revised either to reduce projected expenditures by the credit amount or to show alternative methods o f financing the ensuing gap. (3) Budgetformulation 42. Like many countries in sub-Saharan Africa, Mozambique experiences weak government leadership and limited prioritization in budgetformulation. Historically, this has been linked with a limitedorientation towards results and limitedexperience inresults-based management. Partly due to the substantial external aid that Mozambique receives, the Government i s not always able to direct expenditures inline with nationally-determined objectives. Because the MTFF i s not well integrated into the budgetprocess, annual budget adjustmentsare made across lines and institutions without taking into account previous performance or emerging needs, which means that the Government is not making informed, strategic, and contestable choices on inter- and intrasectoral resource allocations. Moreover, the policy process does not always and explicitly consist inGovernment formulation o f a strategy, which donors then agree to finance inspecified parts. Instead, donors makeproject proposals and, ina decentralized fashion, the Government commits itselfto implementing some o f those projects. The result i s a poorly-integrated mosaic o f programs based on different philosophies, o f differing quality, and with widely differing cost structures. The symptoms o f this fundamental problem manifest themselves inseveral forms: 0 Financialprojections inthe MTFFand P A W A are loosely relatedto actions undertaken. 0 Government strategies can consist inbroadly expressed ideals and statements o f intention to produce precise analyses and recommendations (e.g. the Health Sector Strategic Plan). 0 Outcomes are often not measured or reported, and ingeneral have a weak connection with the policyprocess. 0 Program data are limited. Basic information such as their geographical location, the intendedbeneficiaries, disbursements, measures o f their outputand impact, and so forth are not systematically collected or reported, with the result that they can be hardto find, includinginthe key social sectors (education, health, water and sanitation). 0 Actual donor financing for any givenfiscal year is hardto obtain, and so it i s also hardto obtain information on unit costs and almost impossible, without a dedicated PER-type o f exercise, to compare the relative efficiency o f differing approaches and programs. 43. The main objectives of the 2004 budget are to increase domestic revenues, allocate about 65%of total expendituresto the PARPA'spriority sectors, and increase budget deposits in the banking system to decreasedomestic debt and contribute to lowering inflation. 20  Revenues are expectedto reach 14.6% of GDP in2004, comparedto 14.3% in2003, with additional revenues generatedthrough enhancedtax administration. Total expendituresandnet lending will be reducedfrom 29.4% of GDP in2003 to 27.7% in2004. Salaries and other remunerationare expectedto decrease (from 7.5% of GDP in2003 to 7.3% in2004), and goods and services are expectedto increase (from 3.9% of GDP to 4.0%). Interest payments will continue to be somewhat elevated, at about 1.2% of GDP, with about 75% being for domestic debt obligations. (c) Budget execution 44. Preliminary budget executionfiguresfor 2003 indicate that the overall share of actual expenditures allocated to the PARPApriority sectors, excluding election spending and interest payments, was 64.9%. Within this, the priority sectorsreceivedjust below 50% of the recurrent budget but over 75% ofthe total investment budget. The variability betweenthe budget and actual spendinginMozambique remains a concern. The overall recurrentbudget i s usually implementedwithin 9598% ofplannedspending, while averagevariability inthe capital budget over the past ten years hasbeen around 80-85%, with the biggest variation by far coming in donor disbursements. This may indicate an absorption problem, butmuchof the explanation for the large difference betweenbudgetedaid andreportedbudgetoutturn is under-reportingand, to some extent, overly optimistic budgeting for grant-funded donor-run projects. By reducing variability indonor disbursements,the shift to budget support should reduce the variability in Mozambique's capital budget. 45. Functional classi@ers have been introduced into the budget to enable the identification of poverty-reducing expenditures, as agreed in 2001, but important additional work remains to be done to bring it to the appropriate level of detail. Inparticular, the functional, territorial and organic classifiers needto be revised for use inthe budget andthe budget execution reports, and the Government needs to proceedwith its plansto introduce a source-of-funds classifier which will enable it to track the source of funds for specific projects. Inthis context, too, the Government needs to do more work both(i) capture all funds that are "off-b~dget"~-and to (ii)makethebudgetexecutionreportsmeaningful(the4Q-FY03reportlackedanalysis,and to there are discrepancies betweenMPF and sectoral data). The implementation of SISTAFE should helpto ensure the incorporation of donor funding for particular projects as well as a clearer picture ofbudget execution patterns through the application of the functional classifiers. 46. The 2003PER showed that some sectors in Mozambique regularly underspend while others overspend. Underspending especially affects the water and health sectors, and insome years the roads sector. The water sector spent an average of 63% of its current budget allocation over 1999to 2001, while the health sector spent 86% of its recurrent budget in 1999 and 80% in 2000. Provincial spending also appears to be unequal, though this impressionmay arise from incomplete data coverage as data do not reflect some centralized activities. There are also considerable intra-province differences inexecution rates: for example, inZambCziainthe health sector, execution rates for the 1999budget range from 98% to 52%. The PER 2003 found that there are two main causes of underspending: (i) a lack of capacity to operate the duode`cimo ~~ While the MPF through cross-checkinghas beenableto track an estimated38% oftotal donor off-budget flows andreport on those funds through the budget,the failure of donors to ensure that their funds are capturedby the MPF continuesdirectly to disempower the MPF vis-a-vis spendingagencies that receive substantialfimds directly from donors. 21  allocation system, which involves replenishingaccounts against a rendering o f accounts (viz. proofo f correct use o f the funds) inthe previous month; and (ii)timing problem, as late arrival a o fthe first duode`cimos puts some sectors, whose greatest needs arise at the beginningo fthe year (for example, education), indifficulty. The replenishment arrangement, which i s standard inthe region, is appropriate becauseit creates apowerful incentive for accountability andhelps limit overspending. Yet trainingcontinues to beneededinaccountingandthe use ofthe duode`cimo system to make it work without undue delays. The timingproblem can be addressed by having the relevantsectoral ministriesagree with MPF to align the time patternof advances more closely to the time pattern o f expenditures. Starting in2005 with the rollout o f SISTAFE, this arrangement should change: more operational unitswill be broughtunderthe single treasury account and cash advances will be eliminated as operational units instead will make commitments for whichthe payments will be executed by the treasury. 47. Over thepastfew years, the Bank has worked with the Government and other donors to completean extensive review of Mozambique's publicfinancial management arrangements, coveringitspublic expenditure,procurement andfinancial management systems. A CFAA was completed inDecember 2001;a CPAR inearly 2004; andPERs inDecember 2001 and September 2003. A full account o fthis analytical work can be found inAnnex 3. Boththe Bank's October 2003 CAS andthis PRSC seriesare designed to support implementationofthe action plans included inthese documents. IV. THE WORLD BANKGROUP STRATEGY 48. Theproposed PRSCl is based on the Government'sstrong record over thepast ten years in successfully implementing macroeconomicand structural reforms supported by the Bank, the IMF, and other donors. Successive PRGF reviews, PERs, and supervision missions for the Bank's adjustment operationhave confirmed these achievements. A. Consistency of the PRSCwith the CAS 49. ThePRSC is consistent with the CAS. The base case scenario o fthe CAS for FY04-07 envisages a PRSC to support Mozambique's efforts inbuildingpublic-sector capacity and accountability, improving the investment climate, and expanding service delivery and as a basis for sustainable development. It was planned that the Bank through the PRSC would systematically addressthe issues o fpoverty reduction across sectors identified inthe PARPA. To support the implementation o f the PARPA, efforts to maintainmacroeconomic stability will continue, but the focus is increasingly shifting to cross-cutting public sector management and to sector-level issues, with the key challenge being to replicate a strong macroeconomic policy and implementationrecord at the sector level to facilitate economic transformation and permanent poverty reduction. One o f the key CAS objectives i s to achieve a full alignment o f Bank instruments withthe principles o f local ownership and leadership. Because Government policies andthe Government budget are the key instruments for implementingthe PARPA, the Bank is committed increasingly to providing assistance inthe form o f balance o f payments support. Over the medium term, and provided that the Government achieves expected improvements in budget formulation and execution, the PRSC, accompanied by appropriate technical assistance, will become the maininstrument for policy dialogue andthe transfer of financial resources. 22  50. Thisshijl in lending modalities is needed because investmentprojects have been characterized by variable local ownershipandpoor integration with Government-funded sectoral activities, with the result that impact andsustainabilityhas been low. As donors (including the Bank) have attempted to "ringfence" the service-delivery systems intheir projects usingfree-standing technical assistance, foreign experts, andquasi-independent PIUs, they have failed to achieve improvements inGovernment systems for service delivery. Instead, investment projects have tended to: (i) involve hightransaction costs; (ii) promote inefficient spending (as aid has been "tied" to donor-sourced goods and services andlor allocated to donors' favored projects); (iii) the effectiveness o f Government structures by promoting parallel structures, lower off-budget expenditures, and special staffing arrangements; (iv) corrode the normal structures o f accountability by making government account to donors rather thanto the Administrative Tribunal andNational Assembly; and (v) impedepredictability inbudgetary resources, due to the wide range o f disbursement conditions and implementation requirements connected to large numbers of projects. To correct these imbalances, the Government has asked donors to shift to programmatic lending. Such a shift i sjustified on three grounds: (i) the PARPAandthe PAF matrix have evolved into the overarching framework for policy dialogue and formulation both withinMozambique andbetween the Government andmost ofits externalpartners; (ii) progress on the macroeconomic front has lessenedthe need for traditional adjustment lending; and (iii) progress inplanning and budget management provides increasing confidence that public resource allocations are consistent with the Government's poverty-reduction priorities. 51. I t is envisaged that the transitionto general budget support will be a gradual one. PRSC support will coexist initially with investment support to well-articulated sector programs andtechnical assistanceto 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 inoverall financing inFY04 andFY05 will be approximately 35% (or $120 million in $295 million o f newfinancing over the two years taken together). PRSCl will cover primarily cross-cutting issues, policy dialogue, and other Government actions with no physical impact, while PRSC2 and 3 will increasingly embrace sectoral support (agriculture and health inFY04; educationand rural water supply inFY05), thus enabling both Bank and Government learning and a continued evaluation o fthe appropriateness o fthis approach. Within each supported sector, poverty priorities will be specified inthe context o f PARPA implementation as reportedinthe BdPES. The PRSC recognizes that conditionality initself i s ineffective inimproving economic policy andthat domestic considerations, which are relatively immuneto donor pressures, are the primefactor inachieving and sustaining economic and institutionalreform. Domestic support for reforms i s particularly important at this stage in Mozambique's development, to cushion against a potential backlash from utility and infrastructure privatization and to ensure policy continuity into the new Government (to be elected inDecember 2004), and so the PRSC will continue to draw conditions from the PAF matrix as revised from time to time through biennialjoint reviews. B. SupportingPARPAimplementationthrougha PRSC 52. Theprimary aim of the PRSC is to help achieve, and monitor progress toward achieving,a strategic subset of the objectives defined in the updatedPAF matrix. Given the fact that this i s the first cycle of PRSC multisectoral program support, a strong focus on PARPA implementation processes is required. Disbursements will be contingent on progress toward a subset o fthe PARPA's medium-term objectives, as set out inthe biennially updated PAF matrix agreed betweenthe Government and its external partners. Particular emphasis i s put on 23  establishing an adequate M&E system for the prior actions andtriggers included inthe PRSC series, takingcare to ensure that this system also strengthens the Government's poverty monitoring system, includingthe Poverty Observatory. The information derived from the M&E system will permit an assessment o f the impact and results o f PRSC-supported activities, and future PRSC operations will be contingent on demonstrated progress against these activities. Finally, the resources provided throughthe PRSC will complement Government andother donor resources infinancing priority programs for poverty reduction-including particularly budget andbalance-of-payments support providedbythe G15. 53. ThePRSCseries will also serve as the vehiclefor policy dialogue on buildingpublic- sector capacity and accountability, with a strongfocus on strengtheningpublicfinancial management; improving the investment climate; and (in PRSC2 and PRSC3) expanding service delivery. The PRSC series will leverage the Bank's policy dialogue, and other Bank and donor instrumentswill be usedto provide technical assistanceto define and implement reforms, including support to the public sector reform program, legal andjudicial reform, regulatory reform in selected infrastructure sectors, anddecentralization to municipalities and district authorities. The PRSC series will also be complementary to parallel efforts to reduce income poverty, supported through a large portfolio o f investment projects aiming to fight HIV/AIDS andexpandaccess to education, water andsanitation, energy andtransportationservices. As o f March2004, total Bank commitments amounted to $810million($8 1million grants), o fwhich $474 million was allocated to these priority sectors and $101millionto public sector reform, includingdecentralization of planningand managementauthority to local levels (see Table 11). C. Alignment betweenthe Bankand other donors insupportof the PARPA 54. Consultations between the Government and the G15 donors in 2003-04 emphasized four goals and mechanismsfor coordinatingpolicy dialogue, taking into account the desire for greater coherenceand efficiency in supportingpoverty reduction initiatives: 0 The overall development program for Mozambique i s set out inthe PARPA and all external support should be aligned with the PAF matrix, which serves as the framework for determining priorities and assessingthe impact o f chosen interventions. 0 Coherence inpolicy dialogue around the PARPA andthe progress review process applies not only to cross-cutting issues but also to sectoral interventions. 0 Efficiency indonor approaches to policy dialogue, performance assessment, andproject management i s essential to delivering effective support for poverty reduction. Given the hightransaction costs ofmultiple policy dialogues andmultiple systems o fprocurement, financial management, monitoring andreporting for projects, the G15 donors agreed the goals of rationalizing and ensuring consistency indialogue and performance assessment andusing Government systems, processes, andprocedures to the fullest extent possible. 0 General budget support helps to enhance the flexibility and predictability o f aid flows. 55. Agreement on theseprinciples leads to mutual accountability-of the donors to the Government and of the Government to the donors and to its citizens. Inthis context, it was agreed that the donors should increase the share o f their financing that i s channeled through the budgetand, inorder to increase donor confidence inthe fiduciary system, the Government should aggressively pursue its program o fpublic financial management reform, including procurement reform, improved accounting and auditing, and implementation o f SISTAFE. To 24  this end, the Government andthe G15 donors, which together account for morethanxx% oftotal official development assistance andxx% o f general budgetsupport to Mozambique, have established ajoint program to support PARPA implementation, centered around the PAF matrix. InApril 2004, a Memorandum o fUnderstanding (MoU) was negotiated betweenthe Governmentandthe G15 as a basis for harmonizing the G15 financing instruments, ensuring predictable flows, minimizing transactions costs, and ensuringconsistency o f policy dialogue. As is the case for other participatingdonors, withinthe framework o f the MoU,the Bankretains flexibility to determine specific benchmarks and form an independent judgment as to whether the Government has made significant progress. Nonetheless, all parties to these documents are committed to minimizing differences to the greatest extent possible, inan effort to achieve Table 11: World Bank lending activities in Mozambique Project name Development objectives US$ Undisb Education Sector To increase accessto and improve quality o fbasic education through E71m $43m Strategic Program improving education service delivery and management Higher Education To enhance internal efficiency oftertiary institutions; expand output o f E60m $56m graduates; and improve access, quality and curricular relevance HIViAIDS To improve institutional capacity; strengthen delivery of AIDS-related E55m $58m health services; and fund civil society projects covering prevention, grant advocacy, and care for orphans and people livingwith HIVIAIDS National Water To improve availability ofrural water supply and sanitationservices to $36m $20m Development 1 rural communities and ensure sustainable management o f water resources National Water To improve quality, reliability and sustainability o f urban water supply in$90m $81m Development 2 Maputo, Beira, Quelimane, Nampula and Pemba by promotingprivate sector participation inservice provision ~~ Public Sector To transform public service so that the citizens receive services they need $25.6m $27.7m Reform andthe economy can afford, and entrepreneurs are encouraged to invest grant Decentralized To improve performance o fdistrict authorities to plan andmanage small $42m $45m Planningand infrastructure investments, responding to community demand, by grant Finance providing technical assistance and grants so that they can learnby doing Municipal To help operationalize legal and institutional framework for municipal $33.6m $29m Development governance; and establishing and operating a mechanism for providing grants to municipalities through a pilot program in five cities to finance capital investments for municipal capacity building and infrastructure Roads and To improve roads and protect past investments by rehabilitating priority $162m $184m Bridges roads and resuming regular maintenance; strengthen road sector capacity; and develop private sector contractors and operations Railway and Port To increase the operating efficiency and improve the financial viability of $100m Restructuring the three major port-rail systems, through concessioning, andto reduce the surface transport costs o f all freight traffic Energy Reform To expand use of electricity, thus improvingwell-being inunservedand $40m $44m and Access underserved peri-urban and rural areas; and strengthencapacity to increase access to modem energy Enterprise To boost competitiveness ofprivate firms by expanding accessto support $26m $15m Development services, training and capacity-building services; establish linkages to foreign buyers and investors; enhance access to term finance; and strengthencapabilities o fthe MIC, CPI, and selected business organizations Mineral Resources To encourage private investmentinmining, including small-scale and $18m $13m Management artisanal mining; and develop a data bank and geological maps for potential investors Communications To improve accessto andquality of communications services by $14.9m $12.6m Reform increasing competition and private sector participation intelecom- municatiins, postal services, and air transport infrastructure and services Note: Undisbursedtc Is may exceedcommitmenttotal due to SDR:US$ exchangeratemovements. 25  agreed efficiency objectives and greaterpredictability inresourceflows. As an example ofthe Bank's commitment to harmonization, all seven triggers for PRSC2 are explicitly includedinthe restricted PAF matrix agreedbetweenthe Government and its partners inApril 2004. 56. It is expectedthat the PRSCwill bealignedwiththe IMF's nextPRGF arrangement. Mozambique hashadfour Fund-supportedprograms since 1987. The IMF concludedthe fifth and final review of its most recent program, a PRGF arrangement, inJune 2003 and, inline with new guidelines for prolongedusers of Fundresources, staff subsequently preparedan ex-post assessment ofprogressunder this andprevious programs. To helpaddress the unfinishedagenda, including inparticular inmattersthat fall into the Fund's core competencies(fiscal consolidation, financial sector reform, andmonetary andexchangerate management), the Government requesteda successor Fundprogram. Inlight ofthe Government's request, Fundstaff completed discussions on a macroeconomic framework for 2004-06 as well as structural reforms to be supportedby a successor arrangement, which, if approved, would offer Mozambique IMFresources at levels below its quota. It is expectedthat a new PRGF arrangement will be presentedto the Fund's Board on June 21,2004, just before this PRSC is presented, thus enabling the Bank andthe Fundto alignthe PRSC andPRGF cycles. D. Analytic Underpinningsofthe PRSC 57. As Table 12 shows, the first PRSC series is builton analytical work that was completed inimplementing the PARPA andthat informsthe PRSCwithrespectto the adequacyofpolicies and institutions inareas relating to fiduciary and environmental safeguards. 58. Poverty assessment: Usingthe nationally representativehousehold surveys of 1996-07 and 2002-03, the poverty headcount is estimatedto have fallen from 69% to 54% inthe intervening period. Thus, the goal set inthe PARPA of a poverty rate of 60% by 2005 has already beenachieved, with the reductions slightly swifter inrural areas. These findings, which indicate that the Government's overall poverty program is on the right track and achieving results, broadly agree with results from other data sources: (i)MADERdataindicate that the per capita growth rate of cereal crop productionwas 14% inthe six-year period 1996-2002(Le., a little over 2% annually); (ii)qualitative indicators survey (QUIBB) in2000/01 found that a poverty had decreased by ninepercentagepoints, using an econometric technique to linkthe (purely qualitative) QUIBB with the household survey of 1996; (iii) agricultural surveys indicate growth of total maize output of 7% per annum 1996-2002, while the median crop income per capita increased27%; (iv) inthe householdand agricultural surveys, dramatic increaseswere found inthe numbersof bicycles, radios and other assets over 1996-2003; and finally (v) education and health indicator surveys found strong improvements, particularly inthe areas of primary school attendance, vaccination coverage, and attendedbirths, over 1996-2003. 59. Country economicmemorandum:The last CEMwas preparedinFebruary 2001, in close collaboration with the Government. Its recommendations,which are still relevant today, focused on identifying Government actions requiredto improve macroeconomic stability, agricultural productivity, private-sector-led growth, andprotecting the natural resourcebase (see paragraph 18). A new CEM, now under preparation, will reviewthe findings of the 2001 CEM, update its recommendations,and (inlight o f the recent poverty assessment) analyze more fully the linkages betweenpoverty andeconomic growth inMozambique. Itwill also develop policies for the optimal use of natural resources-including land, forestry, fisheries, mining and water- 26  and integrate their management into the overall growth strategy andthe general policy debate about growth. Analytical work on rural development and tourism, supported by the Bank, will contribute to this exercise. Some o f the findings of these inquiries are expected to be incorporatedinto the new PAWA for the period 2006-2010. CEM FYOl Annex 4 for status. CPAR FY04 CPARactionplanendorsedby GoMandnew legislationsubmittedto Financialsector FYOl- analysis FY03 Legalandjudicial FY03 sector assessment InvestmentClimate FY03 Assessment Ruraldevelopment FY04 strategy Primary school fees FY04 OED reviewsof FY02 adjustment operations 60. Public expendituremanagement: PERs were completedinFY02 (inconjunction with the CFAA) and FY04 ina 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 fthese PERs focus on improving budget formulation, execution and reporting to enable better tracking and informed decision-making concerning poverty-relatedexpenditures. As the Bank and other donors provide larger proportions o ftheir assistance inthe form o f budget or balance-of-payments support, the PER process will be annualized and closely integratedwith the Government's budget cycle to support specific reforms inthe budgetprocess. The objective o f these annual PERs will be, in'thefirst instance, to open the budget process within the executive and to stakeholders beyond the executive, to integrate donor financing within the budget, andto provide required technical support. To improve results-based M&E, some public expenditure analysis andreview will be progressively integrated into the cycle of financial management (e.g. through analyzing several sectors eachyear). This will require buildingcapacity through, inter alia, creating a cadre o f public policy analysts, as MPF is now seeking to do in-house. 27  61. Publicfinancial management: A CFAA was completedin2001 incollaborationwith several donors andthe Government, and an IMF Review o f Standards and Codes (ROSC) and a joint Bank-IMF assessment o fthe Government's capacity to track poverty-reducing expenditures have also been completed. All notedrecent improvements andcontinuing challenges in Mozambique's public financial management and fiduciary systems. They also identified specific action plans for dealing with weaknesses incoordinating support and policy dialogue on these issues. Government actions being supported by the PRSC series will play a central role in helpingto implement these action plans (see Annex 3). 62. Procurement: A CPAR was preparedin 2003 and the Government agreed with its findings, including the key recommendations o f the Action Plan. Inline with these recommendations, and with the support o fthis PRSC, a newprocurement decree following international practice will be submittedto Parliament for approval, following consultations with main stakeholders. Dissemination workshops for the new procurement legislationare being planned, and a new Central Policy Directoratewill be established. Inaddition, new national standard biddingdocuments are being drafted and capacity-building programs inprocurement will be offeredto staff inkey ministries. These new procurement practices will be integrated into SISTAFE, with the result that procurement practices will become clearer and more transparent, leading to fewer procurement problems and therefore lower procurement costs. 63. Financialsector analyses: Since 2000, the Bank has completed a study o f the financial sector, M A on Mozambique's compliance with the Base1Principles, and a formal financial sector assessmentjointly with the IMF (FSAP). The May 2003 FSAPassessment found that the potential vulnerabilities of the banking system lie mostly inits loan portfolio; that banksare exposed to highcredit risk due to highand volatile lending rates (themselves due to volatile inflation, highinterest rate spreads and a poor lending environment); that highinterest rate spreads result from large provisioning requirements, highoverheads, and (for smaller well-run banks) highprofit margins; and that the poor lendingenvironment results from highcorporate leverage, a low number o fbankable projects, a weak repayment culture, and various legal and institutional impedimentsto credit selection and recovery. It also found that the volatility o f the metical threatens financial sector stability and development by promoting dollarization and raisingthe cost o f domestic public debt. The PRSC addresses a number o f these issues by supporting Government action to strengthen banking supervision; improve market oversight through transitioning the banks to international accounting standards (IAS); complete the Government's divestiture from the bankingsystem; and improve the lending environment throughneeded legalreforms (including the adoptiono f a newCommercial Code). Inaddition, a proposed Financial Sector Technical Assistance (TA) investment project will provide follow-up TA to facilitate the implementation ofthe mainFSAPrecommendations. 64. Legal andjudicial sector assessment: This Bank assessment, which is under Government review, found that: (i) Mozambique's legal andjudicial sector institutions have not keptpace with economic growth inthe 199Os, with the result that public confidence inthem is low and they are now perceived to be a deterrent to investment and a hindrance to growth; (ii) the sector's keyproblem is arelative lack o f skilledhumanresources; (iii) sector needsto the develop results-focused management practices and a culture of accountability for results; (iv) while some laws (e.g. regarding landand labor) are a hindrance to growth and shouldberevised, the main effort should focus not on legislative but on administrative reform; (v) sector institutions must fight andbe seen to fight corruption, or their reform efforts overall will become irrelevant. The PRSC series responds to these findings by including conditionality linkedto 28  corruption; helpingto institute a results-focused management process within Government; and benchmarking Government actions intended to improve the administration o fjustice and also to be supported through a proposed Legal and Judicial Sector Capacity-Building project. 65. Investment climate assessment (ICA): The Bank, together with the Investment Promotion Center and the Confederation o f Economic Associations o f Mozambique, completed an I C A in2003. From an analysis o f 193 firms surveyed in2002, the I C A found that the most severe constraints to doing business inMozambique included: (i) lack o f access to and the high cost o f finance (cited by 78% o f the sample); (ii)Mozambique's uncertain policy environment; (iii) costsimposedbyregulatoryandadministrativeprocedures;andfinally(iv)inadequate the infrastructure. The PRSC series will help the Government to complete actions designed to ease some o fthese key constraints, including with respect to the time and cost involved inregistering a business; labor regulations governing short-term hires, expatriate hires andretrenchment benefits; the time involved inclearing imports and exports, including inparticular at the Ressano Garcia border post with South Africa; as well as the cost and reliability of electricity and telecommunications services. Policy dialogue will also address emergingissues, such as undue delays inthe Government payment of VAT refunds. 66. Rural development strategy: The Government is expected to complete its rural development strategy by the end o f 2004. This strategy i s expected to underpin a revised PARPA(expected in2005) and couldprovide the framework for a new reform agenda. A draft Government concept note indicates that the strategic vision i s to increase the resources available for holistic rural development. Key elements o f the strategy include: (i) sustainable rural development with a multi-disciplinary andpluralistic approach to poverty, social and gender equity, local economic development, natural resource management, and governance; and (ii) an agriculture focus that is achieved by integrating infrastructure, technologies, institutions and capacity-building, non-farm activities, andhumancapital development. The strategy is expected to benefit from the poverty assessment andthe agriculture income survey that were bothrecently completed. With a view to informing Government work on the strategy, the Bank i s currently helping to complete strategic pieces o f sector work on rural finance, natural resource management, public expenditure inthe rural space, community-driven activities, andcommercial agriculture. The findings and recommendations that emerge from this work will shape the Bank's support to agriculture and rural development inPRSC2 andPRSC3. 67. Poverty and SocialImpactAnalysis: Participatory poverty andsocial impact analyses (PSIAs) are beingcarried out as part o f the monitoring o f PARPA implementation. This includes work recently initiated by the Bank on the impact o f lowering primary school fees and plannedwork on labor markets. Inhealth care delivery, a planned exercise inMarginal Budgetingfor Bottleneckswill helpto estimate the marginal costs o f overcoming bottlenecks in the availability o f inputs, access, adequacy o f coverage and quality o fthree types o f health sector services (clinical services, outreach services, and family/community services), thus enabling decision-makers to choose betweendifferent combinations o f these services to increase coverage and improve the epidemiological impact o f the service provided. 68. OEDreview of recent adjustmentlending in Mozambique: DuringFY02, OED inone document reviewed eight IDA projects, including four adjustment operations, provided to Mozambique during FY90-FYO1. The adjustment operations aimed to 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, andbegin to 29  create the conditions for private-sector-led growth. While criticizing the adjustment operations for having failed to achieve poverty reduction through private-sector-led growth-a criticism that the recently-completed poverty assessmentindicates may be misplaced-the OED review also identifiedseveral 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 infull appreciation o f Mozambique's political economy at the micro level and complemented byprojectsthat could ameliorate some ofthe weaknesses. This is particularly true regardingthe ability o f Mozambicans to participate effectively inthe privatization program. Second, sequencing financial sector reforms is critical to bothfinancial andprivate sector development. Inparticular, weak state-owned banks should be privatized before they are restructured or recapitalized; state-owned banks should beprivatized before large numbers o f other enterprises are privatized, or else inappropriate resource allocation may occur; state-owned banks should be privatized without permittinga sizeable residual government ownership, as this ownership could result incontinued connected lending, insolvency and budget obligations; and the absence o f 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. V. THE PROPOSEDPRSCl REFORM PROGRAM A. Overview and Objectives of the PRSC Series 69. ThePRSCs constitutea series of one-tranche operations over threeyears, designedto align thepolicy agenda supported by the World Bank with national policy priorities in the PARPA. The financing needs and levels will be basedonthe medium-termfinancing plan contained inthe Government's MTFF. While recognizing the importance o f each o fthe fundamental areas inthe PARPA, the PRSC series will focus the policy dialogue initially on cross-cutting issues, including particularly ingovernance and public financial management, before expanding the dialogue to other PARPA priority areas, such as education, healthand agriculture. Within this general framework, there were four key considerations inMozambique. 0 Given that this is the first PRSC cycle, a focus on the Government's PARPA implementation processes is highly appropriate. 0 A focus onplanning, budgeting andmanagingpublic service delivery, including through government restructuring andthe introduction o f SISTAFE, will have an important medium-and long-term benefit for service delivery. 0 As indicated inthe recent ICA, Mozambique's growth opportunities can only berealized through decisive action to address various longstandingconstraints to businesses, including the highcost o f banking, labor law inflexibilities, and the highcost involved in business registration; hence these are also appropriate areas o f focus. 0 While the Bank will continue, duringPRSCl,to support sector development programs in agriculture and educationthrough existing investmentprojects, policy dialogue inthese sectors will shift to the PRSC as these projects close during subsequent PRSC operations. 70. PRSCl will support cross-sectoralactions to strengthenpublic sectorperformance and enhance efficiency and effectiveness in the use of public resources. These measures will have a direct impact on poverty reduction, as they will enhance public sector capacity to implement poverty reduction programs inthe priority sectors and generate additional funds for poverty 30  reductionby reducing leakages inthe form o f low allocative or operational efficiency o fpublic expenditures. Key areas o f reform include strengthening public financial management through implementingSISTAFE; reformingpublic procurement; reducing aid dependency through implementingrevenue-enhancing measures; achieving demonstrable results inthe public sector reform program; advancing decentralization to local authorities; and implementinga sound anti- corruption strategy. It also supports reducingthe highest tariff levy, from 30% to 25%. 71. PRSC2 will continueto support actionstostrengthenpublicfinancial management and will also intensify the Bank's engagementon the investmentclimate. Inparticular, a decree will be approved establishing new procurement practices that accord with international standards; a new Financial Institutions law, a bank bankruptcy law, as well as a new Commercial Code will come into force; and decree 57/03 will be revisedto ease restrictions on hiring foreign I~ labor. PRSC2 would also begin to add a sectoral focus on agriculture andhealthcare. Box 2: Selection criteria applied in choosing the componentsof PRSC1-2 from the PAF matrix Inselecting focal areas for PRSC1-2 fromthe PAFmatrix, the Banktook into accountthe followingcriteria: Bank's comparativeadvantage: ExtensiveAAA since 2000 has helpedto diagnose the problemsand identify solutions regardinginparticular public financial management,governance, andthe investment climate. Ithas also equippedthe Bankto provideadvice andtechnicalassistance on designingand implementingpolicyand institutionalreformsinthese areas, where donorsare seekingBank leadership. Expected developmentalbenefits: The developmentalbenefitsof the conditionsincludedinPRSCs 1and 2 for povertyreductionare expectedto be high, as they will helpto secure sustainedbroad-basedgrowth as well as to improve the efficiency of public spending inthe key poverty-reducingsectors andcreate a strongbasis for increasedlendingthroughdevelopmentpolicy operations. Governmentownership: Governmentcommitmentto reforms inthe areas indicatedis highand long- standing, andit will help to ensurethe successfulimplementationof measuresto improvethe systems. Governmentinstitutionalcapacity: Althoughthe Government's capacity insomeofthe reformareas (e.g. accounting,auditing, bankingsupervision, and legalandjudicial process) remainslimited,the PRSCsandcomplementaryinvestmentprojectsare intendedpreciselyto help strengthenthese capacities. Potential role of conditionality: Inmany cases, the conditionalityincludedinthe PRSCswill helpthe Govemmentto designthe reformprogramingreaterdetail andensure its implementation. 72. PRSC3 would consolidatereform efforts regardingpublicfinancial managementand the investmentclimate, and begin to add a sectoralfocus on education and rural water supply. The areas o f intensive engagement for PRSC3 are indicative at this stage and would needto be reconfirmed and specified more concretely duringthe appraisal o f PRSC2 (May 2005). B. The ProposedCredit 73. Theprogram that the PRSC will support and that has been agreed between the Governmentand the G15 is based on thePAF matrix. The Government explicitly designed the first page o f this core matrix (see Annex 2) to consist inoutcomes that are not directly inits control, such as the MDGs, and the following pages to include only actions that are directly inits control. Inrecognition o f this distinction, the PRSC matrix draws its prior actions andtriggers from the second and thirdpages, while maintaining an important monitoring stance vis-a-vis actions and indicators appearing on the first page. The Government's commitment to addressing theMDGsis strong and is reflectedinthe PAWA andthe PAFmatrix; the overall objectives o f these instruments are to sustain highlevels o f broad-based growth and to reduce poverty. The 31  program defined inthese instruments, and inthe PRSC program matrix, will be implemented through Government systems controlled by the Government's PES and its annual budget. 74. PRSCl benchmarksprogress in completing Governmentactions under three components, drawnfrom the Government'sLetter of DevelopmentPolicy (Annex 4, para. 5): Buildingpublic-sector capacity and accountability: Underthis component, the Government i s committedto maintainingmacroeconomic stability, improving public financial management, and enhancing governance. The Government will maintain macroeconomic stability through adhering to an appropriate macroeconomic framework withconsistent fiscal andmonetarypolicies. Itwill improve public financial management through: monitoring closely and allocating 65% o f its resources to pro-poor spending; increasing budgetaryefficiency, transparency and accountability by expanding coverage, ensuringa timely flow o f funds, and implementingSISTAFE; and improving the timeliness and quality o fthe national accounts, auditing and budgetary reporting. In addition, it will reduce aid dependency through mobilizing further domestic resources; deepen its understanding o f the incidence and causes o f poverty through completing and analyzing the results o f the second household income survey; and update the PARPA to reflect the country's changed circumstances as well as progress inimplementing reforms. Finally, the Government aims to improve governance by bringingpublic procurement into line with internationalpractice; restructuring its key sectoral ministries to be more responsive to citizen needs; decentralizing the delivery o f services to local authorities to expand community participation and government accountability; and fighting corruption. Improving the investmentclimate: Government action inthis areais intendedto: strengthen the financial sector, particularly by enhancing the supervision exercised by the central bank and completing the divestiture o f Government ownership inthe banking sector; improve the regulatory framework by reducing impediments to entry and exit and increasing the flexibility o f the labor law; and expand infrastructure services by reducing communicationcosts and makingelectricity less expensive and more reliable-all with a view to makingdomestic productionmore competitive. Expansion of service delivery: Government action inthis areaunder PRSC1 is limited. It will include enablingprimary schools to finance locally-identified needs for basic supplies on a timely basis, through continuing the Direct Support to Schools program, which provides all schools with small grants. Inaddition, public expenditure reviews and environmentalwork will be completedinthe agriculture and healthsectors in preparation for bringingthese two sectors into PRSC2. Inhealth, this will involve completing a planning and costing exercise to address the removal o f constraints inthe health system andhelp improve the link betweenhealthbudgetingand outcomes, while inagriculture andrural development, itwill involve benchmarkingprogress in establishing (i)UnifiedNational Agriculture Institute and (ii) a MADER's Strategic and Operational Monitoring System inall o f its central and provincial institutions. C. BuildingPublic-SectorCapacityand Accountability 75. Under this component,the Governmentis committedto maintaining macroeconomic stability,improvingpublicfinancial management, and enhancinggovernance. Government actions underthis component are at the core o f PRSCl as well as critical to reducing fiduciary risk inMozambique; they are also inareas where the Bank (often working with the IMF)has a 32  comparative advantage vis-&vis other donors. Critical follow-up actions will be supported under the remainder o fthe PRSC series, to ensurethat gains are consolidated. Maintaining macroeconomicstability: 76. Maintaining macroeconomicstability is critical to sustaininggrowth. The Government has beenable to control inflation, despite some slippage since 2000-01 when flood emergencies affected the country, but volatility as well as recent rates o f about 13% over the last two years indicate that continued vigilance is required. Inaddition, domestic interest rates needto be reduced, as they are highinreal terms and involve highspreads. Underthe PRSC, the Govern- ment is committed to continuingto develop and implement a macroeconomic framework that it i s agreed with the IMF to ensure that the policies relating to the budget, the management o f money and credit, and the exchange rate as well as to the regulation and supervision o f banksand other financial institutions are consistent and allow the effective pursuito f sustainable economic growth, low inflation, and highemployment. Inthis area, the Government andthe Bank will continue to work closely with the IMF, which will remainthe lead institution on the donor side. 77. To reduce aid dependency, the Governmentis committedto maintaining strong performance in revenue mobilization. About 50% o ftotal expenditures are donor-financed through direct budget support or investmentprojects, includingSWAps. Moreover, donor contributions to Government spending amount to about 10% o f GDP, which i s more than the average for sub-Saharan Afi-ica, and likely to decline over the long term. Current levels o f budget expenditure will not be sustainable over the long term and a fiscal adjustment i s needed. This adjustment will require the Government to imposeupper limitsontotal expenditures as well as on the budget deficit, which could inturntrigger a reductionon the impetus that fiscal policy has beengenerating into the economy's growth (it has been estimated to contribute some 3% to 4% per year o f annual growth). To ensure that this impetusis maintained, the economy needs to continue to grow at 7% or 8% per annum; public expenditure needs to reachhigher levels o f efficiency and efficacy; budgetcoverage needs to be expanded and enhanced to ensure that all available resources are aligned with the poverty reductionpriorities as established inthe PAF; and inaddition domestic revenues needto continue to grow. Despite progress inimplementing new direct taxes introduced in2003 and earlier, efforts to strengthen the tax system need to continue in2004, inparticular inconsolidating implemented taxes and reinforcing administration. It will be critically important to ensure adequate financial and human resources for full operationo fthe new computerized system o f taxpayers registration and tax collection system. StrengtheningVAT implementationi s also key, including inparticular improving the Government's efficiency inprocessing VAT reimbursement claims. 78. To enhance revenuecollection, the Governmentiscommittedto establishinga central revenueauthority (CRA). Constituent activities inthis process are benchmarkedinthe PRSC. This will involve restructuring tax administration by reforming the National Director of Taxes (DNIA)with aview to makingit a semi-autonomous directorate general (DGI). Inaddition, customs administration i s strengthening its internal management and undergoing institutional change with a view to integratingwith DGIinthe future CRA. As the Aide Mbmoire o fthe 2004 Joint Review noted, critical action to be pursued on tax policy includes: (i) approval o fthe regulations and procedures for legally establishing the CRA in2005; (ii) development o f the common information, communication and computerized systems for tax and customs administrations, also in2005; and (iii) the effective establishment o fthe CRA with unified 33  training and collection systems, in2006. Inaddition, further capacity-building i s required in revenue collection, tax projections and modeling, andtax policy analysis. 79. Through supportingsuch actions,PRSCl and its successor operations will help the Governmentto increasedomestic resource mobilization. The Government has hadremarkable success inincreasingrevenues over the past five years, and this performance is expected to continue. InMay 2003 it implementedfuel tariff adjustments and inNovember 2003 it introduced a withholding tax on civil service incomes: these measures together increased Government revenues in2003 by about 0.7% o f GDP. During2004, it will increase specific fuel taxes to compensate for accumulated inflation since May 2003 and adopt an automatic quarterly adjustment mechanismto prevent their further erosion inreal terms. Inaddition, the Government will consolidate the system for collecting indirect taxes; create a municipal tax system; and also introduce a documento anico for the collection o f all taxes. A draft general tax law setting out the principles o fthe law, the guarantees and obligations o f taxpayers, and the treatment to be accorded to tax crimes will also be submittedto the National Assembly. These efforts are projected to increase total revenue by 0.3 percentage points o f GDP in2004, to 14.6% o f GDP. Increased domestic revenues, combined with steady foreign financing at a level of $650 millionper annum, should produce a gradual reduction o f external budget dependency. In addition, the Government will continue to follow its budget rule, prohibiting recourse to domestic bankingfinance to cover its deficit and setting a cap on total budget expenditure and net lending. This rule helpsnot only to maintain budget discipline but also gradually to reduce the deficit and ensure economic stability. Evenso, itremains the casethat available revenues are not expected to be sufficient to attain the MDGs-an issue that requires further in-depth study. Improvingpublicfinancia1management: 80. PRSCl willsupport ongoing Governmentefforts tostrengthenpublicfinancial managementby improvingbudgetformulation, execution and reporting. Transparency and accountability inthe use o f public resources i s a key citizen right and government responsibility as well as a key contributor to ensuringthe efficiency andefficacy o fpublic administration. It i s also a legitimate donor interest, which grows as donors begin to transfer increasingproportions o f their resources throughthe state budget. To meet its responsibilities inthis area, the Government has been modernizing its public financial management systemto improve controls, decentralize planning and execution, and increase transparency and accountability. Inthe past decade, to sustain highgrowth rates and reduce poverty, the Government has allocated about 65% o f total expenditures, excluding interest payments, to the PARPA's priority sector^.^ Inthe context o f the April 2004 Joint Review, the Government committed to maintaining pro-poor spendingat 65% o ftotal expenditures for 2004, with the social sectors receiving halfo fthat amount, though it was also agreed that pro-poor spending targets would be revised in2005 duringpreparationo fthe new PARPA to ensure that the target is realistic. Through 2004-06, the Government is also implementing a multi-faceted public sector reform program and, on the basis o f a CFAA and the two recent PERs, improving public financial management. Maintaining and ~~ ~ Resourceallocation to PARPA priorities was about 66.5% oftotal primary expenditurein2003, but it fell to 64.9% in2004, principallydueto extraordinary expendituresonthe municipal electionsheld inlate2003. Eventhough there has beenadecline inpro-poor spendingas apercentageofGDP since 2000, as aconsequence ofthe strong growth of the Mozambican economy during the interveningperiod, real priority spendinghas risenconsiderably. In other words, despite the decline inpro-poor spendingas apercentageof GDP, more resources were infact allocated to the PARPA priorities in2003 than in2000. 34  deepening this orientation will also help the Government to meet additional HIPC expenditure- tracking indicators. 81. Most of the medium-term actions identified in the 2001 PERfor correcting deficiencies in Mozambique'sfinancial management system have been executed. The 2001PER found serious deficiencies infiscal management, particularly inaccounting (which covered less than half o f Government spending), cash management (which included a multiplicity o funtracked Government accounts) and auditing (which was underfundedand ineffective). To address these deficiencies, the Government in2001passeda new Financial Management law to initiate modernizationo f the Government's fiscal management system. This law aims to ensure: that allocations inthe (one-year) state budgetare based on and consistent with the PARPA and analyses drawn from the MTFF; that allocations incorporate a functional classification that enables strategic andresults-oriented resource allocation; that accounting is cash-based, in accordance with international standards, so that it i s possible to present a balance sheet that reflects all state assets and liabilities as well as multidimensional information customized to individual sector needs; that the payment system i s computerized, on-line, integrated with the registration o f accounts, andmakinguse o f a single treasury account (conta zinica) that registers all information on payments from all other (physical and virtual) Government bank accounts on a daily basis; that all state assets are registered andvalued on a daily basis, usinginternational depreciation practices (an important control for sectors, such as health, that operate a large networkwith expensiveequipment); andthat ensures the completion of adequate financial and performance auditing. Fully implementing the new law is a multi-yearprocess. Complete implementation, to which the Government i s strongly committed, will help significantly to reduce the level o f fiduciary risk inMozambique. 82. The key reform included in the new Financial Management law is the introduction of an integratedfinancial management system, SISTAFE,now underway. Introducing SISTAFE into the Government i s a complex exercise, which i s beingbenchmarked by the PRSC series. It i s not without risk, and it i s also likely to require more time than originally anticipated. While implementation i s proceeding deliberately and insequence, delays have been frequent, and tangible improvements inpublic financial management are still some time off. To date, to prepare for this introduction, the Government has completed a number o f key preparatory reforms, Inparticular, it has: (i) issued regulations for the Financial Managementlaw; (ii) initiated the introduction o f a new and more-detailed functional classifier into the budget; (iii) started to formulate the budget incurrent prices; (iv) introducedrestrictions on banks accounts held by public institutions; (v) started to incorporate off-budget-or "consigned"-revenues (Le. revenues collected at the level o f the Government's different spendingauthorities) as well as donor-funded expenditures into the budget; (vi) reduced the so-called "complementary period" after the end o f the fiscal year (during which payments may be made for commitments made duringthe financial year) from three to two months; (vii) initiatedtraining for budgetstaff in double-entry accounting; and (viii) established a consolidated electronic treasury account, which will helpto improve control oftreasury operations andcash management. 83. Much remains to be done to improve cash management, accounting and internal control before SISTAFE can befully and successfully implemented. While the Government was originally expected to shift from a duodkimo replenishment system to modified accrual accounting inanticipation o f SISTAFE, it has become clear through implementation experience to date that this shift is too ambitious at present. With the implementation o f SISTAFE, a modified cashbasis o f accounting will be applied through the introduction of a budget credit 35  system against which commitments will be registered and accounted for when a transaction i s incurred; the credit releases will serve as virtual cash allocations and will determine and control the spending ceiling for each budget item. The run-upto implementing SISTAFE will require the introduction of double-entry accounting, under a cash basis, and should include as well the introduction of monthly and annual cashplans into spending agencies to enable a more rational use o f resources. To enable MPF to obtain accurate real-time accounting information, "globalizing accounts" have been created to facilitate movement to a single interlinked account .arrangement,but not all accounts have yet beeninventoriedor interlinked, so it remains impossible for the MPF to read off the cash balance o f the Government inreal time. The April 2004 Joint Review agreed that, inmid2004, the top priorities are: further development o f SISTAFEand e-CUTfisica (an electronic systemof control over the Government's accounts) as well as their integration; testingthe system to avoid future breakdownanduser disappointment; establishing and testing a recovery andbackupplan; and strengthening the management o f the international recruitment^.^ It was also agreed that the Government should continue to target a Technical Unit of the Financial Management Reform Program (UTRAFE) through planned rollout to MPF by June 2004 andtesting inMINEDby end 2004, before the rollout proceeds to other ministries, to enable the IT systems to be tested ina full-production environment. Provided that these targets are met, the Joint Review found that for 2005 it was possible to complete a rollout to ministries covering 60% o fthe budget and for 2006 a rollout to all remaining ministries, thoughthe rollout to municipalities and other autonomous spending authorities would probably not be possible before 2007. 84. The Joint Review alsofound a continuing need to improve execution of the audit function in Mozambique. The Review proposed that inthe 2005 PES and PAF matrix, there should be measurable targets for (i) implementing an action planfor strengthening internal audit functions, at the sectoral, provincial and, indue course, municipal levels; (ii) improving the timeliness, quality and coverage o f external auditing; and (iii) more completely implementing the recommendations o f the audit reports in2004 and earlier years. The Government i s expected to finalize a proposal for the institutional role and the functioning o f the external audit by the end of 2004, with a focus on strengthening parliamentary control and follow-up measures, including legal, disciplinary and other responses to instances o f mismanagement and corruption. The PRSC i s benchmarking Government actions intended to help achieve these goals. To this end, the internal audit department (IGF) is expectedto hireadditional staff, andthe Administrative Tribunal, which has already seen its budget increase by 10%inreal terms over 2001-03, is expected to make more effective use o fpartnershipswith private auditing firms. By 2005, the Government i s expected to have progressed significantly towards its goal of auditing state accounts within 12 months o f the close o fthe financial year (it now takes more than 24 months). 85. Other actions are also needed and contemplated, including improving the role of the MTFF and integrating the Government's variousplanning and budgetinginstrumentsmore fully. Makingthe MTFF an operational instrument and integratingit fully with the PARPA and the PESwill improve budgetingand executioninthe PARPA priority sectors; doing so will also help to strengthen the Government's M&Esystems, whichare critically important to assessing its performance inimplementing the PARPA. At present the lack o f a medium-term perspective results inincrementalbudgeting (i.e. budgetadjustments are made across lines and institutions without taking into account previous performance or emerging needs), which means that the A second advisor fromthe IMF was recently recruited. 36  Government i s not makinginformed, strategic, and contestable choices on inter- and intrasectoral resource allocations. To help address this lacuna, the Government andthe donors have agreed that the PAFmatrix will be updated annually and fully reflected inthe MTFF and inthe annual statutorily-required management instruments o fthe Government, namely, the PES and the budget. Inaddition, the BdPES will be further improved as a monitoring instrument, and a more comprehensible format will be developed for the Quarterly Budget Execution Reports (QBERs). Inthe context ofthe April 2004 Joint Review, itwas agreedthat, in2005, the QBERs will be publishedon the internet; the BdPES will be harmonizedwith them and any differences explained; andthe MTFFwill be made a publicdocument. 86. ThePRSCseries will support continued work in implementing the complex reforms that are designed to improvepublicfinancial management. Inparticular, each PRSC will ensure that budget formulation provides allocations to the PARPA's priority sectors as agreed inthe annual reviewsandthat budget execution i s consistent with these allocations. The PRSC will support continued work to expandbudget coverage by includingconsigned revenues anddonor- fundedexpenditures: inthe remainder of 2004, work will be done to establish the legalbasis for capturing these funds, with a particular focus on MINED and the Ministry o f the Interior (Migration). A study will also be done to examine how to include off-budgets inthe budget as well as the effect ofthis inclusiononrecorded revenues andexpenditures. Throughsupporting the SISTAFE roll-out, the PRSC will help to improve the reliability o fbudgettransactions (as measured, for example, by a budget deviation index that expresses the sum o f all shortfalls and overruns as a percenta e o fthe total budget); introduce a functional classification systemthat meets U.N.standards; and enable the clear and detailed identification o f poverty-reducing % expenditures. Progress inthese areas i s expected to help the Government to meet as many as ten o f the 15 HIPC expenditure-tracking indicators by 2007 (as compared to five met today). 87. Tosupport specificreforms in the budgetprocess and monitor their implementation,the Governmentand the Bank have also agreed to annualize thePERprocess and integrate it into the Government'sbudget cycle. This will be achieved through opening the budgetprocess with- inthe executive andto stakeholders beyondthe executive, integratingdonor financing withinthe budget, andproviding required technical support. These reforms are expected to improve the timing o fthe budgetframework exercise; address capacity constraints on sector andintersectoral budget analysis; improve the linkages betweenthe budget and other integrativeprocesses, such as the PES and the PAWA; clarify the respective roles o fthe executive, the legislature and other stakeholders, including the donors; and minimize the impact o fprior agreements with donors outside the budget process. By providing TA on an ongoing basis to build (inaddition to the traditional focus on expenditure controls) a focus on defining and reporting budget outputs and outcomes and feeding this information back into the design o f the next budget, these reforms are expected to result ina stronger performance orientation o f budgetdiscussions. This will enable budgetdiscussions betweenthe MPF andother spendingauthorities to involve an exchange o f proposals and counterproposals backed by properly-developed arguments justifying the proposals by linking resource-allocation with goal-setting andperformance reviews. It will also enable the Council o f Ministers to make more informed, strategic and contestable choices on resource allocations. To help address the demands o f continued coordination o fthe process, the hightransaction costs o fconsultation, andrisingexpectations andtechnical standards onbudget formulation andperformance reporting, the Bank and other donors have agreed to provide TA to assist the Government inthese activities. Throughout, the effort will be to ensure that new The system will include functional, territorial, organic and source-of-funds classifiers. 37  demands on public financial management are realistic and met as far as possible by incremental adjustments inexisting processes andthat resident advisers can continue to provide effective advice to the MPF while also developing opportunities for value-adding external review. Hence the outcome o fthese annual PERs will not consist ina report butinsupport to a developing process that rationalizes the budgetprocess and clarifies its link to policy coordination. Improving governance: 88. Improving governanceremains a key priority of the PARPA. Many Government structures and processes inMozambique remain inefficient, including inareas important to business, and incentives to civil servants to perform their duties are limited. The Government i s proceeding with the decentralization o f authority, including for planning and financing, but capacities at the local level remain very weak. The legal framework i s inmany places outdated and inadditionenforcement is weak and often subject to such long delays that it is rendered almost meaningless. Moreover, corruptioni s widely believedto be growing, and recently approved anti-corruption legislation i s taking time to be fully enforced. To diagnose the current situation more exactly, the Technical Unit for Public Sector Reform (UTRESP) has launched a governance diagnostic assessmentwith TA from the Bank. The assessment will provide data and initial benchmark indicators on key governance dimensions usinginformation about actual experiences (as opposed to perceptions) gathered from citizens, business people and public officials. The results o f the governance assessmentwill also serve as an input for the revision andfinalization o fthe National Governance Strategy that UTRESP is preparing. 89. The Government's overall governanceprogram aims to reduce bureaucracy, deconcentrateand decentralizeservice delivery, reform public institutions to make them more responsiveto citizens' needs, and improve the capacity and efficiency to thejustice system. The main instrument for operationalizingthis governance program is the Government's Public Sector Reform Program for 2001-11 (PSR), which has five components: rationalizing and decentralizingthe structures and processes o f service delivery; improving policy formulation and monitoring processes; professionalizing human resources inthe public sector; improving financial management and accountability; and fighting corruption. At present, the major task being implemented under the PSR involves completing functional analyses o f all Government ministries inpreparation for restructuringtheir functions andhumanresources to improve program formulation, management andmonitoring. This process i s being coordinated with cross-cutting work on decentralization, pay reform, and budget formulation and execution. At present, MPF, MAE, MINED, MADER, M I C and M I S A U are nearing completion o f their functional analyses: M I C has presented its analysis to the Interministerial Commission for Public Sector Reform (CIRESP), the last step, while MAE,MADER, MINED, and MPF have presented theirs to UTRESP,whichreviewsthem and issues written recommendations for improvement (UTRESP reports to CIRESP). UTRESP's quality review o f February 2004 shows that ministries are usingparticipatory approaches that include critical thinkingabout what each ministry does andhow it does it; amassingsignificant amounts o fdata, information andanalysis that help to clarify the strengths and weaknesses o f the ministry; and incorporatingthe decentralization policy and the Local State Organisms Law (LOLE) 8/2003. Most ministries have also included restructuring strategies intheir functional analyses, including base estimates of the financial and human resource needs. 38  90. ThePRSC is benchmarking efforts to restructure Governmentministriesand also providing complementary TAthrough thePublic Sector Reform investmentproject. As UTRESP's report indicates, much work remains to be done to strengthen line ministry capacity inplanning, budgetingandfinancial management. UTRESPhas foundthat ministries' reports tendto be weak in: assessingthe policy challenges facing eachministry; linking policy challenges to goals and outcomes; eliminating non-core functions to focus on a core mission; assessing resource implications andinparticular respecting budgetceilings; and fully incorporating the implications of the Local State Organs Law (LOLE 8/2003), inpart because the corresponding regulations are not yet approved. Experience also shows that the teams undertaking the functional analyses, to be effective, needto include individuals with sufficient authority, public sector reform experience, and substantive knowledge o fthe affected sector; that general TORSneedto be tailored to the specific ministry being analyzed; that a communications strategy must be developed and deployed for each ministry to ensure broad involvement and ownership; and that mission statements for each ministry should be allowed to go beyondthe legal mandate o f the ministryto ensure flexibility and responsiveness to future challenges. The Bank will play a key advisory role inhelpingthe Government to implementthe restructuring plans that emerge from the functional analyses o fthe ministries,with a view to improving the policy reform design, implementation, and impact. Through the PRSC and the PSR project, it will also support the implementation o f several high-visibilityresults o fthe PSR, which in2003 included accelerating landregistration and enabling visas to be obtained at the border (these were prior actions for PRSCl), in2004 i s expected to include simplifyingpublic sector and recruitment, improving the pensionpayments process, and simplifying and accelerating hospital administration and patient registration. . 91. ThePRSC will benchmarkprogress in implementingthe civil servicepay reform initiative. The pay reform initiative is expected to revise civil servants' incentives and relate them to performance. This i s expected to permita further increase inpermanent employment in some priority areas while also reducing the wage bill from 7.5% o f GDP in2003 to 7.3% in 2004. To this end the Government is expected to limit the average wage increase for civil servantsto projectedinflation and to exercise stricter control over temporary employment in some provinces. It i s also expected to initiate a process o fverification and rationalization o f pensionbeneficiaries. To enhance professionalism inthe public sector, it was agreed duringthat April 2004 Joint Review that personnel databaseswill be harmonizedandthe career remunerationsystem (SCR) revised during2004. Inaddition, a MediumTerm Pay Policy (MTPP) will be considered by CIRESP; a pensionreview initiated; andthe first phase o f change management orientation training will be delivered to senior staff in2004. The Joint Reviewalso found that, beyond 2004, agreement is needed on strategies to mainstreamgender and take better account of the impact o f HIV/AIDS on the public sector. 92. ThePRSC will also benchmarkprogress in implementingthe Government's decentralizationprogram, which is expectedto help build the capacity of local authoritiesin planning, budgetingandfinancial management. The National Assembly recently approved a new law on decentralization, the LOLE (this was a prior action under PRSC1). Based on a model o f "integrated administration" which strengthens the territorial dimension o f public sector management vis-&vis the currently-predominantsectoral management model, the LOLE reform gives greater powersto district authorities and also provides the legal basis for treating a district authority as a budgetentity for the first time inMozambique's history. Inthis context, the Government has identifieddecentralized participatory planningas a key element o f its strategy 39  for public sector reform and rural development at the district level and developed a National Strategy for DecentralizedPlanning and Finance, which is being funded in large part by an IDA investmentproject andwhich aims to develop the capacity o flocal authorities to identify, appraise and implementsmall-scale infrastructure projects using grant resources to "learn by doing". Ina complementary fashion, the PRSC will benchmark Government action to further this work, includingapproval ofthe regulations for LOLEand implementationprogress as indicatedby an increasingnumber o f districts that have participatory planning processes inplace. The LOLEregulations, which will helpto ensure consistency inthe approach o f line ministries to decentralization, are ready for approval for piloting in30 districts. Participatory planning i s now being rolled out to an initial 37 districts and inaddition the Government i s expected to start preparingan overall decentralization strategy that clearly distinguishes the roles o f decentralization and deconcentration and reconciles relevant legislation. Inthis context, a functional analysis i s planned for completion inMaputo in2004, and improvements are planned to monitor financial performance o f municipalities anddistricts. Regulationsunder the municipal tax code are also under preparation. 93, ThePRSC will also benchmark continuing Government efforts to reduce corruption by removing opportunities and effectively exposing and sanctioning corrupt acts. While Mozambique compares well with low-income and other African countries inpolitical stability, government effectiveness, and rule of law, it compares poorly incontrolling corruption, where relative performance has declined since 1996. The Government is committed to minimizing corruption. Its anti-corruption strategy involves setting ethical standards, reorganizing institutions to minimize opportunity for corruption, and strengthening investigatory and prosecutory agencies. The Government i s currently establishing a working committee to update the October 2001anti-corruption strategy inlight o fa nationalcorruption survey that itis undertakingwith DFIDand WBI assistance. It is also promoting policy and administrative reforms inknown corruption-prone areas such as the judiciary, the police, public financial management, public procurement, privatisation, customs, andtax administration. Inparticular, the MinistryofJustice (MoJ), Administrative Court, Supreme Court, and Attorney General's Office have finalized an overall reform plan, to be implemented through 2006; the MoJhas established an Anti-Corruption Unit;and the National Assembly unanimously passed a new anti- corruptionlaw inMay 2004 (a prior action for PRSCl), thus legally establishing a specialized anti-corruption prosecutorial unit.7There i s now an urgent need to supply this unitwith adequate staff and financial resources (operations to date have been marginal, as the unit has had no permanent staff and no dedicated budget) as well as to strengthen the capacity o fthe Attorney General's Office. Following-up on these developments, the PRSC series will benchmark the Government's anti-corruption efforts by supporting the completion o f corruption surveys (to households, business people and public officials) using a reputable and independent firm to establish baseline data andmonitor trends; the revision o f the Governance and Anti-Corruption Strategy; andthe establishment an anti-corruption agency within the Attorney's General Office. 94. ThePRSC will also support ongoing efforts to improve the efficiency of Mozambique's courts and legal system, which are inefficient and which significantly increase the risk and uncertainty of doing business. Courts take a longtime to render decisions inMozambique, and 'The National Assembly approvedan earlier version ofthe anti-corruption bill inOctober 2003, but President Chissano requestedchanges to ensure its constitutionality before he would sign it into law. After appropriate changes were draftedinto the bill, it was re-presentedto the NationalAssembly, which approved it unanimously on May 13, PresidentChissano signedthe bill and sent it for publication on May 31. 40  executingjudgments is even more problematic. Consequently, businesses avoid usingthem to settle disputes as muchas possible. Inthe Bank's Doing Business database, Mozambique ranks 79 out o f 84 countries on how long it takes to resolve a business dispute from the time a suit is filed untilajudgment is enforced (see also Table 13). Recently, some stakeholders have reportedthat the courts are improving; and some bankers suggested that ifthey use a skilled lawyer and carefully prepare documents, they are able to obtain quickerjudgments. Even so, for the vast majority o f Mozambique's businesspeople, the judicial system i s not seen as a viable option to resolve disputes. Recently an alternative disputeresolution system of arbitration was established, but o f 193 firms sampled inthe I C A survey in2003, none reportedusing it. It i s clear that civil case disposition, particularly relating to property rights and contract enforcement, i s essential to enhance the business climate for national and foreign investments. Within the court system, productivity (case resolved perjudge) and efficiency (lengtho ftime for case resolution) mustbe improved, and inparticular the trendline inthe caseload backlog, which was still rising in 2004, needs to beginto decline. The April 2004 Joint Review found that budget resources to the sector needto be increased and, to help ensure an efficient use o f resources, all sector institutions mustbe involved inapproving the budget andbudget execution (which i s not the case at present). Efforts are also requiredto prevent, detect and penalize corruption inthe sector through procedural simplification andthe implementation o f performance evaluation, inspection, and disciplinary procedures. A study on I Botswana I 77 I how corruption inthe sector manifests will begin in L SouthAfrica 84 2004 andwill emphasize concrete actions inits Malaysia 90 recommendations. Continued progress inhigh- Uganda 99 I India I profile cases, including the B C M fraud cases 1Oh I Malawi 108 underway inmid-2004, i s essential to demonstrate China 180 the effectiveness o f thejustice apparatus as well as I Zimbabwe I 197 I the supremacy o fthe rule o f law. An integrated I Kenva I 255 I statistical monitoring system should be put inplace Mozambique 540 in2004 to assessperformance o fthe sector, andthe sector should also complete the preparationo f guidelines for the restructuring and reformprogram o fthejustice system. To date, Government efforts to improve the sector's outcomes have been focused on updating several o f the basic legal codes-the Commercial Code, the Code o f Civil Procedure (which includes most o f Mozambique's bankruptcy law), the Civil Registry and Notary Code-and implementing the reform plans prepared by the four brancheso f the legal andjudicial sector-the Ministry o f Justice, the Attorney General's Office, the Administrative Tribunal, and the Supreme Court-but progress has been disappointing. To helpensure promulgation o f a new Commercial Code, discussion o f the new Code inthe National Assembly i s a trigger for PRSC2 (see para. 115). 95. With the support of the PRSC, the Government will also implement actions intended to introduce clarity, transparency, and efficiency intoprocurement practices, with a view to minimizingprocurementproblems and loweringprocurement costs. At present, Mozambique has a weak legal framework for procurement as well as poor enforcement mechanisms. Recently, the MPF completed its review o f a Bank-prepared CPAR and agreed with its principal findings and recommendations. Onthis basis, it is preparinga newprocurementdecree that will follow international practice, for submission to the National Assembly later this year, after consultations with the maininterested stakeholders are completed. Inaddition, newnational standard biddingdocuments are beingdrafted; capacity-building programs inprocurement are 41  being initiated for staff inkey ministries; and a new Central Policy Directorate i s being established. The newprocurement processes are also beingintegrated into SISTAFE. All o f these activities are beingbenchmarked inthe PRSC. As indicatedinthe PAF matrix annexed to the April 2004 Joint ReviewAide MCmoire, some "quick wins" may be available: a draft o f the newprocurement decree could bepresentedfor discussion by mid-2004; selectedprocurement audits could be done inseveral ministriesand their top recommendations implemented; and to speedup the reform, a National Commissionfor Procurement Reform could be established, to operate until such time as the new regulatory body comes into being. Looking forward to 2005, the independent appeal function for bidder complaints withinthe Tribunal Administrativo could be strengthened and audits o fprocurement inthe five major ministries, on a random sample basis, could be completed. 96. Work should also be done, on an urgent basis, to remove the bottleneck that has been created by the TribunalAdministrativo exercising its legal obligation to completea fiscalizagdo prhia @re-review) of all state contracts, regardless of size. Duringthe Joint Review, it was agreed that a review o fthe legislationand the function o f the Tribunal will be completed in2004 to indicate how the reviewing responsibility o fthe TA may be shiftedto a randomlyselective post-review regime; at the sametime the Governmenthas been urgedto evaluate the possibility o f establishing minimumthreshold amounts for contracts due for submission to the Tribunal, for possible application in2005. Inaddition, a review o f pertinent legislationand functions o f the Tribunal should aim at strengthening its ability to handle bidder complaints and ex-post random audits o f public sector procurement. Inthis context, the Government i s expected to preparean action plan, for execution in2005 and 2006, to improve the procurement process and its review andaudit procedures 97. I n conclusion, under the componentfocused on building public-sector capacity and accountability, PRSCl expects to achieve thefollowing results: 0 The PARPA, and inparticular its macroeconomic and structural reform program, will have beenimplemented, which inturnshould help to maintain a stable economy and investment climate that maintains economic growth at more than 7% per annum and brings inflation to about 6% to 8% per annum. This overall result will help to reduce the poverty headcount to 50% by 2006-07-n target to reach the associated MDG; 0 An allocation o f 65% or more o fbudget expenditures (excluding interest payments) will have been made to the PARPA's priority sectors, and a two-month credit limit ceiling applied to the key service delivery agencies inJanuary, with the result that social sector spending and outcomes will continue to improve, though not at a fast enoughrate to achieve the associated MDGs; 0 SISTAFE regulations will have been issued and the roll-out completed for the MPF and MINED,which will result inenhanced, more transparent, andmore timely management o fthe budget as well as quarterly budget executionreports makinguse o f more detailed functional classifications-both with a view to improving transparency and accountability inpublic financial management and equippingpolitical decision-makers to make informed choices about the policy options that they have before them; 0 Budget coverage will have been expanded, through the continued inclusiono f donor- funded expenditures andoff-budget revenues captured by government agencies, with a view to ensuring that budgetarysystems capture all government expenditures; 42  The National Assembly will have approved a bill to create a Central Revenue Authority, andthe MPF will have completed an appropriate action plan for implementingit; 0 Tax revenues will have reached about 14.6% o f GDP, thereby helping Mozambique to continue a fiscal adjustment neededto reduce its highlevel o f aid dependency; 0 The Administrative Tribunal's role incontract pre-reviewswill have beenrationalizedto improve the efficiency o f public procurement; 0 The MPF will have completed a reviewo fthe CPAR and indicated agreement with its principal findings and recommendations, with a view to drafting new procurement legislationfor submission to the National Assembly; 0 Several ministries will have completed functional analyses, with a view to restructuring their operations andhumanresourcesto achieve their missionsmore efficiently; 0 TheNational Assembly will have approved a new law on decentralization; and 0 The National Assembly will have approved a newanti-corruption law, andthe new prosecutorialanti-corruption unit will be strengthened. D. Improvingthe InvestmentClimate 98. Thesecond component of the PRSC will support Government efforts to improve the investment climate,particularly for small- and medium-sized businesses. To reduce poverty, Mozambique needs rapid growth sourced inagriculture and labor-intensive manufacturing and services. Improving agricultural productivity will require usingyield-improving inputs and technologies and rehabilitating essential rural infrastructure. Expanding manufacturing and services will require easing key business constraints, which entrepreneurs consistently identify as lack o f access to andhighcost o f credit, highregulatory and administrative barriers, and inefficiencies inkey infrastructure. PRSCl will help to alleviate some o f these constraints through supporting efforts to: (i) strengthen the financial sector; (ii) improve the regulatory environment; and (iii) improve infrastructure services. Strengthening thefinancial sector: 99.A lack of affordablefinance continues to be one of thefundamental businessproblems in Mozambique. Very few firms are usingexternal credit. Inthe sample includedinthe Bank's 2002 ICA, it was found that enterprises relied on their own funds for 90% o f working capital requirements and almost two-thirds o f their investmentneeds. According to the survey, 12%o f respondents had bank overdrafts, while 29% reportedhaving bank loans. Almost all respondents declared that collateral was a requirement for their most recent overdraft or bank loan, and the amount requiredaveraged 140% o fthe credit amount. Firmsalso stated that highinterest rates impededthe use of bank financing: the nominal interest rate for bank credit reportedby the sampled firms averaged 28%, implyingreal interest rates o f around 13-1 8%. These highrates result from weaknesses inthe lending environment, the large provisioning requirements experienced at several of the larger banks, highbank overheads, and (at least for smaller well-run banks) highprofit margins. One o fthe principal aims o fthis PRSC series is to support Government efforts to makethe banking sector more efficient and credit easier to obtain. This involves continued implementation o f a comprehensive financial sector reform program that has experienced some setbacks over the past few years. 100. Strengthening transparency in thefinancial sector through introducing International Accounting Standards (US) and divestingthe Government's remaining ownership stakes will 43  confirm the Government'scommitment to good governance, anti-corruption, andfiscal transparency and responsibility, thereby encouraging intermediation of credit to theprivate sector as well asprivate direct investment and capital inflows. The need for the Government, as a minority shareholder, to contribute to the recapitalizationo f BAuand BCM/BIM over 2001-03 created enormous pressures on public expenditures, with successive contributions totaling about 4% of GDP. BAu, which today accounts for about 20% o f loans and deposits inMozambique, came into being as a result of the partial privatization o f a Government-ownedbank inthe mid- 1990s. The bank's financial position deteriorated significantly inthe following years and by 2000 it was insolvent. The private majority shareholder refused to recapitalize the bank and abandoned its investmentin2001. The central bank intervened inthe same year and offeredthe bank for re-sale. InDecember 2001,AmalgamatedBank o f SouthAfrica (ABSA) purchased 80% o f the bank's outstanding shares (the remaining20% is heldby the employees o f the bank). BCM, which was the largest commercial bank inMozambique inthe 1990s, with 35% o f loans and deposits, experienced a similar history. Itwas created in 1992 by incorporatingthe commercial activities o fthe central bank and partly privatized in 1996 by selling a 51% stake to a consortium ledby the Mello Group o f Portugal. By 1999 B C Mwas reporting large losses and inlate 2000 andearly 2001 itwas recapitalized, withthe Government as holder ofa49% stake paying about half o f the new capital. At the beginning o f 2000 the Mello Group was acquired by Banco Commercial Portugues (BCP), a Portuguese bank that already owned BIM. To rationalize retained the name o fBIM,became the largest commercial bank inMozambique, with more than its Mozambican operations, BCP merged BIMwith B C M in2001,andthe merged bank, which 50% o f loans anddeposits. Despite two previous recapitalizations, the new entity continuedto have a capital shortfall and was recapitalizeda thirdtime inearly 2002. Inthe context o fthe Bank's EMPSO operation, the Government in2003 committed itselfto notusingany further publicresources for bank recapitalizations. 101. BAu and BIMareperforming at a more satisfactory level since they have beenplaced under new ownership. ABSA has restructured BAu, closing unprofitable branches, strengthening internal controls and information systems and shedding workers. Since end-2002, BIMhas embarkedon arestructuringprocess that will involvebranchclosures, employee retrenchments, and a gradual modernization o fprocesses. Although the bank hasjust initiated this operational restructuring, its loanportfolio is now adequately provisionedandthe bank is in compliance with prudential regulations. 102. The recent history of these banks has shown theperil, to the Government, of weak banking supervision combined with minority Government shareholdings. First, the Government's presence may encourage riskybehavior on the part o f the banks' private management, which may harbor expectations that the Government will practice forbearance when the banks that it partly owns encounter financial difficulties. Second, it has also shown that banking supervision inMozambique requires strengthening andthat domestic accounting standards are belowthe standard requiredto ensure financial health andstability withinthe system. Infact, the supervision o f non-banking financial institutions (such as insurers and pensionfunds) is also weak and may generate problems inthe future; inparticular the public social security system may already represent a sizeable contingent fiscal liability, as the accounting, reporting and management systems usedby INSS are reported to be weak. Recognizingthese weaknesses, the Government is implementing a multifaceted programto improve the financial sector. Inparticular, it i s improving the management o f monetary policy andthe useo fmonetary instruments, with a view to controlling inflation andreducinginterest 44  rates andtheir volatility; undertaking a diagnostic review ofthree ofthe largestbanks (in addition to the one bankreview already completed); revisingthe charter of accounts; improving the supervision capacitiesofthe centralbank; requiring all financial institutions inMozambique to operateunder IAS; and assessingthe impact of IAS implementation on tax administration in the financial sector. The Government i s also committed to preparing the privatization of the remaining Government stakes inthe banking sector so that these stakes can bebrought to the point of sale. Action inseveralof these areas has already beeninitiated underthe Bank's EMPSO operation. 103. Under EMPSO, the Governmentagreed to report on the compliance of all commercial banks with IAS and to ensure that non-compliant banks undertook appropriate corrective measures; dialogue around the PRSC will continue to monitor performance in this area. Usinglocal Mozambican accounting standards, which fall materially short of IAS8,the Government is now furnishing quarterly, and insome cases monthly, data on prudentialratios for each ofthe twelve commercial banks inthe countr). For every period, these data show which banksare inand out of compliance with prudentialratios using domestic accounting standards, enabling the Government to issue corrective guidelines to non-compliant banks andmonitor their observance. The Government i s implementing anaction planto bring all commercial banks in Mozambique into compliance with IAS. O fthe twelve commercial banks, two of the larger ones (BAuandthe StandardBank of Mozambique (SBM)), which are bothsubsidiariesof South African-owned banks, submit accounts according to SouthAfrican standards, which approximate IAS-hence the transition to IAS for these banksi s not expectedto be onerous. Inaddition, the other larger Mozambican banks that are owned by Portuguesebanks (BIMand Banco Commercial e de Investimentos (BCI), which recently mergedwith Banco de Fomento) will be transitioning to IAS along with their parentbanks, which are expectedunder Portugueselaw to adopt IAS fully by the time they submit their annual accounts for 2005. Currently, the target date for transition to IAS for all banks inMozambique is for the accounting reports for the year 2006, which is compatible with the plannedtransition inPortugal and also allows sufficient time for smallbanksto complete the tran~ition.~ 104. I n keeping withprevious commitments to the Board, the PRSC is benchmarking Governmentaction to ensure that timelyprogress is made in transitioning to IAS. With support from the EMPSO operation andother technical assistance from the Bank, the central bank in2002 issuedadecreeto make IAS obligatory for all banksand also developedand started to implementan action planfor bringingall banks into compliance. InMarch2004, the authorities completed a diagnostic review of the largestnon-IAS compliant commercial bank, BIM,to analyzeits financial situation inaccordancewith IAS. The central bank has defined terms of reference and arranged the financing to conduct an IAS compliance review of the three larger remaining banks (BAu, BCI and SBM) inthe systemandtraining for the banking supervision department to support the central bank's transition to IAS. The reviews for the IAS are more demanding than domestic accounting standardsregarding(inter alia) disclosure, the treatment o f deferrals, and the provisioning o f loan losses and therefore give a more accurate statement o f a bank's financial situation, but they are not yet observed inMozambique. Inter alia, IASrequires applyingprovisioning rules to the total amount o f a non-performing loan, notjust its past-due component, as well as switching from pure performance- basedevaluation to a forward-looking-based evaluation. The processoftransitioning to IAS may prove to be particularly burdensome for some of the small banks because the technical demands as well as the costs associated, for example, with changing accounting information technology (IT) can be high. 45  remaining larger banks are expectedto be completedby end-2004. Ifnecessary, aremedial action planwill bepreparedand implementedby each bank as its financial situation becomes known. The outstanding agenda relates to: (i) analyzing the tax implications of transition to IAS; (ii) identifyingthe transition challenges facing the smaller banks and supporting their IAS transition; (iii)providingprogramsto supportthe training of banking, accounting and auditing professionals so as to ensure that they are conversantwith the new accounting practices; and (iv) designing the new chart of accounts and supervisoryregulations as well as a detailed transition planfor adoption ofthe new standards. Providedthat all parties make adedicatedeffort, it is possible for the system as a whole, including the central bank, to complete training for and implementing the transition to IAS in2006. As the introduction of new accounting standards i s a complex task involvingmultiple actors, the authorities have agreedto establish a high-level task force includingall involvedparties (the banks, accounting and auditing professionals as well as the central bank) to preparethe transitionprocess, identifytraining needs, andadvise on transition timetable and implementation issues. 105. ThePRSC will support theprivatization of the Government's remaining stakes in BIM and BAu according to a carefully planned process. The privatization ofthe Government's remaining ownership stakes inthe banks raises complex issues, includingthe Government's obligations to the employees, the shareholders' agreementsbetweenthe Government andthe majority shareholdersof the banks, andthe distribution ofthe costs and revenues of various divestiture options as betweenthe Government andthe employees. The processof preparing for the privatizations may be supportedthrough the Bank's proposedFinancial Sector Technical Assistance project (FSTAP) by financing: (i)resident expert on banking supervision to assist a the central bank inactively monitoring and supervising the condition of the banks; (ii) an investment bank to advise on how to proceedwith due diligence, choice of sales method, and conducting the sale; and (iii) the preparationof documents describing the method of divestiture, information on the banks' financial situation, and the intendedsale procedure. Proceeding according to this program will enable the Government to launch tenders in2005; once the tenders are received, the winners can be selected andthe transactions can proceedto closure withinthe following twelve months. 106. Within the context of the PRSC, the Government is working closely with the Bank to ensure that the diagnostic reviews and actionplansfor transition to U S are duly completed and that theprocess of preparingfor the divestiture of the Government's remaining stakes in the banking system isprogressing according toplan. A Project PreparationFacility (PPF) advance for the FSTAP project has already beenmade available for this purpose. This advance i s supporting the implementation of initialreforms inthe financial sector, including some of the diagnostic work requiredto initiate the transition to IAS. The technical assistance under FSTAP will helpthe Government to finance the capacity-building requiredto undertakethe reforms of the financial sector envisagedunderthe PRSC. The PRSCwill also support financial sector reformmore generally andprovide complementary support to help the Government to: 0 Revise the Financial Institutions law, to give the central bank responsibility for issuing and revoking licenses for financial institutions, provide automatic application of penalties for noncompliance with prudential regulations, andmake managersof financial institutions liable for gross violations of banking regulations (approval of this law by the National Assembly is atrigger for PRSC2); 0 Submit anew bank bankruptcy law to theNationalAssembly; 46  0 Divest completely from the financial sector and, inparticular, bring all bankingsector assets to the point o f sale; 0 Complete an actuarial study o fthe social security system and design a strategy and action planto modernize it and ensure that it is fully funded andproperly supervised; and finally 0 Prepare an action planto make the insurance industry compliant with IAS and adequately supervised. 107. While these reforms are not guaranteedto reduce interest rates or the cost of credit, together with reforms to improvethe lending environmentand thejudiciary (which theBank is supportingthrough the FSTAP) they will address the structuralproblems that appear to contribute to these high rates. Restructuringthe dominant banks inthe system shouldhelpthem to increase their operational efficiency and reduce the share o f nonperforming loans intheir portfolios, and this inturn shouldput downward pressure on the profit marginso f the smaller, healthier, banks. Other things being equal, this should help to lower credit costs and improve access to finance. That said, it i s also clear that these reforms will not inthemselves eliminate all o fthe factors that create a poor lending environment inMozambique, including (for example) highcorporate leverage, a lownumber ofbankable projects, aweak repayment culture, and various legal and institutional impedimentsto credit selection and recovery, so the impact i s likely to be limited untilthese factors are also addressed. Improving the regulatory environment: 108. Another area of critical importanceis the regulatoryframework for commercial enterprises. The Government has created a more business-friendly environment inrecent years. For example, Public Administration Decree 30/2001 o f 15 October 2001 requires government agencies to respond to requests for decisions withina fixed time; inaddition, there are now provisions for export processing zones (called Industrial Free Zones (IFZ) inMozambique) as well as several investmentand export incentives. The Government has also introduced new customs procedures andtransformedthe tax system, including through the introduction o f a VAT. The highestlevel of import dutieswas reduced from 30% to 25% for 2004-a prior action underPRSCl-and it is expected to be lowered further, to 20%, in2006. The business community has welcomedthese changes, but they have not yet hadthe expected impact. Inthe I C A survey, it was found that business managers believe government officials retain too much discretion inimplementing new laws and regulations, with the effect that the laws are often renderedineffective-because officials obstruct implementationo f new policies by delaying or ignoring decrees and insome cases because local officials are still ignorant o f the legislated changes. As a result o f this discretion, businesses experience regional differences inthe application o f law and therefore greater levels of government-related uncertainty. Inaddition, a numbero fkey constraints to business havenot yet been addressed. As notedinthe Bank's October 2003 CAS, the Bank intends to focus attention duringthe next few years on several policy and institutional reforms that fall into this category. The CAS results framework includes three specific targets to be achieved over the CAS period. 109. Thefirst target involvesbringing down to international norms the cost (now 97% of GNIper capita) and time (now 153 days) involved in registering a business. Open economies, where firms can easily enter and exit, have higher growth rates thanless open ones; the competition fostered by new entrants forces existing firms to raise their productivity and improve their competitiveness or be drivenfrom the market. Highbarriers to entry allow low- 47  productivity firms to survive and make it costly to reallocate resources to the most efficient uses; they also discourage foreign investment, which has provento be one o fthe most effective ways o ftransferringtechnology and raisingproductivity. At present, entry into the Mozambican market involvestime-consuming and expensiveprocedures for firmlicensing and registration. As few entrepreneurs are willing to endure the process, much economic activity remains unregistered. Those firms that do attempt to register are typically forced to hire a consultant who specializes inregistering firms and (for fees rangingfrom $1,000 to $1,500, which are addedto the government fees) cancomplete the process inthree to five months, depending onthe nature o fthe business, how politically connected the firm is, and how muchthe firm i s willing to pay. But even after a firmhas registered, it cannot yet beginoperations: it must thenregister with the tax department, and ifa foreign firm it must apply to open a bank account and begin applications for residence, work, and import permits. These tasks can easily add another three or four months to the wait. There is anecdotal evidence that these bureaucratic burdens persuade some companies to abandon thoughts o f investinginMozambique. One o fthe key objectives o fthe PRSC is to reduce these barriers to entry. This goal will be pursued inthe context o f a larger effort-included inthe Bank's country dialogue-to reduce significantly the burdenscreated by the Government's regulations requiringnotarial services. Rgure 7: Percentageof firms inMozambiqueranking issues as problems Source: MozambiqueIndustrial Performanceand Investment Climate 2002 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Credit (average) Cost o f financing Access to domestic credrt Access to foreign credit Government (average) Policy uncertainty (average) Corruption Macroeconomic instability Ant1-competitive practices Economic policy uncertainty Trade rates Crime, theft and disorder Administrative barriers (average) Skills andeducation o f w r k e r s Tax administration Customs andtrade regulations Labor regulations Businesslicences Access to land Infrastructure (average) Electricity Transport ation Telecommunications .Large problem aModerate problem UNOor minor problem I 110. To reduce the cost and time involved in registering a new business, the Government under the PRSC is considering computerizing the registration process; integrating the 48  operations of the three institutions involved in thisprocess; and outsourcing somefunctions to theprivate sector. A "one-stop" shop for business registration is already beingestablished in Maputo and Bank staff are closely monitoring Government efforts to reduce the time and cost involved inregistering a business and will continue to do so. Inparallel, new regulations concerningthe licensing o f industrial and commercial activities will be producedto expedite entry and exit and to reduce the cumbersome process o f inspections that needto be done during the productionprocess. 111. Thesecond target involves obtaining a morejlexible labor market. To be internationally competitive, firms mustretain the flexibility correctly to size their work force, while also respecting the rightsandprotections o ftheir workers. This is particularly important for labor-intensive manufacturing firms, whichdepend on customer orders to keeptheir workers employed. Mozambican firms that wish to retrenchworkers when business slows down or when they adopt labor-savingtechnology can do so only at a highcost. Article 69 o f the Labor Law o f 20 July 1998 requires that a retrenched worker receive up to three months pay for every two years o f service. As a result, many firms (37% o f respondents inthe I C A survey) retain more workers thanthey consider optimal; on average these firms would preferto retain only 63% o f their current work force, withthe results that they are spending on average about 20%ofannual sales to pay unneeded workers. This i s a particularly big burdenfor privatized firms, which were required to take on all current workers and then retrenchthem paying the normal severance. The highcost ofretrenchment also discourages firms from expanding production or enteringnew markets. Firmsalso need to be able to hire skilled labor, butthis i s difficult inMozambique, as the workforce lacks sufficient skilled labor. The 2003 I C A shows that firms inMozambique, on average, have very low labor productivity compared to other countries insub-Sahara Africa. Ina comparisonwith Cameroon, C6te d'Ivoire, Ghana, Kenya, Tanzania, Zambia, and Zimbabwe, Mozambique was the lowest for value-added per worker, and this more than offsets the low wages" that Mozambique offers andthat would have given the country a competitive edge on the wage-productivity ratio, ifproductivity were higher. Inthis context, it i s important for firms to be able to enhance productivity through improved access to skilled foreign laborers andthe training opportunities that they provide. Infact, the Bank's Enterprise Development project shows that firms that hire foreign experts to help them are able significantly to increase sales, productivity and profitability. But it i s difficult for firms inMozambique to obtain permits for expatriate workers. Inthe I C A survey, firms reported that on average it took 90 days and almost $400 to obtain a work permit; some firms took as long as two years and nearly $1,250 to do so. Firmsdeal with these issues indifferent, inefficient ways-all o f which drive up the cost o f loInfact, the minimumwage inMozambique,by developingworldstandards, is not so low, at about $47per month comparedto (say) $30 per monthinChina. $47 per monthinMozambiquetotals about a $564 per annum, which is almost twiceMozambique's GDP per capita. At present, Mozambiquecannot sustainsuchahighminimumwage. Taking intoaccount the higher educationandproductivitylevelsprevailinginChina(and inmanyother countries), Mozambique'srelativelyhighminimumwage andlow labor productivityplainly impedecompetitiveness. Ifin additionadministrativebarriersto productivityincreases (such as the hiringofexpatriate labor) andhighcost short- termhiringare factored intothe matter, labormarketconditions emerge as akey issuefor the sustainability of growth andemployment. 49  business. Some bring inexperts on tourist visas and force them to leave the country every 30-90 days to renew their visas; others have expatriates begin work before obtaining legal authority; and others chose not to invest innew technologies because o fthe difficulty inhiringexperts. Interviews suggest that restrictions on employing expatriates are a significant reasonwhy some investors stay away from Mozambique: almost 48% o f the firms with foreign ownership inthe I C A sample said that hiringexpatriates was a major problem for their business. 112. With supportfrom the PRSC,furtherflexibility will by introduced into the labor law by permitting remuneration through piece rates, simpler and cheaperforeign hires (aprior action under PRSCl), and lower severancepayments. Following protractednegotiations betweenthe Ministry of Labor, the Ministryo f Industryand Trade, andrepresentatives ofthe private sector businesses, Decree 5712003 was revisedto allow firms to hire expatriates without obtaining explicit Government approval to do so (a hire i s legally permittedto proceed ifthe Government does not object to it within 15 days o f receiving notification o f the intention to hire). This is expected to constitute a major improvement, and to helpto raise skills-transfer levels and shiftthe balance away from capital-intensive andtowards labor-intensiveenterprises. Bankstaff are closely monitoring the impact o f the new decree as well as the expected articulation o f a new comprehensive labor law, expected in2005. 113. The third target involves lowering customs clearance times, with a focus on the center andthe north ofthe country, where the delays are longest, and on ground shipmentsfrom South Africa border. Since 1998, it has become easier to obtain import licenses; inspections are more efficient; and recently the pre-declaration system, which required firms to pay a deposit o f 15% o f duties owing before they were permittedto import, was abolished. But there are still long delays inclearing goods. The I C A found that, in2002, the mediantime that it took to clear goods after they arrived at the port o f entry was seven days; the average time almost twelve days; and there was wide variation. Clearingtrucks from SouthAfrica required seven days on average, negating the advantage o f proximity to South African markets, which are only a few hours away by road, and encouraging smuggling. Firmsalso reportedthat they could reduce their inventories by 21% on average, andfree up significant capital for investment, ifcontainer clearance times were reduced to 24 hours-as some Asian countries have done. Exporting from Mozambique i s also difficult, with exporting firms reporting that, in2002, it took an average o f 17 days to clear a shipment-even ifthe firm was shipping goods by sea to another port within Mozambique. Ina world where turnaround times and guaranteed delivery are critical, no enterprise can hope to be internationally competitive given these delays and uncertainties. Knowing that importing and exporting i s difficult and uncertain, most companies adjust their business plans, keep large stocks o f raw materials, anddo not enter contracts that require strict deadlines-with the result that potentially profitable business opportunities are foregone. 114. Further work will be done to determine the bottlenecks in customs clearance and remove them. Specific targets will be benchmarked: inparticular, the average number o f days 50  for clearing exports will target seven days or less and for clearing imports at Ressano Garcia will target five days or less. This will help firms to obtain critical inputs ina timely manner, meet strict delivery deadlines, compete better inexport markets, tie-up fewer resources ininventories, andbemore responsive to their customers. 115. I n addition, the PRSC will support revision of the Commercial Code, which datesfrom the late 1800s and is completely outdated. Virtually all stakeholders agree that the Commercial Code needs an overhaul, but there i s still widespread disagreement about what form that overhaul should take. A new Commercial Code has been drafted and presented to the National Assembly, where it has languishedfor about a year, mired incontroversy. Itappearsthat some members o f parliament believe that the new draft has serious deficiencies: for example, some financing methods (such as leasing) that are already inuse inMozambique are not mentionedin the proposed Code. Inaddition, the private sector has complained that the drafters o f the document did not consult sufficiently (although there were public consultations) and inaddition that some o fthe comments that they offered were not taken into account. Finally, there are differences between MIC-which prepared the new draft-and MoJ about the form and content of the draft Code. To ensure that Mozambicanbusinesses have the benefit o f a sound commercial code withina reasonable timeframe, the PRSC benchmarks progress inrevisingthe draft and obtaining parliamentary approval. Written comments have been solicited from both parliament and the private sector so that their concerns can be analyzed and addressed. With support from the Bank's Enterprise Development project (PoDE), M I C i s reviewing comments andrevisingthe draft Code, both inform andinsubstance. Technical assistance for reviewing the comments and drafting appropriate revisions will be provided, as needed. Discussiono f a new Commercial Code by the National Assembly is atrigger for PRSC2. 116. Country dialogue around the PRSC will alsofocus on several issues of importance to private investors where appropriate action has notyet been agreed, including Government payment of VATrefunds. A key issue for many Mozambican businesses is the Government's failure to pay VAT refunds ina timely manner. Inthe I C A survey o f 193 firms, 24 reported beingowed government refunds onproducts that they had exported or on VAT-exempt products that they had imported, and the average amount was more than 13% o f their annual sales. Those companies that received refunds reportedhaving to pay bribes and waiting an average o f 99 days to receive their refunds (the median time was 30 days). Some companies spoke o f having to wait years becausethey were unwillingto pay up to 10% inunofficial fees to the officials involved. Similar experiences were reported with respect to other investmentincentives, such as duty drawbacks. N o firms reportedreceiving refunds ina timely manner. These delayed refunds seriously affect the firms' ability to manage cash flow and, ina country with highreal interest rates, impose an enormous cost on some firms. Investment incentives are useful only ifthey are credible and firms believe that they will actually receive what has beenpromised. Mozambique has appropriate incentives, but it is indanger o f developing a reputation, especially among foreign investors, as a country unableto deliver on its promises. As part o f the PRSC dialogue on the investment climate, the Bank will bring this issue to prominence. The Government has stated that delayed VAT refundsresult from delayed donor disbursements as well as various technical problems. Evenso, Bank staff inpolicy dialogue will urge the Government to undertake to meet reasonable standards (e.g. repayment within 30 days) and pay market rates o f interest on late repayments or, alternatively, to implement a system that allows exporters access to importedraw materials and intermediate goods at international prices, eliminating the need to 51  pay the VAT andthen await refunds. Inthe context ofthe April 2004 Joint Review, the Government agreedto establishatask force to look into this important issue in2004. 117. Another issue of importance to many Mozambican businesses is the number of Government inspectionsper annum, which many businesses consider to be excessive. The ICA indicates that Government inspections(health, labor, etc.), particularly inthe center of the country, now average six innumberper annum (with localofficials responsible for the higher administrative costs incurred), constituting avery high administrative burdenon businesses. Labor regulations and inspectionsare an irritantfor some firms, and there appears to have been little improvement since 1998, when 37% of surveyed firms saidthat dealing with the Inspectorateof Labor was aproblem. The 2002 interviews cited a similar share ofthe overall sample, with almost 50% of firms with more than200 workers reported that the Inspectorateof Labor was aproblem comparedto only 32% of smaller firms. Labor regulations andinspections impose a cost on all firms, but they are particularly burdensomefor foreign-owned firms and large firms, further discouragingthem from increasing their size or formally registering. This issue too will be investigatedand discussed inthe context of the PRSC-supporteddialogue on the investment climate. Inparticular, work will be done to helpthe Government to review its inspectionsregime, rationalize it and limit the discretion of government officials to interpret it. 118. Improving the security and transferability of urban land use rights is also expected to be an important objective of the dialogue supported by the PRSC. After independencein 1975, landinMozambique becamethe property ofthe state. Although urban landuse rights canbe acquiredthrough a legal procedureof plot assignment, the proceduresrequiredexceed the competence of municipal authorities and are complex, time-consuming and expensive (in Maputo, 103 steps and atotal of about $50 infees and stamps are requiredto register an ordinary plot for residential purposes). Ingeneral, landassignments are poorly documentedand rarely registered; poor records and lack of criteria for assignmentallow discretionary behavior and corruption; andplots are sometimes allocated without any overall landuse plan, or inconsistently with existing plans. The result is that alarge proportion ofthe urbanreal estate marketinvolves illegaltrade inplots. This lack of an urban landmanagementsystem that can provide security of tenure, facilitate the transfer of land use rights, avoid duplication of allocations and support enforcementof establishedrights creates serious obstaclesto urbanplanning, efficient and transparentlanduse administration, and a well-developed housing finance market. Italso discourages local andforeign investment. A new legal framework addressinglandregulation needs to be introduced; this should include introducing and/or updating the cadastral systems; reducingthe bureaucracyfor landassignment and assigningclear responsibilities for planning, assignmentand developmentto central and local levels of administration. While changes in urbanlandmanagement laws andregulations could facilitate the transition to private leasehold tenure, staff recognize that this i s currently unlikely to happen. The Interministerial Commission on Land establishedto produce proposalsfor improvingurban land use regulations didnot consider the possibility of creating freehold tenure andfacilitating development of a free market, and it appearsthat the politicalwillto pursuethis route does not currently exist inMozambique. Nonetheless, work i s currently underway withinthe Government to improvethe regulation of urbanland use. 52  Improving infrastructure services: 119. Improving infrastructure services is also critically important toprivate-sector-led growth. The provision o f reliable and affordable cross-cutting infrastructureto businesses is at the core o f Mozambique's growth strategy. The key areas o f concern to Mozambique's businessesare electrical energy and transportation (whether by road, rail, or air). Recent reforms intelecommunications have considerably improvedthe outlook inthat sector, though smaller businesses continue to experience highcosts and limitedfixed lines imply that internet usage remainsvery limited. O fthese sectors, the PRSC will support policy andinstitutional reforms in electrical energy and telecommunications, while the transportation sector will continue to receive investmentproject support. 120. Nearly 64%of ICA-surveyed manufacturers stated that unreliable electricity is a major or severe infrastructure problemfor the sector, and the Government is implementing an energy sector reform program to address theseproblems. Electricity is an important sector for the country, not only for providing domestic enterprises with their energy needs-including energy-intensive industries such as Mozal-but also for potentially lucrative exports into the southern Africa power pool. The key challenges today are to decrease power losses from the grid, increase reliability, andreduce connectionand distributioncosts. Almost one infour firms own generators (which i s less than inthe 1998 survey (34%) and also less than inChina (30%) andIndia(69%)) andthey generate, on average, about 22% oftheir ownpower needs, thoughthe median value (8%) indicates that most firms are able to rely on the power grid most o fthe time. The ICA survey found that the medianfirm inthe sample suffered power interruptions about five times a month in2002, andthe medianloss to productionfrom power outages was 2% of sales. Because most firms are operatingwell below full capacity, they can delay production to times whenpower is available, but as capacity utilization increases andmanufacturingmoves to processes requiring continuous power, unreliable electricity provision will become an increasingly severe constraint. The difficulties faced by the firms sampled stem from the inadequate performance o f the state-owned vertically-integratedpower company Electricidade de Moqambique (EdM) andthe lack o f periodic tariff adjustments. At present, only about 220,000 (or 6%) o f all households have access to electricity, and the pace o f expansion i s slow: only 31,000 new customers were added between 1996 and 2000, and less than 50,000 are targeted for the next four years (compared to the 100,000 new households that will be established). Moreover, even where customers have access, supply reliability is very low. EdM's energy losses exceed 20%; sales per employee are only about 5 MWhper year; the ratio of payroll to operating expenses has increased from 18% to 24%; andthe level o f receivables has deteriorated from 123 days to 147 days. While some o fthese problems may be partly attributable to the floods o f 2000 and 2001, EdMcould do more to improve performance, including better financial management (e.g., better recurrent expenditure control and capital expenditureplanning), improved operational management, and more timely tariffadjustments. 121. To improve efficiency in the energy sector, the Government is implementing an energy sector reform program that aims to achieve immediate efficiency improvements, unbundle generation and distribution, restructure all non-essential activities, improvefinancia1viability, andfinance expansion of access. The PRSC is benchmarkingprogress inthis sector, which (as the April 2004 Joint Review noted) i s not explicitly benchmarked inthe PAF matrix. In2003, the Council o f Ministers approved the separation o f EdMaccounts for generation, transmission and distribution and also issuedTORfor a transaction advisor for bringing private participation into EdMdistribution business. In2004, it i s expected to initiate the legal operational 53  unbundlingo fthe generation, transmission anddistribution functions into separate entities (Genco, Transco and Distco); to retain a capacity-building advisor for Transco; and also to retain the transaction advisor for bringingprivate participationinto Distco. Inaddition, the Council of Ministersis expected to approve a privatizationoption for Distco. In2005, the Government is expected to complete the unbundlingand invitebids for private participation inDistco. With TA, advisory andfinancial support fromthe Bank's Energy Reform and Access Project, an independent regulator will also be established, and investments will take place to builda short medium-voltage and low-voltage distribution line to expand the consumer base where the grid- based and isolated-grid transmission systems are already inplace. 122. Telecommunications was reported to be the least signijicant in rastructureproblem in firms surveyed in the ICA, though the low uptake of internet services`and the low availability of any kind of telecommunicationsservice beyond the main urban centers are indications that further reforms in the sector are needed. Costs inthe sector remainhigh(both for connections and for continuing service) andreliability limited. Inmost industrial areas, there is reliable telephone service, due primarily to the introduction o f cellular telephone service in 1998-1 999, yet poor communications services continue to be a significant constraint for many small businesses, government agencies, and the general public, especially inthe rural areas. To address these problems, the Government i s implementinga wide-rangingand ambitious telecommunicationreform, which i s already helping to improve access as well as the quality of efficient and affordable communication services. These results are being achieved through creating a more competitive environment and introducing private-sector participation inboth fixedandmobile telephone operations. Thus far, the reform has ledto the establishment of an independent telecommunication and postal services regulator, the Instituto Nacional das ComunicaqGes de Moqambique (INCM). A pro-competition telecommunications law conducive to a multi-operator environment was approved in2004, and key regulatory decrees on interconnection, licensing and I N C Morganizationhave been enacted. Inaddition, a strategy to divest the state-owned fixed-line operator TeZecomunicaq6esde Moqambique (TdM) i s being prepared: inthis context, the two state-owned phone companies (the fixed-line telecom, TdM, andthe mobile phone operator, mCel) are beingphysically and financially separated, which should improve accountability and help clarify associated costs and possible cross-subsidies. The entry inlate 2003 o f a second mobile phone operator, Vodacom, is already enhancing competitiveness and bringingrates down while also improving the quality o f services. The PRSC i s benchmarkingthe key milestones inthese reforms, including inparticular the launcho f a process to award a thirdmobile phone license. As noted inthe Aide MCmoire o f the April 2004 Joint Review,this important sector is not benchmarked inthe PAF matrix, though it i s stressed inthe PARPA. Promoting growth in the agriculture sector: 123. With over 70% of thepopulation dependent on agriculture, in the next tenyears agricultural growth will be key to continued economic growth withpoverty reduction. Post- conflict performance has been strong, principally due to the expansion o f area under cultivation. Overall agriculture growth has beenaround 8% per annum. Recent data from the agriculture survey show strong growth since 1996 inthe cash crop sector and maize, especially inTete and Niassa provinces, based on a strong demand-pull from neighboring countries. Crop income More than 80% ofthe sample statedthat they regularly use cell phones. One infive has a website, but only one in three uses electronic mail. 54  contributes substantially to overall household income among the rural poor. Nonetheless, there are variations by provinces, with households inthe southern provinces attributing about 50% to off-farm income sources. To improve agriculture performance further, much remains to be done to increase the use o f yield-improving inputs; encourage the adoption o f improved farming systems and technologies; set agricultural standards and improve key agribusiness supply chains; and facilitate trade through rehabilitating essential rural infrastructure. 124. Governmentpolicy in the agriculture sector isprimarily toprovide an enabling environmentfor growth in the sector; and the PRSCseries will support thefurther articulation, development and implementation of thispolicy. Ingeneral, the Government's agriculture strategy i s oriented around seven elements: (i) establishing and maintaining policy and institutional frameworks geared toward market-based agricultural development; (ii) improving farmers' access to input and output markets through investments inrural transportation and communications infrastructure; (iii) improving the effectiveness o f agricultural support services through decentralization and outsourcing together with the promotion o f farmers' associations, (iv) establishing a legal and regulatory environment conducive to the development o f efficient agricultural markets while at the same time ensuring the rightso f smallholders and communities; (v) ensuring sustainability andsocial equity inthe exploitation of natural resources; (vi) maintaining a stable macroeconomic environment and takingmeasuresto institutionalize "good governance" and rationalize public expenditure in public agricultural programs and institutions; and (vii) establishing the policy framework and incentives to encourage the private sector activity inrural/micro-finance. The Government has made substantial progress inproviding an enabling environment for implementation o fthe strategy. Inthe policy arena, agricultural markets for inputs and outputs have been liberalized andmost distortionary policies have beenreduced or eliminated, except for tariffs protectingthe sugar industry and an export surtax to protect local cashew processing. Extension services (both funds and functions) have beendecentralized to the provincial level, andthe private sector and NGOs are also providing such services, especially for cash crops and livestock services. The processing o f landuse requests has also beensubstantially simplified. Interms o f the legal and regulatory environment, significant steps have beentaken inseveral areas such as land and natural resource management regulations. There are still prevailing constraints to rural finance, butthese are currently being addressedthrough several rural finance studies andprojects and through new legislation to be passed within the context o f overall financial sector reform. 125. To improve theperformance of the agriculture sector, the Government is taking steps on a number of fronts. Itis formulating a rural development strategy, which will be supported through PROAGRI 2. Within PROAGRI, annual work plans are beingdesignedwith specific actions, outputs and outcomes, as well as financing needs, and these will be approvedby the Government and the international partners. The Government i s also decentralizing the delivery o f agriculture services by strengthening provincial governments and district administrations and fostering the role o f farmer associations inproviding agriculture services. Inaddition, it i s improving public expenditure management by ensuring that all expenditures under MADERare withinthe budget (recently 50% were off-budget); restructuringresearch stations to promote partnerships with farmer groups, NGOs and the private sector; and improving tenure security to the smallholder by facilitating the provision o ftitles. WhenIDAcloses its active sector investment project inJune 2005, further support will consist inpolicy dialogue and analytical work provided to MADERthrough the Bank's PRSC missions, with financing provided through the PRSC itself, andtherefore through the MPF instead ofthrough a dedicated investment 55  project controlled by MADER; inthis way, the multi-year transition inthe agriculture sector from discrete IDA investment projects towards full programmatic support will be completed. 126. To help MADER to make this transition,the Bank is helping to strengthenthe managementinformation and evaluationsystems within the ministry as well as to establish a unified agricultural research institute; these actions are benchmarkedin the PRSC2. A key activity o f MADER i s to conduct the agriculture surveys, which were completed in 1996,2002, and 2003. The monitoring ofmany ofthe current PAF indicators is dependent onthese surveys, which inturndepend on sample surveys. MADER's priorities include establishing an operating management information system (SIG) at the provincial and national levels. Work on operationalizing SIG has started and i s expected to be completed by December 2004. At the same time, MADERi s proceeding with restructuringits agriculture research system. Slow progress inreforming the research system-a public good-has constrained technological development and adoption within the sector. Nonetheless, informal collaboration involving the public research system, NGOs, farmers associations, universities, processors and input suppliers has been successful inpromoting food crops production, and this success has provided an impetus to professionalizingthe research system. This restructuring, which i s already underway, will involve: (i) establishing Zonal Research Centers inNampula, Lichinga, Sussundenga and Chokwk; (ii) establishing an Agricultural ResearchCouncil composed o f major stakeholders, includingfarmers andNGO representatives, andresponsible for policy formulation, broad priority-setting, evaluation and donor coordination; (c) establishing and/or strengthening institutions and programs organized aroundagro-climatic regions and; (iv) creating a competitive grant system to foster public-private partnership. These planned reforms inthe research system have gone through a long process o f preparation and important supporting documentation has already been prepared. The Council o f Ministers i s expected to approve the proposed reforms in 2004 and both the International Service for National Agriculture Research andthe Agriculture Brazilian Research Corporation have prepared plans to support that reform. 127. Finally, as a natural-resource based economy,Mozambique needs to ensure that its environmentalregulatoryframework is appropriateand adequately enforced, so that its natural resource base is not exploitedin unsustainableways. Environmental matters were fully treated inthe 2001 PARPA, but they have not received sustained attention insubsequent Government planning documents and the PAF matrix includes no explicit environmental indicators. The April 2004 Joint Review nonetheless found that efforts to ensure the sustainable management o f natural resources are bearing results. One inthree forestry concessions now has a management plan (compared to one inseven in2002), though quality and implementation remain a major concern; various regulations (on sustainable development and medical waste management) were prepared or revised; a national solid urban waste strategy was prepared; numerous site-specific urban or land-use plans were prepared; a new Land Planning law is being prepared; and some training andpublic notificationactivities were completed. The Joint Review also found that the integration o f territorial planning into the PES and at the district level requires further work. Against this background, itwas agreedbetween the Government andthe G15 that the Government over 2004 would complete the following actions: (1) MICOAwould coordinate annual reports on the integration o f environment issues inseven key economic sectors; (ii) a territorial planning law would be adopted; and (iii) territorial planningwould be integratedinto decentralized economic district planning (for this purpose it was also agreed that the appropriate indicator would be the number o f districts per year). It i s also expected that the South East African tourism investment program will be prepared over the coming period. 56  128. I n conclusion, under the componentfocused on improvingthe investmentclimate, PRSCl expects to achievethefollowing results: The TORSandfinancing will have beenarranged for the diagnostic reviews o fBIM, BAu, SBM, and BCUMF to define actionplansfor transitioning to IAS, andthe BIMreview will have been initiated; The highest level o f import duties will have been reduced from 30% to 25%; A preliminary assessmentofthe time andcost involvedinclearing customs will have been completed to establish baseline indicators; A survey ofthe time and cost involvedinregisteringa business will have been completed to indicate progress towards achieving international norms (against a 2002 baseline); A tripartite body, including representatives o fthe Government, the private sector and labor unions, will have discussed proposed revisions to labor market regulations and restrictions on hiringexpatriate labor will have beensignificantly reduced; TdM and mCe1will havebeenmade into separate corporate entities; A new (mobile) telecommunications provider will have entered the market; The Council o f Ministers will have approved the separation o f EdM accounts for generation, transmissionand distribution and also approved TORfor restructuring EdM; MADERwill initiate work to reform its research institutionsand also to establish its strategic and operational monitoring systems inall o f its central andprovincial institutions. E. Expanding Service Delivery 129. Investing in human capital-by improving health and educationoutcomes and curtailing thespread of HIV/AIDS and malaria-are critical toMozambique's continued economicand social development. The PARPA identifies four priority areas for service delivery: (i) fighting HIV/AIDS; (ii) expanding basic health care; (iii)expanding education, especially for girls andwomen; and (iv) improving access to safe water and sanitation services. The PAFmatrix includes a number of benchmarks ineach o fthese areas. PRSCl does not provide direct support to any o fthese sectors, but PRSC2 will beginto provide support to agriculture and the health sector and PRSC3 to the education sector as well as rural water supply. Expanding health services: 130. Provision of health services has improved over recent years, with assistancefrom IDA. Whenthe civil war ended in 1992, Mozambique found itselfwith a weak healthcare infrastructureand poor human capital. Provisiono f health services was urban-biased, as a result o f boththe colonial system andwar-related destruction inthe rural areas. The health status o f the populationwas among the worst inthe world, with an infant mortality rate (IMR) of 162per 1,000 anda maternal mortality rate (MMR)of 1,800 per 100,000 live births in 1995. The spread o f HIV infection was still limited, but accelerating. Moreover, Government spendingon health hadreached a low o f 1.5% o f GDP in 1994, although this was complementedby financing from 15 donors that contributed more than 40% o f total public spending on health. At the time, the sector priorities were clearly to: (i) increase health spending; (ii) the health network; (iii) expand strengthen the capacity o f doctors and nurses; and (iv) improve donor coordination so as to reduce transaction costs for the Ministryo f Health (MoH). Inthis context, the Bank in 1995 approved the Health Sector Recovery Program (HSRP),which supported the rehabilitation o fthe 57  healthnetwork and helpedimprove the capacity ofproviders so as to increase coverage. The project was designedto finance a time-slice of the government's program, thus layingthe basis for developmentof a SWAp. Duringprogram implementation, IMRfell to 126in2000 and intra-hospital MMRfrom 230 in 1993 to 160in2002. Between 1993 and2000, the overall output of the governmenthealth systemroseby 59% and disparities betweenthe northern region andthe rest ofthe country were somewhatreduced. In1999, Mozambique benefitedfrom the EnhancedHIPC Initiative and social sectors were the major beneficiaries. Inaddition, economic growth was strong andthis allowed the Governmentto increase the MoH budget from $16 million in 1995to $30 million in2003 (theyear inwhich the Bank also approvedthe HIV/AIDS project). In2001, the Government finalized the PARPA, and the Bank andother donors began to consider providingassistance inthe form of budget support. Becausethe health sector is largely financedthrough the government budget, health is an important component ofthe PARPA andthus anatural sector to be part of a series of PRSC operations. 131. Despiteprogress to date, significant challengesremain to improvehealth outcomes and reach theMDGs. Infant andmaternal mortality have improved, but remain high. Inaddition to diarrhea and acute respiratory infection, malaria remainsamajor cause of morbidity and mortality. HIV/AIDS prevalencehas increasedto about 14%, placing Mozambique amongthe ten most affected countries inthe world. The current situation i s likely to worsen unless efforts are scaled up and the responseis better coordinated. The main sector issues are as follows: Human resources are limited. Mozambique has one doctor per 44,000 inhabitants, comparedto one for 22,000 inSub-SaharanAfrica. Physician salaries are low compared to Lesotho, Botswana, and Zimbabwe, and incentives to work inthe provinces are limited. As aresult, humanresourcesare very unevenly distributed: fully 60% of higher-qualified staff are concentratedinMaputo City. There is unevengeographic accessto health services, with a strong bias inservice delivery infavor ofthe southernprovinces. The northern provinces are significantly underservedcomparedto the rest of the country, thus limiting the potential impact on health outcomes. Inaddition, services remain very much facilities-based: mobileteams and community health services are underdeveloped. 0 Quality remainspoor. While the volume of drugs and materials andtheir distribution has improved, problemspersist. There are inequalities of supply betweenprovinces and the 2003 Expenditure Tracking and Service Delivery Survey (ETSDS) found that 58%of facilities hadrunout of at least one essential drug during the previous six months.12There i s also unevenness inthe quality of diagnosis andtreatment, and the supervision o f workers remains weak. e Irregular applicationof user chargesis a disincentivetoseeking care. The user fee system is not consistently applied and enforced, making way for negotiations over the price or improper charging ofpatients. The ETSDSfound that in2002, although The ETSDSaimedto examineandimproveaccountability inthe sector. The survey foundthat delays inbudget executionandweak control systems providedscope for leakagesandundue discretioninresourceallocation, with a potentially negative impact on the quality andefficiencyof servicedelivery. Inparticular,the survey foundthat record-keepingwas very poor, so it was impossibleto track funds betweendifferent levels; that the user charge system is inequitable, lackstransparency, andprovidesrent-seekingopportunities; that six inten clinics ranout of at least one essentialdruginthe previoussix months; andthat only eight inten staffwere actually onthejob at any giventime. Expendituretracking surveysare beingundertakeninother sectors and are expectedto be repeated in the healthsectorto monitor trends. 58  consultations are supposed to be free, 35% o f children were requiredto pay. More analysis o fthis issue i s required, but it i s clear that the lack o ftransparency and uneven application o f exemptions may negatively affect the use o f services. Budget execution is low. For reasonsthat are still not fully understood, the health sector is one o f the sectors with the lowest budget execution rates (about 70% in2003). A number o f factors appear to contribute: (i) may be periods o f liquidity problems at there the centrallevel; (ii) provinces receive their budgetary transfer late inthe year, many resulting inlow levels o f execution; and (iii) delays inthe processing o f accounts by provinces that have accounting capacity limitations contribute to delays inthe replenishment o ftheir accounts by the MoH. 132. Government action aiming to improve health service delivery willfocus on strengtheningmanagement and supervision and improving the coverage and skill levels of paramedical staff. To help improve efficiency inthe use o fresources, MISAUis planningto complete a constraint-focused health planningand costing exercise-an action that the PRSC benchmarks-that will helpthe Ministryto estimate the marginal costs of overcoming bottlenecks inexpandingaccess, providing essential health care inputs, andimprovingthe quality o f coverage inthree types of health sector services (clinical services, outreach services, and family/community services). This will enable decision-makers to choose between different combinations o fthese services, which are tailored to different epidemiological problems and have very different cost structures, to increase coverage and improve the epidemiological impact o f the overall service provided. Onthe basis o fthis and other work, the national health strategy (which i s at present more a list o f areas o f strategic focus than an outcome-oriented strategy for the areas listed) will berevised, anda budgetingand cash flow program which attempts to link inputs with activities, outputs, and outcomes, will be prepared every year indicating quarterly financial needs that will fundedby the MPF. Output andoutcome performance will be monitoredthrough the quarterly budget reports. Conditionality, including associated benchmarks, for PRSC3 will be identified duringthe upcoming Joint Reviews (in August/September 2004 and MarcWApril2005). As a result o f this work, it i s expected that Mozambique's healthbudget would be more strategically designed so as to utilize funds for operations and investment inareas where they would have the strongest impact inachieving better health outcomes. The supply o f good-quality cost-effective services would improve together with the demand for them, and the MDGhealth indicators (as well as the PAF matrix indicators) would improve over time. Achieving universalprimary school completion: 133. The Government is also committed to achieving universalprimary school completion, which numerousstudies have shown to be a significantfactor contributing to high growth rates and substantial reductions in poverty. The ability o f individuals to move into more remunerative off-farm employment, adopt riskier andmore complex agricultural technology, and make a successful transition to an urban livingare all closely linked to literacy and levels o f education. An illiterate individual will find it difficult to learn about and adopt new technologies. Thus, to prepare Mozambicans for a better future, the Government i s committed to increasing basic education opportunities for children and adults. To this end, the Government has raised total education spending substantially, from 3.9% o f GDP to 5.8% between 1997 and 2001 (though Government funding, at 3.1% of GDP, remains below the international benchmark of 3.5% stipulated inthe Education for All Fast-Track Initiative or the 4.0% average for sub- 59  SaharanAfrica). As a result, significant gains have beenmade, for example, inraising gross enrolment andreducing repetitionrates, but challenges remain. Completion rates have risen, but they are still very low (24% o f girls admitted to grade 1 complete grade 5 and only 10% complete grade 7), indicating continuing inefficiency inthe system; enrolment inEP2 (higher primary school, grades 6 and 7) is only about 28% o f the corresponding age group, severely limitingprospects for reaching the education MDGofuniversalprimary education by 2015; and the pupil-teacher ratio, at 64:1, is far above the internationalnormof40:1, indicating anacute shortage o f adequately-qualified teachers. 134. The Government has been takingaction to expand access and improve quality. To achieve these dual objectives, the Government i s revisingthe education sector strategic program (ESSP2) to ensure expansion of access to education andtackle critical issues related to gender, HIV/AIDS and decentralized (district- and community-based) school constructionprograms. It is developinga teacher education strategy which will foster a rapid increase inthe number o f teachers meeting at least minimal qualifications, includingrevising the teacher and trainer profiles, type o f training, deployment andcompensation guidelines. It i s introducing a new primary school curriculum that i s relevant to today's circumstances as well as a lower-cost community-based school-construction model which will enable the country to buildmore facilities (3,800 additional classrooms are needed each year until2015-compared to 2,000 a year beingbuilt-to reach the education MDG, and unit costs inMozambique vary by as much as 400% for similar buildings and on average are substantially higher thaninneighboring countries). It i s also decentralizing sector management and financing. To this end, in2003 it initiated a Direct Supportto Schools (DSS) program, through which all 8,000 primary schools nationwide receive small cash grants (about $300 per school every six months) that arejointly administered at the local level by the school headmaster, a local official, and an elected representative o fthe community, thus enabling schools to finance locally-identified needs, from a positive list, on a timely basis.13 This program, which i s supported under the PRSC, i s expected to enable schools to obtainbooks and other teaching materials, thus addressing one of the issuesthat has been a major source o f dissatisfaction for those attending school. As noted in the Aide MCmoireofthe April 2004 Joint Review, the key Government actions to be completed inthe coming 18-24 months include: (i) improving sector planningand performance mechanisms through the definition o fthe policy andinvestment framework for the education system; (ii) increasing the completion rate inprimaryeducation (EP1and EP2) through, among other things, introducing the new curriculum and implementing the pre- and in-service teacher education programs; (iii) ensuring that funds allocated to the sector are fully disbursed, ina timely manner, andthat efficiency o fresource utilization is improved through, among other things, continuing the DSS program and implementing the pilot phase for the low-cost school constructionprogram; and (iv) improving the efficiency and effectiveness o f post-primary education through ensuringthat interventions inESSP2 are included and costed. l3The availability of these resources is publicly advertised (newspaper advertisements indicatehow muchmoney went to which schools, and when). The DSS follows the Government's operational procedures, which are very simple and have beencodified. Eachschool has an account at the district level, inthe school's name, and to move resources signatures are requiredfrom three individuals: the school headmaster, the district education officer, and the elected representative o fthe community (this can be, for example, the chief or the head o f the local Parents- Teachers Association). The DSS fits well with the Africa region's increasing focus on community-driven development as well as the World Development Report on incentives, because ifthe schools manage the resources well, they get more. 60  135. Thisfirst PRSCseries will not explicitly support educationsector reform until PRSC3, butpreparatory work will be completed in the meantime. Further work needs to be done to analyze the causes for Mozambique's highdrop-out and low completion rates: the contribution of demand-side factors (poverty, direct costs, and opportunity costs) or supply-side factors (incomplete schools, distance to school, language o f instruction, quality o f instruction, teacher gender, school calendar andhours of instruction) are unknown. Understandingthese causes i s critically important, as high drop-out and repetition rates make the system exceedingly inefficient: it takes 18 years o f resource inputs, or $613, to graduate one studentthrough grade 7 (compared to 10 years inZambia, or a planned cost o f $232). A PSIA on the impact o f school fees, which i s believedto be an important cause, will help to close this gap inunderstanding. Expenditure trends inthe sector indicate potential, as well as a need, for reallocation. Recurrent costs inMozambique are highcompared to international standards, especially for the upper primaryand secondary levels, andthe pay differential between teachers at different education levels i s excessive, with upper primary and secondary school teacher salaries well above regional averages: infact, secondary school teacher salaries are double the regional average as a multiple of GDP per capita, unsustainablyhigh, and a significant impedimentto expanding secondary education. Moreover, there appear to be unexploited opportunities for cost recovery inhigher education and for more rational use o f limitedresources at the primary level (e.g. by mergingthe EP1 and EP2 cycles into a single primary education cycle to permit a substantial rationalization o fteacher and classroom resources across the two cycles). According to projections made under the Educationfor All Fast-Track Initiative, achievinguniversal primary school completionwill require sharp efficiency improvements to reduce unit costs as well as a significant increase in external assistance-but even then a financing gap is likely to remain. Inline with the targets identified duringthe April 2004 Joint Review, triggers for PRSC3 will be identified in forthcoming Joint Reviews and are expected to focus on the implementation o f ESSP2 as a whole or o fnationalpriority programs such as the in-service teacher education program (CRESCER), the DSS, or the pilot program on low-cost school construction. Improving access to safe water: 136. The Government recognizes the key importance of the water sector towardsimproving the health status of the nation and reducingpoverty. Mozambique is on track to achieve its 2005 target o f increasing access to safe water to 45% nationally. Inthe urbanwater sector, the Government has been implementing a planto bringthe water supply systems inMozambique's five largest cities underprivate management. Inthis context, the private urbanwater supply operator, Aguas de Mogambique (AdM), has increased access by 20% inBeira and 40% in Nampula; inaddition 90% o f water samples now comply with Government requirements while the tariffhas increased steadily from $0.18 in 1995 to $0.40 in2002, helpingthe operator to approach financial viability. Inthe meantime, AdM has also accelerated delegated construction works and visibly improved the conditions o f offices, stores, plant and equipment, while the water supply regulator (FIPAG) has substantially improved its financial management systems. Significant progress has also been made inimproving water supply inrural areas over the past decade. Between 1992 and 2002, rural water supply coverage increased from about 10% to 25%, andthe Government adopted a sound policy andmore efficient institutional arrangementswhich enabled it to leverage public expenditures through greater participation o f communities, users and the private sector inways that will also improve sustainability. Inparticular, the Rural Water Supply and Sanitation (RWSS) Transition Plan has been piloted successfully ina few provinces and districts, and the policy on tariffs and management models for small pipedsystems 61  i s now being formulated, with pilot implementation inseveral communities. The challenge now i s to nationalize this successful pilot program and build the capacity o f relevant institutions to manage the different programs, especially at the provincial level. While lack of funding has beenidentified as a major impedimentto further increases inthe supply o f water, it is likely that the amount of fundingrequiredcan bereduced with improvedM&Esystems and increased private-sector and community involvement. 137. This PRSC series, under PRSC3, will support reforms intended to improve access to and the sustainability of safe water and sanitation services in rural areas. This will be achieved through expandingimplementation o fthe RWSSTransition Planto additional provinces, adopting and implementing the policy for tariffs andmanagement models for small- pipedsystems, improving M&Esystems, and developing an actionplanto facilitate increased involvement o fthe private sector inrural water supply and sanitationto improve efficiency and bringdownboth investment and recurrent costs. Sanitation andhygiene promotion will be carried out at the community level inconjunction with improving water supply. Inaccordance withthe findings ofthe April 2004 Joint Review, priority in2004 should be givento the implementation o f the rural water transition plan, inparticular to the supply chains, the privatization o f EPARs, the management models for small systems, and experimentationwith newtechnologies, while in2005 and 2006, the focus should be on continuing to decentralize and deconcentrate rural water supply and sanitation programs as well as buildingcapacities at the provincial level and initiating the privatization of the EPARs. As inother sectors to be supported by the PRSC series, key measureswill be identifiedandbenchmarked duringsubsequent Joint Reviewsand drawing on their conclusions. This PRSC series will not support urbanwater supply andsanitation: on the "utility" model adopted inMozambique, recurrent expenditures and small works, such as extensions to distribution systems, are intendedto be supported by the utilities' own cash flow and not the Government. Neededlarger infrastructure investments, such as a $20 million investmentrequiredto expand Maputo's treatment capacity, will instead continue to be funded by the Bank's sector investment loans,14the IFC (ifcash flow is robust enough to handle debt service), and perhaps partial risk guarantees. 138. Government actions to expand service delivery will not be supported until PRSC2 (in the case of health care) or PRSC3 (in the case of education and rural water supply); accordingly, PRSCl does not expect to achieve the results under this component. F. ReformMeasuresandActions TakenPriorto Board 139. The listof prior actions that the Governmentcompletedpriorto PRSCl are noted below: Public Sector Capacity and Accountability 0 The Government maintainedanadequate macroeconomic policy framework. Although the IMF's previous PRGF arrangement ended inJune 2003, Fundstaff inearly 2003 reached an understanding with the Government on quarterly indicative targets to monitor performance during the remaindero f 2003, and these targets were met. 0 The Government formulated its 2004 budgetwith agreed allocations to PAWA priority sectors and executed its 2003 budget consistent with agreed allocations; inparticular, it l4 National Water Development 1 and National Water Development 2 (see Table 13). 62  spent 64.9% o f its 2003 budget (excluding interest payments andexpenditures related to the municipal elections inNovember 2003) on the PARPA priority sectors. The Government adopted regulations for implementing SISTAFE. To reduce aid dependency, revenue-raising measureswere deployed, including a 60% fuel tariff adjustment and application o f a withholding tax on the income o f public sector employees. Three key measuresincluded inthe public sector reform program were achieved: (i) the landregistrationprocess was reduced to 90 days, once all documentationwas prepared; (ii) processofindustrialregistrationwassimplifiedandexpedited;and(iii) the visitor visas are now being issuedat Mozambique's borders. The National Assembly passeda new law on decentralization, the Lei dos Org2iosLocais do Estado. The NationalAssembly passeda new anti-corruption law. Investment climate 0 The highest level of import duties was reducedfrom 30% to 25%. 140. The credit amount of PRSC2, which is expected to be appraised and negotiated in March-April 2005, will be afunction of the outcomes of thefollowing actions, which the Governmentexpects to complete by December 31,2004: Public Sector Capacity and Accountabilitv The Government will maintainan adequate macroeconomic policy framework. The Government will formulate its 2005 budget with agreed allocations to PARPA priority sectors and execute its 2004 budget consistent with agreed allocations; in particular, it will spend 65% o f its 2004 budget (excluding interest payments and expenditures related to the general elections scheduled for December 2004) on the PARPA priority sectors. 0 The MPF will implement SISTAFEinthe ministryand its provincial directorates. 0 The Council ofMinisters will approve a newprocurement decree that bringspublic procurement processes into line with international practice. Investmentclimate 0 The Government will present a new Financial Institutions law to the National Assembly. 0 Decree 57/03 on hiringforeign labor will be revisedto relax some o f the rigidities inthe labor market. 0 The Government will present a new Commercial Code to the National Assembly. Monitoring and Evaluation (M&E) 141. The Governmentand its externalflnancingpartners need to make a major effort to improvethe quality of M&Efor Mozambique's overall developmentprogram. The informational aims o fthe PARPA have not yet been met. A 2001 review o f the policy process found that the mechanisms o f data collection and dissemination within Government are insufficient, and the 2003 PER found that even the sector-wide programs ineducation, health, roads or agriculture do not automatically provide data linking expenditures, outputs and outcomes. While most sectors produce a lot o f data, the key elements for public expenditures 63  and for results-based decision-making are often absent. Specialized efforts are requiredto obtain basic expenditure data (especially for donor-funded expenditures), data on consigned revenues (receitasprdprius)-though as noted above the situation i s improving steadily-or breakdowns o f spendingby level (e.g. hospitals vs. healthposts), location (capital, town, rural) or vertical program (e.g. malaria). 142. Thesecretariat of the Poverty Observatoryis the key agency developing an M&E systemfor implementation of the PARPA, but no real M&E system exists atpresent. During 2003 the Government initiated a series o f Poverty Observatories at which the key documents- including the PARPA and the Annual Progress Report on the PARPA-were discussed with the sectoral ministries andwith key stakeholders outside the Government; the most recent meeting took place on May 18,2004 and was attended by the President, the Prime Minister and several other ministers. Early experience indicates that much work remains to be done to make these observatories results-oriented. The secretariat o fthe Poverty Observatory is currently undertaking a diagnostic assessment o f M&Epractices withinall ministries andprovinces, but it is already clear that M&E focused on the PARPA tends to be ad hoc and unsystematized. Instead, each spending authority that has responsibility for implementing (some) PARPA and PES initiatives employs (as an institutional requirement) a simple and compartmentalized monitoring and reporting system that feeds into the annual PARPNPES reportingcycle. These systems typically use a traditional input-activities-output format as well as an outdated descriptive reporting style that does not lenditselfto meaningful utilization for policy formulation and decision-making. The data collected are not integrated or results-focused and are rarely usedto inform strategic program or project planningandmanagement. The only Government attempt to set up a structured and integrated monitoring system is the National Statistics Institute, which focuses almost exclusively on macroeconomic andhousehold surveys; while this survey work is useful and starting to yield good longitudinal performance data, it does not appear to be systematically linked to the PARPA or the PES and little effort appears to be made to undertake evaluative reviews o fthe monitored data. Infact, the PARPA and PES, though meant to be strategic performance documents, are not well integrated and do not make good use o f the data that i s being collected inMozambique. 143. ThePARPA and PES contain cross-cutting issues, but these are not clearly integrated across sectors and acrossspending authorities, even though they are being taken into account individually. There is now growing concern that the PARPA andthe PES need to be streamlined ifamorecohesive, structured andcost-effective development programisto beimplemented. The Poverty Observatory i s an important feedback mechanismfor PARPA implementationand can serve as a powerful consultativebody to orient all key stakeholders towards implementing the PARPA inamore efficient and effective manner, but it is still relatively untried andits own efficacy will depend strongly on the effectiveness o f the PARPA M&E system that it creates. The PARPA, including the biennially agreed PAF matrix, provides a good starting point as it identifiesthe results that the Government hopes to achieve as well as some o fthe key performance indicators (KPIs). These are supposed to be translated into the annual planning document, the PES, but the PES does not yet provide a clear road-map o f the strategies and actions that are needed to achieve PARPA targets inthe mediumand longterm. As a result, overall planningremains somewhat superficial, and (by and large) national problems are being addressedby discrete, poorly linked, non-national programs that, even when successful, produce limitedandfragmented pockets of success. For example, there are M&Eefforts linkedto projects and other initiatives inthe ministries o f Agriculture, Health, andEducation as well as in 64  connectionwith the Public Sector Reform Program and the decentralization work initiated by UNCDF. But this i s both inadequate and inefficient. The PARPAM&E system shouldtake these independent efforts into account and draw on them, but it also needs to integrate them into a single system that focuses on improving results-based management. To this end, there is an urgent need to provide key stakeholders with adequate exposure to modern planningand management tools. 144. ThePRSC will help the Governmentto improve thepolicy process by using thePARPA toprioritize and expand its leadership and undertake more effective M&E. The Government has already started this process by initiating work on more precisely defining the targets o fthe PARPAthrough the PAF matrix andbringingthe "priority ministries" closer to the process of pursuingthese goals. To support this process, the following will be added: An element o fpublic expenditure analysis andreview will progressivelybe integrated into the cycle o f financial management, through annualizing the PER exercise. This may entail analyzing a handful o f sectors per year, and may incorporatethe hiring-ino f required skills. Intime, such a reviewwould become a constitutive element o f the budget cycle, although this i s likely to require considerably more capacity than is available at present. The 2001review o fthe policy process recommended the creation o f a cadre o f public policy analysts. Inthe context o f the 2003 `PER, MPF has been seeking to create such in-house capacity, but much remains to be done. The action plan o fthe 2001 PER should be completed, creating mechanisms for reporting information on donors' contributions. 0 Civil service reform i s needed, linking compensation to performance, and providing appropriate levels o f compensation. The present environment o f inadequate compen- sation creates undue incentives at the ministerial and sub-ministerial level for seeking donor-funded projects as these usually provide some benefits to the operating units. This inturnbecomesthe driver ofproject selection, inplace ofanoverall perspective that makes portfolio decisions inlight o f the PARPA's overall goals and outcomes. At the same time as civil service reform there should be a general tightening up o fthe conditions for ministerial own receipts; for ifthere i s proper compensation there i s no need for extra-budgetary transfers to support hiringand staffretention. 145. An M&E assessment included in the October 2003 CASindicated that there is substantial Government commitment to monitoringfor results as well as reasonablestatistical capacity, and the Bank will work with the Government through the PRSC to build adequate M&E systemsfor thePARPA and thePRSC. Commitment to monitoring PARPA implementation comes from the highest level o f Government, including the President, the Prime Minister, and several line ministries. Through the PRSC as well as work on updatingthe PAF matrix, the Bank will help the Government and its partners to develop an adequate M&E system for each o fthe indicators linked to the major PARPA outcomes, including the outcomes that are explicitly identified as conditions for the PRSC. Inessence, this implies that Bank staff will help: to conceptualize the linkages betweenthe PARPA's long-term objectives andthe medium- term outcomes that are expected to contribute to achieving those objectives; to identify appropriate indicators for those outcomes; to identify an appropriate data source (donor, or survey, or administrative agency) for each indicator and obtain baseline data (or establish a process to obtain a first measurement to serve as a baseline); and also to determine the quality and reliability o f the indicator as well as the frequency and costs o f data collection and reporting. 65  New measurements against these indicators will thenbe obtained during future updates o fthe PARPA matrix; trends and their causes will be analyzed; and recommendations will be made to reorient Government action inlight o f these findings. G. CreditAdministration 146. The Credit willfollow IDA'Ssimplified disbursementproceduresfor adjustment operations. Accordingly, Credit proceeds will be disbursed incompliance with the stipulated release conditions. Disbursement will not be linked to any specific purchases and no procure- mentrequirementswill beneeded. Once the Credit is approved bythe Board, the Borrower will open and maintain a dedicated deposit account inUS Dollars for the Borrower's use. As the singletranche is released on Credit effectiveness, IDA will disbursethe proceeds o fthe Credit into the deposit account. IDA reserves the right to require an audit o f the deposit account. H. EnvironmentalAssessment andRating 147. Theproject has been designated to be a Structural Adjustment Credit (SAC); hence no formal environment impact assessment (EU) is required. Nonetheless, environmental work is plannedto take place during the implementation of PRSCl andbefore Boardpresentation o f PRSC2, as PRSC2 will include support to the agriculture and health sectors and so i s expected to be designated a Sectoral Adjustment Credit. Inparticular, it i s expected that the Government will undertake anEIA with the objective o f identifying linkages betweenkey macroeconomic and structural reforms policies andthe environmentinan effort to mainstreamthe environmental sustainability dimensioninto the PRSC process. This analysis will develop a set o f measuresat both the national and local government levels that can be taken to reduce poverty and enhance environmental sustainability o fpolicy reforms. The underlying premise o f the analysis is that environment andpoverty are linked inthree major ways: (i) reduction programs should poverty not damage the resource base and the environment on which poor people depend for their livelihoods; (ii)improving environmental conditions can helpto reduce poverty and promote sustainable pro-poor growth; and (iii) mitigating measures, as needed, should be identified as part of policy dialogue. Inworking with the Government and other development partners, this analysis should help to identify strategic entry points for mainstreamingkey issues o f the poverty-environment nexus inMozambique into the PRSC process and ongoing policy reforms. Inthis regard, the PRSC2andPRSC3 reformagendahas specified actions to beimplementedby the Government. Inaddition, environmental work i s plannedfor each o fthe sectors that will be supported inPRSC2 (agriculture and health) and PRSC3 (education andrural water supply). VI. BENEFITSAND RISKS 148. Thisfirst PRSCseriesfor Mozambique involves a number of benefits and risks. Benefits, risks and risk-mitigation measures are detailed inthe following paragraphs. 149. The major benefits of the PRSC relate to the change in the instrument of aid delivery. Inthe short term, the PRSC series is expectedto empower the Government o fMozambiqueinits relations with the donors, by giving it greater control over externally-funded activities and resources; strengthening the MPF, Council o f Ministers and National Assembly as drivers o f public resource allocation; and promoting more coordinated donor behavior around the PARPA 66  andthe partnership agenda. Itwill also strengthenthe MPF inits relationswith other spending authorities inMozambique. These objectives are fully consistent with recent international agreements on aid modalities. Inthe mediumterm, the PRSC series i s expected to transform the quality o f govemance and enhance the Government's capacity to reduce poverty, by reducing transaction costs, increasing the allocative efficiency o f public spending, improving the predictability o f external resource flows, increasing the effectiveness o fpublic administration, and strengtheningthe structures and processes o f democratic accountability. It will also helpto reorient financial modalities, promote newforms o f dialogue situated innational institutional contexts, and refocus TA and capacity-building on mainstream government functions. Inthe long term, o f course, the PRSCs are expected to help reduce poverty. 150. One set of risks concerns the capacity of the Government to implement the measures supported by the PRSC and achievethe gains expected. There may be a gap between the PARPA, which lacks specificity but (or perhaps therefore) has broad commitment, andthe PRSC program matrix, which i s specific but may have less broad commitment, with the result that measures identified inthe PRSC matrix do not have adequate ownership and are not completed. This risk is beingmitigatedthrough the national institutional process being built around the PAF matrix, which is seen as updatingand operationalizingthe PARPA while also attractingbroad commitment; PRSC prior actions and triggers are explicitly a subset o f the actions included in the PAFmatrix. There is a riskthat the MPFwill notbeable to adhere strictly to the financial calendar for releasing budgetary allocations to spending agencies-discipline that i s neededto makethe PRSC work; this riskwill be mitigatedby helpingthe Government to strengthen the MTFFand maintaina sound financial calendar from the beginning. Another risk involves weaknesses inpublic financial management, or rivalry betweenthe MPF and one or more sectoral ministries, which may result instakeholder pressure (notionally or really) to earmark budget support for specific sectors and/or activities, with the result that the MPF andthe Government will be effectively disempowered. This risk i s beingmitigated through an upfront focus on improving the fiduciary framework, including mechanisms usedto control the flow o f funds. Finally, there is a short-term riskthat transaction costs will increase, withthe resultthat some Government stakeholders may wish to abandon this approach before a long-term downward trend has time to establish itself. This risk i s being mitigated by discussing expectations with all stakeholders and ensuring realism to the greatest extent possible. 151. Another set of risks concerns the ability of Mozambique'sfinancingpartners, including the Bank, to stay with the PRSChudget supportprocess long enough to realize its potential. Gains inallocative efficiency, whether inprinciple or inpractice, may be difficult to demonstrate. Liquidity constraints-partly due to donors' unpredictable disbursements-may hamper the timely allocation o f treasury resources. The Bank and other donors are mitigating this riskthrough institutionalizing processesto makebudget support more predictable, andwill monitor budget process gains as a reasonable proxy for improving allocative efficiency. There is also a risk that greater predictability inexternal resource flows will not materialize, as donors make different assessments o f the situation on the ground, experience constraints on their ability to make financial commitments, harbor different expectations about what greater predictability implies, andtake different approaches to usingthe leverage whichhigher levels o f general budgetsupport makepossible (some donors have indicated reluctance to cede this leverage). This risk is beingmitigatedthrough anopen and extensive discussion of donor aid modalities, witha view to understanding eachdonor's systems, expectations, and scope for movement and confirming them inan agreed MoU. There is also a risk that donors (including at times the 67  Bank) will want to introduce externally-generated conditionality into the PRSC and PAF processes: inparticular several (bilateral) donors appear increasingly inclined to introduce political conditionality into their thinkingand actions. This may cause tension between the donors andthe Government and, inthe extreme case, an unwillingness (on one side or the other) to proceed with increased levels o f programmatic lending. This risk i s being mitigated by helpingall donors representatives to recognize that increasing budgetsupport implies support for an agenda that they cannot fully specify and by helpingthe Government to recognize that the donors supporting such an agenda have a reasonable expectation to consultation and influence. 152. Finally, there are some external risks that may impact the Government's ability to implement the reform program that the PRSC supports. National elections will take place in late 2004. Uncertainty over their outcome could leadthe Government to lose focus and fail to implementneededreforms; contentionabout the reported results may also leadto a period o f instability, possibly marred by violence. Whatever party wins, the new Government will also need time to learnto govern, and there i s always the riskthat it will initiate an inappropriate shift inpolicy direction. The Government's commitment to free and fair elections (achieved inall previous elections) as well as its efforts to engage society inarticulating a national vision through the Agenda 2025 exercise and monitoring PARPA implementationthrough the Poverty Observatory will help to mitigate some o fthese risks. Inaddition, the Bank will try to mitigate themby actively engaging the key political parties prior to elections onthe maindevelopment challenges facing Mozambique and by preparinga C E M inFY06 on the challenge o f sustainable broad-based growth. Another set o f risks involves external factors such as an extended global slowdown, commodity price fluctuations, international agricultural trade barriers, regional political and economic developments (particularly inSouth Africa and Zimbabwe), and exchange rate and foreign capital flow fluctuations, which could each impede growth and make it difficult for the Government to remainengaged inreform. To help mitigate these risks, the Bankwill work closely withthe Fundandlike-minded donors to help the Governmentto maintain macroeconomic stability; it will also address some o fthe larger geopolitical issues throughout its policy dialogue at senior levels within the institution. VII. CONCLUSION 153. Mozambique is apoor country which has realpotentialfor growth as well as a Government that has demonstratedcommitment topoverty reduction, manifested by a sound reform program and its recent PARPA Progress Report. Recent householdsurvey data indicate that the country's potential, coupled with its commitment and programs, are yielding encouraging results. Yet there are many challenges that need to be fully and adequately confronted ifMozambique's full potential i s to be realized. Selecting the right development constraints to address at the right time, inan environment o f significant commitment but limited capacity, has been an important contributor to the success o f the Government and of the World Bank Group inMozambique. This PRSC aims to help the Government to focus its development efforts on the matters which are country priorities right now. Buildingpublic-sector capacity and accountability, improving the investment climate, and expanding service delivery are all part of the long-termdevelopment agendainMozambique andover time they are likely to helpbring growing prosperity to all o f its citizens, including especially the poor. 68  ANNEX 1: PROGRAMMATRIX Prior actionsfor PRSCl and triggers fro PRSC2 are indicatedinboldtype; other measures are benchmarks. Issue PRsCl PRsC2 PRSC3 OUTCOME COMPONENT 1: BUILDINGPUBLIC SECTOR CAPACITY AND ACCOUNTABILITY Sub-component 1A: Maintaining a Sound Macroeconomic Policy Framework Macroeconomic G o M maintained an G o M will maintain GoM will maintainan framework: adequate an adequate adequate macroeconomic macroeconomic macroeconomic policy framework policy framework policy framework Sub-component 1B: Improving Public Financial Management Budget formulation, execution, reporting: Budgetaryallocations GoMformulated2004 G o M will formulate GoM will formulate Direct poverty- and actualpoverty budgetwith agreed 2005 budget with 2006 budgetwith reducingexpenditures spendingnot yet allocationsto PARPA agreed allocations to agreedallocationsto as ashare of actual consistent with priority sectors PARPA priority PARPApriority expendituresremains PARPApriorities sectors. sectors at or near 65% G o M executed 2003 GoM will execute GoM will execute budget consistent 2004 budget 2005 budget with agreed consistent with agreed consistentwith agreed allocations; in allocations; in allocations; in particular, it spent particular, it will particular, it will 64.9% of its 2003 spend 65% of its 2004 spend 65% of its 2005 budget (excl. interest, budget(excl. interest, budget (excl. interest) elections) on PARPA elections) on PARPA onPARPA priority priority sectors priority sectors sectors Budgetnot complete Donor-funded Tax incentives and Public sector fiscal Improvedbudget and public sector expenditures, receitus contingent liabilities data (central coverageand fiscal data not prdprius includedin will be includedin governmentbudget, transparency consolidated budgetand actual budget municipalities, state receipts in budget enterprises)will be execution reports consolidated GoM humanand SISTAFE SISTAFE will be SISTAFE will be GoM better ableto institutionalcapacity regulations adopted; implemented in MPF implemented in managepublic for public financial conta linica de (incl. provincial ministriescovering expenditures managementlimited, tesourojisicu directorates) and 60% of the budget, and the fiduciary establishedand MINED, with andpossiblypayroll environment governmentcheques functional andasset management classifiedas high risk (titulos)abolished classifications Accountingand Budgetary allocation Double-entry State accounts for Improvedintemal auditingfunctions for Administrative accountingwill be 2004 will be audited control and auditing; poorlyexecuted Tribunal (TA) initiated;intemal within 12monthsof improved increasedby 10% audit department their closure Parliamentary over 2001 (IGF) will receive oversightof own budget line, hire expenditureprocess additionalstaff; TA will be enabledto set own salary scale 69  ANNEX 1: PROGRAMMATRIX Prior actions for PRSC1 andtriggers fro PRSC2 are indicatedinbold type; other measures are benchmarks. Issue PRsCl PRsC2 PRsC3 OUTCOME Aid deoendencv: Ministerialdecree and Bill to create CRA CRA will be created Higher revenues, G ~ M cas MPF actionplanfor submittedto NA; enablingfiscal unsustainablyhigh aid the creationof a NationalDirectorate adjustment and lower dependency, and a CentralRevenue o f Taxes will be aid dependency over gradual fiscal Authority (CRA) strengthenedto time adjustment (founded approved prepare for merger partly on higher with Customsin new domestic revenues)is CRA needed Revenue-raising Indirecttaxation measuresdeployed, system will be incl. automatic fuel consolidated; tariff adjustments municipaltax system and withholding tax will be created; on G o M employee documento linico for incomes collectionof all taxes will be introduced Tax revenues 14.1% Tax revenues 14.6% Tax revenues 15.0% lllly M&E: Lack ofattentionto GoM completed Secondnational PSIA on healthfees Stronger M&E andcoordinationin second national householdsurvey will will be completed; capability in GoM M&E, particularly householdsurvey be reported, including first Governance focusedonplanning regardinghow trend data drawn from assessmentwill be andbudgetingfor povertyrespondsto first survey completed servicedelivery GoM action PSIA on education fees will be completed GoM has agreed MTFF, PESand QBERs publishedon updatedand PARPAwill be internet; BdPES prioritized PAF harmonized,andthe harmonizedwith matrix of actionsand MPF's annualreport QBERs, with indicatorswith donors onPES implement- differences explained; ation (BdPES) will MTFF madeapublic report on PARPA document implementation Sub-component 1C: Improving Governance Procurement: Weak legal MPF/GoM completed Council of Ministers New procurement Clear, transparent framework for and review of CPAR and will approve new practiceswill be procurementpractices poor enforcementof agreed with findings, procurement decree integratedinto introduced, leadingto procurementrulesand including the key in line with SISTAFE; new few procurement regulations recommendationsof international CentralPolicy problemsand draft Action Plan practice, after Directoratewill be therefore lower consultations with established; oversight procurementcosts mainstakeholders; role of Tribunal nationalstandard Administrativo biddingdocuments reviewedand will be drafted; streamlined capacity-building programsin procurementwill be undertakenfor staffin key ministries 70  ANNEX 1: PROGRAMMATRIX Prior actionsfor PRSCl and triggers fro PRSCZ are indicatedinboldtype; other measures are benchmarks. Issue PRsCl PRSC2 PRsC3 OUTCOME Public sector reform: GoM structures and MISAU, MINED, MISAU, MINED, MISAU, MINED, Line ministry capacity processesinefficient; MADER, MA!? and MADER, MAE and MADER, MAE, MIC in planning, budgeting limited incentivefor MIC completed MIC will have restructuringplans andfinancial civil servants to functionalanalyses preparedrestructuring will be implemented management performtheir duties plans. MF'Fand and restructuring strengthened,so GoM MINT will have plansfor MPF and actions responsiveto completedfunctional MINT will be needsof citizensand analyses prepared businesses Salary structure not competitiveand Councilof Ministers First phaseof salary inconsistentwith will have approved reformimplemented sustainablecapacity salary reform building and performance Three key public Threekey public sector reform sector reform measures achieved measureswill have (land registration in beenachieved(publiC 90 days; industrial sector recruitment registration simplified; pension expedited; visas paymentsprocess issued at borders) improved; hospital administration simplified) Decentralization: Limited participation NationalAssembly NationalAssembly Decentralizationlaw Local authority of local authoritiesin approved law on will have approved will be implemented capacity inplanning, projectplanningand decentralization (Lei regulationsto budgeting, financial management; and dos Orglios Locais implementlaw ` managementbuilt to hence limited do Estado) managedecentralized accountability infrastructureservice 21 districts have 37 districts will have 53 districts will have delivery; 8 participatoryplanning participatoryplanning participatoryplanning municipalitiesand up processes processes processes to 49 districts "learning by doing" by 2007 Anti-corruption: Corrupt acts not National Assembly Anti-corruption National Assembly Higher GoM capacity effectivelyexposed or approved anti- prosecutorialunit will will approve anti- to identify corruption sanctioned corruption law; first be staffed and corruptionactionplan issues anddevelop anti-corruptionsurvey budgeted; actionplan and implementation plansto address them initiatedwith updatedin light of will begin; second more aggressively reputableconsulting findings of anti- survey will be firm corruptionsurvey; initiated governanceand anti- corruptionsurvey completedand baselineindicators established 71  ANNEX 1: PROGRAMMATRIX Prior actions for PRSCl andtriggers fro PRSC2 are indicated inboldtype; other measures are benchmarks. Issue PRSCI PRsC2 PRsC3 OUTCOME Legal reform: Key legalcodes Commercial Code NationalAssembly Implementionof new Legalframeworkfor outdated, impeding revised will approve new CommercialCode business strengthened business; Commercial Code; will begin limited humanand Penal, Civil institutionalcapacity Procedure, and Civil in legalsector; RegistryandNotary commercial dispute Codes will be revised resolution exceedingly slow Integratedstrategic Planning, budgeting Dedicatedjudicial Time requiredfor planfor legalsector andmonitoring sectionswill be judicial resolutionof reformcompleted system will be createdfor business disputed introducedto give commercial dispute reduced(currently priority to deliveryof resolutioninNampula 540 days pass judicial services; betweenfiling suit dedicatedjudicial andenforcing sectionsfor judgment) commercialdispute resolutionwill be establishedinMaputo and Sofala COMPONENT 2: IMPROVING THE INVESTMENT CLIMATE Sub-component 2A: Strengtheningthe FinancialSector Bankingsector: Banks notyet New Financial NationalAssembly More effective compliantwith IAS; InstitutionsLaw, will approve new supervisionof bankingsupervision which strengthens Financial bankingandnon- weak; high interest independenceof Institutions law; bankingfinancial rate spreads(19%), Banco de remedialpowersof institutions;more which (in a 193 firm Moqambique(BM), B M strengthened efficient and sample) force self- submitted to profitablebanks, financingfor 90% of Parliament leadingover time to working capitaland lower credit costs; 60% of investment TORSandfinancing Diagnosticreviewsof All commercial banks complete GoM arrangedfor all bankswill be will be broughtinto divestiturefrom diagnostic reviewsof completed; action compliancewith IAS bankingsector, BIM, BAu, SBM, and plans will be prepared reducingmoralhazard BCIBFto define IAS to bring eachbank transitionplans, and into compliancewith BIMreview initiated IAS GoM will divest of GoM interest in BIM sharesheldintrust for will be broughtto BAuemployees point of sale Insurance sector: Insurersnot compliant Action planfor Insuranceindustry Modemizedinsurance with IAS makinginsurersIAS will bebroughtinto industry compliant will be compliancewith IAS implemented 72  ANNEX 1: PROGRAMMATRIX Prior actions for PRSCl and triggers fro PRSC2 are indicated inboldtype; other measuresare benchmarks. Issue PRSCl PRSC2 PRSC3 OUTCOME Sub-component 2B: Improving the Regulatory Environment Trade: Tradebarriers are Highest levelof Highestlevel of Mozambicanfirms detrimentalto import duties import duties reduced maintainalower level competitiveness, and reduced from 30% from 25% to 20% of inventory; and needto be lowered to 25% more Mozambican further, in line with enterprisesentering SADC agreements Assessment of time Assessment of Average number of contracts, which andcost to clear constraintsto days for clearing requiremeetingstrict customscompletedto improvingcustoms exportswill be delivery deadline establishbaseline clearance time will be decreasedto 7 days or indicators completedand action less; number of days plan will be adopted requiredfor clearing to removethese importsat Ressano constraints Garciawill be decreasedto 5 days or less Regulatory framework: Survey of time and Cost andtime Cost andtime Lower business costs Cost andtime cost to start up a requiredto register a requiredto registera andinventories, requiredto register a business completedto business will be business will be resultinginhigher businessmuchhigher establishbaseline loweredfrom 97% to loweredfrom 65%to levelsof economic than globalaverage, indicators 65%GNI per capita 45% of GNI per activity; and investors discouragingformal or less and from 153 capitaandfrom 105to with less cash-flow business to 105 days or less 60 days or less strain GoMpaymentof GoM paymentof GoM paymentof VAT refunds slow VAT refundswill be VAT refundswill be reducedto no longer reducedto 30 days than60 days Labormarketis A tripartite body, Decree 57/03 on New draft labor law, An efficient and inefficient,and includingthe hiring foreign labor revisinghiringof flexible labor law, inflexible; obligations representativesof the will be revisedto expatriates, allowing Mozambican to workers hiring Government, private ease restrictionson simplifying short-term businessesto impedebusiness sector and labor firms hiring hiring, andreducing restructure, increase restructuring, stop unions, is established expatriate employees time and cost hiring, andprofit from knowledgetransfer to discusslabor associated with knowledgetransfers, from foreign experts market legislation retrenchingexcess thereby becoming revisions labor will be more competitive submitted to National Assembly Decree will be issued to regularizeproperty rights inurbanareas andenhancetransfer- ability 73  ANNEX 1: PROGRAMMATRIX Prior actions for PRSCl andtriggers fro PRSC2 are indicated inboldtype; other measuresare benchmarks. Issue PRSCl PRSC2 PRSC3 OUTCOME Sub-component 2C: Improving Infrastructure Services Communications: Communicationcosts TdM and mCel are NationalAssembly Announcement of the Lower telecoms costs, are high; access to made separate will approve new offer for sale of TdM higher access, services is limited, corporateentities; a telecoms legislation, will be published; including for particularly inrural new implementedthrough process to award a businesses, and areas; and quality of telecommunications issuing subsidiary third mobile phone improved quality; communications provider entered legislation on inter- licensewill be teledensity raisedto services is low market connection, licensing, launched 4% overall and 0.5% competition, universal inrural areas services, radio- communications, and tariffs; INCM, N A C boards will be operational Electricity: Costs are high, access Council of Ministers Legal operational Unbundlingwill be Electricity more i s limited, and approves separation of unbundlingof Genco, completed; bids will reliable (grid losses reliability is low EdMaccounts for Transco, and Distco be invited for private 45%; gridextended generation, will be initiated; participationin EdM to 30,000 households, transmission and Council of Ministers distribution 300 clinics, schools; distribution; TORfor will approve option connection costs transaction advisor for for private <$goo; losses of private participation participationin productiontime due inEdMdistribution Distco; EdMTransco to power outages less issued capacity building than 2%) advisor will be retained Environmental regulations: Framework and 12 communities have 20 communities will 35 communities will More efficient and enforcementare both adoptednatural have adopted natural have adoptednatural sustainable land weak resource management resource management resource management management; env. for Plan plan; SEATIP will be Plan private-sector-led established tourism improved Sub-component 2D: ExpandingAgricultural Productivity Agriculture: Low productivity and MADER will Farmersuse new poor crop quality, as establishits strategic technologiesto smallholders do not and operational increase productivity; use yield-enhancing monitoring system in average yield of inputs or technologies all its provincial and maize raised from 0.9 central institutions to 1.Omtiha, and rice from 1.1to 1.2mt/ha Council of Ministers between2002-03 and will pass adecree 2006-07; more establishingthe efficient landuse, UnifiedNational with incentives to Agriculture Institute improve land 74  COMPONENT 3: EXPANDING SERVICE DELIVERY Healthcare: Limited supply of MISAUwill conduct Improved sector health services; poorly constraint-focused management and trained staff, poor health planningand better outcomes; staff incentives and costing exercise; intrahospital MMR little deployment to priority health reducedto 0.15 by rural areas; poor servicespackage will 2006; BCGcoverage managementand be defined 98%; DPT, hepatitis supervision of health and polio coverage services 95% Education: Slow progress Direct Supportto Direct Supportto Direct Support to More efficient and building Schools program will Schools program will Schools program will higher quality implementation continue continue continue education system; capacity for education gross EP1 admission services; failure to New curricula will be rate reaches 128% by adopt community introduced nationally 2005; EPI completion school construction ingrades 2,4, and7 rate reaches47% by model, scale-up 2005 (from 40% in teacher training, and In-service training 2003); girls constitute decentralizeresps; will cover 60% of 46% of all EP donor failure to shift EPII2 teachers students by 2005 aid to program support Ruralwater supply: Lack of funding for 1,300 additional rural Sustainableincreases water supply; capacity water points will be inrural accessto safe constraints, esp. in completed water and sanitation provinces; failure to services adopt management 43% of population modelsneeded for with access to safe ongoing water supply water; 37% to maintenance adequatesanitation 75  I  2 -I a, 2 0 3 a, D C m 2 -I n 5 m -I - I '5 E m i i 2  0 rz) r-rz) X m (0 .-0h C u) c 0 .-C0 -m c .-fn -a, u) U .-8 c E > .-E a v)z >a  Annex 3 PublicFinancialManagement 1. Over the past few years, the Bank has worked with the Government and other donors to complete an extensive review o f Mozambique's public financial management accountability arrangements, covering its public expenditure, procurement and financial management systems. A Country FinancialAccountability Assessment (CFAA) was completedinDecember 2001;a Country Procurement Assessment Report (CPAR) inlate 2003; and Public Expenditure Reviews inDecember 2001 and September 2003. The results ofthiswork, andthe status ofthe action plans derived from them, i s detailed inthis Annex. 2. Public Expenditure Review of December 2001: The 2001 PER found serious deficiencies inthe fiscal management system, particularly inpublic accounting, cash management and auditing. Inparticular, public accounting covered only a quarter o f Government spending, ignoring both ministerial own receipts (receitasprdprias) and donor- fundedexpenditures; cash managementwas inefficient and lacking intransparency becausethere were large numbers o f Government accounts which were not beingtracked; and internal auditing was ineffectual due to a lack o f capacity and funding. The Government moved boldly to modernize the system in2001 by passing a new law, the Lei daAdministraqGoFinanceira do Estado, which inprinciple modernizes the entire fiscal management system. This step was taken to correct a set o f difficult legacies from the past: single-entry accounting; a multiplicity o f government accounts rendering cashmanagement extremely difficult; and limited budget coverage inthat receitasprdprias (ministerial own receipts) were tolerated and donor-funded expenditures not recorded. The key reform o f the new law was to provide for an integrated financial management information system, entitledthe SistemaIntegrado de Administraqfio Financeira do Estado (SISTAFE). Inorder to prepare the way for the SISTAFE, a three-phase program o f actions was agreed uponwith the authorities: "pressing actions" (reproduced in Table 1below) to be done duringthe course o f the preparatory work of the PEMR, "priority actions" (Table 2) to be done during2002, and mediumterm actions for the period 2003-2005 (Table 3). 3. Most of the short term `pressing actions" have been executed (Table 1). A new, more detailed functional classifier was introducedinto the budget, consistent with UnitedNations (U.N.)guidelines, witha view to trackingpoverty-relatedexpenditures more accurately, butits implementation has been incomplete, as only the broad categories were used. The detailed classifier, which will permit tracking o fpoverty-related expenditures, will be implementedwith the introduction of SISTAFEin2004. The budget, which hadpreviously beendone inreal terms, owing to the highrates o f inflation o f the early 1990s, is now being done innominal terms. The regulations o fthe newfinancial management law were completed, and restrictions were introduced on banks accounts heldby public institutions (such accounts have to be authorized by the Direcqlio Nacional do Tesouro(DNT) as a co-holder and they have to be closed three months after the budgetyear to which they applied). 4. Progress with the "priority actions"for 2002 was good but is incomplete. As Table 2 shows, a significant share o f receitasprdprias (off-budget revenues, or "consigned revenues" as they are now identified by the budget) were included inthe 2003 Government budget. The 2003 budget forecasts a collection of consigned revenues on the amount o f Mt 106 billion--equivalent to about $4.4 million. The 2003 first semester budget report states that collections o f these 79  revenuesamounted to about Mt 86.7 billion. Moreover, and as a result o f work done by the MPF, an additional Mt 4.3 billion were also collectedbut were not included inthe first semester budgetreport. The total amount o f consigned revenues raised inthe period January-June 2003 add up to Mt 91 billion, or the equivalent o f $3.8 million. It i s likely that the total amount o f these revenues to be registered along 2003 will exceed $7 million (studies done inthe past had estimated that these revenues could potentially generate about $7.5 millionper year). These revenues are expected to grow as the Government implementsreforms such as the introduction o f SISTAFE andthe revision o fthe planning andbudget systems. Eleven items inhealth and public works, as well as the education, agriculture and other ministries, are still e~cluded'~. Area Budgetformulation Submit 2002 budgetusing new budget functional End-2001 Partly done ~ classification. Formulatethe budget incurrentprices, startingwith i Done the 2002 budget. Legalframework Draft implementationregulations of new Public March Done FinanceManagementLaw (PFML). 2002 I Cash and asset Instructions on bankaccounts ofpublic institutions End-2001 Done management authorizedby DNT, DNT a co-holder, closedby DNT on March31ofnext year 2001 ' I Partly done 5. Budget execution reporting has improved, but most donor-funded expendituresare still excluded. The quarterly budget execution reports now present all actual expenditures usingthe newbudgetfunctional classification, but only inbroad categories; the detailed classifier has not yet beenimplemented, and the revised appropriation o fNovember 2002 was not reported inthe budget executionreport o fthe first quarter o f 2003. A major step forward was made inthe budget executionreport o fthe first halfo f2002, when for the first time tables were presented reporting donor-funded expenditures on the investment account. Yet as o f late 2002 the reported executed expenditures were only 8% o f the budget plan. 6. Double-entry accounting needs to be introduced. The so-called "complementary period" after the end o fthe fiscal year, duringwhich payments may be made for commitments duringthe financial year, was reduced from three months to two. Some training indouble-entry accounting was done, but double-entry has not yet been introduced throughout the system. The proposed shift from the duode`cimo system o freplenishment to modified accrual accounting i s probably too ambitious for the time being. Untilsuch time as the SISTAFE system is `*Some progresswas made inthat the receitas consignadas inthe Budgetincreasedfrom Mt 48.3 billionin2001to Mt 67.6 billion in2003 (inreal 1998 Mt), viz. an increaseof 40%. This amount ($6 million) would be increasedby another $3 millionby adding inthe identifiedreceitasprdprias inthe Ministries of Health andPublic Works. Of a list of 11receitasprdprias inthese ministries, turnedup by a Government-sponsoredstudy, none hadbeenincluded inthe 2003 budget. They are: (i) Serviqode clinica especial;(ii) Serviqode atendimentoespecial; (iii) HCM HCM DirecqcToNacional daSazide: Vendade medicamentospelo ServiqoNacional de Sazide;(iv) Centro Regional de DesenvolvimentoSanitdrio: Alojamento e habitaqcTopagos pelos estudantes;(v) Produp50 de material diddctico; (vi) ComisscToCentral deAvaliaqcTo eAlienaqcTode Imdveis de habitup70 do estado;(vii) Laboratdrio de Engenharia de Maputo: Vendade ensaios laboratoriais; (viii)Fundo de Foment0 de HabitaqcTo (FFH): Percentagem nu vendade imdveis do Estado; (ix) FFH:Juros; (x) FFH: Vendade casus construidascom cre`dito; and (xi) AM-SUILaboratdrio de Engenharia de Moqambique: Vendade dguas brutas. The other ministries are believedto account for another $3 million. 80  implemented, it would be more prudentto improve the replenishment system, through appropriate training, and make it more flexible. A modified cash basis of accountingwill be appliedwith the implementation o f SISTAFE through the introduction o f a budget credit system against which commitments will be registeredand accounted for when a transaction i s incurred. The release o f credits will serve as virtual cashallocations andwill determine and control the ceiling o f spending per budget line item. Inthe meantime, while the SISTAFE system i s being implemented, the replenishment ("duodicimo") system needs to be made more flexible and training should be givento enable the lowest level units to operate within it efficiently. 7. Much remains to be done in cash management. The multiplicity o f Government accounts with the central bank and the commercial banks needs to be inventoried. Although "globalizing accounts" have been created with a view to moving to a single interlinked account arrangement, this has little meaninguntil such time as all the accounts are interlinked and the MPF is able to read o f f inreal time the amount o f cash held. 8. Much remains to be done in internal controland auditing. The internal audit department (IGF) was to have its own budget line, butthis was not done. It was also to be strengthened with new hiringbut this is still under consideration. The budgetary allocation for the Administrative Tribunal was increased by 10%inreal terms between 2001 and 2003. It was proposed that the Administrative Tribunal set up partnerships with private auditing firms and twinningarrangements with foreign supreme audit institutions, but as of 2003 such arrangements as hadbeen made have had only a low level of impact. 9. Themedium termprogram offiscal managementreform needs to be completed. The actions included inthe mediumterm reform program of the PER2001, reproducedinTable 2, remain important and will continue to be addressedwhile SISTAFE is being implemented. Among the major elements here are: (i) the enhancement ofthe role o fthe MediumTerm Financial Framework (MTFF).l6Makingthe MTFF into an operational instrument will aid budgetingand execution inthe PARPApriority sectors (currently, the lack o f a medium-term perspective results inpurely incremental budgeting(that is, spending authorities receive a fixed percentage increase over the previous year's budget) with no real link with activities or outputs or outcomes); (ii) the introduction o f double-entry accounting, under the cash basis17;(iii) cash planningandbudgeting are among the corner stones o fthe conceptual business model underlying SISTAFE and an integral part o fthe design o f the system; introducing monthly and annual cash plans will enable more rational use o f resources, resulting inconsiderable savings because it will be possible to hold less (non-interest-earning) cash overall and to resort less frequently to usingtreasury bills; (iv) reports on domestic and external debt, lending, cash flows, andtax expenditures alongside the Conta Geral do Estado will enable a comprehensive view o f state finances which i s one o f the ultimate objectives o fthe newFinancial Management Law"; l6Note that the DirecqgoNacional do Plan0 e Orqamento issueda study, "A experienciacom o Cenfirio Fiscal do MCdioPrazo e opqbes para seu futuro desenvolvimento" (2003). A modified&basis of accounting will be appliedwith the implementation of SISTAFE through the introduction of abudget credit systemagainstwhich commitmentswill be registeredand accountedfor when a transactionis incurred. The release of credits will serve as virtual cashallocations andwill determine and control the ceiling of spendingper budget line item. Inthe meantime, while the SISTAFE systemis being implemented,the replenishment("duodkcimo") system needsto be made more flexible and training should be given to enable the lowest level units to operate within it efficiently. '*Note that under the cashbasis of accounting, as definedby the Public SectorCommittee o fthe International Federationof Accountants (IFAC), it is standardto include information about accruals, as memorandum items, not 81  (v) auditing the state accounts (Conta Geral do Estado)within 12months o fthe close o fthe financial year will enable Parliament to exercise closer control o fthe expenditure process (at present long delayslginissuance o f the documents render the documents irrelevant). 1.Budzet coveraze Receitas prdprias: Ensure that a significant share of 2002 Partly done Includeinthe budget documents submittedannually to Not done the National Assembly information on tax expenditures starting with the 2003 budget. 2. Reporting Quarterly budget executionreportsshouldpresent (i) 2002 :i) done, not :ii)notdone, [iii) partly done Some partial information on donor-fundedactualexpenditures reporting accordingto the action plan preparedby the MPF started 3. Legalframework Implement the new Public FinanceManagementLaw 2002 Action plan, through the approval and implementation ofthe regulations regulationsand accordingto atime-bound action plan. done and being implemented 4. Public accounting Issue instructionsto spendingunits reducing the Before Done complementary period for FY02 by one month. Oct. 2002 April Some training and modifiedaccrualaccounting 2002 done 5. Cash and asset Inventory all bank accounts ofpublic institutions inthe Mar 2002 Underway, but management Banco de Moqambique (BM) and incommercial banks. not completed Close all bank accounts not related to the FY02. Jun 2002 Done Create globalizing bank accounts for revenueand 2002 Underway, but expendituresinBM. not completed Create task force composed of MPF and BMstaff to Jan 2002 Done monitor the introduction ofthe treasury single account and the new paymentssystem, 6. Internal control 11Introduce specific budget lines for Internal Audit 2002 Not done and auditing Department(IGF) in2003 budget and allocate an appropriate level ofresources. Continue to implement reforms to raise IGF's capacity. Increase budgetary allocation infavor ofthe Done (10% in Administrative Tribunal (TA) realterms) Grant TA the ability to set its own salary scale. Not done Administrative Tribunal should establishpartnership Done, but not agreements with private audit f m s , and atwinning effectively arrangement with a foreign Supreme Audit Institution. 10. An ambitious timetable has been setfor the installation of the SISTAFE. During2001 and 2002, the technical unit for reform o f State Financial Management (Unidade Te'cnicapara a Reforma daAdministrap70 Financeira do Estado,UTRAFE)was set up andthe regulations for the new law were prepared. At the same time planning was done for the installation of the ledger entries. The following are normally reported:financial assets receivable, longterm debt, contingent liabilities andguarantees, and other liabilities. l9The Conta Geral do Estado for 2001 became availableto the public inearly 2003. 82  information managementsystem, SISTAFE. A budget of $27 million was developed, and funding for the bulk of it was secured from donors including the World Bank. The timetable anticipates procurement (viz. determination of the information technology architecture and account component package) inthe second half of 2003, roll-out of the system inthe Ministries of Finance andEducation inthe last quarter of 2003, andextension to the remaining sector ministriesin2004. The focus will initially be on the introduction of a single treasury accountin 2003 for all line ministriesandthe improvement of accounting. After 2004 the focus will shift to internal control, auditing, accounting for state property (PatrimGnio) and debt management. Timing Budgetformulation Reinforce the MTFFby (i) integrating it inthe decree for 2003 Not yet done the revisedregulationsofthe SISTAFE and (ii) making it apublic document. Eliminate the Three-Year InvestmentPlan(PTIP) as a Not yet done stand-alone document andtreat investment expenditures within the normalbudget formulation process. Develop the Economic and Social Plan(PES) as the key Underway instrumentto monitor and program the implementation ofthe PARPA. Public accounting Launchthe introduction of double-entryaccounting. 2004 Expectedin`04 Free the accounting department(DNCP) of all activities 2003- Not yet done not relatedto accountingandreporting. 2004 Reporting Develop, and make available on aregularbasis, financial 2003- Now envisaged reports inaddition to the ContaGeral do Estado, starting 2004 for a later phase with (i) areport on short and medium-term external and o fthe domesticdebt, (ii) areport on lending andon-lending, SISTAFE. (iii)reportson cash flows, and (iv) areport on tax expenditures. Cash and asset Introduce atreasury single account simultaneouslywith Sept. management SISTAFE. 2003 Improve financial planning with the introduction of 2004 Expectedin annualcash plans, budget implementationplans and 2004 monthly cash plans, Extendthe current mechanismof VAT collection through Not yet done the banking systemto other taxes after assessingits feasibility by banksoperating inMozambique. Introduce, whenever possible, a single document (Documento Unico) for the collection of all taxes. Internal control and Ensurethat the state accounts (ContaGeral do Estado, 2004- To be done in auditing CGE) are audited within 12months after the endofthe 2005 2004 fiscal year, starting with the 2003 CGE. Launch budget evaluation function. 11. CountryFinancial AccountabilityAssessment (CFAA): The CFAA sought to enhance knowledge of financial accountability arrangements inthe public sector inMozambique and was ajoint undertaking of the government, Bank, and other donors. It found that, untilthe public financial management systemi s strengthened, the risk ofwaste, diversion and misuse of funds in Mozambique was high. The CFAA also found that material receipts and payments were excluded from the budget and from Government accounting and reporting systems; accounting systems and standardswere outdated; internal auditing, external auditing, and parliamentary oversight remainedweak; and so financial managementcontinued to involve ahigh fiduciary risk. To strengtheninstitutional capacities andreduce these risks, the Government has been pursuing apublic sector reformprogram aiming to establisha newpublic financial management 83  system; improve the legal, judicial and court system; reform the Government pay scale and reduce the number o f "ghost" workers (estimated at 15% o f all civil servants); gradually decentralize civil services to more local authorities; and implement a broad training program for the public sector to enable governance to face futurechallenges. Inaddition, consistent with PARPApriorities, the Government has undertaken a number of important initiatives to enhance efficiency, transparency and accountability inthe public sector: 0 MPF has published quarterly budgetexecution reports since May 2000 and developed procedures for obtaining data on donor disbursements, to be annexed to these reports; 0 A financial management informationsystem (SISTAFE) has beendesigned, together with a detailed plan for introducingit into spending authorities, andthe system will also introduce detailed functional and program classifiers into the budget; Public Expenditure Reviews (PERs) were completed in2001and 2003 jointly by the Government and donors, and a series o f annual PERs i s plannedfor the coming years; 0 A new Public Finance Management Law was approvedinNovember 2001 and regulations were passed in2002; 0 Treasury accounts at the central and commercial banks are being rationalized; and 0 A Country Procurement Assessment Report (CPAR) has beencompleted. 12. To improveMozambique'spublicfinancial managementsystem, a number of prioritized recommendationswere highlightedin the CFR4DevelopmentAction Plan. Table 4 reproduces this action planand summarizes progress to date. The Bank and DfIDare working with the Government to complete a new fiduciary assessmentto fill inexisting knowledge gaps. 13. CountryProcurementAssessment Review (CPAR): Completed inFY03, the CPAR reviewed the Government's procurement system against the generally accepted international principles o f sound procurement management, i.e. transparency, economy and efficiency necessary for an optimal use of scarce public funds. The report provided: (i) an analysis o fthe country's public sector procurement, including the legislative framework, organizational responsibilitiesand capabilities, present procedures and practices, and how well these work; (ii) a general assessment of the institutional and organizationalrisks associated with the procurement process; and(iii) a detailed action plan for improvements. The CPAR recommendations were coordinated with other donors that are also engaged inprocurement reform initiatives with the Government. 84  Implement Public Finance Management Law EnactPFML; prepare action plan and EnactedinNovember 2001;supporting promulgatesupportingrules andregulations regulationsin2003 Adapt chart of accounts to new budget Implementedat aggregate level; 140-odd functional classification detailedlevel to follow through SISTAFE Implement PFML, rules andregulations Partlydone Provide training, incl.double-entryaccounting Initiated _____ Strengthen public sector auditing capacity: Administrative Tribunal (AT) Enhance independenceof AT by increasing Partly done; budget allocation increased10%in budget and liberating staff salaries real terms; staff salaries not liberated Seek hndingto implement TA dev. plan Initiated Review structure, service conditions Initiated Provide training Partlydone Retain int. auditing firm to improve quality Done, butnot effectively Audit state accounts within 12months Notdone Strengthen public sector auditing capacity: Internal Audit Department (IGF) Review structure, service conditions Inprogress, with support PSRprogram Recruit qualified staff Recruitment initiated in2004 Provide training Training inprogress Recruit experiencedinternal audit managers Not done Strengthen financial management (FM)in local government: provinces and districts Produceregulationsto improve intemal control Regulationsformulated, following passage of and implement them Local State Organs law, and under MPF review DetermineF Mcapacityrequirements Done for districts Recruit qualified staff to meet requirementsand Initiated; done for 13 initialdistricts inDPFP's provide training four provinces; other 36 districts by 2008 Strengthen financial management (FM)in local government: municipalities Introduce Municipal Law regulations Notdone Produceupdatedfin. procedure manuals Partly done; expectedin2005 DetermineF Mstaff requirements Partly done, through IDNdonor assessments Review grades, determinevacancies Partly done, through overall HRreview, but needs to be done by each municipality as well Recruit qualified staff to meet requirements Initiated; done for 8 municipalities underMDP Provide training Partly done, through IDNdonor programs Develop accountancy profession Appoint representativecommittee to create Accountancy professiordaccountancybody to Moz. Association of Accountants (MAA) be establishedwith support fromPSR; Strategic Obtain fmancial support for committee DevelopmentPlanto be preparedby Preparestrategicdev. plan for profession international consultantexpectedto start in Draft M A A constitution, regulations Sept. 2004. Obtain Govt approvalof constitution, regs. Strengthen accountancy programs at tertiary education institutions Prepareimplementationplanto guide future International consultantto be hiredunder the direction of accountancy education PSRby Sept. 2004 to prepare implementation Determine coursesto offer, institutions to do so plan, determinecoursesto offer, and support Support course provision by qualified qualifiedinstitutions. institutions 85  14. The CPAR found that standardcriteria (i.e. comprehensive andtransparent legal framework, modernized procurement procedures, proficient staff, independent control mechanism, anti-corruption measures) are partially satisfied inMozambique, andthat improvements are necessary ina number o f areas, either by starting reform initiatives suggested inthe report or by completingreforms already underway underthe procurementcomponent of the Government's Civil Service ReformProgram(CSRP). Other new reform initiatives, suchas . the procurement code, the establishment of an adequateprocurement body andthe training of staff, are being supported by IDA'SPublic Sector Reformproject. The CPAR recommended implementation o f a set o f priority actions, including enhancing the capacity o f the Task Force for procurement reform; preparingcomprehensive procurement legislationbased on the existing legal framework already present, to meet internationally acceptable standards; preparing standard and comprehensive biddingdocumentsandproceduresmanuals; strengthening the MPF's Procurement Department to assume the functions o f a Procurement Policy and Monitoring Directorate; promoting dissemination and use o f ethics code inthe context o fthe CRSP; launching a sustained procurement capacity-building program; and involving the private sector and civil society as a whole inprocurement reform. The risksresulting from resistance to change that could hamper a successful implementation o fthe proposed reforms are considered to be low becausethese reforms are fully compatible with the general aim o fthe Government to modernize procurement regulations and practices andwith the Government's decentralizationpolicy. 15. As seenabove, the recommendations ofthe CFAA, CPAR and PERs were considered by the Government and donors andconsolidated into action plans. Among the key outcomes o f these plans are: improvedpredictability o f resource allocation and resource flows at the central andprovincial levels; improved quality and transparency o f fiscal data; enhanced integrityo f public sector institutions andan increased supply o f critical skills. Activities to achieve these outcomes are being addressed through Government initiatives and programs including the Public Sector Reform Program. Moreover, there i s significant donor involvement and coordination in initiatives to strengthen fiduciary management as well as harmonization around assessing and managing fiduciary risks when providing budget support. 86  Improve fiscal management DisseminatePER 2003 Done IntegratePERs into budget cycle by: identify- Done ingmonitoringtargets, strengtheningstatistical capacity, and developingreporting systems Clean up GoM accounts by completing invent- Initiated, to be completedin2004-2005 tory and closing accounts not linkedto this FY Alleviate underspendingthrough training No longerplanned; SISTAFE changes needs Improve internal auditing Ongoing Introduce SISTAFE Underway, to be completedduring 2004-2005 Initiate civil service reform Implement Public Sector Reform Programby: Report on Pay Reform being completed; GoM (i)restructuring, (ii)linking pay to requestedspecific recommendationson options performance; and (iii) reviewing pay scales to be finalized bythe end of June. Investigate/eliminate"ghost" employees PMrequestedassessment by end-2004 Study AIDS implications for GoM spending Coordinatedwith UNDP Improve education outcomes RaiseEPl completion from 30% to 60% by: New curriculum implemented ingrades 1,3,6 curriculum reform; near-automaticpromotion; inJan. 2004; schoolfees study expectedmid- reduction infees; increase infemale teachers 2004; gender strategy inDec. 2003, but limited actionto increase number of female teachers. Eliminate "ghost" teachers Not done Merge EP1andEP2 into one cycle Not done; GoM agreement recently reached Expandteacher training Teacher supply increased, but quality lags Decentralizeschool construction PreuaratorvAAA done for EP1schools Improve health outcomes Consolidatehealthstrategy and policy Underway; Bank support through Marginal documents into single planning system Budgeting for Bottlenecks exercise Review and rationalize user fee system Not done; focus of PRSC andpolicy dialogue Reflect user fees, other funds, on budget Not done; MoHbudget includesuser fees, other funds, butnot registeredinMPFbudget Expand road network SeparateRoadFundfrom ANE Done Restorefuel tax to real 1997 level Done, albeit with delays Fully fundroutine, periodic maintenanceand Routine maintenancefully funded; prov. not subject all to competitive bidding fully funded; all subject to competitive bidding Privatize parastatalmaintenancecompanies Partly done Improve access to safe water Raiseurbanhouseholdconnectionsper year No improvement while management contracts from 2,500 to 22,000 by 2015; apply full cost being renegotiated; civil works underway tariffs by 2008; improve standpipe service quality; scrap rules againstwater resale Raiseruralwaterpoint developmentper year 1,200 boreholesconstructedor rehabilitated in from 900-1,300 to 1,400; reduce percentage of 2003; non-functioning water points reportedto non-functioning waterpoints (from 35% now) be 27%, but reporting systemnot accurate 87  Annex 4 REPUBLICA DE MOCAMBIQUE MINISTER10 DO PLAN0 E FINANCAS GABINETE DA MlNlSTRA No. gy /GWMPF/O4 Maputo,June I,2004 H.E.JamesD. Wolfensohn,President The WorldBank 1818If Street,N.W. Washington,D.C. 20433 U.S.A. SUBJECT:Letter of DevelopmentPolicy First Poverty ReduciionSupport Credit (PRSCl) I. Iamwriting,onbehalfof theGovernmentof Mozambique,torequesta , US860.0millionfiom the International DevelopmentAssociation,to continueSUP ortingthe Government Fredit in the amounl of of Mozambique'sstructural reform program under theproposed First Poverty ReductionSupport Credit 4 (PRSC r). This request comes in the context of the Memorandum of Understanding (Mov, signed on April S, 2004, between the Government of Mozambique and several of its international aid partners, including the World Bank. This MoU outlines theparticipants' approach in ect of the provision of budget or balance-of-payments support,among other relatedmeasures. 2. The aforementioned Credit will help to meet the balance-of-payments financing requirements that Mozambiquefaces to implement its Action Planfor the Reduction of AbsolutePoverty, the PARPA; its Economic and Social Plan, the PES; and its annual budget, the OE; c o n ~ i b u to~cover budgetmy ~ g needs throughthe generatedcounterpartfunds. :. I TheProgram 3. The main objective of the Government's PARPA is a substantial red ction in the levels of absolutepoverty in Mozambique through the adoption of measures to improve the capacities and the opportunities available to all Mozambicans, especially the poor. A specific ob ective is to reduce the incidence of absolute poverty Pom 70percent in 1997 to less than SO perce t by 2010. The last household expenditure survey, completed in 2002/2003, showsthatpoverty incide ce headcount has been reducedto 54percent in 2003 @om 69.4percent in 1997). TheGovernment'seo mitment to addressing the Millennium Development Goals (MDGs) is strong and is reflected in the PAI PA and the matrix of actions and indicators included in the Perjormance Assessment Framew rk agreed with the Government's direct budget support and balance-of-payments supportpartners. heprogram dejneal in Tp these instruments, and in the PRSC matrix, will be implementedthrough Govern+ent systems controlled by the Government'sannual Economic andSocialPlan (PES) and the annual Budget (OE). 4. The overall aim of the economic program for 2004-06 is to reduce poverty by consolidating macroeconomic stability, address remaining structural creation and ensure that budgetaiy allocationsare compatiblewith the 88  5. TheGovemnrentprogramincludes tlrree main components that are an integralpart ofthe wider PARPA and PAF: Theseare: Buildiiigpublic-sector capacity and accountability: Under this component, the Govemment is committed to maintaining macroeconomic stability, improving public financial management, and enhancing governance. The Government will maintain macroeconomic stability through adhering to an appropriate macroeconomic pamework with consistent fiscal and monetary policies. It will improve public financial management through: monitoring closely and allocating 65% of its resources or more to pro-poor spending: increasing budgetary eflciencj, transparency and accountability by expanding coverage and implementing SISTAFE; and improving the timeliness and quality of the national accounts, auditing and budgetary reporting. In addition, it will reduce aid dependency through mobilizing further domestic resources; deepen its understanding of the incidence and causes of poverty through completing and analyzing the results of the second household income survey; and update the PARPA to reflect the country's changedcircumstancesas well asprogress in implementing reforms. Finally, the Government aims to improve governance by bringing public procurement into line with internationalpractice; restructuring its key sectoral ministries to be moreiresponsive to citizeu needs; decentralizing the delivery of specifiedservices to local authorities to expandcommunity participation andgovernmentaccountability; andjghtingcorruption. Iniproving the investntent climate: Governmentaction in this area is intended to: strengthen the Jinancial sector, particularly by enhancing the independence of the centraI bank and completing the divestiture of Government ownership in the banking sector; improve the regulatory framework by reducing impedimentsto enby and exit and increasing theflexibility qf the labor law; and expand infrastructure services by reducing communication costs and making electricity less expensive and more reliable-all with a view to making domestic productioii more competitive. Exparision of service delivery: Government action in this area under PRSCl is limited to enablingprimary schools tofinance locally-identified needsfor basic supplies on a timely bash:, throughproviding all schools with small grants throughthe Direct Support to Schoolsprogram. In addition, public expenditure reviews and environmental work will be completed in the agriculture and health sectors in preparation for bringing these two sactors into the PRSC series in PRSC2. 6. A Joint Review heldfvom March24 to April 6, 2004 between the Government, the donor community providing direct budget support (G14) and the World Bank,' in sukport of the PARP,4 implementation,found thatgoodprogress had been achievedin a number of areas, giving a reliable basis for the G14donors and the WorldBank to continue toprovide budget or balance-of-payments support to Mozambigue. P a r t i c i p a t i n g external partners included Belgium, Denmark, the Europ' an Commission, kinland, France, Germany, Ireland, I t a l y , Netherlands, Norway, PortugLl, Sweden, Switzerland, the United Kingdom and the World Bank (these 15 support f o r providing budget/balance o f payments support), which have signed Understanding w i t h the Government. Observing external partners i n c l u Japan, Spain, the United States, the United Nations, the Internationa P and the African Development Bank. - n 89  Overview andActions in 2003 7. Over the past years, Mozambique has succeeded in creating a macroeconomic environment supportive of economic growth. PARPA implementation in 2003 was broadly positive, as concluded in the April 2004 Joint Review (involving the Government, most major donors and the World Bank). In particular, the Joint Review found that the Government actions included in the 2003 Performance Assessment Framework (PAg matrix, which updates the PARPA'Soperational matrix, were largely met, including in the PARPA priority sectors (education, health, agriculture and rural development, and infrastructure). In terms of cross-cutting reforms, notable achievements in 2003 were the revision of some labor market rigidities through a new decree, the Jinancial audit of the country's largest commercial bank, the rise in tax revenues, the integration of the PARPA implementationreporting into theBalanco do PES, and the approval of the legal andjustice sector strategicplan. 8. Theprior actionsfor PRSCl were also met. Inparticular, there wasprogress in implementing SISTAFE, withpublication of the SISTAFE regulations in Decree I7/2002. The Technical Unitfor the Public Financial Management Reform Program (UTRAFE) has been established, the Data Processing Center has beensubstantially strengthened, andphase I of the eCUT-fisica system is now operational. 9. In addition, in 2003 the Government allocated 64.9%of its total budget expenditures (excluding interest payments and spending on the November 2004 municipal elections) on the priority sectors referred to in the PARPA (see Table 1attached). 10. Domestic tax revenue mobilization increasedfiom 12.5% in 2002 to 13.3% in 2003 mainly through adiusting thefuel tari$f(in accordancewith Decrees 19/2003 and 56/2003) and implementing a withholding tax on the income of public sector employees (in accordance with Decree 20/2002 and Ministerial Diploma 22912002). These two measures increased Government revenues in 2003 by approximately 0.7% of GDP. II. Inpublic sector reform, thefollowing Government actions werecompleted: The land registration process was reducedfrom over 120days to a maximum of 90 days, once all necessary documentation is presented, in accordance with Circular OOl/GDN/2002, issued by the Ministry of Agriculture and the National Directory of Geography and Cadastre; with the result that the number of registrations completed rosefrom 1,301in 2002 to 2,462 in 2003. A new regulatoryframework has been adopted, in accordance with Decree 39/2003, to simplify and expeditetheprocess of industrial registration. Visitor visas are now being issued at Mozambique's borders, in accordance with Decree 38/2000 as well as a Ministerial Decree issued by the Ministry of the Interior on October 17, 2000 (which activated it). 12. In addition, the Parliament passed a new law on decentralization, tlie Local State Organs Law 8/2003. This law provides for increased autonomy of district authorities as well as the legal basisfor treating a district authority as a budget entity, thereby strengthening the territorial dimension of public sector management. 13. Finally, the Parliament alsopassed an anti-corruption (Law Numberpending;). This law will be signed by the President of the Republic before June 7, 2004 and will be imme in tlie Boletim da Repriblica. 90 3  14. Notwithstanding thispe@ormance, the economy remainsfragile, and there were some shortfalls in fully meeting the PAF outcome targets for 2003. Primary education (EPl) completion rates fell slightly short of the target and continue to be off-track for meeting the MDG goal. Progress in roads rehabilitation andperiodic maintenance was slow due inpart to the appreciation of the Rand against the Metical and existing concerns within the VAT system. In addition, the reform of the legal andjudicial sector is showing slowprogress. Mncroecononiic nianngement 15. The Government in 2003 implemented appropriate macroeconomic management, as most of its quantitative targets were met (e.g. revenue, real GDP growth, international reserves) or missed by a small margin (domestic primary deficit), and important structural benchmarks were also met (the Xzx Tribunals Law was approved by the Parliament). Thus, real GDP grew by 7.1 percent in 2003, which was in line with the average of about 6per cent annually between 1996and 2002. 16. Annual injation, which rose to 13.8% at year-end against a 10.8% target, constituted an important exception. The 2003 inflation was due to 0) the impact on food prices from the regional drought earlier in the year, (ii) the appreciation of the rand against the metical, and (iii) signifcant monetary expansion associated with the concentration of Governmentspending in late 2003, financed. with delayeddisbursements of external aid that was not sterilized by sellingforeign exchange. Goventmice 17. The Governmentmadeprogress in implementingits medium-termpublic sector reform program in 2003. Efforts have been made to create supportfor the reforms both within the government and in the general public. All ministries are undertakingfunctional analyses to determine how to optimize thcir functions, Five ministries are at an advanced stage in their work (MADER, MSAU, MINED, MAE and MPF), and one (`MIC) is nearing completion. In addition, the Parliament has pawed an anti-corruption bill, and a corruption survey is underway to evaluate the experiences of entrepreneurs,private citizens and civil servants with poor governance, which will enable the Government to establish a governance baseline, The Government has also signed the Affican Union Convention on anti-corruption, which needs to be ratified, and the SADCprotocol on anti-corruption. 18. Progress hm also been made in the area of deconcentrating state administration through passing /he Local State Organs law, but further work is required to (i) create siifjlcient financial and administrative capacity at district (and provincial) levels; (ii) involve all stakeholders in the planning process; (iii) strengthen the ability of districts to collect their own revenues; and (iv) institutionalize consultativemechanisms at the local level. Public Finance Managentent 19. In thefield of publicfinancial management, ongoing reforms are being implementedto improve effectiveness and transparency in usingpublic resources, and to build capacity in public administration in order to increaseeficiency. 20, Taw reform made signifcant progress during 2003, with the introduction of new income taxes (individual and corporate income), a motor vehicle tax, and a large increase in the fire1 tax to offet accumulatederosion through inflation. Totalrevenues roseffom 13.3%to 14.3% of GDP in 2003, with a strong performance on income tax (increasingpom 18%to 22% of total tax receipts). Aiming at@rther increases in tax mobilization, the Governmentis in theprocess of creating a Central Revenue Authority: the actionplanfor its establishment by 2006 was approved by the Ministry of Planning and Finance and 91  theprocess has started through restructuring the Directoratefor Taxes andAudit (DNIA), which will be integrated with the Customs Directorate (DGA) under the new revenue authority. Improvements were also observed in customs clearance procedures, with new legislation simpli&ing customs control. Additionally, pursuant to Decree 36/2002, the top import duties on consumption goods were reduced from 3Oper cent to 25per cent beginning in January 2003. Privatesector mid business environment 21. Recognizing the important role of the private sector in promoting economic growth and employment, Government policies and reforms will improve the business environment for the development of private sector activities, and reinforce the role of the market in the economy. In this regard, the Government will continue to gradually reduce its direct interests in commercial bank at the same time that it will revise the legal framework and Central Bank capacities to strengthen bank: supervision. 22. The most important actions completed in 2003 in the reform of thefinancial sector include: (0 u comprehensive review of BIM (Banco Intemacional de MoCambique), which found the bank to be adequately capitalized under international accounting standards (US), (ii) restructuring, including downsizing and strengthening of internal control measures, within both BIM and BAu (Banco Austral), which improved their financial results, (iig submitting to parliament a new Financial Institutions law enhancing the central bank's author@ and establishing theframework for micro-financial institutions, and (iv) some training at the central bank to enable greater oversight offinancial institutions, including during andfollowing the transition to US. In addition, the Governmenthas initiated aforensic audit ojf BAu commissioned through the OfJice of theAttorney General,which will take legal action as needed. 23. Agricultural growth in 2003 surpassed the PARPA targets of 8percent, with strong growth in cashcrops,primarily in tobacco (73 percent),sugar cane (22percent), cashew (17percent)and livestock (18percent), and a slight increase infood crops, hampered by unfavorable rains during the 2002/2003 growing season. All of these crops, with the exceptionof sugar cane, areproduced and marketed by the small family) sector where most of thepoor are. Concernremains over the limited coverage of extension services; coverage is improving but has reached so far only 18 percent of farming households. Vaccination of poultry and cattle has improvedconsiderably,withpositive effects on diseasecontrol. The enabling environmentfor the availability of credit in rural areasfor farmers and small and medium- sized enterprises (SMEs) also continues to need improvements. Processing of land titling improved considerably in 2003, with registration now taking a maximum of 90 days against more than 120 days in 2002. In addition, new legislation now enforces managementplanningfor forestry concessions, although the approval process has to befurther accelerated. 24. There has been progress in protecting the environment. Esforts to ensure the sustainable management of natural resourcesare bearingresults: for example, one in threeforestry concessions now has a managementplan comparedto one in seven in 2002. 25. The main actions completed in the infrastructure sector, in 2003, include: (i)issuance of a second mobile telephone operator, to Vodacom; (io granting a 15-year concessionin the Maputoport to aprivate operator, resulting in improved clearance times; (iii) revocation of a decree that had granted LAM (Mozambique Airlines) a monopoly on air transportation, opening spacefor other carriers; and (iv) activepursuit of private participation in other air transportation. 26. Road rehabilitation andperiodic maintenance proceeded at a slower pace than expected. The sharp rise of the South A>ican rand and concerns with the VAT system createdfinancing dipculties. Nonetheless, in 2003, the Road Fund was legally established; open tender for 92 5  maintenance contracts rosefrom 25 percent to SO percent; and the provincial road inspectorates were privatized. In the energy sector, the PARPA goal of electrifying all 128 district capitals was brought within reach (only 8 remain without electricity). In addition, to improve EdM's performance,i its operations were separated into new business centers; the Government is exploring options introducing private-sector participation in distribution; and it has also decided to permit adjustmentsover a three-yearperiod. Service delivery 27. In the area of HIVAIDS, the national response is being implemented under institutional and strategic di@culties and the Governmentrecognizes that revision of the strategic plan was slow in 2003. The human and institutional capacity of the National AIDS Council needs to be strengthened to lead the national response effectively. 28. Outcomes in the health sector over 1997 to 2003 were good, with strong improvements in'the outpatient utilization rate, child vaccination, the infant mortality rate(Im),the under-five mortality rate (USMR), and the contraceptiverate. Particular concern continues tofocus on thedoctorlpopulation rate, which is already among the worst in the world andstill trending downwards. 29. In education, the targetsfor gross and net primar)) school enrolment rates were exceeded in 2003 and targetsfor the repetition rate and gender equity were also met, while the completion rate fell short ofthe target (40%). In this context, the sector strategy is being revised; the new primary education curriculum was piloted; a strategyfor community school constructionprogram wasfinalized; and the Direcl Support to Schools (DSS) program was launched, enabling all 8,000primary schools nationwide to receive small cash grants that local oflcials could use tofinance locally-identified needs on a tirqely basis. 30. In the water sector, the key PAF/PES indicator, viz. access to safe water, reached 38%, exceeding the annual target of 36%. There was also goodprogress in water resource management, as stakehoIder meetings were held with a view to developinga new strategy, negotiating international river issues and creating international basin commissions. Actionsfor 2004-2005 31. The Government recognizes that maintaining macroeconomic stability is key to sustai ing growth. The Government will continue to pursue fiscal and monetary policies that are targetel to bringingthe injlation rate into single digits, while at the same time developingpolices towards helpin to reduce domestic interest rates and spreads. The Governmentwill also continue to develop and implement 9 a macroeconomicjamework that is agreed with the IMF to ensure that policies relating to the budget, the management of money and credit, and the exchange rate as well as to the regulation and supervision of banks and otherjnancial institutions are consistent and to allow the effective pursuit of sustainable economicgrowth, low inflation, and high employment. 32. Transparency and accountability in the use of public resources is a key citizen right and government responsibility as well as a key contributor to ensuring the eficiency and efjcacy of public administration. To meet its responsibilities in this area, the Government of Mozambique has bken modernizing its public financial management system (SISTAFE) to improve controls, decentralize planning and execution,and increase transparency and accountability. I n this respect, and to ensure the beginningof the roll-out of SISTAFE among the diyerent governmentagencies in 200.5, the SISTAFEwill be implemented in the Ministry of Planning and Finance and itsprovincial directorates during 2004. To sustain high growth rates and reduce poverty, the Government is committed to spending at least 65per 93  cent of its resources (excludinginterestprryinents and spending on national elections in December) in th priority sectors of the PARPA. A new procurement decree that brings the public procurement into line with internationalpractices will also be approved by the Councilof Ministers. 33. Aiming to strengthen the authority of the central bank, the Banco de Moqambique, th Parliamentpassed the new Financial Institutionslaw in 2004. 1 34. In addition, to improve the investment climate in Mozambique and ensure an environment thd encourages theprivate sector to drive economic growth in the countty, the Government will revise th b regulations regardingforeign hires to enable companies to hire the workers they want and need and it will also support the Parliament in drafting a revised and updated Commercial Code, which the Parliament is expectedto discuss and approve in thenearfuture. Finally, the Governmentexpectsto take appropriate legal and regulatory measures to improve the management of urbanproper& including the rights related to the use and benejlts of suchrealproperg. I 35. Many of the actions that the Government expects to complete in 2004 have been agreed to b chosenaspotential triggersfor PRSC2. Conclusion poverty through the implementation and monitoring and evaluation systems that the Government i,g developingaround thePARPA, thePAF matrix, its Economic andSocialPlan, and its annual budget. Withhighest consideration, YoursSincerely, Minister of Planningand Finance 94 P  .  Annex 5 Mozambique at a glance 6/3/04 Sub- POVERTYand SOCIAL Saharan Low- Mozambique Africa income 1 Developmentdiamond* 2003 Population, mid-year (m/llions) 18.8 688 2,495 Life expectancy GNI percapita (Atlas method, US$) 210 450 430 GNI (Atlas method, US$ billions) 3.9 306 1,072 Average annual growth, 1997-03 Population (%) 2.0 2.4 1.9 Laborforce (%) 2.1 2.5 2.3 j GNI per Most recent estimate (latest year available, 1997-03) capita Poverty(% ofpopulationbelownationalpovertyline) 54 Udan population (% of totalpopulation) 34 33 30 i Life expectancyat birth (years) 41 46 59 Infant mortality (per 7,000 live births) 101 105 81 Child malnutrition (% of children under5) 24 I Access to improvedwater source Access to an improvedwater source (% ofpopulation) 57 58 76 Illiteracy (% ofpopolationage 75+) 60 37 37 Gross primaly enrollment (% of school-agepopulation) 106 86 95 Male 107 92 103 1 --Mozambique Low-incomegroup Female 95 80 87 KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1983 1993 2002 2003 Economlc ratlos' GDP (US$ billions) 3.2 2.1 3.6 4.3 Gross domestic investmenWGDP 11.6 12.7 30.3 27.9 Exportsof goods and services/GDP 6.1 13.2 23.5 22.6 Trade Gross domestic savings/GDP -5.0 -22.4 15.6 11.3 - Gross national savings/GDP -3.9 -16.0 15.8 12.8 Currentaccount balance/GDP -15.6 -39.2 -24.3 -18.6 interest payments/GDP 0.0 3.6 4.9 3.8 Domestic Investment Total debffGDP 1/ 13.0 214.6 75.4 66.0 savings Total debt service/exports1/ 0.0 19.0 5.1 4.0 i Presentvalue of debWGDPl/Z/ 24.8 23.2 Presentvalue of debffexports1/2/31 96.0 91.2 Indebtedness 1983-93 1993-03 2002 2003 2003-07 (average annualgrowih) GDP 3.6 8.1 7.4 7.1 7.6 -Mozambique GDP percapita 2.6 5.7 5.3 5.1 5.8 Low-income group ~ Exportsof goods and services 5.0 17.6 14.1 16.2 17.0 STRUCTUREof the ECONOMY 1983 1993 2002 2003 , Growthof Investmentand GDP (Oh) (% of GDP) I Agriculture and fishery 37.6 29.5 26.6 27.1 Industry 27.5 20.7 31.2 33.5 Manufacturing 7.3 14.9 15.5 Services 34.9 49.8 42.2 39.4 Private consumption 101.o 110.7 73.4 77.3 Generalgovernmentconsumption 16.6 11.7 11.0 11.5 Importsof goodsand services 22.8 48.4 36.2 39.4 1983-93 1993-03 2002 2003 Growthof exports and imports (%) (average annualgrovdh) I B 0 - Agriculture and fishery 2.9 6.1 7.2 8.0 Industry -3.5 18.2 14.0 7.2 Manufacturing 18.1 4.0 12.8 Services 7.7 2.6 -1.5 5.3 Private consumption 2.8 2.0 2.0 13.9 Generalgovernment consumption 1.7 6.2 5.0 8.6 Grossdomestic investment 6.3 14.8 18.9 -14.6 Importsof goodsand services 0.0 4.0 13.9 5.6 Note 2003 data are preliminary estimates Groupdata are through 2002 *The diamonds show four keyindicators in the country (in bold) comparedwith its income-groupaverage If data are missing,the diamondwill be incomplete I / Public and PubliclyGuaranteeddebt Excludes pnvate non-guaranteeddebt 2i Dataincludeimpactof total debt relief underthe enhanced HlPC initiative,additional bilateral assistance, and new borrowing. 96  Mozambiaue PRICES and GOVERNMENT FINANCE 1983 1993 2002 2003 Domesticprices ,120 Inflation (Oh) (% change) - Consumer prices 28.2 42.3 16.8 13.5 ImplicitGDP deflator 13.0 51.4 11.5 12.6 Government finance 5 (% of GDP, includescurrent grants) 0 Current revenue inci. current grants 18.0 18.5 18.0 18.4 98 99 W 01 02 03 Current budget balance -2.1 3.6 2.2 2.5 I Overallsurplusldeficitafter current grants -17.8 -11.o -15.8 -11.4 -GDP deflator -CPI I Overallsurplus/deficitafter all grants -16.0 -3.6 -7.9 -4.9 TRADE 1983 1993 2002 2003 (US$ millions) Export and import levels (US$ mill.) 1 II Total exports (fob) 132 132 679 880 Cashew nuts and raw cashew 16 20 I 17 17 2 0 W T 1500 Prawn 31 69 64 64 i1 Aluminum 361 519 000 Manufactures 7 13 15 500 Total imports(cif) 830 1,351 1,445 l I o Export priceindex (1995=100) 97 99 01 96 90 74 78 98 00 02 Import priceindex (1995=100) 99 89 82 83 Eqorts Imports Terms of trade (1995=100) I/ 97 101 90 94 I O3 BALANCEof PAYMENTS 1983 1993 2002 2003 (US$millions) 1 Current account balanceto GDP (Oh) Exportsof goods and services 222 312 1,058 1,230 Importsof goods and services 694 958 1,745 1,820 Resourcebalance -472 -646 -687 -590 Net income -33 -179 -189 -213 Net cunent transfers 0 0 0 0 Current account balance before grants -505 -825 -876 -803 Financingitems (net) 462 778 970 975 Changes in net reserves 43 46 -94 -172 -35 1 Memo: Reservesincludinggold (US$millions) 15 187 825 1,007 Conversionrate (DEC, local/US$J 40.2 3,723 23,667 23,782 EXTERNALDEBTand RESOURCE FLOWS 1983 1993 2001 2002 (US$ millions) 1Composition of ZOO2 debt (US$ mill.) Total debt outstanding and disbursed2/ 422 4,514 2,402 2,716 IBRD 0 0 0 0 IDA 0 512 777 985 Total debt service 21 0 71 49 56 IBRD 0 0 0 IDA 0 3 7 12 Compositionof net resourceflows 2/ Officialgrants 90 503 469 428 Ofkial creditors 202 134 103 223 Privatecreditors 0 0 0 0 Foreign direct investment 0 32 255 372 E 1,029 World Bank program Commitments 0 123 229 180 A - IBRD E Bilateral Disbursements 0 93 52 149 B IDA - D -Other multilateral F Pnvate G- Short-term -- Principalrepayments 0 0 3 6 C IMF . Net flows 0 93 49 143 Interest payments 0 3 4 6 Nettransfers 0 90 44 137 ~~~~ Development Economics 6/3/04 I / Includes aluminumprice. 2/ Publicand PubliclyGuaranteed. Datafor 2001 includesimplementationof November 2001 Paris Club underthe EnhancedHlPC Initiative. Datafor 2002 includesall signed agreements underthe Enhanced HlPC Initiativesigned by end 2002. Excludes private non-guaranteeddebt estimatedat US$ 1.6 billionin 2001 and 2002. 97  Annex 6 Mozambique Social Indicators Latest single year Same regionlincome group Sub- Saharan LOW- 1970-75 1980-85 1996-2003 Africa income POPULATION Total population,mid-year(millions) 10.5 13.5 18.8 688.9 2,494.6 Growth rate (% annualaveragefor period) 2.2 2.3 2.0 2.4 1.9 Urban population(% of population) 8.7 16.8 34.3 33.1 30.6 Total fertility rate (births per woman) 6.5 6.4 5.0 5.1 3.5 POVERTY ("7 of population) Nationalheadcountindex 54.1 INCOME GNI per capita (US$) 260 210 450 430 Consumer price index (1995=100) 1 259 INCOMEiCONSUMPTIONDISTRIBUTION Gini index 39.6 Lowestquintile (% of incomeor consumption) 6.5 Highestquintile (% of income or consumption) 46.5 SOCIAL INDICATORS Public expenditure Health (% of GDP) 4.1 2.5 1.1 Education(%of GDP) 2.3 2.6 3.4 3.1 Net primary school enrollment rate (% of age group) Total 51 60 80 Male 56 63 65 Female 47 56 74 Access to an improved water source (% of population) Total 57 56 76 Urban 81 83 90 Rural 41 46 70 Immunization rate (% of children ages 12-23months) Measles 39 58 58 65 DPT 29 60 54 65 Chiid malnutrition(% under 5 years) 24 42 Life expectancy at birth (years) Total 43 44 41 46 59 Male 42 42 40 45 58 Female 45 45 42 47 60 Mortallty Infant (per 1,000live births) 163 140 101 103 79 Under 5 (per 1,000 live births) 278 233 153 174 121 Adult (15-59) Male (per 1,000population) 498 468 674 519 310 Female (per 1,000 population) 382 361 612 461 259 Maternal(modeled,per 100,000 live births) 980 Births attended by skilled health staff (%) 48 Note: 0 or 0.0means zero or less than haif the unit shown Net enrollment rate: break in series between 1997and 1998due to changefrom ISCED76to iSCED97. immunization:refers to children ages 12-23 monthswho received vaccinations beforeone year of age. 2004 World DevelopmentIndicatorsCD-ROM,World Bank; MozambiqueHouseholdSurvey,O2/03 and MozambiqueHealthSurvey, 2003 98  Annex 7 Mozambique Key EconomicIndicators - Estimate Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Sational accounts (as % of GDP) Gross domestic producta 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 37.2 32.9 30.9 26.8 26.7 26.6 27.1 25.5 25.6 25.4 Industry 18.9 23.4 24.5 26.6 2 7 6 31 2 33.5 37.0 37.8 38.5 Services 43.9 43.6 44.7 46.5 45.7 42.2 39.4 37.4 36.7 36.1 Total Consumption 98.9 93.2 91.0 89.4 81.7 84.4 88.7 85.1 83.9 77.5 Gross domestic fixed investment 20.6 24.2 36.7 36.6 32.0 30.3 27.9 23.3 27.7 28.1 Governmentinvestment 12.1 9.8 11.6 10.6 16.6 14.3 13.0 12.0 11.6 11.1 Privateinvestment 8.5 14.5 25.1 25.9 15.4 16.0 14.9 11.3 16.1 17.0 Exports(GNFS)b 11.3 10.5 10.1 12.9 21.8 23.5 22.8 24.8 23.5 22.3 Imports(GNFS) 30.8 27.9 37.8 38.9 35.4 38.2 39.4 33.2 35.1 27.9 Gross domestic savings 1.1 6.8 9.0 10.6 18.3 15.6 11.3 14.9 16.1 22.5 Gross nationalsavingsc 1.0 5.9 10.0 14.4 15.6 15.8 12.8 11.3 12.1 18.5 Memorandum items Gross domesticproduct 3448.9 3958.7 4091.0 3627.7 3435.3 3600.2 4320.6 5212.8 5726.5 6187.1 (US0 millionat current prices) GNP per capita(US%,Atlas method) 180.0 210.0 220.0 220.0 210.0 200.0 210.0 230.0 260.0 290.0 Realannual growthrates(%, calculated from 1995 prices) Gross domesticproduct at market prices 11.1 12.6 7.5 1.5 13.0 7.4 7.1 8.4 6.8 6.5 Gross Domestic Income 11.2 12.8 8.2 -2.3 9.6 6.6 2.2 4.3 7.4 13.2 Realannual per capitagrowth rates(%, calculated from 1995 prices) Gross domesticproduct at market prices 8.4 10.4 5.5 -0.7 10.6 5.3 5.1 6.5 5.0 4.7 Total consumption 5.3 5.5 6.2 -5.2 1.9 -2.0 5.0 0.4 3.3 3.3 Balanceof Payments (US%millions) Exports(GNFS)b 508.7 530.8 601.3 732.3 1004.1 1058.0 1229.5 1617.1 1682.4 1723.5 MerchandiseFOB 230.0 244.6 283.7 364.0 703.1 679.3 880.2 1257.3 1310.8 1340.8 Imports (GNFS)b 937.5 1063.5 1539.8 1546.2 1665.2 1744.8 1819.8 1800.8 2108.0 2180.1 MerchandiseFOB 760.0 817.3 1199.8 1162.3 1063.4 1350.8 1445.4 1446.0 1711.8 1777.5 Resource balance -428.8 -532.7 -938.5 -813.9 -661.1 -686.7 -590.3 -183.8 -425.6 -456.6 Current account balancebefore grants -610.7 -748.4 -1152.1 -1041.6 -966.6 -876.1 -803.4 -646.0 -887.1 -938.5 Current account balanceafter grants -297.8 -435.8 -718.0 -477.7 -497.2 -456.2 -267.3 -95.2 -384.9 -436.4 Net privateforeigndirect investment 64.4 212.7 381.7 139.1 255.4 379.8 341.7 109.0 212.7 204.8 Long-termloans(net) 116.1 50.1 231.7 139.8 -220.2 631.1 193.7 86.1 257.2 231.6 Other capital(net, incl. debt relief, short termanderrors & ommissions) 4154.2 234.8 172.9 392.5 455.9 -460.9 -96.2 -100.0 -85.0 0.0 Change inreservesd -114.6 -61.8 -68.3 -193.7 6.1 -93.9 -172.0 0.0 0.0 0.0 Memorandum items Resourcebalance(% ofGDP) -12.4 -13.5 -22.9 -22.4 -19.2 -19.1 -13.7 -3.5 -7.4 -7.4 Realannual growthrates( YR95 prices) Merchandiseexports (FOB) -0.5 32.9 34.6 23.3 105.9 -10.9 22.5 41.4 -1.2 -2.5 Merchandiseimports(CIF) 4.3 15.5 47.2 -5.3 -4.0 27.3 5.7 -0.5 17.1 3.0 (Continued) 99  Mozambique Key EconomicIndicators - (Continued) Page 2 of 2 Estimate PrOJected Indicator 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Public finance (as % of GDPat market prices)e Current revenues 11.3 11.4 12.0 13.2 13.3 14.2 14.3 14.6 15.0 15.2 Current expenditures 10.7 11.2 12.2 13.5 14.5 15.8 15.9 15.6 15.1 14.8 Current account surplus (+) or deficit (-) 0.6 0.2 -0.2 ~0.3 -1.2 -1.6 -1.6 -1.0 -0.1 0.4 Capital expenditure 11.9 9.8 11.6 10.6 16.6 14.3 13.0 12.0 11.6 11.1 Overall balancebefore all grants -11.7 -10.5 -13.2 -14.0 -21.4 -19.7 -15.5 -13.1 -11.6 -10.6 Foreign financing incl. grants 14 8 12.8 13.5 12.3 19.4 18.7 15.4 13.5 12.0 11.1 Monetary indicators M2IGDP 18.6 18.6 22.7 29.5 30.6 31.9 31.4 29.5 29.3 29.4 Growthof M2 (%) 24.4 17.6 35.1 42.4 29.7 24.8 18.7 15.0 14.5 14.5 Private sector credit growth/ 359.7 972.8 100.2 84.6 74.5 48.7 151.7 114.5 126.7 120.3 total credit growth(%) Price indices( YR95 =loo) Merchandise export price index 82.1 65.7 56.6 58.9 55.3 59.9 63.4 64.0 67.6 70.9 Merchandise import price index 119.8 1 1 1.5 111.2 113.7 108.3 108.1 109.4 1100 111.2 112.1 Merchandise t e r m of trade index 68.5 58.9 50.9 51.9 51.0 55.4 57.9 58 2 60.8 63.2 Real exchange rate (US$LCU)f 62.7 56.6 57.8 55.6 50.4 46.9 45.5 Consumerprice index ("31change) 6.4 0.6 2.9 12.7 9.0 16.8 13.5 12.9 7.8 7.3 GDP deflator (% change) 9.5 4.6 2.9 8.0 10.6 11.5 12.6 12.9 7.8 7.3 a. GDP at factor cost b. "GNFS" denotes "goods and nonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Consolidated central government. f, "LCU" denotes "local currency units." An increase inUS$/LCU denotesappreciation. 100  (D m t P Ln F? r N : N m m x r h N a E m : L n o o m " ~ N - m m o m m t t t -mm n o o m o o o o o m m o o o o o o n o o m o o o o o m m o o o o o o r N N r N N N N N r r N N N N N N .-Y m .-m0 c 2 n 0 VI r h m . m N t a8 E 2 .-a2e c Nr- n II m .-e 0 n n U c -0m .-e n  Annex 9 Relationswith the IMF Public Information Notice (PIN) No. 03/148 InternationalMonetary Fund December 22,2003 700 19thStreet, NW Washington, D.C. 20431USA IMFConcludes 2003 ArticleIV Consultationwith the Republicof Mozambique 1. On December, 10,2003, the Executive Board o f the InternationalMonetary Fund (IMF) concludedthe Article lV consultationwith the Republic of Mozambique.' Background 2. Mozambique's performanceunder the authorities' program duringthe first three quarters o f 2003 continued to be satisfactory. Manufacturing output, construction, and services performed strongly duringthe first halfo f 2003, and the target o f real GDP growth o f 7 percent for the year as a whole appears achievable. After peaking inMay 2003 owing to the impact o f drought on food prices andthe appreciationo f the South African rand against the metical, the 12-monthrate o f inflation declined to 13.6 percent inNovember(underthe program, end-year inflation was targeted at 10.8 percent). Average commercial bank lending rates have declined from 37 percent to 30 percent since end-2002, with interest rate spreads remaining highat 19 percent. 3. The government's fiscal program for 2003 seeks to contain the domestic primary deficit at 3.7 percent o f GDP, with tax revenue strengthening as a result o f the implementation of the new code for the personal and corporate income taxes approved in 2002, the full-year effect o f a new andmore transparent fiscal incentives code, and a significant increase inthe specific taxes on domestic petroleum products implementedin May 2003. Available information for the periodthrough September 2003 indicates that the government's deficit was lower than programmed, reflecting a lower level o f locally financed capital outlays owing to delays inproject execution associated inpart with shortfalls in external assistance. 4. External developments duringthe first half o f 2003 continued to be influencedby exogenous shocks and large scale foreign investmentprojects. For the year as a whole, the external current account deficit after grants i s expected to widen to 15 percent o f GDP (12 percent in2002), reflecting an increase ininvestment inthe mega projects duringthe second half o f the year. 5. The consultationdiscussions focused on the macroeconomic policies for 2004-06 andthe government's plans to address pendingstructural reforms to broaden and sustain growth and further reduce poverty. Real GDP growth i s projectedto increase to over 102  8 percent in2004 largely because o f the coming on stream o f MOZAL I1(the expansion o f the aluminum smelter) andthe gas pipeline, and end-year inflation is targeted to fall to 9 percent. The government's domestic primary deficit i s projected to decline to 3.4 percent o f GDP in2004, owing to a hrther strengthening o f revenue and steps to start addressing the significant increase inthe government's wage bill that has taken place in recent years. The overall deficit after grants, however, would be somewhat higher than in 2003. 6. Discussions on structural issues concentrated on the authorities' plans to remove a numbero fobstacles to private sector development. Particular attentionwas paidto (i) reducingred tape and simplifyingthe regulatory framework; (ii) addressing labor rigiditiesthat hinder competitiveness; (iii) improving basic infrastructure; (iv) reforming thejudicial system; and (v) moving aheadwith reforms to increase efficiency inthe public sector. Inaddition, the staff discussed with the authorities several recommendations to address remainingvulnerabilities inthe financial system made by a joint team from the Fundandthe World Bank inthe context o f the Financial Sector Assessment program (FSAP). Executive BoardAssessment 7. Executive Directors welcomed the opportunity to review, under the new guidelines on assessments o f countries with a longer-term program engagement, the experience with the four Fund-supported programs since 1987.Directors commended the Mozambican authorities for their pursuit o f sound macroeconomic policies and wide- ranging structural reforms over the past fifteen years. The authorities' efforts have ledto the strong growth ofthe economy, a strengtheningo fthe international reserves position, substantial debt relief, and a steady decline inpoverty rates ina context o fpolitical stability. Notwithstanding the considerable progress that has been made, Mozambique remains a very poor country with significant weaknesses and vulnerabilities, including institutional capacity constraints and the negative impact o f HIV/AIDS. Directors therefore urged the authorities to persevere intheir efforts to consolidate macroeconomic stability and accelerate and deepen structural reforms with a view to sustaining economic growth, encouraging employment creation, and further reducing poverty. 8. Directors commendedthe authorities for the satisfactory implementationo f their economic program, which was manifestedinMozambique's continued favorable economic performance during2002 and 2003. Output growth has remainedstrong, the international reserves position has beenstrengthened, andsignificant progress has been made inimplementing structural reforms, including by taking important steps to mobilize additional revenue. Directors also noted the advances made toward achieving Mozambique's poverty reduction strategy (PARPA) objectives, especially inthe areas o f health and education. Inparticular, they were encouraged bythe preliminary information from the recent National HouseholdSurvey that the proportion o f the population living below the poverty line in2002 fell below the PARPA's 2005 target o f 60 percent. 103  9. Directors welcomed the government's economic program for 2004, which seeks to maintain macroeconomic stability and addresses an important agenda o f unfinished reforms. They emphasized that achieving the program's fiscal targets will require a further strengtheningo f government revenue anda close monitoring o f current expenditure. Crucial specific steps inthis regardwill be improvements intax administration, early introduction o f an automatic mechanism of adjustment for the specific fuel taxes, andprompt implementation o f the withholding o f the income tax on the salaries o f government employees. Directors also underscored the importance o f limitingthe wage increase for government employees to projected inflation and exercising strict control over the payroll inorder to contain the recent sizable increases in the wage bill. Key priorities going forward will be to evaluate and address the challenges posedby HIV/AIDS while making progress toward the achievement of the Millennium Development Goals. Directors welcomed the authorities' intention to integrate the monitoring o f the PARPA and the budget execution into a single document, which could be the basis for the next review of the PRSP inearly 2004. 10. Directors urgedthe authorities to press aheadwith ongoing efforts to improve public expenditure management and fiscal transparency by adheringto the revised timetable for introducing the new financial management system (SISTAFE) and by bringingall extrabudgetary activities within the budget framework, especially inview of the likely expenditure pressures associated with next year's elections. They encouraged the authorities to move forward vigorously on public sector reform, with the support o f the World Bank, including byreducing employment redundancies in some sectors. 11. Directors called on the authorities to closely monitor monetary developments, particularly inlight o f the resurgence of inflation in2003 and the volatility of broad money growth. The authorities should tighten liquidityconditions as needed, and limit interventions inthe foreign exchange market to cushioning the impact o f temporary shocks and achieving the program's reserves targets. 12. Directors called on the authorities to implement promptly the recommendations resulting from the FSAP exercise. Strengthened monetary and exchange rate management will be essential inMozambique, particularly inview of the highdegree of dollarization. This will include steps to enhance the consistency between the centralbank's sales o f foreign exchange andthe pace of expenditure financed with external support, to improve the use o findirect monetary instruments, to better coordinate the actions of the central bankandthe Ministryo f Finance, andto strengthenthe balance sheet o fthe centralbank. Directors welcomed the comprehensive program o f technical assistance being developed byFundandWorld Bank staff, inclose coordinationwith the authorities, to support the implementation o f the FSAPrecommendations. 13. Directors emphasized that the authorities should give priority to addressing the remainingvulnerabilities inthe financial sector. They urgedthe authorities to monitor developments inthe financial system very closely and to strengthen bank supervision in line with internationally-accepted practices. Inaddition, the diagnostic reviews o f the main banks will help identify appropriate remedial actions and enable a gradual move 104  toward international accounting standards (IAS). It will be important to lower the wide bank spreads and expand access to credit by fostering competition inthe financial system, improving loan recovery procedures, and reviewing land tenure regulations to facilitate the use o f land as collateral. Inaddition, the regulatory framework for microfinance activities should be reviewed to facilitate access to financial services by the poor. 14. Directors stressedthe need to broaden growth and stimulate employment inthe manufacturing, services, andrural family sectors by enhancing human capital and removing obstacles to private sector development. They encouraged the authorities to reduce redtape; improve basic infrastructure; reduce labor rigiditiesby simplifying procedures for hiringexpatriates and lowering retrenchment costs; and press ahead with the reformo fthejudicial system to speedupthe administration o fjustice and strengthen the enforcement o fcontracts. Directors called for the prompt approval o fthe regulations for the anti-money laundering law passed in2002, and for the development o f legislation on the combating o f the financing o f terrorism. Several Directors underscored the importance o f improving market access for Mozambique's exports. 15. Directors encouraged the authorities to redouble their efforts to complete the bilateral agreements with remaining Paris Club creditors, and they urged the non-Paris club creditors who have not yet done so to provide debt reliefon HIPC Initiative- comparable terms. 16. Directors welcomed Mozambique's participation inthe Fund's General Data Dissemination System. They underscored the needfor a determined effort to address remaining weaknesses inthe statistical system, based on the recommendations made in the context ofthe recent data Reports on the Observance of Standards and Codes exercise. 17. Looking forward, most Directors expressed readiness to consider a successor low- access PRGF arrangement based on a strong program, which would help the authorities address the remaining challenges. A few other Directors encouraged consideration o f other possible forms o f engagement outside o f a formal Fundarrangement. I_"_" lllllllll""l"ll_"-"- Public Information Notices (PINS)are issued, (i) the request o f a member country, following the at conclusion o f the Article IV consultation for countries seeking to make known the views o f the IMFto the public. This action is intended to strengthen IMF surveillance over the economic policies o f member countries by increasing the transparency o f the IMF's assessmento f these policies; and (ii) following policy discussions inthe Executive Board at the decision o f the Board. 105  Mozambique: Selected Economic and Financial Indicators, 2000-03 2000 2001 2002 2003 Actual Actual Prel. Proj (Annual percentage change, unless otherwise specified) Nationalincomeand prices Nominal GDP (inbillions o f U.S.dollars) 3.6 3.4 3.6 4.3 Real GDP growth 1.5 13.0 7.7 7.0 Consumer price index (end o fperiod) 11.4 21.9 9.1 10.8 Externalsector Merchandise exports 28.3 93.2 -3.O 31.5 Merchandise imports -3.1 -8.6 18.8 26.8 Terms of trade -2.8 5.7 0.6 1.4 Real effective exchange rate (endof period) 1/ -3.7 -9.3 -6.4 ... (Annual change inpercent o f beginning-period broad money, unless otherwise specified) Moneyand credit Net domestic assets 11.6 9.1 0.2 10.8 Ofwhich: net credit to the government 4.1 5.3 3.3 -0.5 Broad money (M2) 42.4 29.7 20.1 13.5 Interest rate for 90-day treasury bills/TAMs (inpercent; endofperiod) 21.8 31.7 18.5 ... (Inpercento fGDP) Governmentbudget Total revenue 13.2 13.3 14.2 14.4 Total expenditure and net lending (incl. 27.3 34.7 33.8 28.0 residual) Overall balance, after grants -6.0 -6.6 -7.9 -3.2 Domestic primarybalance (excluding bank -5.1 -6.3 -3.6 -3.7 restructuring) (Inpercent ofexports ofgoods andnonfactor services) Net present value o ftotal public external debt 194.4 109.8 91.7 85.4 outstanding 2/ External debt service (nonfinancial public sector) Scheduled, after original HIPC Initiative 5.5 5.8 8.2 7.2 assistance Scheduled, after enhanced HIPC Initiative assistance and additional bilateral assistance ... 3.5 4.3 3.8 106  (Inmillions ofU.S. dollars, unless otherwise specified) External current account, after grants -478 -497 -421 -644 Overall balance ofpayments -352 -421 94 31 Net international reserves (end o fperiod) 526 531 625 656 Grossinternational reserves (end o fperiod) 746 727 810 832 Inmonths ofimports ofgoods andnonfactor 6.3 5.8 5.9 5.0 services Sources: Mozambican authorities; and IMFstaff estimates and projections 1/ A minus sign indicates depreciation. 21Public and publicly guaranteed, inpercent o fthe three-year average o f exports. The data for 1999 2000 include the impact o ftotal debtreliefunderthe original HIPC Initiative. Data for 2001-03 include the impact o ftotal debt reliefunder enhancedHIPC initiative, additional bilateral assistance, and new borrowing. 107