Document of The World Bank FOROFFICIALUSEONLY ReportNo: 33574-MZ PROJECTAPPRAISAL DOCUMENT ONA PROPOSEDCREDIT INTHEAMOUNT OFSDR7.3 MILLION (US10.5 MULLIONEQUIVALENT) TO THE REPUBLIC OF MOZAMBIQUE FORA FINANCIAL SECTORTECHNICAL ASSISTANCEPROJECT November3,2005 FinanceSector Unit Ahca Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contentsmay not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (Exchange Rate Effective 30 September 2005) Currency Unit = Meticais Meticais 24,550 US$1 US1.44891 = SDR 1 FISCALYEAR January 1 - December31 ABBREVIATIONSAND ACRONYMS AfDB African Development Bank AML Anti-money Laundering AT Tribunal Administrativo (Administrative Tribunal) AT1 Administraqzo Tributaria dos Impostos (Deparment o f Taxation) BAu Banco Austral (Austral Bank) B C M Banco Comercial deMoqambique (Commercial Bank of Mozambique) BCP Base1 Core Pnnciples BIM Banco Internacional deMoCambique (International Bank of Mozambique) B o M Banco de Moqambique (Central Bank) BSD Banking Supervision Department CAS Country Assistance Strategy CCCP Caixa Comunitaria de Crkdito e Poupanqa (Savings and Loans Cooperatives) CFAA Country FinancialAccountability Assessment CIDA Canadian International Development Agency CQ Consultant's Qualification CSD Central Securities Depository DAF Financial Administration and Human Resource Department DCA Development Credit Agreement DFID UnitedKingdomDepartment for InternationalDevelopment DSA Debt Sustainability Analysis EMOSE Empresa Moqambicana de Seguros (National Insurance Company) EMPSO Economic Management and Private Sector Operation FATF Financial Action Task Force FCIU Financial Crime Investigation Unit FMP Financial Monitoring Plan FMR Financial Monitoring Report FMS Financial Monitoring System FSAP Financial Sector Assessment Program FSCBP Financial Sector Capacity BuildingProject FSTAP Financial Sector Technical Assistance Project FSWG Financial Sector Working Group GDP Gross Domestic Product G o M Government o f Moqambique GTZ Gesellschaftfuer Technische Zusammenarbeit (German Technical Cooperation) HIPC Heavily IndebtedPoor Countries I C Individual Consultant ICB International Competitive Bidding ICR Implementation Completion Report IDA InternationalDevelopment Association IFAD InternationalFundfor Agricultural Development IFB Instituto de FormaqZo Bancaria (Bankers' Training Institute) IFRS International Financial Reporting Standards IGF Inspecqlo Geral das Finanqas (Financial Administration) IGS Inspecqlo Geral de Seguros (Insurance Supervision) N F International Monetary Fund INSS Instituto Nacional de SeguranqaSocial (National Social Security Institution) IT Information Technology KfW Kreditanstaltfu'r WiederauJbau(German Fundfor Reconstruction) LDP Letter of Development Policy MFD Monetary and Financial Systems Department (IMF) MFI Microfinance Institution MMF Mozambique Microfinance Facility M o F MinistryofFinance MoJ Ministry o f Justice MTR Mid-term Review NGO Non-governmental Organizations NORAD Norwegian Agency for Development NPL Non-performing Loans OED Operations Evaluation Department PAF Performance Assessment Framework PARPA Poverty Reduction Strategy PDO Project Development Objective PFMA Public Financial Management Assessment RFSP RuralFinance Support Program PW Project ImplementationUnit PIM Project ImplementationManual PIP Project ImplementationPlan PMR Project Monitoring Report PPF Project Preparation Facility PRSC Poverty Reduction Support Credit QCBS Quality and Cost-Based Selection RFSP Rural Finance Support Program RTGS Real Time Gross Settlement SADC Southern African Development Community SIDA Swedish International DevelopmentAgency SISTAFE Sisterna deAdrninistraqio Financeira do Estado (Financial Management Information Systems) SME Small and MediumEnterprises SOE Statement o f Expenses TAM Titulos deAutoridade Monetdria (Treasury Bills) TOR Terms o f Reference TWG Technical Working Group UNCDF UnitedNational Capital Development Fund USAID United States Agency for International Development UTR Legal Task Force Vice President: GobindNankani Country Director: Michael Baxter Sector Manager: Antony Thompson Task Team Leader: Sherri Archondo REPUBLIC OFMOZAMBIQUE FinancialSector TechnicalAssistance Project CONTENTS Page A. STRATEGIC CONTEXT AND RATIONALE ................................................................. 1 1. Country and sector issues.................................................................................................... 1 2. Rationale for Bank Involvement......................................................................................... 2 3. Higherlevel objectives to which the project contributes .................................................... 4 B . PROJECTDESCRIPTION ................................................................................................. 6 1. Lending instrument ............................................................................................................. 6 2. Project development objective andkey indicators.............................................................. 6 3. Project components ............................................................................................................. 7 4. Lessons learned andreflected inthe project design............................................................ 9 5. Alternatives considered and reasons for rejection............................................................ 10 C. IMPLEMENTATION ........................................................................................................ 11 1. Partnership arrangements.................................................................................................. 11 2. Institutional and Implementation Arrangements .............................................................. 12 3. Monitoring and evaluation o f outcomes/results ................................................................ 14 4. Sustainabihty..................................................................................................................... . . . 14 5. Critical risks and possible controversial aspects............................................................... 15 6. Credit conditions and covenants ....................................................................................... 16 D APPRAISALSUMMARY . ................................................................................................... 17 1. Economic and financial analyses ...................................................................................... 17 2. Technical........................................................................................................................... 17 3. Fiduciary ........................................................................................................................... 18 4. Social................................................................................................................................. 18 5. Environment...................................................................................................................... 18 6. Safeguard policies............................................................................................................. 19 7. Policy Exceptions and Readiness...................................................................................... 19 Annex 1: Country and Sector Background .............................................................................. 20 Annex 2: Major RelatedProjects Financed by the World Bank and/or other Agencies ....29 Annex 3: Results Framework and Monitoring ........................................................................ 31 Annex 4: Detailed ProgramDescription ................................................................................... 36 Annex 5: Project Costs............................................................................................................... 49 Annex 6: Implementation Arrangements ................................................................................. 50 Annex 7: Financial Management and DisbursementArrangements ..................................... 54 Annex 8: Procurement ................................................................................................................ 62 Annex 9: Economic and FinancialAnalysis ............................................................................. 66 Annex 10: Safeguard Policy Issues ............................................................................................ 66 Annex 11:Project Preparation and Supervision ..................................................................... 67 Annex 12: Documents inthe Project File ................................................................................. 69 Annex 13: Statement of Loans and Credits .............................................................................. 70 Annex 14: Country at a Glance ................................................................................................. 72 Annex 15: Letter of Development Policy .................................................................................. 74 MOZAMBIQUE FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT PROJECT APPRAISAL DOCUMENT AFRICA REGION Date: November 3,2005 Team Leader: Sherri Archondo Country Director: Michael Baxter Sectors: Financial Sector (80%), Sector Managermirector: Antony Thompson macroeconomic management (20%) Project ID: PO86169 Environmental screening category: C LendingInstrument: Sector Investment Credit Safeguard screening category: C For Loans/Credits/Others: ASSOCIATION OTHERS 0.00 4.00 4.0 Total: 1.25 13.25 14.50 Borrower:RepublicofMozambique Responsible Agency: Ministryo fFinance Project ImplementationUnit:locatedinMaputo, Praqa 25 de Junho, Edificio da Geologia Nr. 380. 3rdFloor). FY 06 07 08 09 10 11 0 0 0 1 Annual 0.75 I 2.95 3.50 2.00 1.00 0.30 0.00 0.00 0.00 Cumulative 0.75 1 3.70 7.20 9.20 10.20 , 10.50 ,I 0.00 0.00 0.00 I s approval for any policy exception sought from the Board? [ ]Yes [XINO Does the project include any critical risks rated"substantial" or "high"? Re$ PAD C.5 [XIYes [ ] N o Does the project meet the Regional criteria for readiness for implementation? Re$ PAD D.7 [ X]Yes [ 3 No Project development objective Re$ PAD B.2, Technical Annex 3 Withinthe overall framework o fthe multi-donor program, the project development objective (PDO) o fIDA'S contribution to the program is to improve the soundness o fthe Mozambican banking sector and improve public debt management. Project description Re$ PAD B.3, TechnicalAnnex 4 This will be supported by: (a) strengthening the bankingsector and enhancing the capacity o fthe B o M in terms o f banking supervision, management o f the banking system, and financial infrastructure, including a real time gross settlement system (RTGS); (b) improving financial accountability and transparency by introduction of IFRS to commercial banks (first phase) and corporate entities (second phase); (c) strengthening public debt management capacity, including development o f a debt management strategy and reorganization and strengthening of the Public Debt Department o f the MoF; and (d) improving money and government bond market efficiency and depth, including the introduction of a central securities depository (CSD) and related assistance. Which safeguard policies are triggered, ifany? none Significant, non-standard conditions, if any, for: none Boardpresentation: 0 IDA receivedthe final LDP on October 27,2005. 0 Other (mainly legal) conditions were specified in the Minutes o f Negotiations dated October 14,2005. Loadcredit effectiveness: 0 The Government has adopted the PIM in form and substance satisfactory to the Association. The manual will include, but not be limited to the financial and accounting procedures to be carried out by the financial unit. 0 The PIU will adopt a financial management system which, in the future, will be converted into the SISTAFE system (procurement has begun). 0 The Government has recruited an independent auditor with TOR satisfactory to IDA (auditor has been recruitedfor PPFs) Covenants applicable to project implementation: Before signing the Development Credit Agreement (DCA) (only applicable if signed in Washington), the Association must receive from the GoM, letters or telexes appointing a representative to execute and deliver the Development Credit Agreement and related documents for the above-mentioned project. A report will be prepared by the Government and reviewed by IDA by June 30 and December 31 o f each year, which integrates the results o f monitoring and evaluation activities inthe implementationo f the project and achievements o fproject objectives. Accounts will be audited annually by a qualified auditor and the audits will be sent to IDA no later than June 30 o f each year (which is the standard six months following the year-end). Conduct in collaboration with, IDA a Mid-Term Review (MTR) of the project no later than30monthsfollowing effectiveness Maintain a financial management system at the PIU in the form and with functions, staffing and resources acceptable to IDA Six months after the end o f each financial year, annual reports o f all licensed financial institutions will be sent to IDA Every six months, the B o M Supervision Department will provide the IDA with a monitoring summary o f its on-site and off-site activities. A. STRATEGICCONTEXTAND RATIONALE 1. Country andsector issues The Government o f Mozambique (GoM) i s committed to an overall objective o f poverty reduction through economic stabilization and the promotion o f economic growth. During the past decade, the Government has taken key steps to provide a stable economy, consistent and comprehensive fiscal and monetary policies, enhanced financial sector management and supervision, a gradual reduction o f government bureaucracy, strengthening o f institutional capacities, and improved governance. The Government recognizes that the scope and efficiency o f the financial sector play an important role in facilitating economic and private sector growth, and reforms inthe financial sector need to continue to bepursued. The GoM has worked closely with the International Development Association (IDA) and other donors to prepare and implement comprehensive development and investment frameworks, in particular, the Poverty Reduction Strategy (PARPA in Portuguese, 2001-2005), which emphasizes economic growth, public investment inhuman capital and productive infrastructure, and institutional reform to improve the environment for private investment. IDA has, in turn, worked with the G o M to prepare its Country Assistance Strategy (CAS) in support o f the PARPA. The CAS, presented to the World Bank Board o f Directors on October 20, 2003, focuses on three areas: (i) improving the investment climate; (ii) expanding service delivery; and (iii) building public sector capacity and accountability structures. In the identified areas, the recent Financial Sector Assessment Program (FSAP) has highlighted a series o f issues to be addressedinthe proposed Financial Sector Technical Assistance Project (FSTAP). The core o f the Mozambican financial sector is the banking sector, comprised o f 12 commercial banks. The banking system became fragile following the privatization o f two large, state-owned commercial banks in 1996-1997 and liquidity crises in 2000 at both Banco Austral (BAu) and the Banco Comercial de MoFambique (BCM). This necessitated Government contributions to their recapitalization in both 2001 and 2002 amounting to about 6 percent o f Gross Domestic Product (GDP). Further strengthening o f banking supervision, as well as implementation o f International Financial Reporting Standards (IFRS) by the commercial banks and divestiture o f the GoM o f its remaining holdings inthe banking (11percent) and insurance sectors, continue to be a priority. The macro-monetary framework needs to be strengthened. The domestic capital market is still underdeveloped and domestic debt in Meticais is small, consisting mainly of Treasury bonds issued for the recapitalization o f the Government's share in the B C M and BAu, Treasury bills issued by the Ministry o f Finance (MoF) and short-term paper issued by the Banco de Moqambique (BoM). Money and bond markets, the mechanism that could be used for monetary management, are too narrow to be effective. In addition, the debt management framework i s weak with respect to the GoM's authority to borrow, institutional responsibilities and overall governance structure. A comprehensive public debt management framework and related capacity building are needed to manage external and domestic debt. At this stage, the first objective should be to develop the market for Government securities, thereby providing a market-drivenbenchmark yield-curve for the issuance o fprivate securities. At the sector level, a key weakness o f the financial sector is limited access to financial services by Mozambican households, notably inrural areas, and by private enterprises, especially micro, 1 small and medium-sized enterprises (SMEs). Non-bank lending institutions exist, but remain relatively small and ineffective. There are currently three leasing companies, two venture capital companies, and various microfinance institutions, as well as the stock market. Institutions reside primarily in the capital city with a limited corporate and household clientele, and access to financial services is inadequate. There are multiple microfinance institutions, but with the exception o f the largest, which are converting or have converted to microfinance banks, they remain largely weak and disparate, without access to services that could strengthen their operations. The legal and regulatory environment does not support prudent regulation and supervision o f the non-bank lending institutions. Domestic lending and savings environment in this segment o f the market i s vulnerable, with low judicial capacity, inconsistent financial reporting standards, problems in the credit information system, and weaknesses in the legal framework for bankruptcy. Sustained high interest spreads and transaction costs reflect inherent structural problems. Without improvements in the above, financial sector deepening for SMEs and inthe rural sector will remain constrained. Institutions that could promote greater depth in the financial sector, such as the insurance and pension sectors, are small and suffer from a lack o f transparency, as well as weak institutional and regulatory capacity. Currently five insurance companies operate in the sector, which is dominatedby a state company, Empresa Moqambicana de Seguros (EMOSE), with 35 percent o f the market but limited capacity. The pension sector i s dominated by the state-owned, unfunded pension scheme administered by the Instituto Nacional de Seguranqa Social (INSS) which is under the auspices o fMinistry of Labor. In view of the above challenges, the GoM has collaborated with its development partners to prepare a comprehensive program of financial sector reforms to address policy, institutional and legal constraints to encourage a more efficient operation o f the sector. The Government will give high priority to: (i) designing measures to support the soundness of the banks, including financial transparency and disclosure, and a broad-based strengthening o f BoM's regulatory and supervisory capacity; and (ii)stimulating a deeper and more vibrant market for assets denominated in Meticais, through a concerted effort to strengthen monetary, foreign exchange and debt management. The Government i s also committed to initiating reforms related to improving access to financial services (savings and credit) and the lending environment, as well as to support the development o f markets for longer-term financial obligations associated, for example, with finance o f pensions and insurance. An immediate concern in these areas is to strengthen supervisory capacity to prevent regulatory arbitrage between the relatively large, mainstream banking sector and other, considerably smaller non-bank financial intermediaries andmicrofinance institutions. The Letter o f Sector Development Policy (Annex 15) provides an in-depth description of how Government intends to address the key problems inthe sector. The FSTAP, funded by IDA, jointly with other development partners will provide critical financial and technical support to the GoM's program (see Section B1 on Implementation, Partnership Arrangements). 2. Rationale for Bank Involvement The World Bank (the Bank) has been involved in the Mozambican financial sector since 1993, when the country, recovering from its long civil war, put priority on developing and strengthening institutions related to policy and institutional reforms in the financial sector. In this context, the Financial Sector Capacity Building Project (FSCBP, Cr. 2607-0, TF-20849), 2 which closed in March 2001, supported the Government's initial efforts to transform the financial system from a mono-bankingsystem to a market-based financial system. The project aimed at: (a) strengthening the Central Bank to enable it to administer monetary policy and carry out effective regulation and supervision o f the financial sector; (b) providing a regulatory and institutional framework to deepen the financial sector; and (c) supporting the systematic issuance of Treasury bills to manage liquidity. The Operations Evaluation Department's (OED) evaluation o f the Implementation Completion Report (ICR) concluded that the project's outcome was satisfactory. The project recorded improvements in a number o f areas, in particular in increasing the capacity o f B o M to supervise the financial sector and conduct monetary policy. There was increased capacity in other departments o f the B o M and improvements in the legal and regulatory framework for the financial sector. In addition, the Instituto de Forma@o Bancdria (IFB), the bankers' training institute, was established under the FSCBP and continues to operate on a sustainable basis with participation from the commercial banks. A lesson drawn from OED's audit of Bank-financed projects was the importance o f sequencing financial sector reforms for both financial and private sector development. The proposed intervention builds on the relationship established during the FSCBP and the FSAP undertaken in 2003, whose analysis underpins muchofthe work plannedunder the FSTAP. The proposed operation also builds on the efforts o f the World Bank's Economic Management and Private Sector Operation (EMPSO) which supported the Government's program to consolidate macroeconomic stability and to lay the foundations for sustained private sector-led growth over the medium-term. The EMPSO included measures, among others, to resolve the financial difficulties o f two of the commercial banks, strengthen licensing procedures and supervision in the financial sector, and further dilute government ownership in the financial sector. The GoM receives a substantial amount o f external support from donors, with the trend moving from direct interventions to budgetary support. The Second Poverty Reduction Strategy Credit (PRSC2) was signed on September 16, 2005. Donor concerns in a number o f macroeconomic and financial sector areas mirror those o f the Bank, and the Mozambican authorities requested the Bank to coordinate donor interventions in these areas. This request has enabled unprecedented cooperation among development partners in the sector and is well-aligned with the Paris Declaration. The result is a broad-based comprehensive financial sector reform program, comprised o f three distinct projects financed by multiple donors under one umbrella. These are: (i)the proposed IDA-financed project with support from the United Kingdom Department for International Development (DFID) and the Swedish International Development Association (SIDA); (ii) a project financed by the African Development Bank (AfDB); and (iii) a project managedjointly by the German Technical Cooperation (GTZ) and the GermanFund for Reconstruction (KfW). All o f the three distinct donor projects carry the name "FSTAP" to emphasize the coordinated nature o f the projects. The cooperation under FSTAP extends to the semi-annual Joint GovernmentDIonor Review of the Government's Performance Assessment Framework (PAF), undertakenby most donors active in Mozambique. This review includes a Financial Sector Working Group (FSWG), which is co-chaired by the World Bank. Finally, the Bank is the critical development partnerworking on the financial sector inMozambique and the only institution that takes a comprehensive viewpoint o f the sector.. The Bank's working relationship with other development partners enables maximum leverage and coordination o f disparate interests and activities inthe financial sector, as well as in other vital sectors (e.g. legal reform). 3 3. Higher level objectives to which the project contributes The proposed comprehensive program, to which the proposed IDA-financed project contributes, is fully in line with the GoM's financial sector objectives as described in its PARPA and Five- year Plan, namely: (a) modernize the expansion o f the financial system; (b) reinforce regulation and supervision and reduce vulnerability that might affect the financial system; (c) encourage and promote entry o f new financial institutions, therefore increasing competition and diversifying products o f the financial market; (d) promote measures to expand the banking services for better regional coverage with emphasis to the rural areas; (e) continue with actions that contribute to the growth o f national savings; (f)promote the emergence o f credit institutions specialized in micro-finance; (8) increase the degree o f monetization o f the national economy; (h) adopt international accounting standards; (i) expand financial services in rural areas; 6) develop financial services accessible to the medium enterprises and family aggregates; and (k) improve insurance services and social protection (pensions). These are hrther described in the PARPA matrix, which has actions defined for the following strategic objectives: 0 Reinforce the regulation and supervision o f the financial system in order to minimize the risk o f financial crises; 0 Modernize and expand the financial system (new instruments, increased regional coverage etc.); 0 Increase savings on a national basis; and 0 Improve the insurance and social protection sector. The FSTAP supports assistance toward reducing a number o f the constraints cited above, as well as the Government's objectives under the PAF, which i s the mechanism through which development partners and Government jointly evaluate progress on the overall reform program. The PAF matrix has three objectives related to the financial sector: (i)strengthening accountability in the financial sector; (ii) improving financial intermediation to better cater to SMEs and households without bank accounts; and (iii)improving insurance and social protection. PAF targets, which are actions related to the objectives, are established jointly by the Government and development partners on a semi-annual basis. Targets for 2005 include, for example, submission o f a Bankruptcy Law to Parliament, withdrawal o f the Government from ownership in the banking sector, and carrying out o f an actuarial study o f the social security system. These and other reforms will be supported by technical assistance financed by IDA and parallel projects of other development partners as shown inthe table below. 4 PARPA Matrix PAF Outcomes Reform Program Comportents Reinforce the regulation Strengthenaccountability in Strengtheningthe Banlung and supervision of the the banlungsector Sector [IDA] financial systeminorder to minimize the risk of Improve financial Improving Financial financial crises intermediation, including Accountability and for micro, small, medium Transparency [IDA/DFID] Modernize and expandthe enterprises andthe financial system(new householdswithout bank StrengtheningPublic Debt instruments, increased accounts Management [IDNSIDA] regional coverageetc.) Improve insuranceand Improving Money andDebt Increase savings on a socialprotection sectors Markets [IDA] national basis Micro andRural Finance Improve the insurance and [KfW/GTZ] social protection sector Insurance [AfDB] Pensions [AfDB] Improvingthe Lending Environment [AfDB] Anti-money Laundering [AfDBI The proposed IDA-financed operation contributes to the objectives defined in the CAS, in particular, under the pillar o f improving the investment climate and that of building public sector capacity and accountability. These objectives are, in turn, consistent with those defined in the PARPA and the PAF. The success o f the components financed by the IDA-financed project is dependent on delivery o f the support committed by the other develop partners (International Monetary Fund [IMF], UnitedKingdom Department for International Department [DFID] and Swedish International Development Agency [SIDA]). However, the risk o f failure due to this relationship is marginal as IDA financing follows on work already delivered or ongoing. Annexes 2 and 4 provide a description o f technical assistance programs o f other development partners that are involved inthe sector. According to Mozambique's medium-term growth strategy and the Bank's private sector development strategy included inthe CAS, one o f the three principle economic challenges facing the GoM is the need to address constraints in the financial sector. Recommendations included: (i)expanding the scope o f financial intermediation with viable banking and non-bank financial institutions; (ii)improving the environment for commercial banks by strengthening supervisory and market oversight, payment systems, and monetary and foreign exchange management, including the introduction o f IFRS; (iii) supporting the development o f the local fixed-income 5 market by improving public debt management; and (iv) improving the legal and judicial environment for financial transactions. B. PROJECTDESCRIPTION 1. Lendinginstrument The comprehensive financial sector program was prepared with total costs estimated to be US$28.5 million equivalent. It will be jointly funded by IDA, other development partners and the Government o f Mozambique. The IDA operation will be a US$10.5 million, five-year technical assistance investment credit. Other development partners include: AfDB, DFID, SIDA, GTZ and KfW. In addition, the IMF is providing technical assistance in a number o f different areas, including banking supervision. The team had explored options for basket funding, however at this time this is not feasible. The other main donor, AfDB does not have the mandate for pooling resources and will provide parallel financing. Furthermore GTZ and KfW do not lend directly to the Government, but provide technical and financial assistance (see Section B1on Implementation, Partnership Arrangements). IDA opened two Project Preparation Facilities (PPFs) following requests from the GoM in amounts of US$890,000 andUS$169,800 on November 18,2003 and July 8, 2004, respectively. The initial PPF funds are being used to finance activities to resolve some o f the banking sector issues while the second PPF is used to finance the start-up costs o f the Project Implementation Unit(PIU). 2. Projectdevelopmentobjectiveandkey indicators Within the overall framework o f the multi-donor program, the project development objective (PDO) o f IDA'Scontribution to the program is to improve the soundness o f the Mozambican banking sector and improve public debt management. This will be supported by: (a) strengthening the banking sector and enhancing the capacity of the B o M in terms o f banking supervision, management of the banking system, and financial infrastructure, including a real time gross settlement system (RTGS); (b) improving financial accountability and transparency by introduction of IFRS to commercialbanks (first phase) and corporate entities (second phase); (c) strengthening public debt management capacity at the Public Debt Department o f the M o F and other implicated agencies; and (d) improving money and Government bond market efficiency and depth, including the introduction o f a Central Securities Depository (CSD) and related assistance. The key performance indicators at the outcome level are: 0 The percentage o fbanks compliant with improved prudential regulations 0 Debt burdenindicators do not signal a reasonable risk o fdebt servicing difficulties The above outcome indicators are complemented by the following results indicators related to specific components: 6 Strengthening of banking sector: 0 Number o fBasle Core Principles (BCP) that BoMis incompliance with 0 Reduction o f time needed to transfer funds between banks Improvingfinancial accountability and transparency: 0 Percentage o fbanks whose financial reportingis inaccordance with IFRS 0 Percentage o f large enterprises with financial reporting inaccordance with IFRS 0 Percentage o f medium enterprises with financial reporting inaccordance with a simplified IFRS StrengthenedPublic Debt Management 0 Annual publication o f public debt reports, including a comprehensive debt inventory 0 Publication o f regular debt forecasts Improved Money and Debt Markets 0 Treasury security auctions heldon a monthly basis A more comprehensive results framework is provided in Annex 3. In addition to monitoring project implementation, the project team will develop and monitor output indicators for the specific activities in each component on a regular basis. This will provide feedback regarding the effectiveness o fproject investments and technical assistance. 3. Project components As noted above in part 1, "Lending Instruments", using the FSAP as the analytical framework, IDA will fund four technical and one administrative component. Recognizing the capacity constraints which exist in Mozambique, the design o f the technical assistance is demand driven, based on in-depth discussions with counterparts. Staff training and institutional capacity building play a dominant role in the project design. Activities are prioritized to facilitate implementation and are reflected inthe cost tables (costs are budgeted per year by task) and will be part of the monitoring and evaluation exercise. The work program will be reviewed on an annual basis by the Technical Working Group (TWG), which is comprised o f representatives from each beneficiary. It may be necessary to adjust the priorities to the needs o f the country duringthe course o fimplementation. 7 The IDA project cost is estimated to be US$10.5 million equivalent, brokendown as follows: (a) Strengthening the Banking Sector, including the B o M (US$4.8 million); (b) Improving Financial Accountability and Transparency (US$1.5 million); (c) Strengthening Public Debt Management (US$1.05 million), (d) Improving Money and Government Bond Market Efficiency and Depth (US$1.65 million); and (e) Project Implementation (US$1 million). US$0.50 million will remain as unallocated andmay be used at a future time. Component 1: Strengthening the Banking Sector, including improving the Institutional Capacity of BoM (US$4.8 million equivalent). This component will support activities to strengthen the banking sector by: (i)building institutional capacity o f the BoM, to include supporting the process o f implementing international practices in off-site and on-site supervision and improvements o f financial market infrastructure and information technology (IT); (ii) financing an advisor for the Government to assist with its strategy to divest from the banking sector; and (iii)strengthening the training capacity at the IFB. Component 2: Improving Financial Accountability and Transparency (US1.5 million equivalent). This componentwill support: (i) the transition o f the banking sector to IFRS (phase 1); and (ii) transition o f the Mozambican corporate sector to IFRS (phase 2). Additional the support will be provided to the accounting profession, through existing public and private institutions, to modify the accounting curriculum to be in compliance with new international accounting standards. Component3: StrengtheningPublicDebt Management(US$l.05 million equivalent). This component will support efforts to introduce a comprehensive public debt management framework, which includes policies and strategies to provide, inter alia, better coordination o f the issuance o f debt between the B o M and the MoF. IDA will follow on SIDA's support to the GoM o f the development and implementation of a comprehensive public debt management framework to ensure transparency and accountability inpublic debt management. Inparticular, IDAwill support: (a) restructuring o fthe Public Debt Department o fthe MoF and strengthening procedures and controls; (b) consolidating and reconciling the debt database for all public debt; (c) capacity building for staff o f the Public Debt Department; (d) strengthening information analysis and reporting, including debt forecasting, risk and cost analysis and monitoring, debt sustainability analysis, analysis o f loan agreements, and preparation o f an annual report on debt management;and (e) improvingthe GoM's cash management policies andprocedures inorder to reduce the cost o f borrowing and simplify monetary operations. This would include the provision o f technical assistance to review procedures for management of cash balances in commercial banks and exposure limits, improve liquidity forecasting capabilities, and extend cash-flow forecasts toward a rolling 12-month horizon. In addition, assistance will be provided informulating procedures usingTreasury bonds andbills. Component 4: Improving Money and Government Bond Market Efficiency and Depth (US$1.65 million equivalent). This component will support the development o f more liquid money and debt markets, and strengthen the capacity o f the B o M to implementmonetary policy by: (i)improving the efficiency of the primary Government debt market through regular auctions; (ii) increasing the depth o f the secondary market by providing a range of instruments; (iii)developing the repurchase (repo) and reverse repurchase (resale) markets; (iv) improvingthe 8 financial market infrastructure with the introduction o f a CSD; and (v) enhancing registration procedures and tracking o fprivate external-corporatedebt. Component5: ProjectImplementation(US$l millionequivalent). The PIUwill be the focal point and coordinating unit between the development partners and the beneficiary institutions. This component will provide financial support to a professional PIU established to assist in project implementation by financing PIU salaries, office facilities, operating expenses and transportation. As needed, short-term national or international specialists, including a high-level financial sector advisor who will assist the PIU, will be recruited. The auditing h c t i o n , which will be carried out annually by independent, external auditors, will also be financed under this component. 4. Lessonslearnedandreflectedin the projectdesign Special attention has been given to ensure that the project design reflects both the Bank's experience in Mozambique and that o f financial sector reform projects in other countries. In particular, project design takes into account the challenges inherent in a sector with multiple stakeholders and interests, diverse links with the macroeconomic framework and the real sector, long leadtimes for reforms to take effect, and the need for significant skill and capacity building. Inparticular: 0 The project recognizes the importance o f sequencing financial sector reforms for both financial and private sector development and builds on success o fthe FSCBP. 0 The project takes into account that the implementation o f reforms has multiple steps and takes a significant amount o f time. Project implementation i s therefore anticipated to take five years, recognizing that capacity building, dialogue and decision-making among both public and private stakeholders, drafting and implementation o f new standards and regulations, and the carrying out o f studies, analysis of findings, and decisions regarding follow-up take considerable coordination and time, and are often subject to interruptions that do not necessarily indicate lack o f commitment on the part o f beneficiaries. When such interruptions occur in individual sub-components, overall project implementation will be able to continue, ensuring ongoing dialogue in all areas o f implementation. In addition, the project comprises a substantial amount o f technical assistance and takes into account the institutional constraints by prioritizing and sequencing activities according to the capacity o f the institutions to implement the various components. 0 Ultimate responsibility for project implementation lies in a single Government ministry. The MoF will be the principle counterpart for the project, and the PIUhas been integrated into the Ministry. The PIU will be the focal point to work with beneficiary agencies to implement the project. Given the number o f end-beneficiary agencies, the intention is to reduce the risk that individual sub-components are "lost" or that responsibility for results i s diffused across several agencies. 0 The project does not assume that a single intervention can affect overall financial intermediation. As a result, development partners came together to design a comprehensive financial sector program, which takes a holistic approach to addressing constraints in financial sector development, including assistance in public debt, banking 9 supervision, financial sector infrastructure, financial transparency, and micro and rural finance, the lending environment, insurance sector reforms, and changes to social security and pensions. Most importantly, the project recognizes that changes in laws and regulations are unlikely to have the desired effect without parallel technical assistance and capacity building. This unfortunately cannot guarantee that the project will be successful, but it is expected that interactions among measures will have a positive impact over the long-term. 5. Alternativesconsideredandreasonsfor rejection The scope o f the project is more limited than that initially considered. The original project design included technical assistance to a much broader range o f financial sector sub-sectors. Following the review o f the Project Concept Note, IDA'Sproject was reduced in scope to four areas o f intervention. However, the other sub-sectors have not been neglected. Support for other areas o f Government reform in micro and rural finance, insurance, pensions, anti-money laundering, and improving the lending environment, are supported inparallel operations from the AfDB, KfWand GTZ. There was support within IDA for the project to include a component for judiciary reform, which directly affects the development o f the financial sector, particularly in light o f the low judicial capacity for enforcement o f decisions pertaining to lendingand commercial activities. However, the Bank team agreed that, rather than including a component in the project, a stand-alone legal capacity project will be prepared. Inaddition, the AfDB has incorporated several activities into its project which are related to the legal environment, including assistance for the establishment of a financial investigationsunit. There was also notable interest within IDA for the project to include a component to support the expansion o f financial services to rural areas. However, over the last ten years, numerous development partners have supported the establishment o f microfinance institutions; several o f these have proven quite successfil, and have the potential to transition and become microfinance banks under the new Microfinance Law. Although these MFIs have limited outreach in rural areas, they are increasing their efforts in this direction. Furthermore there is already a major donor intervention in the area - a joint AfDBhternational Fund for Agriculture Development (IFAD) Rural Finance Support Program (RFSP). At a total o f approximately US$30 million equivalent, the project aims to support policy, legal and regulatory, and institutional aspects o f rural finance, as well as to finance potential rural investments. Also, GTZ and KfW which have significant experience in the sector, will (i)support the development o f a microfinance association that will have the capability to provide services to microfinance institutions (MFIs) and (ii)provide assistance to existing MFIs to upgrade systems and capacity as part o f their FSTAP project. Given the size and scope o f the RFSP and the GTZ and KfW intervention, IDA will not provide direct assistance to the micro and rural finance sector. Since there are already significant interventions in this area by other partners, it was felt that IDA could not provide added value. In contrast, it was feared that a rural finance component could simply increase confusion in the sector. An information sharing mechanism with the RFSP will be established to ensure close coordination and collaboration. At the specific component level, there was some discussion on the details o f the public debt component. The identity o f the institution responsible for carrying out debt sustainability 10 analysis (DSA) was discussed indetail by the World Bank team and the MoF. It was agreed that best practice would suggest that there be a clear allocation o f responsibilities betweenthe unit doing the D S A and that responsible for debt management. The ideal location for the unit doing the D S A is in a macroeconomic unit inthe Treasury, but outside o f the Public Debt Department. However this is not possible as the Treasury does not have such a unit. Therefore it was agreed that the DSA will be done by the middle office o f the Public Debt Department, once the department has gone through its restructuring. The validity o f supporting a RTGS, particularly given the small financial market was also reviewed by the team. The payment system program falls within the purview o f the Southern Africa Development Community (SADC) and it was agreed that the Bank should support this activity under this regional initiative, o fwhich Mozambique is part. Finally, various alternatives were analyzed for project implementation. The first alternative for B o M to implement the project was rejected because the B o M indicated that the MoF should take the lead. The second alternative to use existing M o F staff to form the nucleus for project implementation was also rejected. The Minister o f Finance communicated to the Bank that its staff did not have sufficient capacity to implement a program which is very complex and there remain a number o f sector issues being addressed inthe program which still need to be resolved. Thus, a hybrid approach was adopted. A separate PIU that reports directly to the Minister o f Finance was established. In addition, the TWG, comprised o f the beneficiaries, was established to work closely with the PIU (see Section C.2 on Institutional and Implementation Arrangements). C. IMPLEMENTATION 1. Partnershiparrangements In response to a request fiom the Government and in line with the newly signed Paris Declaration, the World Bank led the effort to coordinate and harmonize donor efforts to prepare a financial sector reform program. The h i t o f this work is the comprehensive financial sector reform program described in Annex 4. Each development partner agreed to finance clearly- defined activities. Severaljoint preparationmissions were carried out and partners agreed that to the extent possible, they would harmonize program implementation and coordinate supervision missions in the field. It i s anticipated that these supervision missions will also coincide with the Joint Government/Donor Review o f the PAF, which is carried out semi-annually. To further facilitate this approach, the PIU under the auspices o f the MoF, will be the focal point for implementation and ensuring that all fiduciary requirements (procurement, financial management, monitoring and evaluation and reporting) are met. As mentioned above, pooling resources is not a viable option for AfDB which does not have a mandate to pool resources nor for GTZ and KfW whose support is provided inthe form o f direct technical and financial assistance. SIDA and DFID provided preliminary support to the components managed by the World Bank, while AfDB, GTZ and KfW manage distinct components. The table below summarizes the financial support being provided by each o f the development partners. 11 Table 1. BreakdownofFinancialSector ReformProgram(by Financier) 2,000,000 In addition, the Bank team is working closely with the Monetary and Financial Systems Department of the IMF (MFD), which is assisting the B o M to address recommendations from the FSAP, primarily in banking supervision, monetary policy and foreign exchange operations. They have agreed with Government on a two-year medium-term program. 2. Institutionaland ImplementationArrangements The GoM, on behalf o f the Republic o f Mozambique, will borrow US$10.5 million equivalent from IDA. The project will be implemented over five (5) years. Institutional responsibilities for coordinating and managing the project on a daily basis and providing procurement and accounting services to components will be delegated to a professional PIU. The PlU will be headed by the Project Coordinator who reports directly to the Minister o f Finance. He/she will be supported by a procurement specialist, a financial management specialist, other technical specialists (such as the financial sector advisor), and an executive assistant. The PIU will be responsible for providing the necessary guidance to beneficiaries for procurement o f consultants, goods and services, as well as monitoring and evaluation. It will also provide advice on the overall thrust o f financial sector reforms and cross-cutting issues. Wherever necessary, timely short-term technical assistance will be sought to strengthen the team. This technical assistance could include, but may not be limited to, expertise in financial sector and debt management issues, as well as financial management and procurement and can take the form o f specialized training or recruiting short-term consultants. The TWG will be chaired by the Project Coordinator and includes high-level representatives from the beneficiary agencies. The TWG will provide overall program guidance and strategic oversight. It will be comprised o f staff from the beneficiary institutions who are empowered to make strategic decisions and commitments on behalf o f their agency to ensure that the project continues to advance. It will meet at least once every quarter to review the progress o f the project and agree on the next steps. Ongoing communication between the TWG and the PIUwill be important for the success o fthe project. Members o fthe TWG will prepare quarterly reports on the progress o f their respective activities towards meeting project objectives that will be consolidated into a report and be reviewed at a quarterly TWG meeting. Once agreed at the 12 TWG, the report will be discussed with the Minister of Finance and a copy will be sent to IDA andother development partners. The primary forum for high-level policy dialogue between the Government and the development partners will be the Joint Government/Donor Review o f the PAF. The PAF matrix, which comprises 50 performance indicators, serves to provide a yardstick for measuring the Government's progress in many areas o f donor collaboration. Financial sector reform, considered a priority o f Government is included and has five indicators elaborated. The Joint Review process includes the submission o f progress reviews and proposed indicators by various sector working groups. As the FSWG i s co-chaired by the BoM, DFID and IDA, there will be close linkages between the FSWGand the FSTAP. There will also be close collaboration with the IFAD/AFDB funded RFSP. This will be done with regular meetings between the project coordinators o f the two programs and information sharingonbothprograms across all donors. To maintain the bottom-up approach which began during preparation, each beneficiary will be responsible for preparing (with the assistance o f the PIU) the terms o f reference (TOR)for consultants, including required qualifications o f consultants and technical specifications for procurement of goods. Beneficiaries will implement their respective components and report to the PIU on a quarterly basis, including any modifications to the procurement and/or training plans. The higher than usual capacity constraints of the implementing institutions are a concern for successful project implementation and will be periodically evaluated. The detailed work plan will thus be carefully aligned to the implementation capacity o f each participating agency and carefully monitored. The work plan will be updated on an annual basis. The implementation period is five years which should provide ample time for the project's execution. It i s anticipated that there will be adequate prioritization and sequencing o f activities to enable the institutions to advance at a pace which i s comfortable and will provide maximum sustainability. As noted above, the PIU will be responsible for ensuring that all fiduciary requirements (procurement, financial management, monitoring and evaluation and reporting) are successfully maintained. It will be responsible for financial management and coordinate project accounting, maintain overall records and manage disbursements for the IDA project and those o f the other development partners. The PIU will produce quarterly financial monitoring reports and annual financial statements and ensure their timely audit in accordance with International Auditing Standards. The PIU will adopt a financial management system which, in the future, will be converted into the SISTAFE (SistemadeAdministra@o Financeira do Estado) system, which i s the national accounting system that Government is developing. Annex 7 provides the financial management and disbursementarrangements in greater detail. As noted above, the PIU will be reinforced with specialized training and additional staff (as needed) to ensure that it has the capacity to implement such a vast program involving many development partners. By building capacity in the PIU, the team will be able to provide qualified fiduciary services. It is anticipated that the program approach will prevent a proliferation o f PIUs which further reflects progress towards meeting Paris Declaration objectives. To ensure that beneficiaries have the capacity to implement their components, the technical assistance program was designed based on in-depth consultation with counterparts and taking 13 into account the Government's absorptive capacity. Consequently, substantial training and capacity building exercises have been built into the program. The challenge o f developing sustainable capacity in Mozambique (as well as many other countries in Africa) does not only rely on the design o f the program but requires that much deeper policy issues (such as salary scales and retention rates) be addressed at a higher political level and may not be resolved in the context o f FSTAP. 3. Monitoring and evaluation of outcomes/results The FSTAP will be guided by a comprehensive results framework as agreed with the IDA and other development partners' (see Annex 3). The IDA-financedproject i s only one facet o f a global program. As such, Annex 3 was separated into two parts: Annexes 3(a) and 3(b) provide the results framework for the IDA-financed operation. Annex 3(c) provides a comprehensive results framework o f the partners. For the ICR, implementation o f the IDA-financed project would be assessed on its own merit. For the majority of the outcome and results indicators for individual components, adequate baselines and targets were established at project inception. For some indicators as specified in Annex 3, the baseline will be established and targets agreed within the first year o f project implementation. It is anticipated that Annex 3(c) will be discussed further with the development partners as the program is implemented. Monitoring and evaluation o f project activities are key functions that will be carried out by the PIUon a regularbasis. A quarterly monitoring table andprogress reports will bepreparedby the PIU, approved by the Minister of Finance and then submitted to IDA and other funding donors for review. These reports will assess achievements against the Project Implementation Plan (PIP), a Financial Management Plan (FMP) and overall Procurement Plan that will be prepared and incorporated into the Project Implementation Manual (PIM). The PIU will be responsible for updating the PIP on an annual basis, taking into account experiences and the strategic focus of the project. The PIM includes, among others, guidelines on all period reporting, and monitoring arrangements. The Mid-Term Review (MTR) o f the IDA-operation will be 30 months into the project and will include an update o f the FSAP (subject to agreement with Government) that will assess progress in the reform program and provide the basis to make changes inthe project. An ICR will be undertaken six months after the closing o f the project. 4. Sustainability The financial sector reform program in general and the IDA project in particular, have a good basis for sustainability, being founded on the Government's national development strategy and its continued commitment to strengthening the financial sector. This has been demonstrated by Government's track record in implementing financial sector reforms during the past ten years. The Government's request for a FSAP and then a comprehensive program based on the recommendations, highlight its continued interest in advancing the financial sector agenda. This project provides a second generation o f financial and technical assistance and associated institutional and policy support for a well-defined, time-boundprocess involving financingsector strengthening. The nature ofmost ofthese actions andthe undisputed commitment ofthe current Government on these reforms enhances the likelihood that, once implemented, they will be ' Th e comprehensive results framework was extracted fiom the project documents o f each contributing partner (AfdB, KfW,GTZ) 14 sustained. Moreover, having the inclusion under one umbrella of different donor-supported reforms inthe financial sector is an important asset to sustain ongoing reforms. As mentioned above, the IDA- operation builds on work supported by the EMPSO and FSCBP. OED concluded that the project's outcome was satisfactory. The project recorded improvements in a number o f areas, inparticular in increasing the capacity o f BoM to supervise the financial sector and conduct monetary policy. There was also increased capacity in other departments o f the BoM, as well as improvements inthe legal and regulatory framework for the financial sector. In addition, the IFB, which was established under the FSCBP, continues to operate on a sustainable basis with participation from the commercial banks. A lesson drawn from OED's audit o f Bank-financed projects was the importance o f sequencing financial sector reforms for both financial and private sector development. The project team has built upon this lesson in project design and will continue to work with the Government on the proper sequencing o f reforms. Given the Government's commitment, the team is confident that actions taken under the proposed project will also be sustainable. The capacity to analyze issues and to develop and implement strategies is crucial to the success of reform programs. Recognizing the weaknesses in base capacity across some o f the beneficiaries, in addition to sequencing activities, the project implicitly includes building capacity in all o f its components. More importantly, several components focus explicitly on building the institutional capacity, e.g. assistance to strengthen the Public Debt Department o f the MoF. This process had already begun as part o f the FSAP and during preparation o f the project, which was preparedjointly by the beneficiaries and the Bank team. 5. Critical risks and possible controversial aspects There are several risks inherent to the success o f meeting the PDO and ensuring sustainability. These include: 0 The soundness o f the banking system at the end o f the project rests on the ability of the B o M to enforce the new regulations and commercial banks' capacity to implement them. Establishing more stringent regulations regarding loan classification and provisioning may meet resistance from the banking community and the BoM's authority may be challenged. The project will work closely with the IMF whose Monetary and Financial Systems Department is providing technical assistance inthis area. (M) 0 There are institutional and legal issues and risks that currentlykeep lending interest rates highthat cannot be addressed through this project. The Government is working with IMF to improve monetary policies in an effort to provide a good economic framework for financial sector development. Several judicial initiatives are underway including the World Bank Legal Project. (S) 0 The implementation o f IFRS for the corporate sector (especially for medium enterprises) may take longer than expected since a significant amount o f preparatory work is required. The implementation o f IFRS in all sectors requires additional resources to update supporting infrastructure (hardware, software and human capacity). In addition, if the accounting profession is not strengthened, it will be difficult for the public and 15 corporate sectors to implement the new accountingprocedures under IFRIS. The project will work on the frameworkandthe timetable will be evaluated duringthe MTR. (S) 0 Capacity constraints o f implementing institutions may cause delays. To minimize this risk, substantial capacity buildingand training activities as requested by the institutions (demand driven) i s included. (M) 0 The success o f the components under the proposed IDA-financedproject i s dependent on delivery o fthe complementary support committed by the other develop partners (IMF-MFD, DFID and SIDA). However, the risk that this support will not be available is marginal for the following reasons: (a) The IMF, through MFD, i s currently providing technical assistance to the BoMinstrengthening banking supervision, transition o f B o M accountingto IFRS, foreign exchange management and monetary policy management. These funds have been put in the medium-term program (already approved), in terms of technical assistance over the five-year period o f the project. (b) SIDA has already provided the support for the formulation o f the debt strategy and agreed to provide support to the Department o f Debt Management in the Treasury. (c) DFID has provided support to the B o M in the project related to the transition to IFRS for the banking sector. DFID has already funded the first two phases o f this project and the third phase i s expected to begin in November 2005. The total estimated cost o f this fhding is approximately US$2 million equivalent o fwhich more than US$1million equivalent has already been disbursed. (N) 6. Credit conditionsand covenants Conditionsfor Negotiations: The following conditions for negotiationswere satisfactorily completed. 0 The Government submitted a draft Project Implementation Manual inform and substance satisfactory to the Association. The document included, but not be limitedto: - General project description; Description o f components with detailed work plan, procurement plans, training plans, budget, timetable and performance indicators and detailed job descriptions for each member o f the project team, including administrative andprofessional staff; 9 Clear definition o f responsibility o f focal points or beneficiaries (for TORS, . specifications, evaluations, certification and supervision); Procurement filing procedures 0 The Government submitted to IDA, by September 30, 2005, a draft Letter o f Sector Development Policy (LDP) for Financial Sector Development. This LDP was agreed upon as part of negotiations. It included a description o f the Government's policy on financial sector reform and the process that Government will follow to implement recommendations providedby the FSAP report. 0 The project chart o f accounts was designed inaccordance with SISTAFE law. 16 Conditionsfor Board have been satisfactorily completed: 0 IDAreceivedthe signed LDP on October 27,2005. 0 Other (mainly legal) conditions that were specified in the Minutes o f Negotiations dated October 14,2005. Conditionsfor Effectiveness: 0 The Government has adopted the PIM in form and substance satisfactory to the Association. The manual will include: (a) financial procedures; (b) procurement procedures; and (e) monitoring and evaluation procedures. 0 The Government has started the procurement process to recruit an independent auditor with TORsatisfactory to IDA. Other conditions: 0 A report will be prepared by the Government and reviewed by IDA by June 30 and December 31 o f each year, which integrates the results o f monitoring and evaluation activities inthe implementation o fthe project and achievements o fproject objectives. 0 Accounts will be audited annually by a qualified auditor and the audits will be sent to IDA no later than June 30 o f each year (which is the standard six months following the year-end). 0 Conduct in collaboration with IDA a MTR o f the project no later 30 months following effectiveness. 0 Maintenance o f the financial management system at the PIU in the form and with functions, staffing andresources acceptable to IDA 0 Six months after the end o f each financial year, audited annual reports of all licensed deposit-taking financial institutions will be made available to the public; otherwise the B o M would have taken appropriate measures to bring the financial institution into compliance D. APPRAISAL SUMMARY 1. Economic and financial analyses Given the character of this operation, a quantitative economic and financial analysis is not an appropriate tool to assess the returns o f this project. The pace and depth of the reforms envisionedwill determine the ultimate economic and financial benefits ofthe credit. 2. Technical The technical merits o f the project design have been examined by Bank staff over the course of project preparation and are considered sound andinline with international standards. The design 17 i s based on analytical work undertaken over the past two years, including the analysis and recommendations from the joint Bank/Fund FSAP, preparatory work undertaken in conjunction with the Bank's proposed Legal and Judiciary Reform Project, work done in conjunction with the PRSC and the PAF. In addition technical assessments will continue throughout the implementation period. Substantial preliminary work and foundations have been laid inthe course o f project preparation with support o f the PPF. The beneficiaries have completed the necessary feasibility and needs assessment studies and the detailed work plans and budgets are a reflection o f this groundwork. The procurement planwas accepted by IDA on October 11,2005. 3. Fiduciary The overall conclusion of the financial management assessment is that the current financial management arrangements invarious beneficiaries do not fully satisfy IDA'Sminimum financial management requirements. The financial management o f the project will therefore be centralized at the PIU and based on the systems established by the MoF in order to mitigate financial risks. The financial management team o f the PIU will be strengthened according to its needs. In addition, to establish an acceptable control environment and to reduce financial management risks, the Action Plan outlined in Annex 7 was agreed with IDA and will be implemented prior to project effectiveness. 4. Social Access to appropriate financial services is a critical tool for poor households to reduce vulnerability. While the IDA-operation will not directly address this issue, the project will assist the Government to establish a framework for increased and more efficient access to financial services, andwill support studies on existing constraints on demand and supply. Overall, by reducing the fiscal drain from state involvement in the financial sector and from emergency interventions in the sector, and by improving fiscal and debt management, it i s expected that available resources for important expenditures in health, education, water, and sanitation will be increased. The project will coordinate its interventions with the AfDB/IFAD RFSP, where possible, to leverage information and dialogue with the Government on access of financial services to the rural area. Inaddition, KfW and GTZ are providing complementary support inthis. Extensive consultations were held with a broad range o f stakeholders, including banks, corporations, and MFIs. All o f which are expected to participate in key project tasks, in particular, implementation of IFRS, payments systems modernization, banking supervision strengthening, and capacity building in various areas. Such stakeholders will continue to be consulted during project implementation. 5. Environment Not applicable 18 6. Safeguard policies Not amlicable _________~ Safeguard PoliciesTriggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [ I [XI Natural Habitats(OP/BP 4.04) [I [XI Pest Management (OP 4.09) [I [XI Cultural Property (OPN 11.03, beingrevisedas OP 4.11) [I [XI Involuntary Resettlement (OP/BP4.12) [I [XI IndigenousPeoples (OD 4.20, beingrevisedas OP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safety of Dams (OPBP 4.37) [I [XI < Projects inDisputedAreas (OP/BP/GP 7.60)* [I [XI [X 7. Policy Exceptions and Readiness Nopolicy exceptions. * By supporting theproposed project, the Bank does not intend toprejudice thejinal determination of theparties' ciainis on the disputed areas 19 Annex 1:Country and Sector Background MOZAMBIQUE:Financial Sector Technical Assistance Project Mozambique is one o f the world's poorest countries, ranking 170 out o f 173 countries on the Human Development Index. The country is rich in under-exploited resources, and in recent years, peace, better policies, rising foreign investment and continued external assistance have all contributed to encouraging economic performance. GDP grew an average o f 7.9 percent between 1994 and 2003, despite a sharp fall in growth in 2000 due to the devastating floods o f that year. GDP growth for 2004 was 7.2 percent and is estimatedto reach 8 percent for 2006. Medium-term prospects for Mozambique are bright, but the country faces many challenges. A key priority o f the Government is the reduction o f poverty through economic stabilization and promotion o f sustainable growth. Duringthe past decade, the GoM has demonstrated its strong commitment and has taken steps to provide a stable economy, consistent and comprehensive fiscal and monetary policies, enhanced financial sector management and supervision, a gradual reduction o f Govemment bureaucracy, strengthening o f institutional capacities and improved governance. Financial Sector Overview The Mozambique financial sector is small, bothinabsolute and relative terms, and is dominated by the banking sector. The sector was transformedduringthe 1990s from a Government-owned, centrally plannedsystem, inwhich two state-owned banks were essentially arms of Government fiscal policy, to a privately-owned and market-based system. Private-owned banks now represent more than 95 percent o f the total financial system assets. The system is highly concentrated, with the largest bank accounting for 46 percent o f total deposits, and with a five-bank ratio o f 94 percent (compared to a median o f 83 percent in sub- Saharan Africa and 71 percent in low-income countries). It is also characterized by increasing "dollarization". In 1997, 41 percent o f deposits and 37 percent o f loans were in foreign currency, while in 2005; these figures were 45 percent and 61 percent, respectively. The system's role in financial intermediation is quite small, and despite low deposits, is highly liquid. The system is also characterized by a highlevel o f non-performing loans (NPL) - approximately 21 percent as o f end-2002 - althoughthis i s mainly drivenbyNPLs within the two major banks. High levels of NPLs inthose banks were, inpart, due to loans made to state-owned enterprises, and inpart due to highly risky and/or fraudulent loans made following the banks' privatizations in 1996 and 1997. Subsequent crises at BAu and B C M necessitated Govemment contributions to recapitalize in 2000 and 2001, amounting to six (6) percent o f GDP. Four years later, however, the Government has proven its commitment to returning the banks to private ownership. The Government i s no longer a shareholder in BAu, and it has publicly announced its intention to withdraw from Banco Internacional de Moqambique (BIM), the successor to BCM. The banks are now controlled by qualified private owners and banking supervision has been enhanced to ensure that all financial institutions abide by the prudential regulations issued by the BoM. At the same time, the IMF is providing technical assistance to strengthen the technical capacity o f the supervision team. 20 Mozambique has a low level o f credit relative to GDP (18 percent). However, low levels of financial intermediation is not unusual inpoor countries, as saving mobilization and the marginal propensity to save, as a percentage to GDP i s generally lower in poorer countries. In addition, the level o f financial intermediation is influenced by weaknesses in the macro-economic and macro-financial environment, the overall lending environment and the weak capacity o fpotential borrowers. The high credit risk to which banks are exposed results from high and volatile real lending rates and a generally poor lendingenvironment. Real lendingrates inMeticais over the period 2001-2005 averaged 16.1 percent (fluctuating between 28 percent and 9 percent). Such high rates mostly reflect large interest rate spreads (14.5 percent), partly caused by the high provisioning requirements on NPL, high operating costs and limited bank competition, which allows banks to profit from adopting the margins o f the least efficient institutions. Weak property rights, land titling, collateral protection, and legal and judicial systems also contribute to low financial intermediation. Inparticular, it i s largely not possible to pledge real property as collateral, andthe unreliability o f thejudicial sector inenforcing creditor or collateral rights encourages lenders to rely on cash (for trade finance) and personal and foreign bank guarantees as the main forms o f collateral. Given the high cost o f finance, the high level of collateral required, and the procedural delays in obtaining external credit, Mozambican enterprises are severely capital-constrained. A large majority o f them have to rely on their own resources to meet their investment and working capital requirements. This i s well exemplified by the fact that, on average, the 193 firms surveyed for the "2003 Investment Climate Assessment" rely on their internal funds to finance 90 percent o f their working capital and 65 percent o f their investment needs. The study hrther showed that only 29 percent o f the firms surveyed reported having bank loans. Thus, a Mozambican enterprise's ability to invest and conduct business may be restrictedbythe amount o f internal hnds available at any givenmoment. Strengthening banking supervision will be crucial to improving the soundness o f Mozambique's banking sector. Some progress has taken place inthis area over the past two years, since the last assessment of the BCP, although significant work remains to be carried out inthe following five key areas. First, as most Mozambican banks are foreign-owned, the Banking Supervision Department (BSD) needs to establish regular communication with the head offices o f the banks and the banking supervisors in their countries o f domicile. Second, the current loan classification and loan loss provisioning systems need to be brought in line with international best practices. Third, trigger points need to be established that will prompt one or more legal actions once a financial institution's capital falls below the minimum prudential requirements. Fourth, clear steps need to be taken to build the core knowledge o f supervision staff, especially to ensure their capacity to independently validate information received from financial institutions. In addition to the above recommendations, it i s important to improve market oversight through the adoption o f IFRS for all commercial banks, which could best be achieved with a well-structured convergence plan. Finally, on matters o f intervention and discipline, the FSAP recommended that B o M rely more on specific restructuring actions than on monetary fines, and that B o M undertake a review o f the legal and regulatory framework for bank resolution. Institutional and capacity in the accounting profession remains weak. The Government recognizes that without an effort to strengthen the accountancy profession, in terms o f restructuring the curriculum of the accounting courses, provide training and promote the relevant private and public institutions, it will be difficult for the SISTAFE, as well as the IFRS to be 21 successfully implemented. Therefore, there is a crucial need to better promote private accounting institutions in the country that will enable the country to start developing a pool o f qualified accountants and auditors. There is currently an Association o f Professional Accountants inBeira and this effort needs to be extended to Maputo. Related to banking supervision, the Government enacted an Anti-Money Laundering (AML) Law inFebruary 2002, which established the legal framework for combating money laundering. Regulations under the law were approved inAugust,2004. Ingeneral, the law and its regulations are considered comprehensive and in line with international requirements. Inparticular, the law complies with the recommendations o f the Financial Action Task Force (FATF) on money laundering. The law obligates financial institutions to undertake customer due diligence, obtain information on complex and/or unusual transactions and maintain good record-keeping. Financial institutions are required to report suspicious transactions to the prosecutor's office, without disclosing the information to the customer under investigation. The law also provides for the confiscation o fproperty used or to be used for money laundering activities. There are no provisions for the establishment o f special investigation unit for financial crimes which is needed for the effective implementation o f the AML law. The need is borne out o f the fact that the nature o f financial crimes is very different from other types o f criminal activities, and therefore requires different types o f resources (skills, equipment, etc.) for investigation and prosecution. The Government has thus agreed to set up a special Financial Crimes Investigation Unit (FCIU). Technical assistanceto establish the unit, train staff, and develop procedures and programs will beprovided by the AfDB. MonetaryPolicy,PublicDebtManagementand Developmentof the MoneyMarket The B o M conducts monetary policy in a difficult setting characterized by a highpropensity to transact incash, and shallow financial markets. This i s further complicatedby the influx o f large external grants and loans (in excess o f 10 percent o f GDP) to finance the country's large fiscal deficit and poverty reduction strategy, which injects vast amounts o f liquidity into a thinly monetized economy. Although the sharp tightening of monetary policy that took place inmid- 2001 appears to have been effective in stabilizing prices and the exchange rate, it contributed to the high level and volatility of interest rates mentioned above. Inorder to reduce such volatility (of both prices and interest rates) and enhance the scope for local currency intermediation, the B o M needs to adopt a more transparent, consistent and forward-looking, monetary management. To achieve this goal, the current monetary framework needs strengthening. The framework currently lacks transparency, and market participants apparently do not fully understand the goals or operational framework o f monetary policy. This partlyreflects the need for the B o M to increase its efforts to communicate and explain its goals and operating procedures, as well as improve the operation o f its monetary instruments that send conflicting signals on the BoM's stance on monetary policy. Acting preemptively to limit deviations from monetary policy objectives will also require strengthening BoM's analytical capacity and greater emphasis on inflation targets and liquid management. At the same time, it is important to rely more closely on an intermediate monetary target. To enhance transparency and avoid interfering with market signals, B o M may need to conduct its monetary operations inthe overnight money market. The IMFisprovidingtechnical support inthis area. 22 Domestic debt in Meticais i s small, consisting mainly o f Treasury bonds issued for the recapitalization o f banks. The money and bond market are too narrow to be effective in monetary management, Le., to provide an anchor for yields o f longer maturities and to manage aggregate demand. A credible monetary policy i s essential to anchor expectations, encourage the balanced use o f foreign and local currency for financial intermediation and promote financial deepening, particularly for longer maturity instruments. Ingeneral, enhancing the credibility o f monetarypolicy should remain a key priority. Developing a strong government securities market is a key step towards deepening the scope o f financial intermediation and promoting the development o f a capital market. In addition, it would help the financing o f the government deficit in a less destabilizing manner and limit the Government's currency exposure. There are a number o f issues that need to be tackled, however, before the government securities market can be developed more fully. This includes changes to the Government's management of the public debt, as well as establishing the infrastructure for government bond issuance and trading, i.e., the money market. The Government anticipates working to strengthen the management of public debt and develop a medium to long-term strategy for the management o f both external and domestic debt. This would include: (i) developing a sound institutional and legal framework for debt management, including the preparation o f laws and regulations and o f written procedures and the clarification o f the borrowing authority; (ii)preparing a medium-term strategy aimed at post-HIPC (Heavily Indebted Poor Country) debt sustainability; (iii) building capacity for incurring and sustaining the domestic debt, which would include the development o f public securities market; and (iv) carrying out an evaluation o f the private sector foreign debt to identify risks and vulnerabilities to fluctuations in the exchange rates. Efforts would include a focus on improving governance and the formulation o f a debt management strategy adopted by the G o M and the development o f a comprehensive and reliable database o fpublic debt, which i s an essential. A common issue for HIPC countries is where to placethe responsibility for performing DSA. In a number o f sub-Sahara countries, preparing a DSA is seen as the role of the Debt Management Unit. However, as sustainability is mainly a fiscal policy issue, the macroeconomic forecasts and/or future budget surpluses, for example, will decide whether the debt is potentially sustainable or not, while debt management deals with the structure and risk exposure of the debt. While the risk profile is an important element in determining whether or not the debt is sustainable, the responsibility for performing DSA should lie outside o f the debt management office, with the Debt Management Unit providing input inthe form o f projected costs to the debt under different scenarios for the government's primary deficit and market rates. While this is best practice, the project design recognized the constraints on the ground. In Mozambique, the ideal location for the Unit should be in a macroeconomic unit in the Treasury but outside o f the Public Debt Department. This is not possible as the Treasury does not have such a unit. Therefore it was agreed that the DSA will be done by a middle office o f the Public Debt Department, once the department has gone through its restructuring. With respect to the development o f the money market, a number o f areas need to be strengthened. Activity in the money market is currently concentrated in public sector debt instruments and the overnight inter-bank market. Progress has been made in liquidity management operations, which are now carried out mainly through the use the Treasury bills and ultra-short TAMS (Titulos de Autoridad Monetaria). However, structural issues that contribute 23 to segmentation of liquidity among banks should be addressed, including the lack o f a repurchase market and other operational risks. In addition, the Treasury bill market is shallow, in part because the volume issued at each maturity i s quite variable, which produces a fairly discontinuous yield curve and precludes the emergence o f a stable benchmark for market rates. In coordination with the goals for public debt management, focus should be on developing security issues whose rates can be a reference point to other instruments and that also enjoy a fair level o f liquidity. Micro and Rural Finance Improving access to finance for micro enterprises would also contribute to enabling micro and small business growth. The microfinance industry i s relatively young. Although it has grown rapidly and shows significant promise, it still has a relatively small outreach, with a high concentration in Maputo. There are good prospects for its development in Mozambique and several best performing MFIs are already in partnership with well-known, international microfinance service providers. Ingeneral, the microfinance sector inMozambique is still at an embryonic stage with few large MFIs moving towards consolidation and the majority, mainly smaller donor-funded programs strugglingto survive and grow. The B o M recently issued a new regulation for the microfinance sector, establishing multiple categories o f "microbancos", or MFIs. Some fall under the prudential regulations o f the BoM, while others require only registration with the MoF. The emergence o f this regulatory framework is expected to elevate the status o f microfinance industry, which is becoming an essential sub-sector o f the formal financial sector inMozambique. Microfinance institutions can be categorized intwo groups. The first group comprises the large MFIs (Novobanco, SOCREMO, Tchuma) that are making the transition to commercial sustainability and are converting to prudentially-regulated microfinance banks. These institutions are targeting the top tier o f micro-enterprises through individual lending. These programs have grown significantly, both in terms o f portfolio and outreach, with a fairly large numbero fclients and average loansizes. The second group includes the smaller, donor-financed MFIs which are more often insecondary cities or inrural areas. These institutions are struggling to achieve operational self-sufficiency and are far from reaching financial sustainability goals. Average salary and administrative costs are high, due to the very limited supply o f qualified staff, administering relatively small loan portfolios. This group still remains well outside o f the larger financial community. The latter tend to concentrate on poorer segments o f the population, often without ongoing businesses, per se, using group methodologies. The Mozambique Microfinance Facility (MMF) is an ongoing CIDA-funded (Canadian International Development Association) project that acts, in part, as a clearinghouse for sector information. The number o f microfinance clients has remained relatively stable over the last several years (approximately 50,000 clients), while the total microfinance portfolio has increased substantially, from approximately US$5 million inlate 2002 to nearly US15 million at the end o f 2004. These figures do not include extremely small MFIs generally located outside o f urban areas. There are perhaps an additional 10,000 clients and US$3 million inoutstanding portfolio from these programs. Outside o f the largest programs, there remains a significant need to bring more professionalism and transparency to the sector. Approximately 12 MFIs are incontact with the MMF. However, 24 there may be as many as 20 to 30 extremely small programs supported by donors and small NGOs throughout the country. Significant funds have been directed to the sector (inmany cases far more than the portfolios o f programs themselves), but this has not necessarily been accompanied by the transmission o f experience developed elsewhere. These multiple efforts have not been well tracked or analyzed. There i s a recognized need for good technical partners that can work with the smaller MFIs, for transparency through an accepted monitoring tool, and capacity buildingto improve management systems. Withonly a few exceptions, microfinance does not serve rural areas due to highcosts involvedin service delivery. Constraints to providing financial services in rural and remote areas include: very low population densities, low levels o f economic development particularly weak or non- existent markets, poor physical and communication infrastructure, and low skills and experience. There i s economic activity extending into these areas such as in Manica, where Zimbabwean farmers are bringing skills and experience, and inthe Beira corridor, infrastructure and financial services will follow. The two large MFIs servicing the rural communities are not able to achieve scale and generate sufficient profits. CCCP (Caixa Comunitaria de Crkdito e Poupanqa) and FCC operate inrural areas in northern Mozambique. However, FCC is closing down their work in Nampula following continued poor performance and pull-out o f the UnitedNational Capital Development Fund(UNCDF) support. CCCP reports sufficiently goodperformanceo ftheir associatiodgroup lending schemes in Cab0 Delgado, although it i s not yet operationally self-sufficient. In addition, U S A l D (United States Agency for International Development) reports good performance o f commercial (non-MFI) lending to segments o f agriculture in the Beira-Nacala corridor. The commercially-oriented MFIs report that they have looked into operations in rural areas, but that until operational and commercial viability is more likely, they will not expand into remote rural areas. There i s a strong case for increased donor investment to initial operations o f MFIs willing to expand operations to cover the under saved remote rural communities. The plannedparallel AfDB and IFAD projects (RFSP), which is under the auspices o f the Ministry o f Planningand Development, will assist the Government to develop and implement a strategy for rural financial development, including support to institutions interested in establishing or expanding operations into rural areas and funds for on-lending. MFIPortfolio Information, end2004 (US$) Source: Mozambique Micro finance Facility (MMF) 25 Few MFIs (Novobanco, SOCREMO, Tchuma) have already registered under the Banking Law, and are regulated and supervised in the same manner as commercial banks, although with lower minimum capital requirements until end-2005. Novobanco began accepting deposits approximately a year ago, and the number o f deposit-only clients is already far larger than borrowing clients. SOCREMO is slowly experimenting with deposit services as well. The success o f Novobanco in this regard points to the strong demand o f micro clients for formal savings services, which are not offered by commercial banks. Novobanco is considering to expand its deposit-taking activities into rural areas. The new regulation appears to encourage diversification o f the microfinance industry, particularly the postal financial services and rural financial intermediation. The next tasks for both the B o M and MFIs would be to operationalize the regulations, to adapt supervisory practices to MFIs that are prudentially supervised or may fall under the new "microbank" rules, and to bring MFI reporting to an appropriate level o f professionalism. Insuranceand Pensions The insurance and pension sectors in Mozambique are small and suffer from a lack o f transparency, as well as institutional and regulatory capacity. This could mask sizeable contingent fiscal liabilities, as neither the state insurance company (EMOSE), nor the state pension scheme (INSS), regularly disclose reliable financial statements based on independent actuarial evaluations. The insurance sector (regulated by the MoF) and the pension sector (regulated by the Inspeq6o Gerul de Seguros [IGS]), need to strengthen the capacity o f the regulator. The InsuranceSector The insurance sector in Mozambique is very small, dominated by EMOSE, and has limited capacity. Total insurance premiums at the end o f 2001 were US$20.4 million (0.6 percent o f GDP). Life insurance is negligible, at only two percent o f the sector, mainly due to low income levels and adverse health conditions, as well as some technical issues such as outdated mortality statistics. Non-life insurance includes property, natural hazards, construction and engineering insurance products. The monopoly o f EMOSE was ended by the liberalization o f the sector in 1991 and currently four companies operate in the market. There are no restrictions on foreign ownership o f insurance companies and since the sector's liberalization, a few insurance foreign insurance companies have entered the market. However, EMOSE holds the largest share in the market, valued at approximately US$30 million. As a result o f the country's limited capacity to underwrite risk, around 30 percent o f insurance premiums are reinsured abroad. The regulatory body for the insurance industry, IGS, has been in place since July 1999. It has seven technical staff composed o f lawyers, economists and accountants, but does not have an independent budget. Despite the improved regulatory framework for insurance supervision brought about by the new Insurance Law enacted in January 2003, several important issues remain to be addressed. It is recommended that the new law be reviewed and revised in order to address several identified weaknesses, including the regulation o f insurance contracts, guidelines on investments, and the enabling o f proactive supervisory action against weak institutions. The IGS has yet to establish a detailed supervisory framework and prudential regulations to guide the conduct o f the sector, which it needs to do. Also, although a new chart o f accounts for insurance companies has been developed and has been in effect since mid-2005, the IGS needs assistance 26 in developing transitional measures for its implementation. In conjunction with these actions, the technical capacity o f the IGS needs to be substantially strengthened to be able to effectively supervise and enforce the laws and regulations governing the sector. Most IGS officers lack insurance supervision experience; a few officers have a background in economics and law, most lack in-depthknowledge o f insurance. There is, therefore, an urgent need to develop a robust capacity buildingprogram for the IGS if it is to adequately perform its regulatory functions. In addition, the insurance law gives the responsibility o f supervising supplementary pension funds to the IGS. While there has been discussion o f legislation for the establishment o f such funds, there is no detailed framework as yet. There is therefore a significant need to develop an appropriate framework for such funds and to develop the skills to regulate them. The Pension System and the Social Security System Pension institutions are generally good sources o f long-term funds which are made available to the financial sector. The pension sector in Mozambique, however, is dominated by a state- owned, unfunded pension scheme administered by INSS, which is also the supervisor o f the sector. Potential quasi-fiscal contingencies need to be assessed through an actuarial evaluation. Inadditionto the state-owned scheme, some corporate pensionschemes exist, however, these are not regulated or supervised. The current social security system covers only the formally employed. Given that the Mozambican population is predominantly rural and/or self-employed; the coverage o f the system relative to the economically active population is very low. For example, available data shows that there are 31,000 registered companies in Mozambique, employing about 300,000 workers, against an economically active population o f 9.4 million. The low level o f coverage raises equity questions. There is, therefore, the need for a detailed study to look at viable options to strengthen the social security system inthe country. The level o f compliance in the existing system is very low. INSS records show that there are approximately 543,000 registered participants in the system, representing 68 percent o f salaried workers. However, more importantly, only 164,000, or about 30 percent o f the registered participants, are active contributors to the system. One reason for this low level o f compliance is the weak administration which does not give confidence to the participants in the system. The processing and payment of benefits is very slow, and beneficiaries suffer significant delays before receiving their benefits, if at all. Most o f INSS' activities are processed manually, with little or no IT assistance. The manual processing o f large volumes o f information explains the large number o f staff o f the INSS, about 1,830, as compared to the active participants. New IT i s being developed for the INSS which should address some o f INSS' administrative deficiencies. However, the INSS's organization weaknesses go beyond lack o f technology and a complete reengineering o f the institution is recommended. There is a need to improve the transparency and accountability o f the pension system. For instance, the INSS does not disclose its financial statements or its investment policies. There i s no legal reason why this should be so. The INSS legislation requires the agency to prepare and publish its financial statements in its annual report. The INSS also needs to adopt more transparent and professional procedures inmaking its investment decisions. 27 The LegalEnvironment for Lending Efforts to improve the Mozambican financial system needto take into account the poor legal and judicial environment inwhich financial transactions take place. Lncluded inthis environment are the inadequacies o f the contractual framework inMozambique. The provision o f credit requires predictable, transparent and affordable enforcement o f both secured and unsecured credit claims by efficient mechanisms outside insolvency, as well as a sound insolvency framework. The procedures for enforcing rights should enable parties to rely on contractual agreements, which in turn, support confidence in lending and investments. Uncertainty about the enforceability o f contractual rights increases the cost o f credit to compensate for the increased risk o f non- performance. Debt recovery through the courts inMozambique is highly inefficient (it has been estimated that it takes on average 540 days to resolve a case in Maputo, much more than in neighboring countries). Resolving insolvency in Maputo requires undergoing an inordinate amount o f time. Judges are perceived to have inadequate knowledge o f commercial law and to avoid commercial cases. The weak contractual framework, coupled with a number o f legal and institutional impediments to effective credit selection and recovery, leads to a weak repayment culture and undermines the development o f an efficient credit-based economy. A numbero fmeasures havebeenor are being taken to improve the lending environment. A new commercial code was drafted through a consultative process and is still awaiting enactment into law. The code o f civil procedure, which dated back to 1967, has been revised and i s also awaiting enactment. The revised code has streamlined judicial processes, in order to reduce delays and perception o f corruption. A study, financed by the Norwegian Agency for Development (NORAD), on the computerization o f the commercial registry has been finalized, and implementation is underway. In addition, an arbitration center was created to resolve some o f these disputes, but despite the encouraging steps, significant measures to improve the lending environment are still required. Additional measures include updating the legal framework for secured transactions. Landcannot be used as collateral, and there are restrictions on pledging movables, on using future property, and on using a changing pool o f assets, such as buildings under construction. Lack o f clear property title and inefficiency and corruption in the property and mortgage registries are also major obstacles. As next steps in these and other areas, it i s recommended that the Government tackle the development o f a new bankruptcy law, the development o f commercial judicial sections, modernization and linking o f property registries and improvements to the credit registry. 28 Annex 2: Major RelatedProjectsFinancedby IDA and/or otherAgencies MOZAMBIQUE: FinancialSector TechnicalAssistance Project There have been a number o f projects financed by IDA and other partners that have contributed to the development o f a sound financial and private sector. The FSTAP was designed to build upon completed reforms or complement ongoing work. Projectsfinanced by the World Bank The proposed project builds on the FSCBP, which closed in March 2001. The development objective was to develop and strengthen the institutions charged with implementingthe policy and institutional reforms in the financial sector. The project aimed at: (a) strengthening the Central Bank to enable it to administer monetary policy and carry out effective regulation and supervision o f the financial sector; (b) providing a regulatory and institutional framework to deepen the financial sector; and (c) supporting the systematic issuance o f Treasury bills to manage liquidity. The ICR concluded that the project's outcome was satisfactory, recording improvements in a number o f areas, inparticular inincreasing the capacity o f B o M to supervise the financial sector and conduct monetary policy. There was increased capacity in other departments o f the BoM, as well as improvements inthe legal and regulatory framework for the financial sector. In addition, the IFB, established under the FSCBP, continues to operate on a sustainable basis with participation from the commercial banks. The project also continues the efforts o f EMPSO, which closed inJuly 2004. The primary objective o f EMPSO was to support the Government's program to consolidate macroeconomic stability and to lay the foundations for sustained private sector-led growth over the medium-tern. The program included measures, among others, to resolve the financial difficulties of two o f the commercial banks, strengthen licensing and supervision in the financial sector and further dilute government ownership inthe financial sector. The Enterprise Development Proiect (PODEMP049874), which is ongoing., includes a credit line for support to Small, MediumEnterprises (SME's). This component, due to the highinterest rates inthe country and conservative lending practices, has not been well-utilized. On the other hand, the technical support to the SME group, made available with a matching grant fund, has made substantial gains in strengthening SMEs to be able to compete and secure commercial bank financing. The Legal Capacity Building Proiect (P090905) i s under preparation. The planned Board date is February 2006. It will address three primary areas: (a) court management; (b) training o fjudicial officials; and (c) access to justice. This will complement work being done by the AfDB on improving the lendingenvironment. 29 Projectsfinanced by other Development Partners The IMF, through MFD, i s currently providing technical assistance to the B o M in strengthening banking supervision, transition o f B o M accounting to IFRS, foreign exchange management and monetary policy management. It has approved a medium-term, technical assistance program o f approximately US$500,000 over the five-year period o f the project. AfDB prepared a parallel project which would finance components 6, 7, 8 and 9 of the broad-based FSTAP Program described inAnnex 4. The total estimated cost o f this financing i s US$10.2 million equivalent. The project was approved by AfDB Board o f Directors on October 6,2005. SIDA has providedsupport to the Department o fDebt Management inthe Treasury. DFID has been providing support to the BoM inthe project related to the transition to IFRS for the bankingsector. DFID has already funded the first two phases of this project and the third phase is expected to begin in November 2005. The total estimated cost o f this hnding i s approximately US$2 millionequivalent. The US$30 million IFAD/AFDB Rural Financial Service Program (RFSP) was recently launched. This is a comprehensive program to support rural finance. KfW and GTZ have prepared projects for the micro and rural finance sector. The combined projects are estimated to cost US$3.6 million and will be coordinated as part o fthe broader ruraldevelopment program. CIDA has provided support to the MMF, which acts inpart as a clearinghouse for micro and rural sector information. 30 Annex 3: Results Frameworkand Monitoring MOZAMBIQUE: FinancialSector TechnicalAssistance Project LesultsFramework(IDA only) PDOOutcome S formation [mproved soundness o f the Percentageo fbanks incompliance aonitoring the results indicators Mozambican banking sector and with improved prudential vi11provide feedback regarding improved public debt management. regulations. 3oM enforcement capacity, and whether additional technical Percentage o f outstanding treasury issistance andor capacity building Securities traded on the secondary .s necessary. market. Component One: ComponentOne: Component One: Enhancedcapacity o f the B o M in Number o f BCP B o M is compliant Monitoring the results indicators terms o fbanlung supervision and with. will provide feedback regarding provision o f financial infrastructure. BoM enforcement capacity and Reduction o f time neededto transfer strength o f financial infrastructure, finds betweenbanks. and whether additional technical assistance andor capacity building is necessarv. ComponentTwo Component Two Component Two Improved financial accountability Percentage o f banks whose financial Monitoring the results indicators and transparency. reporting is in accordance with will provide feedback regarding IFRS. penetration of IFRS infinancial and corporate sector. The proposed Percentage o f large enterprises with timetable may be adjusted, if financial statements inaccordance necessary. with IFRS. Percentage o f medium enterprises with financial statements in accordance with IFRS. ComponentThree: Component Three: ComponentThree: Strengthened public debt Annual publication o fpublic debt Monitoring the results indicators management capacity. reports including comprehensive will provide feedback regarding debt inventory. GoMenforcement capacity, and whether additional technical Debt forecasts are published on a assistance andor capacity building regular basis. is necessary. ComponentFour ComponentFour: ComponentFour: Improved money and Government Regular Treasury securities auctions Monitoring the results indicators bondmarket efficiency and depth. held on a monthly basis. will provide feedback on activity o f primaryand secondary treasury security mkt and will indicate add7 capacity buildingrequirements. 31 E 3m zm 3m FU .I es 2 g .I + E i 2 U e s VI r- +rr r r EL s 5+u L 000 E 0 I: -E80 .C I 0 s 3 scI m i- e! 0 I . 4 m 3 s S i- VI 0 0 e, M e, . 52 5sM m U s m C e 8 8 N 0 0 0 0 0 -53 E4 Ea d d 2 B 0 B0
Группа Всемирного банка · Project Appraisal Document
Mozambique - Financial Sector Technical Assistance Project
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