Mozambique - Third Poverty Reduction Support Credit (Development Policy Lending)

37970 Revised Documentof The World Bank FOROFFICIAL USE ONLY ReportNo. 37970-MZ INTERNATIONALDEVELOPMENT ASSOCIATION PROGRAMDOCUMENT FORA PROPOSEDTHIRD POVERTYREDUCTIONSUPPORTCREDIT INTHE AMOUNT OF SDR46.6MILLION(US$70MILLIONEQUIVALENT) TO THE REPUBLIC OF MOZAMBIQUE December 19,2006 PovertyReductionandEconomicManagement - AFTP1 Africa Region This document has a restricteddistributionandmaybeusedby recipientsonly inthe performanceof their official duties. Itscontents maynot otherwisebe disclosedwithout WorldBankauthorization.  MOZAMBIQUE GOVERNMENT - FISCAL YEAR January, I -December 32 CURRENCY EQUIVALENTS (ExchangeRateEffective as of December 1,2006) Currency Unit Metical U S $ l.oo 25.20 Weights andMeasures Metric System ABBREVIATION AND ACRONYMS BdPES Balanqodo Plan0 Econ6mico e Social (Assessment ofthe Social and Economic Plan) BIM Banco internacional de Mozambique (InternationaI Bank of Mozambique) CAS Country Assistance Strategy CDD Community-Driven Development CEM Country Economic Memorandum CFAA Country Financial Accountability Assessment CFMP CountryFinancial ManagementPIan CNCS AIDSNational Council CPAR Country ProcurementAssessment Review CTA ConfederationofEconomicAssociationso fMozambique EU EuropeanUnion FSAP Financial Sector Assessment Program GBS Generalbudgetsupport GDP GrossDomestic Product GNP GrossNational Product GoM Governmento fMozambique HIPC HeavilyIndebtedPoor Countries I A S InternationalAccounting Standards IBRD InternationalBank for ReconstructionandDevelopment ICA Investment ClimateAssessment ICR Implementation CompletionReport IDA InternationalDevelopmentAssociation IFC InternationalFinanceCorporation IFRS InternationalFinancial Reporting Standards IMF InternationalMonetary Fund INE National StatisticsInstitute INSS National Institute for Social Security (National PensionSystem) JSA Joint Staff Assessment LDP LetterofDevelopmentPolicy LFL Bankruptcy Law LICSF BankingInstitutionsLaw MDGs MillenniumDevelopmentGoals MEC Ministryof EducationandCulture MIC Ministry o fIndustryandCommerce M M A G Ministry o fAgriculture MoF Ministryof Finance MoH MinistryofHealth MoU Memorandum ofUnderstanding  FOROFFICIAL USE ONLY MOZAL MozambiqueAluminiumCompany MPD Ministryof PlanningandDevelopment MTEF Medium-TermExpenditureFramework MTFF Medium-TermFinancialFramework MYR MidYear Review OE State Budget PAF PerformanceAssessment Framework PAP ProgramAid Partners PAPPA ProgrammeAid Partners' PerformanceAssessment PARPA ActionPlanfor the Reductionof AbsolutePoverty PEN NationalStrategic Plan PER Public ExpenditureReview PES PlanoEcon6micoe Social PMTCT Preventionofmother-to-childtransmission PRGF PovertyReductionandGrowthFacility PRSC PovertyReductionSupportCredit PRSP PovertyReductionStrategyPlan PSIA Povertyand Social ImpactAnalysis QAG Quality AssuranceGroup QUIBB QualitativeIndicators Survey SADC SouthemAfricanDevelopmentCommunity SDR SpecialDrawingRights SISTAFE IntegratedFinancialManagementSystem TA TechnicalAssistance UFSA CentralProcurementSupervisionUnit UGE ExecutiveManagementUnitfor BudgetExecution UTRESP TechnicalUnit for Public SectorRestructuring VAT Value Added Tax ActingVice President: HartwigSchafer Country Director: MichaelBaxter Sector Manager: EmmanuelAkpa Task TeamLeaders: GregorBinkertRrancisco Cameiro This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.   THEREPUBLICOFMOZAMBIQUE THIRDPOVERTY REDUCTION SUPPORT CREDIT TABLE OF CONTENTS I INTRODUCTION 1 I1 .. .................................................................................................. ..................................................................................... A. Country Overview.................................................................................................. COUNTRY CONTEXT 2 2 B. Macroeconomic Context ........................................................................................ 5 I11.BoxTHE 1:Mozambique: Progress towards the Millennium Development Goals.........6 ......................................... A. PillarI:GOVERNMENT'S PROGRAM: PARPA I1 9 B Pillar 11:HumanCapital....................................................................................... . Governance ............................................................................................. 10 11 C Pillar 111:Economic Development ....................................................................... 11 I V .. ................................................. A. Linkto CAS ......................................................................................................... BANK SUPPORT TO GOM'S PROGRAM 12 B. Linkto Other Bank Operations ............................................................................ 12 C. Collaboration with the IMF.................................................................................. 14 D. CollaboratiodHarmonization with Donors.......................................................... 15 16 E. Paris Declaration onAid Effectiveness................................................................ 17 F. Performance under PRSC 1andPRSC 2.............................................................. G. Lessons learned.................................................................................................... 17 18 v THE PROPOSEDNEW .H. Analytical Underpinningso f the PRSC ............................................................... ..................................... 19 A. Overall Description.............................................................................................. PRSCSERIES: PRSC3 . 5 23 23 B. PRSC 3 ................................................................................................................. 24 a. Prior Actions for PRSC 3: .1 ............................................................................. 25 a.2 Governance.............................................................................................. a Macroeconomic Management................................................................. 25 26 26 C. Triggers for PRSC4 and PRSC5 .......................................................................... a.3 Economic Development .......................................................................... 28 VI . ........................................................... A. MonitoringandEvaluation................................................................................... OPERATION IMPLEMENTATION 30 B Credit Amount andTranching.............................................................................. 30 C. Supervision........................................................................................................... . 30 D. FiduciaryAspects................................................................................................. 31 E. DisbursementandAuditing.................................................................................. 31 32 F. Environmental and SocialAspects ....................................................................... G. Risksand RiskMitigation.................................................................................... 33 34 ANNEXES Annex 1: Policy Matrix and Results Framework for the PRSC Series........................... 37 Annex 2: Performance Assessment Framework (PAF) for 2007-2009 ...................40 Performance Assessment Framework for 2006.............................................. Annex 3: 44 Annex 4 Letter o fDevelopment Policy ......................................................... -48 Annex 5: Mozambique at a Glance.................................................................................. Mozambique - Selected Economic and Financial Indicators.......................... 53 Annex 6: 54  Annex 7: MillenniumDevelopmentfor Mozambique................................. -56 Annex 8: World Bank Lending Activities in Mozambique: September 2006 (US$ million.. ............................................................ -57 Annex 9: Policy MeasuresandOutcomesAchieved by the Endof PRSC2by Major SectorPolicy Area ..................................................... .58 Annex 10: Mozambique: Relations with the Fund ....................................... 61 The Credit was preparedby an IDAteam consistingof Gregor Binkert,FranciscoCarneiro, Antonio Nucifora, Maria Benito-Spinetto, Adelina Mucavele, Ligia Murphy(AFTP1); Peter Nicholas, Paola Ridolfi (AFCMZ); Aniceto Bila, Lurdes Malate (AFC02); Louise Fox, Rui Benfica (AFTPM); Eduardo de Sousa, Daniel De Sousa (AFTS1); Gilbert0 de Barros (AFTPS); Ana Ruth Meneses, Xiaoyan Liang, Jean-Jacques de St. Antoine, Humberto Cossa, Bina Valaydon (AFTH1); Kate Kuper, Jane Walker, Ali Alwahti (AFTU1); Guenter Heidenhof, Jose Luis Macamo (AFTPR); Ravi Ruparel (AFTFS); Mohamed Khatouri, (AFKL); Brighton Musungwa (AFTFM); Albert0 Ninio, LIE Meza-Bartrina, Jordi Agusti-Panareda, Beth Dabak (LEGAF); SlaheddineBen-Halima, IsabelNhassengo(AFTQK); Ani1Bhandari,Dieter Schelling, KavitaSethi (AFTTR); Wendy Hughes(AFTEG);JosephNarkevic (EWDAF); Natasha Beschorner,IsabelNet0 (CITPO); CharlesSchlumberger(TUDTR). Peer Reviewers: JacquesMorisset(AFTP4)andNwanzeOkidegbe(ARD). The IDA team collaborated closely with 17 other development partner agencies that also provide general budget support under the Memorandumof Understandingsigned in 2004; this group is presently chaired by PeterFlik andJolke Oppewalofthe RoyalDutchEmbassyinMaputo.  THEREPUBLICOFMOZAMBIQUE THIRDPOVERTY REDUCTION SUPPORT CREDIT CREDIT AND PROGRAM SUMMARY Recipient The Republic o f Mozambique ImplementingAgency Ministry o f Finance Amount SDR46.6 Million(US$70 millionequivalent) Terms Standard IDA terms: 40-year maturity with a 10-year grace period Tranching Single tranche to be disbursedupon effectiveness Description The proposed Third Poverty Reduction Strategy Credit (PRSC 3) i s the first in a new PRSC series designed to assist the Government o f Mozambique (GoM) to implement key policy actions outlined in its Second Action Plan for the Reduction o f Absolute Poverty (known as PARPA I1 by its Portuguese acronym) and in the Performance Assessment Framework agreed by the Government and the 18 external partners that provide general budget support (GBS) to GoM. PARPA I1 i s mainly focused on shared growth and on the need for decentralization. Within this context, PRSC 3 i s expected to help the GoM in: (a) the consolidation and deepening o f the institutional reforms inthe area o f macroeconomic management; (b) reforms in governance by supporting decentralization to enhance public investments and service delivery at the provincial and district level, and by supporting public sector reform; and (c) economic development by improving the investment climate, removing constraints to growth, such as infrastructure, and promoting agricultural growth. Benefits The operation will help Government maintain ~~ the macroeconomic stability while it continues to pursue a reform agenda that cannot be fully financed from domestic sources. The reforms would enable Mozambique to make further progress in reducing absolute poverty, improving the delivery o f services and achieving the MDGs. The alignment with the general budget support programs o f 18 other donors and a joint focus on the priorities set out by the Government in its comprehensive poverty reduction strategy, and on a common set o f indicators to measure progress, should help improve the resource flow and improve aid effectiveness, thereby enhancing the chances o f progress towards the MDGs. Risks One set o f risks i s concerned with the potential for macroeconomic instability. Instability may arise as a result o f terms o f trade shocks, deteriorating finances, or unpredictability o f donor disbursements. While terms o f trade shocks and regional instability are exogenous, better public finance management, and the adoption o f MoU's with development  partners has made aid flows more predictable. A second set o f risks concerns weak administrative capacity to implement reforms. To mitigate this risk, the Government and donors agreed during the Joint Review to develop an integrated strategy for capacity development in public finance management, and to strengthen the coordination and management o f reforms. A third set o f risks concerns a deterioration in governance that could compromise economic reforms and poverty reduction efforts. To mitigate this risk, the Bank has intensified its policy dialogue on governance issues in harmonization with the G18 and has restructured its public sector reform project to support the second phase of public sector reforms; a new component in support o f capacity buildinginthe judiciary sector has also been included. A final set o f risks concerns the potential impact of HIV/AIDS in reducing human and institutional capacity to deliver public services and may pose a contingent liability regarding the future costs o f treating this disease. Project ID Number PO83459  PROGRAMDOCUMENTFORA PROPOSEDCREDIT TO THE REPUBLIC OF MOZAMBIQUE FORA THIRD POVERTY REDUCTIONSUPPORT CREDIT I. INTRODUCTION 1. Thisprogram documentproposes a Third Poverty Reduction Support Credit (PRSC 3) to the Republic of Mozambique for SDR 46.6 million (US$70 million equivalent), on standard I D A terms and outlines the triggersfor moving to PRSC 4 and PRSC 5. The proposed operation i s an integral part o f the Bank's strategy to support the implementation o f Mozambique's Second Action Plan for the Reduction o f Absolute Poverty (known as PARPA I1by its Portuguese acronym), aided by the Performance Assessment Framework (PAF) agreed by the Government and the eighteen external partners (the G-18) providing general budget support (GBS). This, the second PRSC series, will include three annual operations to be delivered over FY07-09. While the PRSC operations will provide financial support for implementing the whole PARPA, they are to be disbursed against the upfront completion o f a number o f specific reform measures identifiedinthe PAF. 2. The first series of Poverty Reduction Support Credits was successfully deployed. PRSC 1 was approved as a single-tranche operation by the Board o f IDA on July 6,2004 for SDR 40.9 million (US$60 million equivalent) and PRSC 2 was approved as a two-tranche operation by the Board on September 17, 2005 for SDR 83.3 million (US$120 million equivalent). PRSCl and 2 supported programs covering primarily cross- cutting issues: (i)macroeconomic stability; (ii)public finance reforms, including the design and implementation o f a new integrated electronic financial management system (e-SISTAFE), budget comprehensiveness, improved accounting and accountability, strengthenedinternal controls, reform of the procurementprocess, and improved linkages between budgeting, planning and the delivery o f service; (iii)the efficiency o f the delivery of services through civil service reforms; and (iv) the investment climate for private sector development. Overall progress on the reforms has been satisfactory, and the Government continues to pursue a far-reaching reform agenda. Although there has been progress, it was from a very low base after 16 years o f war, and significant challenges remain. 3. Theprogram supported by theproposed new PRSC series is well aligned with the PARPA II. PARPA I1 i s structured around three pillars (Governance, Human Capital, and Economic Development) and is the operational plan o f the Government's Five-Year Program. Interms o f sequencing, the PRSC series i s designed to focus first on key constraints in cross-cutting areas such as public financial management and the business environment, which are the areas that provide the rationale for the prior actions of PRSC 3. The series then evolves to support decentralization and shared growth through the incorporation o f triggers for PRSC 4 and 5. All the prior actions and triggers - 1 -  o f the PRSC series are indicators contained in the Performance Assessment Framework (PAF) in order to be consistent with the government's own monitoring framework and to be inline with donor harmonization for general budget support (see Annex 1). 4. The program supported by the PRSC series has been informed by a signifcant amount of analytical work completed over the pastfew years. This includes two PERs (FYO1and FY03), two Country Economic Memoranda (CEM, FYO1, FY06), a Country Financial Accountability Assessment (CFAA, FY02), a Country Procurement Assessment Review (CPAR, FY03), an Investment Climate Assessment (ICA, FY03), a Financial Sector Assessment (FY03), a Public Financial Management and Fiduciary Risk assessment undertaken with other donors (2004), an Assessment o f Financial Management for 2004/05 using the PEFA methodology (2006), a Country Health Status Report (FY05), a PSIA on the impact o f school fees (FY05), a study on the effectiveness o f agricultural extension (FY05), a poverty profile publishedby the Government (2004), an analysis o f changes and determinants o f poverty (FY06) and an agricultural development strategy (FY06). Bank-IMF work on tracking public expenditures in HIPC countries has also played a role inprogram design. 5 . Progress on the reforms is monitored with the aid of the PAF. The monitoring o f progress on the reforms i s done through the Joint Sector Working Groups, which also includes Government representatives. The assessment i s done on the basis o f the indicators contained in the PAF (see Annexes 2 and 3), and through an annual Joint Review conducted in April. Another review in September sets goals for the subsequent year. The sector working groups have become a good mechanism for policy dialogue, donor harmonization, and for reaching agreement between the Government and all the donors involved in a specific sector. Furthermore, a joint Budget Working Group meets on a quarterly basis with the Government to monitor budget execution, particularly inthe priority sectors. 6. Joint Reviews were completed successfully in April and September 2006. The review o f achievements against the agreed PAF indicators in April found that there was progress in terms o f expansion o f service delivery, but that reforms in the area o f governance were still lagging. The Mid-Year Review o f September 2006 noted that the pace o f these reforms should be accelerated, with the results made visible in order to assure that popular support for the reforms become stronger and help make service delivery expansion andpoverty reduction sustainable. 11. COUNTRY CONTEXT A. COUNTRYOVERVIEW 7. Mozambique has been one of the star performers in Africa, as it recovers steadilyfrom the damage of the civil war. Since 1992, infrastructure has been improved and i s now approaching its pre-war levels. The economy has registeredan average annual growth rate of 8 percent between 1996 and 2005, incomes have risen considerably; and - 2 -  the poverty headcount index has fallen from 69 percent in 1996/97 to 54 percent in 2002/03. Economic expansion has been made possible by overall macroeconomic stability, policy reforms and continuing strong donor support, permitting broad-based expansion across most sectors o f the economy. The sectors that contributed the most to economic growth were agriculture, transport, communications and infrastructure, notably roads. The decline in the poverty headcount index to 54 percent by 2002/03 beats by more than 5 percentage points the PARPA Itarget o f reducing poverty to 60 percent in 2005. In addition, poverty levels decreased more in rural than in urban areas, making Mozambique only the second country inthe world (other than Vietnam) to have achieved this.Visibleprogress occurredinsocial conditions as evidence ofdecliningpoverty. 8. Mozambique's jirst Poverty Reduction Strategy (PARPA I) was discussed by the Board of I D A in 2001. Over the five years o f its implementation there was consistent economic growth, averaging 8 percent per annum and a major reduction in poverty, by 15.3 percentage points between 1996 and 2003. Other progress include the following: e The number of children in primary school was almost doubled from approximately 2 million to 4 million inthe PARPA Iperiod. e Maternal mortality was reduced from an estimated 1,000 per 100,000 live birthsinthe early 1990sto 408 per 100,000 live birthsin2003. e Under 5 mortality rates decreasedfrom 219 to 178 per 1,000 live births e Infant mortality decreased from 147 to 124per 1,000 live births. e The capacity o f the health system was expanded to start providing free ARV treatment for HIV infection. 9. The new Government elected in December 2004 is committed to sustaining that process by deepening reforms to accelerate the reduction of poverty. The new Government submitted its Five Years Program to Parliament in March 2005, where it outlined an ambitious reform program to reduce absolute poverty. The Program emphasizes the need to strengthen the market economy; develop a crash program for vocational training; accelerate legal andjudiciary reforms; promote entrepreneurship for small and medium businesses; and accelerate rural development by empowering district administrations and communities. 10. Mozambique's economyperformed well in 2004 and 2005. Real GDP growth was robust in both years, at 7.5 percent in 2004 and 7.7 percent in 2005 (Table 1). Looking back, the growth record has been spectacular, averaging 8 percent from 1966 to 2005. This performance has been driven by mega-project construction, investment from neighboring countries and abroad, buoyant donor support, and healthy agriculture growth'. Good rainfall, following the 2005 drought, resulted in a regular harvest season and has improved food security. End-of-year inflation, which had shown an increase from 2004 (9.1 percent) to 2005 (11.2 percent), i s on a declining trend in 2006 as a result o f lower food prices and the target o f single-digit inflation under PRGP-supportedprogram i s now within reach, despite some added pressures on price stability stemming from ' A detailed analysis on the sources o f growth in Mozambique can be found in the Country Economic Memorandum o f 2005, Report No32615-MZ.  higher world oil prices. The foreign exchange rate has remained stable following the introduction o f a temporary exchange rate band in the interbank foreign exchange market in November 2005. As expected, the external current account deficit, excluding grants, widened in 2005 due to a rise in cereal and oil imports, but international reserves remained comfortable, reflecting an increase in donor inflows. The domestic primary deficit narrowedby nearly 2 percent o f GDP in2005 (nearly 1percent o f GDP better than programmed under the IMF-supported PRGF) compared to 2004, explained by 1% percent o f GDP rise in domestic revenue, and expenditure restraint. Importantly, the share o f priority expenditure inthe budget remained above the PARPA target. Table 1: BasicMacroeconomicIndicators,2000-2006 2000 2001 2002 2003 2004 2005 2006 Real GDP growth rate 1.9 13.1 8.2 7.9 7.5 7.7 7.9 Nominal GDP (Mt.trillion) 58.4 76.5 96.9 113.8 133.5 153.0 180.8 Nominal GDP (US$ billion) 3.7 3.7 4.1 4.8 5.9 6.6 6.9 Inflation(period average) 12.7 9.0 16.8 13.4 12.6 6.4 9.5 Gross domestic savings/GDP 11.6 8.0 11.0 11.7 14.3 10.7 18.6 InvestmenUGDP 33.5 25.9 29.8 27.4 22.6 20.4 24.9 Current account balance/GDP (excluding grants) -27.2 -26.1 -23.1 -19.9 -14.1 -17.0 -17.4 Exchange rate (Mt'OOO per US$) 15.2 20.7 23.7 23.8 22.6 23.1 26.1 NPV externaldebt/ exports 177.1 109.8 91.7 102 83.8 83.6 32.3 Sources: GoM, IMF and Bank staffestimates(2005) and projection (2006). 11. Public financial management (PFM) systems have shown major improvements. Substantive progress has been made through the rollout o f the integrated financial management system (e-SISTAFE), according to the latest PEFA assessment. The Homoine version o f e-SISTAFE was satisfactorily rolled out to six ministries (agriculture, education, finance, health, planning, and public works) in July 2006. The six ministries to which the system was rolled-out are now satisfactorily executing their budgets for goods and services and capital expenditures2The authorities' medium-term PFM Action Plan and Budget (APB) for 2006-0g3 includes the following main elements: the rollout o f the budget execution module to all central and provincial entities, and its customization to district and municipalities needs; the introduction o f Phase I1 o f the budget formulation module; and the development o f new modules and functionalities. The APB i s well-structured and the proposedphasing o f implementation is ambitious but feasible. 12. There is a stable relationship with the IMF, with recent collaboration anchored on a PRGF that was approved by the IMF's Board in June 2004. The fifth review o f the program was successfully completed in December, 2006, and the main Payments of salaries continue to be executed centrally by the accounting department o f the Ministry o f Finance. By end-June 2006, the government and the donors reached an agreement on the AE'B for 2006-09 and a new Memorandum ofUnderstanding (MoU). - 4 -  conclusion o f the review was that the performance during January 2006-September 2006 was favorable. Fiscal performance for the first semester o f 2006 was better than programmed with revenue collection above target, led by buoyant corporate VAT tax collections, and domestic expenditures broadly in line with the program. The review also found that public financial management reforms had made good progress with the implementation o f a new version of the e-SISTAFEand that there had been progress in reforming revenue administration and widening the tax base. Furthermore, the review noted that progress on structural reforms in 2006 accelerated, particularly in the areas o f public sector, labor market, and trade-related reform. Areas where slower progress was noted included reforms to improve access to finance through an improved lending environment, i.e. legal and judicial reform, as well as the deepening o f domestic debt markets . B. MACROECONOMIC CONTEXT 13. Mozambique is likely to achieve the poverty Millennium Development Goals (MDGs)as well as the water MDG targets. The number ofpeople who were lifted out of poverty inMozambique is estimated at 3.7 million over the period 1996-2003. Assuming that the current trend continues, Mozambique is expected to halve the population living in absolute poverty by 2015. In the water sector, the share o f people with access to safe drinking water in urban areas has increased significantly and the MDG for sustainable coverage for urban water supply i s expected to be met. There has also been substantial progress toward achieving the MDG targets, specifically on improving universal primary education, gender equality and women's empowerment, reducing child mortality, and improving maternal health. Nevertheless, more progress will be required to meet these MDGs, while combating HIV/AIDS, malaria and other diseases remains a serious challenge (see Box 1andAnnex 7). - 5 -  Box 1: Mozambique:Progresstowardsthe MillenniumDevelopmentGoals - 6 -  14. The government's near-term policy aims are outlined in the Economic and Social Plan submitted to Parliament in late 2006. The policies seek to ensure macroeconomic stability, thereby setting the platform for high and sustainable rates o f economic growth that will reduce poverty while improving social services. kconomic policy i s also guidedby the PARPA 11, placing greater emphasis than its predecessor on boosting broad-based economic growth, decentralization and improving the quality o f public spending. The PARPA I1i s to run over the longer timeframe o f 2006-10 and it operationalizes the Government's Five-Year Plan approved by Parliament last year. It coordinates the high level o f donor support expected to flow into the country in support o f achieving the MDGs. 15. After increased demand for foreign exchange, mainly due to increasing general aggregate demand and high oilprices, and depreciation pressures in 2005, the exchange rate has remainedfairly stable in 2006. The widening o f the trade deficit from 9 percent o f GDP in 2004 to 10.9 percent o f GDP in 2005 created depreciation pressures on the exchange rate. In 2005, exports grew by 16.1 percent in U.S. dollar terms; o f which 14.2 percentage points were contributed by mega-projects (e.g., aluminum, electricity, and natural gas). On the other hand, imports grew by more than 20 percent (drivenmainly by higher cereal andpetroleumimports relatedto the drought and oil price shock). The increase indemand for foreign exchange driven by changes inleads and lags o f export and import payments contributed to a reemergence o f exchange rate depreciationpressures inthe last quarter o f 2005 and first quarter o f 2006. Inresponse to mounting exchange rate volatility, the Bank o f Mozambique (BM) temporarily introduced an exchange rate band inthe interbank foreign exchange market inNovember 2005. Together with growth in traditional exports and a tighter monetary policy stance, the exchange rate has remained stable since April 2006 16. The pace of expansion in credit to the economy has become more prudent. The 12-month rate o f growth o f credit to the economy jumped from a negative rate o f - 5.6 percent at end 2004 to an estimated 57.1 percent by the end o f 2005. A similar trend was observed for the 12-month rate o f growth o f broad money (M3) that jumped from 5.9 percent in 2004 to 27.1 percent by the end o f 2005. A recent assessment by the IMF suggests that the recorded increase incredit to the economy seems to have been drivenby borrowing by domestic petroleum distributors related to the syndication o f oil import transactions, the inclusion o f the operations o f a leasing company purchased by Banco Internacional de Moqambique (BIM) inthe monetary survey since December (accounting for about 7 percent o f total domestic credit) and, in part, due to structural factors associated with banks resuming consumer credit (e.g. credit cards, loans to purchase durable goods) following the completion o f their restructuring plans that have resulted in healthier balance sheets. The trend was reversed in the first half o f 2006 and the rate of growth o f base money declined accordingly. 17. Mozambique's debt is sustainable as confirmed by a new debt-sustainability analysis carried out by the Bank and the Fund earlier this year taking MDRI into account. As a result o f the MDRI, the NPV o f public external debt i s estimated to be approximately halved, from about 25 percent to about 12 percent o f GDP in 2006. The joint Bank-Fund DSA shows that debt dynamics remain sustainable under the baseline and stress tests, albeit susceptible to a ratcheting up o f non-concessional external - 7 -  borrowing. In this respect, the authorities are appropriately committed to seeking non- recourse financing for the transfer o f majority ownership o f the Cahora Bassa dam operating company, HidroelCtrica de Cahora Bassa (HCB), so as not to increase the government's liabilities to commercial creditors. Inaddition, final agreements have yet to be reached with Paris Club creditors (Japan and Portugal) as well as with some large non- Paris Club bilateral creditors (e.g. Algeria, Romania, Libya, and Iraq) in the context o f the enhancedHIPC Initiative. 18. The medium-term macroeconomic outlook is favorable. The fifth review o f performance under the PRGF program concluded that the prospects for 2007 remained favorable, including for strong growth and the maintenance of a sustainable external position, as the Government i s committed to take the necessary fiscal measures and pursue a monetary program consistent with a further reduction of inflation. The Government i s also committed to take measures to strengthen the banking system, foster private sector development and revive the public sector reform. Real GDP growth i s projected to be 7.9 percent in 2006, and is expected to remain around 7 percent in the subsequent three years (see Table 2). The leading sector would be agriculture, followed by construction and then by wholesale and retail trade. Cumulative inflation inthe year through November 2006 stands at 7.2 percent, which means that the year-end inflation should remain in the single digit. With slower expansion in credit and some leveling off in oil prices, inflation is expected to remain in the single digit throughout the period ending in 2009. Central to this strategy will be a gradual strengthening o f the fiscal position underpinned by an average increase in revenue o f 0.5 percent o f GDP per annum. Some o f the factors that have contributed to a positive macroeconomic outlook include the adoption o f conservative fiscal policies, sizable efforts to increase revenue mobilization, no external borrowing on commercial terms, minimal subsidies to the productive sectors, and targeting about two-thirds o f public expenditures to priority sectors for poverty reduction. - 8 -  I Table 2: Macroeconomic Framework, 2004-2009 2004 2005 2006 2007 2008 2009 Est. Est. Proj. Proj. Proj. Pro). Output and Prices Real GDP growth rate 7.5 7.7 7.9 7.0 7.0 7.0 Inflation(period average) 12.6 6.4 9.5 8.0 5.7 5.4 Exchange rate-avg (Mt'OOO per US$) 22.6 23.1 26.1 28.6 29.3 30.0 Money ond credit (12 monthspercent change) Broad money (M2) 16.7 22.1 18.5 17.5 15.5 14.5 Credit to the economy -2.5 22.5 17.1 13 12.2 11.4 Public Finances (76 of GDP) Total revenue 12.6 14.0 14.4 14.9 15.4 16.0 Total expenditure and net lending 24.4 22.6 27.8 28.3 27.5 26.9 Interest 1 0.8 0.9 1.2 1.1 0.9 Non-interest expenditures 23.4 21.8 26.9 27.1 26.4 26.0 Overall balance before grants -12.0 -8.9 -13.4 -13.4 -12.1 -10.9 Primary balance aAer grants -3.5 -1.5 -1.5 -3.4 -2.8 -2.4 Financing 4.5 2.3 2.4 4.6 3.9 3.3 Foreign financing (net) 2.8 3.3 4.8 5.0 4.4 3.7 Privatization 1.9 0.3 0.1 0.1 0 0 Domestic financing (net) -0.2 -1.3 -2.5 -0.5 -0.5 -0.4 Sources:GoM, IMF and Bank estimates(2005) and projections (2006-2009). Despite the promising progress, signijkant challenges remain. The country remains poor (US$3 10 per capita income); infrastructure i s inadequate; social indicators are low; and poverty rates remain high. Adult literacy rates are low (approximately 47 percent) and life expectancy at birth (42 years) i s one o f the lowest in Africa. The country also relies heavily on foreign aid, which makes up about half o f its overall budget. Additionally, the impact o f HIV/AIDS and malaria on the population has serious consequences if not controlled. Malaria alone accounts for 35 percent of deaths among children below five years o f age, 60 percent o f admissions in pediatric wards, and 40 percent o f overall outpatient consultations. It has been found that in Sub Saharan Africa, malaria reduces GDP growth by an estimated average o f 1.3 percent per year. As for HIV/AIDS, current projections indicate that in 2010 the Mozambican economy will be 14-20 percent smaller than it would otherwise be due to the impact o f HIV/AIDS. The Government's development and poverty reduction strategy focuses on tackling many o f these concerns. 111. THE GOVERNMENT'SPROGRAM: PARPA I1 19. I n September 2006, the Government formally adopted the Second Poverty Reduction Strategy (PARPAII). PARPA I1 was prepared through broad-based consultations with major stakeholders and civil society involving four national and ten provincial Poverty Observatories. It i s built on the experience o f PAWA I,including the PRSP Annual Progress Report (BdPES, or Balanqo do PES in Portuguese) presented to the ExecutiveBoards o fDirectors of IDA and the IMFinJune 2005, along with the Joint Staff Advisory Note (JSAN). P A W A I1 i s the operational plan for the governments' Five-Year Program (2005-09) and for the first time includes a strategic matrix o f key indicators, a joint effort by the government, donors and civil society. These indicators - 9 -  will be fully integrated into and monitored through the annual reporting instruments o f the Economic and Social Plan (PES inPortuguese). 20. The quality of poverty diagnosis in PARPA 11represents an improvement over PARPA I. The definition o f poverty has been broadened to include qualitative dimensions, largely as a result o f pressure from civil society through the Poverty Observatories. The data used in P A W A I1i s considered to be relatively reliable and o f good quality, not least because it was possible to draw on the second household survey results to analyze trends over a 5 year period. Other improvements are that PARPA I1 offers both quantitative and qualitative information, information on the depth and severity o f poverty levels, and poverty determinants. 21. While maintaining its commitment to improve quality and access to social services, PARPA II recognizes that the "rapid, sustainable and broad-based growth" warrants more emphasis on the growth of the productive and private sectors. This strategy i s reflected in a pillar approach based on the Five-Year Government Program in contrast to the sectoral approach used in P A W A I.This shift ensures consistency with the principal policy framework o f the Government enabling the building o f synergies within each pillar and cross-cutting themes. In addition, an essential role is attributed to districts as the focus of development, while small and medium enterprises (SMEs) form the engine o f employment generation. There i s also a clear recognition o f the challenges relatedto HIV/AIDS, with a credible strategy for accelerating the national response to the AIDS pandemic. Overall, the priority areas for public policy to sustain growth and poverty reduction, and improve service delivery are arranged under three pillars: (i) economic development; (ii) capital; and (iii) human governance. 22. The PARPA 11 will be implemented with the aid of a medium-term expenditure framework. Economic growth i s expected to remain at about 7 percent while inflation is kept to single digits. The medium-term fiscal scenario (CFMP) translates P A W A I1 into an expenditure framework. Its approval by the Council of Ministers for the first time in 2006 lends the CFMP credibility as a tool to guide the preparation o f subsequent budgets and formed the basis for disseminating the 2007 budget ceilings. The expenditure framework i s based on trends in sector expenditures compatible with the objectives and goals o f PARPA 11, rather than on a full costing of policies and programs envisaged. There i s a needto continue improving the planning and budgetingprocess by buttressing the information on donor-financed expenditures in the CFMP including multi-year commitments both for program and sector level support. These go along with the needto strengthen the monitoring and evaluation system. A. PILLARI:GOVERNANCE 23. PARPA 11sets out a broad and ambitious agenda of governance reforms. The proposed reforms target the areas o f public administration, public financial management, decentralization, the judiciary sector, as well as anti-corruption measures. These are to be complemented by increasingpopular participation at local level, focusing on the district as the key unit o f service delivery. The reforms in public administration will include a complete census o f all civil servants, the unification o f the three existing databases on civil servants, the formulation o f a new salary policy, and functional analysis o f the key - 10-  ministries to provide better services. Decentralization includes the gradual transfer of decision making power to the district administration by allocating an investment budget to each district, giving them more authority over human resources 'management, and strengthening the Consultative District Councils; an increase in the number of municipalities with elected city governments; and rethinking intergovernmental fiscal relations. Reforms inthejudiciary sector will address inefficiencies and lack o f capacity in the administration o f justice with the objective o f making justice more accessible to the citizens. Key elements o f the anti-corruption strategy include the reduction o f red tape that offer opportunities for rent-seeking, increased transparency inpublic financial management and access to information by the public, as well as a strengthening o f the institutions prosecutingcases o f corruption. B. PILLAR 11:HUMAN CAPITAL 24. This pillar seeks improvements in human capital through interventions in the social sectors and potable water infrastructure. Overall the approach laid out for the health, education and water sectors in the PARPA I1text i s considered o f good quality and consistent with the sectoral priorities and with achieving the MDG targets. For the period 2007-2009, the objective is to reduce infant and maternal mortality; almost double the number o f people benefiting from ARV treatment o f HIV/AIDS; increase the net schooling rate and the conclusion rate o f primary education for girls; improve the quality o f teaching by reducing the student-teacher ratio; increase access to drinking water; and expand social protection programs among others. This will require significant investments in expanding primary health and education infrastructures; the hiring and training o f large numbers o f health personnel and teachers; developing an effective outreach and treatment program for people living with HIV/AIDS; and a strengthening o f the planning capacity to provide sustainable water services at the local level. PARPA I1also attaches great importance to vocational training oriented towards the job market by reforming the curriculum and the institutional framework, and through the rehabilitation and expansion o f the network o f vocational schools. It will also be important to consider the relative contribution o f infrastructure interventions in human development outcomes. For example, drainage and water are critical for malaria and cholera reduction in urban areas, as are roads and sanitation for education and health outcomes. C. PILLAR 111:ECONOMICDEVELOPMENT 25. Overall, PARPA N deals with the key dimensions of a broad-based growth strategy. PARPA I1emphasizes the importance o f a market economy and the need to strengthen the private sector to make it more competitive by improving the investment climate, reducing the time it takes to start a business and to make the formal labor market more flexible. This should be achieved through the elimination o f administrative barriers; the streamlining of the administration, such as introducing one-stop windows and the computerization o f notarial records; and new labor legislation. It proposes public-private partnerships where the private sector alone would not be able to succeed, particularly in agriculture and tourism. Irrigation systems will be rehabilitated with public funds (mainly donor financed projects) and managed by the beneficiaries, and the number o f peasants assisted by public extension services i s expected to double between 2007 and 2009. By - 11-  2009, it i s expected that 78 percent o f the national road network, which includes secondary and tertiary roads, be in good or reasonable conditions. PARPA I1 also proposes job creation programs, such as labor-intensive programs for maintaining tertiary and vicinity roads andby including women inroads projects. 26. Thispillar addresses the improvement of the investment climate and removing key constraints tofurther growth. Reforms and measures under this pillar are aimed at (i)strengtheningmacroeconomic management, (ii) improving the business environment, (iii)development of the financial system, (iv) promoting the creation of a strong, dynamic, competitive, and innovative private sector, (v) promoting the priority sectors, broadening the business class, and creating jobs (this includes agriculture and agrarian services, natural resource management, industry, fisheries, tourism, mineral extraction, oil exploration, and several employment creation programs); (vi) improving the integration o f Mozambique into the regional and international economy; and (vii) promoting the integration and consolidation o f the domestic market. The latter includes road and water transport, ports and railways, bridges, marketing systems and regulation o f internal trade. IV. BANKSUPPORT TO GOM'S PROGRAM A. LINKTO CAS 27. The PRSC series is consistent with the CAS. Bank support to the PARPA i s through the FY04-07 Country Assistance Strategy (CAS) (Report No. 26747-Moz). The base case scenario o f the CAS envisages programmatic support through four consecutive PRSCs to support Mozambique's efforts in building public-sector capacity and accountability, improving the investment climate, and expanding service delivery. The PRSCs would support the maintenance o f macroeconomic stability and focus on cross- cutting public sector management and governance issues, with the key challenge beingto replicate the strong macroeconomic policy and implementation record at the sector level to facilitate economic transformation andpermanent poverty reduction. 28. One of the key CAS objectives is to achieve a full alignment of Bank instruments with the principles of local ownership and leadership. As government policies and budget are the key instruments for implementingthe PARPA, the Bank is committed to supporting and aligning with the budget process. PRSC 4 and 5 will be a part o f the new CAS that will be submitted to the Board o f IDA in the middle o f CY07. Preliminary discussions with the Government and the other development partners confirm the centrality o f the new growth agenda and the importance o f accelerating shared growth through infrastructure, rural and private sector development, and enhanced governance reforms. The PRSC series i s also well aligned with the Bank's principles on conditionality, namely (i)reinforce ownership; (ii)strengthen harmonization; (iii) customization to country circumstances; (iv) criticality o f actions; and (v) transparency and predictability (see Box 2). - 12-  Box 2: Good PracticePrincipleson Conditionality Principle 1: Reinforce Ownership The proposed operation is an integral part of the Bank's strategy to support the implementation of Mozambique's Second 4ction Plan for the Reduction of Absolute Poverty (known as PARPA II by its Portuguese acronym), and the Performance 4ssessment Framework (PAF) agreed by the Government and the eighteen external partners (the G-18). PARPA II is structured around three pillars (Governance, Human Capital, and Economic Development) and is the operational plan of the Government's Five-Year Program. The first PRSC series was successfully deployed in 2001 and overall progress of the reforms has been satisfactory as the government continues to pursue a far-reaching reform agenda with the new government elected in December 2004 deepening reforms to reduce poverty. The PRSC series has also been informed by significant amount of analytical work completed over the past few years, including two PERs (FYOI and FY03), two CEMs (FYOI and FY06), a CFAA (FY02), a CPAR (FY03), a Public Financial Management and Fiduciary Risk Assessment with other donors (FY04),a PEFA (FY06) among others, that have been discussed with the government and fed significant input into the policy making process. Principle 2: Agree up front with the government and other financial partners on a coordinated accountability Framework Progress on the reforms is monitored with the aid of the PAF. Improved service delivery in PARPA priority sectors, i.e. agriculture, health, education, rural water supply, infrastructure,justice and related governance sectors, is monitored through Joint Sector Working Groups. Progress in achieving all the indicators contained in the PAF is assessed twice a year through the Joint Review in April and the Mid-Year Review in September.The sector working groups have become a good mechanism for policy dialogue, donor harmonization,and for reaching agreement between the Government and all the donors involved in a specific sector. Furthermore, a joint Budget Working Group meets on a quarterly basis with the Government to monitor budget execution, particularly in the priority sectors. Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances The PRSC series is designed to focus first on key constraints in cross-cutting areas such as public financial management and the business environment, which are the areas that provide the rationale for the prior actions of PRSC 3. The series then evolves to support decentralization and shared growth through the incorporation of triggers for PRSC 4 and 5. In order to reduce the transaction costs for the Government, the Bank carries out all supervision jointly with the other donors. A Joint Review takes place each year in April (year n). It assesses the performance of the government in the previous budget year, which corresponds to the calendar year (year n-1). The review focuses on evaluating progress with regard to the indicators defined in the Performance Assessment Framework and makes an overall assessment of progress. The second event is the Mid-Year Review in September. This review is mainly forward-looking and formalizes the agreement on the performance indicators and targets for the following year (year ntl). Programmatic lending will be complemented by investment support. PRSC support will coexist with investment support to well-articulated sector programs, and with technical assistance to develop government systems and capacitiesnecessary for an increased reliance on them. Principle 4: Choose only actions critical for achieving results as conditions for disbursement All the prior actions and triggers of the PRSC series are indicators contained in the Performance Assessment Framework (PAF) and were selected because of their criticality for achieving objectives which are consistent with the government's own 3monitoringframeworkwith 12triggers for PRSC 4 and 8 indicative triggers for PRSC 5. There are no benchmarks. and to be in line with donor harmonizationfor general budget support. The results framework for PRSC has 7 prior actions, Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support The Bank's supervision of the PRSC series is aligned with the supervision of the joint General Budget Support program of the G18. Both the Joint and the Mid-Year Review are a multi-sector exercises, and Bank staff participate in all relevant sectors. Disbursements will be contingent on satisfactory progress towards a subset of the PARPAs medium-term objectives as set out in the PAF matrix. In addition, the review process is explicitly designed to allow announcing budget financing amount early in the year in the budget preparationcycle and to disburse early in the budget year, a principle to which the Bank now adheres to after a two-tranche interim PRSC 2. - 13-  B. LINKTO OTHERBANKOPERATIONS 29. Development policy lending will be complemented by investment support and technical assistance. PRSC support will coexist with investment support to well- articulated sector programs, and with technical assistance to develop government systems and capacities necessary for an increased reliance on them. The share o f policy-based lending in overall IDA financing in FY04-06 was 44 percent (or US$180 million out o f US$407 million o f new commitments over the three years taken together). The new PRSC series would increasingly embrace the new growth agenda and support the Government's focus on development at the district level. These objectives are also supported by several IDA projects, thereby creating strong synergies. 30. The PRSC series serves as a vehicle for policy dialogue. The policy dialogue focuses on public sector capacity and accountability with a strong focus on strengthening financial management, improving the investmentclimate and expanding service delivery. This policy dialogue has become institutionalized through the Joint Reviews with the Government and the G18 and the 24 sector working groups that monitor the implementation o f the PARPA. Technical assistance i s being provided through separate projects for public sector reform program, judicial reform, regulatory reform in selected infrastructure sectors, private sector development, financial sector strengthening, and decentralization to municipalities and local governments. The PRSC series i s complementary to parallel efforts to reduce poverty supported through a large IDA portfolio o f investment projects in HIV/AIDS, education, water supply and sanitation, agriculture, tourism, roads, railways, and other infrastructure. 31. Strengthening governance is a cross-cutting objective of the interventions supported by the PRSC series. The PRSC series i s contributing to this overarching objective through several channels, including strengthening the capacity, transparency, and accountability o f state institutions, including in key sectors, such as for example public finance management, and at the local level through decentralization; raising the demand for better governance by supporting participation and oversight by civil society, as for example through the activities associated with the Poverty Observatories; fostering a competitive and responsible private sector through interventions aimed at improving the business environment and the investment climate; and contributing to strengthen accountability overall through the process o f joint reviews that monitor progress in implementation o fthe PARPAIL4 32. There are strong synergies between the PRSC series and the investment and technical assistance programs supported by IDA. The cross-cutting institutional and governance reforms are supported with technical assistance and training through the Public Sector Reform Project, while reform o f the social security system i s supported Overall, the PRSC series is well aligned with the Bank's strategy to enhance governance and anti- corruption in client countries, as laid out in the paper entitled "Strengthening Bank Group Engagement on Governance and Anticorruption", released on September 8,2006. - 14-  through the Financial Sector Technical Assistance Project, which supports the development o f a sound financial system in general. Decentralization capacity building efforts is being supported through the Decentralized Planning and Finance Project. Rural development including the expansion o f the transport infrastructure i s being supported through investment operations in agriculture and inthe roads sector. Inreturn the policy and institutional actions under the PRSC make for a facilitating framework in which activities inthe various projects are implemented. 33. The investment portfolio, with 23 projects, is diverse and supports the three pillars of the CAS. As o f September 2006, total Bank commitments were US$1,009 million. Details o f the investment programs are in Annex 8. Several operations support the pillar o f governance and macroeconomic management by supporting public sector reform including decentralization and the strengtheningo f municipalities, public financial management, and the improving the soundness o f the banking sector. In what concerns economic development, support has been provided to a sector-wide assistance program (SWAP) in agriculture that seeks to improve the impact o f public expenditures and provide an enabling environment for sustainable and equitable growth in the rural areas. A CDD-type smallholder development project was approved in FY06. In transport and infrastructure there are four investment programs supporting rehabilitation and maintenance o f roads, railways and ports, and reforms inthe energy sector. Strengthening the investment climate and encouraging private sector participation has been supported through projects in the communications and minerals sector, and through the private enterprise development project (closed in June 2006; a successor operation i s under preparation). c. COLLABORATION WITH THE IMF 34. The Bank and the IMF cooperate closely within their respective mandates in assisting the Government to implement the PARPA. The IMF leads the policy dialogue on macroeconomic policy (including fiscal, monetary, and exchange rate policies), the integrated financial management information system (SISTAFE) and tax and customs reforms. The Bank leads the policy dialogue on public expenditure management, sector structural reforms, reforms o f the civil service, and poverty and social impact analysis. Areas o f close collaboration include banking supervision, financial sector issues, trade issues, the PARPA, and external debt sustainability. 35. The IMF approved a PRGF in 2004 which complementsBank support. InJuly 2004 the IMF approved a new arrangement under the Poverty Reduction and Growth Facility (PRGF) to support the Government's economic program for the period 2004- 2006. The structural reforms supported by the PRGF aim to consolidate macroeconomic stability and sustain strong broad-based growth, consistent with the PARPA. The fifth review under the program was successfully concluded inDecember, 2006. - 1 5 -  D. COLLABORATION/HA~ONIZATIONWITHDONORS 36. A Memorandum of Understanding has been signed between the Government and 18 donors (G18) providing general budget support. In addition to the World Bank, the following countries and multilateral institutions are members: African Development Bank, Belgium, Canada, Denmark, European Commission, Finland, France, Germany, Ireland, Italy, Holland, Norway, Portugal, Spain, Sweden, Switzerland, UK. The IMF, USAID,Japan andUNDP are observers. 37. This MoU is a breakthrough in donor harmonization in Mozambique. Two o f its fundamental principles are predictability and alignment with domestic systems. To align with the local budget cycle, support for year n+l i s based on the assessment o f the Joint Review in year n, which looks at the government's performance in year n-1 using the Performance Assessment Framework (PAF) matrix agreed to in year n-2. The M o U also spells out that disbursements o f general budget support can be interrupted within the year if any one o f the underlying principles i s violated. Macroeconomic stability i s such an underlying principle, as are the government's respect for human rights, democratic governance, and commitment to sustainable poverty reduction. 38. A third basic principle is that monitoring has to be donejointly and that all "conditionality" has to be based on the common PAF. This means that prior actions and triggers can only be drawn from the PAF, and the fundamental assessment whether the Government's performance has been sufficient to merit further budget support will be undertaken duringthe Joint Reviewtaking place each year inApril. 39. Afourth principle is that no separate reporting to the donors is required. This reduces transaction costs for the Government and enhances domestic accountability. The agreed PAF has become an annex to the Government's annual Economic and Social Plan approved by Parliament together with the annual budget, and the annual Joint Review i s based on the progress and budget execution reports submitted to and discussed by Parliament. 40. A fifth principle is mutual accountability. A Performance Assessment Framework for donor behavior to monitor that they are living up to their commitments. Donors' performance i s assessed annually by an independent consultant. The criteria for assessing donor performance have evolved since 2004. This year's donor PAF is modeled using many o f the indicators o f the Paris Declaration, but some o f the targets here are more ambitious. 41. Harmonizedgeneral budget support has become an important aid instrument. The amount o f general budget support given in 2000 was around US$lOO million, by 2005 it was US$274 million, and the amount committed for 2006 reached US$344 million, as more and more partner agencies have joined the harmonized mechanism by signingthe MoU, as shown inTable 3. - 16-  Table 3: General Budget Support Disbursements(2000-2005) and Commitments (2006-2007) in USD Millions Sweden 10.90 9.80 10.60 - 13.60 14.90 25.2C 41.09 Switzerland 4.70 5.00 4.50 5.30 7.70 7.40 6.60 6.54 UK 15.20 14.40 14.20 15.60 27.40 58.00 61.EO 67.07 World Bank - - -- -_ 60.00 60.00 60.00 70.00 Total 98.40 126.80 100.70 142.00 243.50 273.90 343.70 369.78 Source: GI8 Secretariat * As o fDecember 2006, Canada has not yet finalized the amount to be provided for GBS in 2007. E. PARISDECLARATIONAID EFFECTIVENESS ON 42. Implementation of the Paris Declaration is monitored by the G18, the UN agencies and other development partners. The big challenges are to align project aid with the national budget system, integrate it as much as possible with the government's treasury and reporting system, and reduce the number o f Project Implementation Units. 43. There has been progress in 2006 to bring project aid on-budget. As a result, the budget has become a meaningful instrument for decision-making on resource allocation, and linking resources to results. The 2007 budget submitted to Parliament made further progress. External resources increased by 40 percent, most o f which due to recording more o f the project finance inthe budget; before these projects were off-budget. 44. PRSC1and 2 supported a broad reform agenda covering institutional reforms to achieve three objectives. They were grouped in pillars: (i)improve public sector capacity and accountability, (iii) improve the investment climate, and (iii) expand social service delivery. While significant progress was made justifying an overall positive assessment, it has to be kept in mind that many challenges remain, that capacity i s still weak, and that some reforms were implemented more slowly than originally envisaged. Reforms in strengthening public financial management made impressive progress and key pieces of legislation were adopted improving the investment climate; but public - 17-  sector and judiciary reforms were slower than expected with the exception o f decentralization. G. LESSONS LEARNED 45. Ownership is important. PRSC 1 and 2 achieved their main objectives due to strong ownership o f the reform program by the Government. The Government elected in December 2004 renewed this commitment. As a result, the medium term reform strategies never sufferedreversals, despite delays in implementation. For example, there were delays in implementing an ambitious new electronic public financial management and information system in 2004 and 2005. But these delays have in the meantime been overcome and the transition to the new system i s now proceeding smoothly with good results. A similar story could be told regarding civil service reform. The first phase produced limited results, but after a thorough external review and extensive internal consultations, a new strategy has been developed for the second phase that is fully owned by the Government and which has started its implementation with a lot o f dynamism. The lesson about the importance o f ownership has been taken into account inthe design o f the new PRSC series: all the prior actions and triggers are drawn from the PAF which is based on the PARPA 11. They are consistent with the sector strategies, reform programs and their monitoring frameworks. This ensures a high degree o f internalization and ownership by the concerned institutions. 46. Reform programs must be accompanied by coordinated capacity building efforts. It would have been impossible to carry out the reforms contemplated under the first series o f PRSC's ifthey had not been supported through extensive capacity building programs. In the past, much capacity building occurred through isolated technical assistance projects, often driven by the priorities o f a donor. This has changed in the past years, and multi-donor sector wide approaches have been developed and common funds have been established, also for technical assistance and capacity building. This new approach was essential to achieve the results that are visible now. This lesson has been taken into account in the design o f the new PRSC series, as the reform program i s supported largely through coordinated technical assistance and capacity building programs. One example is decentralization where a decision was taken inAugust that the three major area-based projects for decentralized planning and finance will be consolidated into a single national program o f technical assistance from 2008, with a parallel mainstreamed multi-sector budget process (via formula) to finance the district plans themselves out o f the national budget. 47. Alignment, predictability and donor harmonization are essential to improve the quality of the budgetplanning and executionprocesses. The MoU o f the G18 aligns general budget support with the Mozambican budget cycle, improves the predictability o f resource flows, and harmonizes the donors regarding policy benchmarks, the reporting and review process. It i s a powerful instrument to improve the quality o f budget planning and execution and enhance the effectiveness o f aid. Largely as a result o f donor harmonization, some reforms that had long been advocated, e.g. increasing budget coverage for externally financed projects and own revenues - this was an important recommendation o f the 2001 PER - became implemented. Comparing the quality and - 18-  comprehensiveness o f the 2007 budget with the one o f 2004 shows remarkable progress o f bringing externally financed projects into the budget, and reporting on budget execution has become more complete. This lesson has been taken into account in the design o f the new PRSC series; the exceptions which the Bank requested under the original M o U will be reduced in order to align the Bank's support with the Mozambican budget cycle, to enhance predictability and to be harmonized with the other budget support partners. 48. Integrating general budget and sector issues produces better results. The fact that the PAF contains indicators on the performance o f all priority sectors has led to an integration o f views on macro and sector issues. The Joint Review has become a comprehensive stock taking exercise and the 24 sector working groups have gained in importance and relevance due to their role in the Joint Review process. Having a strong link between sector strategies, sector monitoring, policy dialogue and general budget support ensures a more effective framework for planning and implementation. This lesson has been taken into account in the design o f the new PRSC series by making the outcome o f the annual Joint Review the main prior action for the PRSC and by choosing prior actions and triggers both with regard to macroeconomic management and sectoral service delivery results. 49. Defining monitoring indicators and a results framework early helps steady progression from year to year. PARPA Iwas approved in 2001, but the first PAF was only developed in 2004. As some o f the choices were made in an ad hoc manner, the indicators in the PAF kept changing from one year to the next making multi-year monitoring more difficult. This lesson has been taken into account in the design o f the new PRSC series. As part o f elaborating PARPA 11, a strategic matrix was established which used a results framework. The new 2007-09 PAF i s a prioritized sub-set o f this strategic matrix. This makes it possible to use the results framework for monitoring the implementation o f the program. The targets for each indicator have already been defined for 2007-09 to the extent possible. H. ANALYTICALUNDERPINNINGSOFTHE PRSC 50. The PRSC series is built around a consistent set of analytical work. The analytical foundations o f the PRSC seek to assess whether government policies and institutions are adequately set up and do in fact contribute to the overall objective o f reducing poverty and whether the systems and procedures for channeling resources to support these strategies are appropriate. The Bank i s relying on core ESWs, including CEM, PER, CFAA, CPAR as well as on analytical sector work and PSIAs. Table 4 presents the current status o f these analytical underpinnings. The main conclusions o f this analytical work are summarized inthe next paragraphs. - 19-  Table 4: Analytical Underpinnings Done Poverty assessment FY04 March 2004; trend data, drawing on a first national survey completed in 1998 have been analyzed in a working paper in FY06. A new integrated poverty, social and gender assessment i s currently under preparation. CEM FYO1; Mozambique's growth prospects and reform agenda were thoroughly reviewed in FY06 February 2001, and a new CEM was finalized in September 2005. PER FY03 This was the secondvolume o fa PER started inFYOl. CFAA FYOl CFAA action plan endorsed by GoM and under implementation. CPAR FY04 CPAR action plan endorsed by GoM and new legislation was approved in2005. Financial sector FYO1- The PRSC supports the implementation o f key recommendations o f a joint Bank-Fund analysis FY03 financial sector assessment completed in May 2003 and complements a proposed Financial Sector Technical Assistance project. Legal andjudicial FY03 This assessment found that conuption, a lack o f skilled human resources, poor sector assessment accountability for results, and numerous administrative weaknesses are the key sectoral challenges. Investment Climate FY03 An assessment of Mozambique's industrial performance and investment climate was Assessment completed in July 2003; implementation o f recommendations is supported by the PRSC series. PSIA on Primary FY05 The analyses concluded that school fees while important are not the major constraint to school fees enrollment and retention. I t is rather the distance to primary schools in rural areas, and the existence o f other direct costs (school materials) that have the most impact. A follow up analysis is underway to assess the impact o f a number o f reforms designed to reduce the financial cost o f education to households. Health Sector FY05 A comprehensive report on the health sector inMozambique. Status Report Economic Analysis FY06 Major efficiency and equity gains in natural resource management could be achieved by o fNatural implementing better mechanisms for charging for both services and access to resources. Resources The policies recommended could increase natural resource rents from 5% of tax Sustainability revenues to 10%-20%. Agricultural FY06 I t documents how agricultural growth in the post-war period was based on the extension Development o f the cultivated area, rather than increasing yields. It advocates a two-pronged approach Strategy o f enhancing productivity for smallholder agriculture and strengthening the bargaining power o f smallholders who participate inout-grower schemes. 51. Poverty Assessment. As affirmed earlier, the poverty headcount is estimated to have fallen from 69 percent to 54 percent between 1997 and 2003. These findings indicate that the Government's poverty program i s achieving results and are also broadly in agreement with other data sources: (i) MINAG data indicate that the per capita growth rate o f cereal crop production was 14 percent in the six-year period 1996-2003 (`1.e. a little over 2 percent annually), and mean household income increased by 61 percent; (ii) a qualitative indicators survey (QUIBB) in 2000/01 found that poverty had decreased by nine percentage points, using an econometric technique to link the (purely qualitative) QUIBB with the household survey of 1996; (iii)in the household and agricultural surveys, dramatic increases were found in the numbers o f bicycles, radios and other assets over 1996-2003; and finally (iv) education and health indicator surveys found strong improvements, particularly in the areas o f primary school attendance, vaccination coverage, and attended births, over 1996-2003. The interventions associated with the area o f economic development in the PRSC series will contribute to the Government's efforts to reduce poverty. - 20 -  52. Country Economic Memorandum. A new Country Economic Memorandum completed in September 2005 reviewed the economic performance in recent years, provided a thorough analysis o f the poverty profile in Mozambique based on the new household survey data, and analyzed the linkages between economic growth, macroeconomic policies, and poverty in Mozambique. It suggests policies for the optimal use o f Mozambique's natural resources - land, forestry, fisheries, mining and water - and for integrating their management into the overall growth strategy. Analytical work on rural development and tourism, supported by the Bank, has contributed to this exercise. Many o f the findings o f these inquiries have been incorporated into the new PARPA for the period 2006-2010 and were usedto define the prior actions for PRSC 3 and the triggers for PRSC 4 and 5. 53. Public Expenditure Reviews. PERs were completed in FY02 (in conjunction with the CFAA) and inFY04, in a participatory process that brought together central and sectoral government institutions, local and international academic and research institutes, the private sector, and a variety o f donors. The recommendations of these PERs focused on improving budget formulation, execution and reporting to enable better tracking and informed decision-making concerning poverty-related expenditures through reforms which are supported by the PRSC series. 54. Public Financial Management. A Country Financia1Accountability Assessment (CFAA) was completed in 2001 in collaboration with several donors and the Government, an IMF Review o f Standards and Codes (ROSC), and a joint Bank-IMF assessment of the Government's capacity to track poverty-reducing expenditures, have also been completed. All noted improvements and continuing challenges in Mozambique's public financial management and fiduciary systems. They also identified specific action plans for dealing with weaknesses in coordinating support and policy dialogue on these issues. Government actions being supported by the PRSC series play a central role inhelpingto implement these action plans. 55. Procurement. A Country Procurement Assessment Review (CPAR) was prepared in 2001, but it was only in 2004 that the Government agreed to take action. In line with these recommendations, and with the support o f this PRSC, a new procurement decree following international best practice will be submittedto the Council o f Ministers for approval following extensive consultations with main stakeholders including development partners. 56. Financial Sector Analyses. Since 2000, the Bank has completed a study o f the financial sector, AAA on Mozambique's compliance with the Base1 Principles, and a formal financial sector assessment jointly with the IMF (FSAP). The May 2003 FSAP assessment found that the potential vulnerabilities o f the banking system lie mostly in its loan portfolio; that banks are exposed to high credit risk due to high and volatile lending rates (themselves due to volatile inflation, high interest rate spreads and a poor lending environment). It also found that the volatility o f the Metical threatened financial sector stability. The first PRSC series addressed a number o f these issues by supporting Government action to strengthen banking supervision; improving market oversight through transitioning the banks to international financial reporting standards (IFRS); and improving the lending environment through needed legal reforms (including the adoption o f a new Commercial Code). In addition, the proposed Financial Sector Technical - 2 1-  Assistance investment project i s facilitating the implementation o f the main FSAP recommendations. 57. Legal and Judicial Sector Assessment. This Bank assessment, which i s under Government review, found that: (i) Mozambique's legal and judicial sector institutions have not kept pace with economic growth in the 1990s, with the result that public confidence inthem i s low, and they are now perceivedto be a deterrent to investment and a hindrance to growth; (ii) the sector's key problem i s a relative lack o f skilled human resources; (iii) the sector needs to develop results-focused management practices and a culture o f accountability for results; (iv) while some laws (e.g. regarding land and labor) are a hindrance to growth and should be revised, the main effort should focus not on legislative but on administrative reform; (v) sector institutions must fight and be seen to fight corruption, or their reform efforts overall will become irrelevant. The dialogue leading to the new PRSC series highlighted the issue, leading to the decision to include a trigger that will reflect the implementation o f a results-focused management process within Government and the benchmarking o f Government actions intended to improve the administration o fjustice. 58. Investment Climate Assessment. The Bank, together with the Investment Promotion Center and the Confederation o f Economic Associations o f Mozambique, completed an I C A in 2003. From an analysis o f 193 firms surveyed in 2002, the I C A found that the most severe constraints to doing businessin Mozambique included: (i) lack o f access to and the high cost o f finance (cited by 78 percent o f the sample); (ii) Mozambique's uncertain policy environment; (iii) costs imposed by regulatory and the administrative procedures; and (iv) inadequate infrastructure. The first PRSC series took many o f the ICA's recommendations into account and tangible progress regarding changes in the legal framework has been achieved. The new PRSC series aims to consolidate these reforms, particularly reducing the time and cost involved in registering a business. Policy dialogue will also address emerging issues, such as delays in the Government payment o f VAT refunds. 59. Education PSIA. A Poverty and Social Impact Analysis (PSIA, FY05) has studied the impact o f school fees on primary school enrollment and retention. It was undertaken to fill the information gap on the impact o f direct costs (formal and informal school fees and related schooling expenses), and opportunity costs on enrollment and pupil retention in primary education. The main recommendations were for the Government to: (i) the current policy on school fees, to clarify the type (if any), revise purpose, frequency o f fee contributions, payment mechanisms and accountability o f funds; (ii)initiate public information campaigns to educate communities on the right of children to attend primary school; (iii) increase resources that are channeled directly to the schools, mainly through the Direct Support for Schools program, to ease the burden on households, especially when it comes to purchasing pupil's school materials; (iv) ensure better deployment o f teachers so as to distribute qualified teachers, especially in rural areas; and (v) build schools closer to the communities, so as to reduce the travel time to school, and consolidate lower and upper primary schools into one physical place to increase the likelihood o f continuation from one level to the next. Eventhough the new PRSC series has no specific prior action or trigger in the field o f education, the analytical - 22 -  work informs the Bank's policy dialogue on the composition o f the budget and quality o f public expenditures ineducation. 60. Better Public Health Spending to Reach the MDGs. The main sector issues identified are: the lack o f adequate human resources (in 2003, Mozambique had one doctor per 40,000 inhabitants compared to one for 22,000 in Sub-Saharan Africa) and low pay; uneven geographic access and utilization o f health services; weaknesses in quality o f services; irregular application o f user charges that are a disincentive to receiving care, and low budget execution. Key recommendations include the need to be more strategic in preparing the budget, and to focus on strengthening management and improving the coverage and skill levels o f paramedical staff. Eventhough the new PRSC series has no specific prior action or trigger in the field o f health, the analytical work informs the Bank's policy dialogue on the composition o f the budget and quality o f public expenditures inhealth. 61. Agricultural Development Strategy. The strategy documents how agricultural growth in the post-war period was based on the extension o f the cultivated area, rather than increasing yields. It advocates a two-pronged approach o f enhancing productivity for smallholder agriculture and strengthening the bargaining power o f smallholders who participate inout-grower schemes. V. THE PROPOSEDNEWPRSCSERIES:PRSC3-5 A. OVERALL DESCRIPTION 62. The main objective of the new PRSC series is to support the implementation of PARPA II.Inline with this objective, the proposed operations focus on policy reforms in two o f the pillars o f PARPA 11: Governance and Economic Development. IDA'Sfocus will be geared at specific areas, which are a subset o f the PAF (which itself is a subset o f the strategic matrix o f PARPA 11). Key reforms in public financial management were treated in the text o f PARPA I1partly under the pillar o f Governance, and partly under the pillar of Economic Development. The strategic matrix and the PAF highlighted the importance o f these reforms by creating a fourth domain: Macroeconomic Management. The new PRSC series will also support reforms inthis area. 63. The PRSC series aims at helping the Government make progress towards a strategic subset of objectivesdefivledin the PAF matrix. This strategic subset focuses on consolidating cross-cutting institutional reforms, decentralization and accelerating shared growth. Under the PRSC series, the Government would complete the computerization o f its public financial management system including procurement, and substantially strengthen audit controls. Decentralization would be accelerated to improve the quality o f service delivery and empower communities to decide more about the investment programs in their districts. The PRSC series would also monitor policy reforms that would facilitate the achievement o f two key measures to improve shared growth: the maintenance and expansion o f the national road network (which includes rural roads) and programs to enhance agricultural productivity. In the context o f Mozambique, where about 70 percent o f the population still lives in rural areas, shared growth necessarily means rural development. This will be complementary to the various mega-projects inthe - 23 -  extractive industries sectors, where Mozambique has been very successful. These projects attracted large foreign direct investments and created growth spurts during the construction phase; but they are not labor intensive once completed. Therefore, labor intensive rural and agricultural development i s essential to reduce poverty. 64. PRSC 3 focuses on key constraints in cross-cutting areas such as public financial management and the business environment. These are the areas that provide the rationale for the prior actions of PRSC 3. The triggers for PRSC 4 and 5 then are defined to support policy reforms in support of shared growth (infrastructure, agricultural extension, etc.) at the local level andways to do better inthe decentralizationprocess. All the prior actions andtriggers ofthe PRSC series are indicators contained inthe PAF. This i s an important feature o f the proposed operations as, by relying on the PAF, the PRSC series will remain consistent with the government's own monitoring framework and will also be in line with donor harmonization for general budget support. As intermediate outcomes, the PRSC series will support: (1) Macroeconomic management by consolidating and deepening the institutional reforms inthis area. (2) Reformsin governanceby supporting decentralizatioddeconcentration to enhance public investments and service delivery at the provincial and district level, andby supporting public sector reform. (3) Economic development by improving the business environment, removing constraints to growth, such as infrastructure, and promoting agricultural gr~wth.~ B. PRSC3 65. The criteriafor selectingprior actions and triggers are based on their criticality for contributing to achieve the PARPA objectives. In summary, these criteria reflect the following broad principles: 1. The expected policy or institutional reform is critical to remove a key constraint to poverty reduction and growth, or i s an implementation activity o f a reform initiated earlier. 2. They are part o f the Performance Assessment Framework (PAF), and the assessment can be done easily, e.g. verifying whether a law or some regulation has been approved. (All assessments requiring performance data and analysis are done duringthe Joint Review.) 66. Thepolicy matrix and resultsframework for 2006-2008 in Annex 1presents a sub-set of the PAF that highlights the specific areas that will be supported by the new PRSC series. It i s worth noting that some o f the entries appear as outcomes (kilometers o f roads in good conditions; areas irrigated). This i s done to remain in keeping with the G18 partners and use the formulation inthe PAF. The full PAF is presented inAnnex 3. 5 The second PARPA I1pillar (Human Development) is monitored through the Joint Review and the sector working groups. The Bank is closely involved inpolicy dialogue regarding human development through investment operations and AAA work, but no specific prior actions or triggers will be required under this pillar inthe next series ofPRSCs. - 24 -  IDA will continue to monitor also the implementation of the policy actions that make such outcomes possible. Inwhat follows, the prior actions for PRSC 3 and the triggers for PRSC 4 and 5 are presented. a. Prior Actionsfor PRSC 3: a.1 Macroeconomic Management 67. Prior Action 1: Improve Budget Allocation for Priority Sectors: Actual expendituresfor 2005 and budgeted expendituresfor 2006 were at least 65percent for priority sectors. Expenditures for the priority sectors as definedinthe PARPA were 67 % in2005, of which 55 % was for education and health, i.e. the latter two sectors received 37% o f all expenditures. The 2006 budget allocated over 69.5 % o f the resources to the priority sectors, although some o f this increase can be explained by moving some donor- financed off-budget projects into the budget (which i s desirable). Budget execution inthe first semester o f 2006 was 61 % for the priority sectors, but the government is confident that the 65% target can be achieved by the end o f the year, as the information about externally financed priority activities was not available at the time the budget execution report was compiled, and many priority sectors spendmore inthe second semester due to the procurementcycle. 68. Prior Action 2: Improve Efficiency of Public Financial Management: Rollout of basicfunctionality of e-SISTAFE to three more ministries. The main functions o f e- SISTAFE (treasury, budget execution, accounting) were rolled out to the Ministries o f Agriculture, Health, and Public Works at the central and provincial level in July 2006. They had previously been rolled out to the Ministries o f Finance, Planning and Development, Education and Culture. As a result, the main spending ministries are utilizing e-SISTAFE as o f July, 2006. 69. Prior Action 3 - Enhance Revenue Generation Capacity: Creation of the Central Revenue Authority. The law and the regulations had been approved by September 2006. Its president was appointed in November, 2006. This implies that an important milestone in the multi-year institutional reform program o f the revenue administration has been achieved. 70. Prior Action 4 -Improve Budget Comprehensiveness: Increase in the 2007 budget of own revenues of the Ministries of Education, Health, Agriculture, Public Works, Tourism, Mineral Resources, and Youth and Sport. This indicator was contained inthe PAF for 2006, and the Government has achieved it. Own revenues from the mentioned ministries included in the 2007 budget as submitted to Parliament are about 70 percent higher inreal terms than in2006. 71. Prior Action 5 - Enhance Procurement Practices: Implementation of new procurement system up to the district level. The legal, regulatory and institutional frameworks have been created for the new procurement system. UFSA, the unit within the Ministry o f Finance supervising the procurement system, had its director appointed with the rank o f Deputy National Director. The unit was given quality premises and the hiring of staff is under way. An initial program o f courses on the new procurement - 25 -  system and regulations has been carried out at central and local level. A more systematic, broader and sustainable training program i s being finalized with assistance o f an international consulting firm. The procurement units in the line ministries are being staffed. The standard bidding documents were finalized and published in September 2006. a.2 Governance 72. Prior Action 6 - Decentralization: Definition of criteria for allocation of the investment budgetfor districtsfor the 2007 budget. Each district received a block grant o f 7 billion Mt (Mt o f the old family; about $350,000) as an investment budget in 2006. The priorities were decided at the district level in collaboration with the Consultative District Councils. This was the first time that the district had any kindo f decision making role regarding investments. For the 2007 budget, each district receives at least the same amount as in 2006, but the actual amount i s determinedaccording to its population size, the relative poverty of the province (poverty data at the district level are statistically not representative), and the percentage o f a district's own revenue collection to create an incentive for the efficient management o f public resources. a.3 EconomicDevelopment 73. Prior Action 7 Strengthen the Business Environment: Simplification of the - proceduresfor starting a business.It took 153 days to open a new business in 2005. The new Commercial Code (approved in December 2005) and the new Code for Registry of Legal Entities (approved in March 2006) simplified the procedures. The commercial registry has largely been computerized, which reduces the number o f days to open a businessby at least 30 days. Furthermore, inSeptember 2006, the government approveda decree whereby the registration becomes effective as soon as it is published on the government's official website. This will reduce the time for starting up a business by an average o f 80 days, the time it normally takes for the articles o f incorporation to be published in the official gazette. Given that the registration process, including the first step o f it (obtaining a certification o f unique name - certidao negativa) has been computerized, the accuracy o f the registry has also increased. As a result o f these reforms, it i s now possible to open a business in about 30 days. It i s worth noting that the Doing Business 2007 report states that it takes 113 days to open a business; this i s based on the information available in the beginning o f 2006; the changes that occurred since then will be reflected in the Doing Business 2008 report. The reforms were not done at the expense ofchangingthe requirementsfor doing environmental impact assessments. The Prior Actions for PRSC3 and the Triggers for PRSC 4 and 5 are summarized in Table 5. - 26 -  Table 5: PriorActions and Triggers for PRSC 3-5 Government Medium. PRSC 3 Prior Actions PRSC 4 Triggers PRSC 5 Triggers term Objectives (From PARPNPAF) Improve efficiency and Actual expenditures for 2005 Actual expenditures for priority Expenditures for priority sectors effectiveness of public and budgeted expenditures for sectors were at least 65 percent in in budget planning and execution financial management 2006 were at least 65 percent 2006. in line with the MTEF in 2007. for priority sectors Rollout of basic functionality of Rollout of basic functionality of e- Rollout of basic functionality of e- e-SISTAFE to 3 more ministries SISTAFE to 22 ministries by end SISTAFE to 25 ministries, (agriculture, health, public 2006 organs, and at least 291 UGE's works) by July 2006 by end 2007 Creation of the Central Revenue Elaboration and approval of the Authority Information Technology Development Plan of the new Central Revenue Authority Improve Increase in the 2007 budget of comprehensiveness of own revenues of the Ministries budget of Education, Health, Agriculture, Public Works, Tourism, Mineral, Youth and sport. Make the State Implementation of new Implementation of new Implementation of new procurement system for procurement system up to procurement system up to district procurement system up to district goods and services district level (first phase create - level (second phase -UFSA fully level (third phase -performance transparent and UFSA, issue standard bidding staffed; website operational; measurements: # of contracts efficient documents) monitoring database available; complying with procedures; capacity building at central and capacity building; # of local level; audits taking place) controlslaudits taking place) Increase coverage and Audit of 20% of districts and Increase in number of central & efficiency of internal municipalities by the Inspectorate provincial level bodies with and external audit General of the Ministry of Finance operational internal controls bodies by end of 2006 Conclusion of court opinion of 70 Conclusion of court opinion of 90 financial audits by Court of financial audits by Court of Accounts in 2006 Accounts in 2007 rnt 2: Governance Strengthen institutional Definition of criteria for National strategy for planning and capacity of local allocation of the investment finance at district level approved governments budget for districts for the 2007 including a common M&E budget framework; National Decentralization Strategy completed. Improve human Completion of the census of civil resources servants, and create an integrated management in public payroll system. sector Improve efficiency and Disposition of 150 court cases celerity in the provision per judge per year in 2007 of justice services - 27 -  extension information c. TRIGGERS FOR PRSC4AND PRSCS 74. Triggersfor PRSC 4 and 5 assess whether the implementation of PARPA 11is on track. In line with the overall objectives and expected intermediate outcomes for the new PRSC series, the triggers are chosen as milestones whose achievement would indicate that the reform program and the implementation o f PARPA I1are on track. 75. The successful conclusion of the Joint Review remains as a key underlying condition. The successful conclusion o f the Joint Review, where the performance in all sectors i s thoroughly assessed according to the PAF, continues to be the fundamental condition for going forward with PRSC 4 and 5, and for determining the amounts. It i s expected that PRSC4 and PRSC5 are o f a US$70 million equivalent each under the condition that the Joint Review i s concluded successfully. This would represent about 40 percent o f expected new IDA commitments in FY08-09 under the assumption that the envelope o f IDA resources available for Mozambique remains broadly stable. 76. The triggers are drawn from the PAF. PRSC4 triggers are drawn from the 2006 PAF for all indicators that need to be assessed by the Joint Review o f April 2007 and from the 2007-09 PAF for the policy actions that will be carried out during 2007. The triggers for PRSC 5 are drawn exclusively from the 2007-09 PAF. It is worth noting that some o f the triggers for PRSC 4 and 5 are output/outcome indicators drawn from the PAF rather than policy and institutional actions (e.g., percentage o f road network in good shape; and number o f hectares irrigated). These indicators aim at capturing key milestones towards the achievement o f PRSC end-of-series outcomes. They will directly result from policy and institutional actions under the program supported by the PRSC series. In particular, a key policy measure will be to ensure that budget allocations (and outturns) are sufficient for improving the availability o f road transport and irrigation, in line with sector policies. - 28 -  77. Under macroeconomic management, the triggers cover the areas o f resource allocation for poverty reduction, institutional reforms to enhance domestic revenue mobilization, budget management, procurement systems, and auditing. The expected outcomes at the end o f the PRSC series are: (i) the composition o f actual public spending i s in accordance with the objectives o f PARPA 11; (ii) revenue administration i s more efficient; hence total revenues are a higher percentage o f GDP, despite the lowering o f import duties; (iii)budget execution i s less time-consuming and transparency has improved; (iv) the budget document i s comprehensive; (v) the public procurement institutions are functioning more effectively and transparently up to the district level; (vi) the coverage and quality o f audits at the local level have improved, and the external audit institutionhas improved its capacity to issue opinions on more financial audit reports. 78. Under the governance pillar, the triggers cover the areas o f civil service reform, decentralization, and reform o f the judiciary system by making its administration more efficient. The latter will ensure better access to justice. The expected outcomes under this pillar at the end o f the PRSC series are: (i)districts have strengthened institutional capacity to decide on local investment programs in a participatory manner, and more resources are transferred to local governments; (ii) the capacity to monitor the wage bill o f civil servants i s inplace ;(iii) productivity o fjudges benefiting from justice sector the reform measures has increased, as illustrated by an increase in the number o f cases tried perjudge per year. 79. Under the economic development pillar, the triggers cover the investment climate, essential infrastructure, such as the roadnetwork and irrigation, the reform o f the administration o f the national pension system, and better agricultural extension services. The PRSC series would support the policy reforms required to make sector interventions more effective. For example, in order to achieve the targets for the construction and rehabilitation o f the national road network, the following key policy actions are required inimplementingthe new integrated Road Sector Program: (i) successful restructuring the o f the National Roads Administration both at headquarters and in the provinces; and (ii) the internalization o f the procurement process with the NR4. With regard to extended irrigated areas, among other requiredpolicy actions, an appropriate policy framework to increase water storage and distribution and to strengthen beneficiary organizations should be prepared by the government; and communities with access to irrigation resources have to be strengthened. 80. The expected outcomes under this pillar at the end of the PRSC series are: (i) the time to open a businesshas been reduced from 153 days in2005 to 30 days in2009; (ii)the national road network (primary, secondary, and tertiary roads) is in better conditions thereby reducing transport costs as illustratedby an increase in the percentage o f roads in good or reasonable conditions from 71% in 2006 to 78% in 2009; (iii) the pension system is on a sounder footing due to the implementation o f the recommendations o f the actuarial study, and the National Social Security Institute has an investment strategy defined, thereby contributing to the development o f the financial sector; (iv) agricultural productivity i s increased and vulnerability to irregular rainfall is reduced in areas where irrigation systems have been constructed or rehabilitated (13,600 hectares in total are expected to brought under irrigation and management by the beneficiaries during the period 2006-2009); (v) 411,000 farmers are benefiting from extension services compared to 193,500 in2006. - 29 -  VI. OPERATION IMPLEMENTATION A. MONITORINGAND EVALUATION 81. Thepolicy matrix of theproposed credit highlights the linkages between policy actions and results in support of specific objectives and actions defined in the PARPA monitoring framework, the Strategic Matrix. The Strategic Matrix represents the results framework o f the PARPA I1and it was prepared by a joint Government and donor team led by the Ministry of Planning and Development and involving all line ministries, key agencies as well as representatives o f civil society, with technical support from the Bank. The Government is now preparing a monitoring plan to implementthe Strategic Matrix, including reviewing the quality and relevance o f sector indicators and identifying responsibilities and costs associated with the monitoring exercise. At the time this document was being finalized the Government was initiating a study to define the main elements o f the Plan. 82. The Strategic Matrix provides the results chain of the PARPA strategy. It includes the links between objectives, indicators and relative baselines and targets at results and output levels, as well as sector specific actions and responsibilities for monitoring and it will be included as an annex and monitored through the annual Economic and Social Plan (PES) and PARPA Annual Progress Report (BdPES), discussed inParliament. The Strategic Matrix links the PARPA program with the budget cycle and the democratic process through the economic and social plan, the Plano Econdmico e Social (Economic and Social Plan, PES), discussed in the National Assembly, and its progress report, the Balanco do Plano Econdmico e Social (Progress Report of the Economic and Social Plan, BdPES), which assesses performance on implementation o f the PES during the previous year. 83. The indicators and actions of the new PRSC series are aligned with a subset of the Strategic Matrix selected by the joint Government and donors group providing budget support (G18) and laid out in the Performance Assessment Framework (PAF). While the 2007-09 PAF indicators will serve as the monitoring framework during the implementation o f the PRSC series, the indicators for 2006 were taken from the 2006 PAF that was based on PARPA I.In addition, it i s expected that the quality o f the Strategic Matrix (and PAF) indicators will benefit from the definition o f the Monitoring Plan currently under preparation. B. CREDIT AMOUNT AND TRANCHING 84. The Credit i s a single tranche operation o f a US$70 million equivalent. - 30 -  C. SUPERVISION 85. The Bank's supervision of the PRSCs is aligned with the supervision of the joint General Budget Support program of the G18. In order to reduce the transaction costs for the Government, the Bank carries out all supervision jointly with the other donors. It participates in the Troika Plus (consisting o f three donors/a chair/co-chair and outgoing chair, forming the troika chairmanship -- EC and WB are permanent members, thus forming the Troika Plus), the overall coordination mechanism set up by the G-18, and all the relevant coordination meetings. All Bank sector missions working for the PRSC team liaise closely with and through the respective joint sector working groups to assure maximum coordination with all other sector partners. 86. The MoU dejines two key review events per year. A Joint Review takes place each year inApril (year n). It assesses the performance o f the government inthe previous budget year, which corresponds to the calendar year (year n-1). The review focuses on evaluating progress with regard to the indicators defined in the Performance Assessment Framework and makes an overall assessment o f progress. The second event i s the Mid- Year Review in September. This review i s mainly forward-looking and formalizes the agreement on the performance indicators and targets for the following year (year n+l). Both the Joint and the Mid-Year Review are a multi-sector exercises, and Bank staff participate in all relevant sectors. The reviews are prepared at the technical level by the variousjoint sector working groups. 87. I n addition, the supervision of the PRSC is done on a continuous basis in harmonization with the other general budget support donors. The Task Team Leader for the operation i s based inthe field, and participates in all relevant coordination and the monthlyjoint government-donor steering committee meetings. Progress in each sector i s monitored by joint government-donor sector working groups. Bank staff actively participates in these meetings through its staff in the field offices and Washington (through missions or by videoconference). 88. Furthermore, the Bank participates in joint IMF-Bank missions to monitor progress in the macroeconomicframework. The Bank and the Fund also monitor jointly progress inimplementing the PARPA. D. FIDUCIARYASPECTS 89. Fiduciary aspects and strengthening of the Government's own systems are key in this operation. The public financial management system i s considered to be reasonably adequate to support the PRSC series. Weaknesses are found ininternal control systems, the limited coverage o f the external audit, and the high-level o f off-budget spending mainly from external project finance. According to the latest PEFA assessment, the quality of the PFM is expected to continue improving as a natural consequence of ongoing reforms such as e-SISTAFE. The main challenges o f Mozambique's public expenditure management and financial accountability systems were studied in the CFAA and the PERs conducted in 2001 and 2003. An action plan focusing on comprehensiveness and financial accountability system i s being implemented. A follow up o f the implementation of the CFAA's action plan has been part o f the PRSC  supervision and preparation. With regard to the procurement system reform, following the 2002 CPAR, an action plan was agreed with the Government and i s being implemented in steps over the series o f PRSCs. A key milestone was the approval by Cabinet o f a new Procurement Code in December 2005 (a trigger under PRSC 2) which brought Mozambique's procurement legislation to international standards, and which separated the regulatory and supervisory functions from actual procurement. The central procurement supervision unit was created and staffed in 2006 (prior action under PRSC 3). Public financial management has been improving steadily in line with government commitment to reform, and the dialogue between the Government and the donors has been constructive. The budget can be considered to be a credible document with final out-turns reasonably close to initial approvals and there has been a steady improvement inrevenue collection andadministration. 90. The Central Bank is subject to the Fund's safeguards assessment policy under the PRGF Arrangement approved on July 6, 2004. The assessment, which was completed on August 18, 2004, identified weaknesses in the areas o f financial reporting, internal audit, and the system o f internal controls and proposed specific measures to address weaknesses. The implementation o f these measures i s being monitored by staff under the PRGF arrangement. In particular, progress is being made in making the necessary adjustments so that the balances in the BM's accounting records match the balances confirmed by the correspondents and other third parties. The reconciliation o f monetary data with audited financial statements and its review by the internal audit department will be completed by end-December 2006. A new foreign exchange law was submittedto Parliament in 2006. Once approved, the Mozambican Government intends to accept its obligations under Article VI11 sections 2, 3 and 4 of the Fund's Articles o f Agreement. E. DISBURSEMENTANDAUDITING 91. The proposed credit will be disbursed following standard I D A disbursement procedures. The credit will be released as a single tranche at the request o f the Ministry o f Planning and Development. IDA will deposit the funds in a dedicated foreign exchange account o f the Bank o f Mozambique inFrankfurt. It i s the same account which i s usedby other GBS donors to transfer their GBS contributions, as specified in the MoU. Within two working days, Bank of Mozambique will credit the Metical equivalent counterpart funds to a specific Transitory Account o f the Ministry o f Finance. It will be transferred from the Transitory Account to the Central Treasury Account in accordance with the treasury plan and will be used as state budget revenue and recorded in the state accounts as such. 92. Auditing procedures are the same as defined in the MoU. A legally registered, private and independent audit company meeting international standards will perform annual audits based on the quarterly financial reports according to Terms o f Reference attached to the MoU. The audit costs will be met by GoM. The final audit report will be submitted annually to G o M as well as to GBS donors including the Bank no later than three months after the year's end. - 3 2 -  F. ENVIRONMENTAL AND SOCIALASPECTS 93. Theproposed series of PRSC operations will support policy actions that should create the enabling environment to support poverty reduction. These policy actions by themselves do not have a significant environmental impact. However, it is expected that regular investment activities will benefit from such policy actions, and therefore are likely to have stronger results. Potential environmental impacts of such interventions will be analyzed and monitored by the responsible authority. For example, in the case of the rehabilitation and construction o f the road network, the National Roads Authority has received institutional strengthening for environmental management under the Bank- supported Roads and Bridges Management and Maintenance Program, in particular through the social and environmental unit o f the National Roads Authority. A similar situation prevails in the case of the expansion o f irrigated agriculture. The Ministry o f Agriculture has received much support - including from the Bank - to build up its capacity to carry out EIA's. And the institutional framework for the water sector i s largely consistent with international good practice, and includes the ongoing establishment o f Regional Water Administrations ( A M s ) responsible for water resource management. 94. Oneprior action in PRSC 3 is the reduction in the number of days required to open a new business.This has been achieved through computerization and simplification o f the procedures for registration o f a business. This reform i s not expected to affect the environmental clearance process, managed by the Ministry of Environmental Coordination (MICOA). The proposed series of PRSC operations also supports the decentralization process, which has the potential to improve social services and trigger economic activities at the community level as responsibilities are devolved to local levels more in-tune with local conditions. The Bank-supported Decentralized Planning and Financing Project aims to improve the institutional capacity o f District Administrations, including for environmental management. 95. The analytical underpinnings of the PRSCseries include an Economic Analysis of Natural Resources Sustainability, completed in FY06. This report estimated that more effective management o f natural resources could increase rents from 5% o f tax revenues to 10%-20%. The proposed measures will be discussed during preparation o f PRSC 4 ind 5. 96. Analysis has been carried out of the impacts of growth on poverty reduction. According to the recently concluded CEM, macroeconomic stability and good public financial management are important to keep inflation low and to secure fiscal discipline, two important pre conditions for economic growth and poverty reduction. The C E M estimates that if growth can be maintained at the expected levels o f 7 percent per annum in the coming years, and inequality remains stable, the poverty rate can be reduced significantly increasing the likelihood that Mozambique will reach the Millennium Development Goal for poverty reduction by the year 2015 by reducing its poverty headcount from 54 percent in 2002/03 to 31 percent in 2015. The reforms supported by the PRSC series shouldcontributetowards that overall goal. - 33 -  G. RISKSANDRISKMITIGATION 97. One set of risks is concerned with the potential for macroeconomic instability. Instability may arise as a result o f terms o f trade shocks, regional instability, deteriorating financial sector performance, or unpredictability o f donor disbursements. Some o f these risks, such as terms of trade shocks or regional instability, are exogenous and could be more important in the long term rather than being o f concern to PRSC 3 itself. Considering the highlevel o f reserves, the end o f the drought that affected the country in 2005, the robust increase o f exports over the past five years, a flexible exchange rate regime and low external debt vulnerability, the likelihood o f terms o f trade shocks causing severe macroeconomic instability i s low, even though no stabilization mechanism exists at this point. Regarding financial sector performance, the new legal framework for the banking sector and strengthened supervision have reduced the risk o f banks accumulating a high share o f non-performing loans. Furthermore, the Financial Sector Technical Assistance Project provides support to reduce the vulnerability o f Mozambique's financial sector. Regarding the unpredictability o f donor disbursements, the Government has made significant progress to make them more predictable in the short and medium term, last but not least by signing the M o U with the 18 GBS donors and several MoU's for sector support. 98. A second set of risks concerns weak administrative capacity to implement reforms and effective decentralization. To mitigate this risk, the Government and donors agreed during the Joint Review to develop an integrated strategy for capacity development in public finance management, and to strengthen the coordination and management o f reforms. A new strategy for the second phase o f the public sector reforms was agreed with all stakeholders including the development partners and was approved by Cabinet in October 2006. To strengthen capacity at the district level and to improve control mechanisms (auditing), several decentralization projects are being integrated into a national program that i s expected to deliver capacity building and oversight more effectively. 99. A third set of risks concerns a deterioration in governance that could compromise economic reforms and poverty reduction efforts. The Bank has noted that reforms in the legal and judiciary fronts are not moving at the desired pace. A deterioration in governance can have negative effects on economic growth and compromise poverty reduction. To mitigate this risk, the Bank has held an active policy dialogue with the authorities on the subject and closely monitors developments associated with governance. In addition, the restructured Public Sector Reform Project has a new legal sector capacity building component. A further approach to enhance accountability o f the executive is increased disclosure o f information to the public, particularly regarding financial management. Some progress has been made through the use o f an official internet portal o f the Government, but more effort i s still required. 100. A final set of risks concerns the impact of HIWAIDS. This pandemic has two potential impacts: it can reduce human and institutional capacity to deliver public services and it may pose a long-term contingent liability. Free ARV treatment i s rapidly expanding financed by donors. Should donor support wane at some point, then there would be big pressures for the health budget to pay for it. The Bank i s taking the - 34 -  HIV/AIDS pandemic very seriously and is dealing with it as an essential cross-cutting issue in all of its projects in addition to having two dedicated HIV/AIDS prevention and treatment programs. - 35 -  ANNEXES: - 36 -  8 c E U W 8 -0 U I c U W 8 -0 U I c U W 8 - 0 s9 n cd 0 cv c  s N 3 +-  m I m  63 ? 0 I - 0 d. I 1PC  l- P h E e E e c 22 0 i e ; e ly c   -r I rr) d li I  - P u a m 3 a X x X x 0 0 0 N X I P 0 0 CJ k 0 rcI h E 4 PI v x&4 0 za 3 k h CI c a, 5 (I) a, (I) (I) 4 a, V E: a k E 0 CCI Ll a, PI m X ca, E: 4  - N a 0  - x a a 3 a ._. f w c  I B  ANNEX 4 REPirBLICA DEMOCAMBIQUE MINISTkRIO DA PLANIFICACAQ E DESENVOLVIMENTO GABINETE DO MINISTRO Oflcio no352/MPD/QM/2006 Subject: Letter of Development Policy for the Third Poverty Reduction Support Credit (PRSCIII) Dear Mr. Wolfowitz, 1. Iam writing on behalf of the Government of the Republic of Mozambique, to request a Credit (PRSC-111) in the amount of US$ 70 million from the International Development Association (IDA), to support the continuing reform programme under the proposed Poverty Reduction Support Credits. This request comes in the context of the Memorandum of Understandkg (MoU) between the Government of the Republic of Mozambique and international aid partners, including the World Bank Group. The MoU outlines the participant's approach to the provision of budget support, among other related measures. 2. The aforementioned Credit will help to meet the financing requirements that Mozambique faces to implement the Second Action Plan for the Reduction of Absolute Poverty (PARPA-II), through the Economic and Social Plan (PES) and the annual budget (OE) for the year 2007. The Programme 3. As set out in the 2005-09 Five Year Programme, my Government has as the main objective the reduction of the levels of absolute poverty in Mozambique. To achieve this goal, PARPA-I1 presents a strategy and programme focused on the following key priorities areas: human capital development (including education, health and access to potable water): governance (good governance, legality and justice including public and legal sector reform]; economic development (including the promotion of national entrepreneurship and infrastructure development); and cross- cutting issues including environment, HIV/AIDS and gender. The PARPA- I1 adopted by the Council of Ministers in May 2006 is clearly aligned with these priorities. 4. My Government is justly proud of the progress made under PARPA-I which covered the period 2001-05. The specific objective of PARFA-I was to reduce the incidence of absolute poverty to less than 50 percent by 2010. 531.. 48  ANNEX 4 Overview of Recent Progress 5. The implementation of PARPA in 2005 was broadly positive, as noted in the April 2006 Joint Review involving my Government and the Programme Aid Partners (PAPS)including IDA. The Mozambican economy continued to grow strongly achieving a GDP growth rate of 7.7 percent and a rate of inflation just above 10 percent in 2005. Satisfactory progress was made in health, education, and water and sanitation service delivery. The integration of the PES, OE and CFMP and the strengthening the Government progress report, thus Balanqo do PES (BdPES) to monitor the PARPA has proved to be a success. Significant improvements have been made in quantitative poverty analysis and dissemination. Steps to improve the monitoring system were also noted. 6. The monitoring of the PARPA continued to improve and there was some progress towards the key PES including de indicators matrix of ensuring the integration of the PES, OE and CFMP and strengthening the BdPES. The expenditures in priority sectors were 67% above the target of 65% of the total, of which 55 o/o went to education and health (hence attaining the 50% indicators). Performance against PES targets in public service delivery was positive. In education, performance was broadly on-track and all targets were exceeded. In health, the indicators matrix continue to show positive progress, in particular in relation to the average up-take of services measured by consultations per inhabitant, which surpassed the target defined in 2005. Positive progress was made both in indicators matrix and Millennium Development Goals (MDG) indicators. Although the 2005 indicators matrix targets were met, HIV/AIDS as well as malariaremains one of the greatest threats to Mozambique's development and once again a stronger and better coordinated gender sensitive multi- sectoral response is needed. 7. In terms of The. environment for private sector development, significant progress was made in 2005. These progresses are best illustrated by the reduction in the time it takes to start a business, which fell from 153 to 90 days reflecting the government's commitment. In addition, to improve t h e investment climate in Mozambique and ensure an environment that encourages the private sector to drive economic growth in the country, the Council of Mihisters has approved a new labor law and submitted to the parliament for approval,, In addition, the 1888 Commercial Code has been revised'and a new code approved by the parliament. Furthermore, the reduction of the maximum duties tax from 25 to 20 and the commercial registry of legal entities has largely computerized associated with the approval, in September 2006, of a decree whereby the registration becomes effective as soon as it is published on the Government's official website, thus reduce the time for starting up a business. 8. The impact of this, progress on poverty reduction continues to be significant. The last household survey, completed in 2002/2003, 49  ANNEX 4 that poverty incidence (based on the headcount index) declined to 54 percent in 2003 (from 69.4 percent in 1997). 9. My Government's commitment to address the Millennium Development Goals (MDGs) remains strong, This is reflected in the PARPA-11, whose key actions are summarized ina matrix, along with indicators included in the Performance Assessment Framework (PAF) agreed with my Government's direct budget support partners, to permit monitoring. The Programme defined in these instruments will be implemented through Government systems with monitoring and evaluation reported in my Government's annual Economic and Social Plan (PES) and the annual State Budget (OE) that are submitted to the Parliament for approval. 10. My Government's programme being submitted for support with PRSC-111 includes three main components that are an integral part of the wider PARPA, PES, and PAFmatrices. They are: Macroeconomic Management a) Under this component, my Government remains committed to maintain macroeconomic stability, improve public financial management, and enhance governance. The Government will maintain macroeconomic stability through adhering to an appropriate macroeconomic framework with consistent fiscal and monetary policies. It will improve public financial management through: monitoring closely and allocating at least 65% of its resources to pro-poor spending; increasing budgetary efficiency, transparency and accountability by expanding coverage and implementing "Sistema de Administravao Financeira do Estado" (STSTAFE); and improving the timeliness and quality of the national accounts, auditing and budgetary reporting. b) After the successful introduction in 2004 in the Ministry of Finance and all the ProvincialDirectorates of Planningand Finance, the year 2005 9aw the initiation of the use of e-SISTAFE for budget execution and budget accounting and reporting, and early in 2006 e-SISTAFE was extended to the Ministries of Planning and Development' Education and Culture, Agriculture, Health and Pubic Works both at central as well as provincial level. At the present moment efforts are being made to roll-out to all Ministries and other Government institutions untilthe end of the year. c) In addition, my Government continues committed with the objective of increasing tax mobilization. The process has started through restructuring the Directorate for Taxes and Audit (DNIA) in to DGI for Domestic Taxes Administration, to be integrated with the Customs Directorate (DGA) under the new Central Revenue 50  ANNEX 4 Authority (ATM)which was created by law in late 2005 and whose by-laws were approved in 2006. Effective total revenue reached 14% of the GDP in 2005. Aiming to improve the efficiency in revenue collection, the following areas were improved: the identification and collection of tax arrears; audits on the larger tax payers; customs inspections and smuggling control; simplification of customs clearance procedures; better information to the tax payers and, training for tax administration staff. Progress was also observed in the process of VAT reimbursements, with reduction of the processing time from 90 to 30 days, also as the result of better performance by the taxpayers. Governance d) Governance is one of the three pillars of PARPA-11. My Government is committed to be closer to the people and has therefore accelerated the decentralization process by making the district the pole of development. Each district has now its own budget over which they can decide in a participatory manner. Every district received the same amount of investment funds in 2006. For 2007, to reflect the diverse conditions,namely District Population, District criteria were defined for allocating investment funds for each district Area, Poverty Index. Furthermore, my Government aims to improve governance by bringing public procurement in line with international practice; restructuring its key sectoral ministries to be more responsive to citizen needs from the district level; decentralizing the delivery of specified services to local authorities, to expand community participation and government accountability; and fighting corruption. Economic Development f) Recognizing the main role of the private sector in the economic growth and employment, Government policies and reforms have improved the environment for the development of private sector activities, and reinforced the role of the market in the economy. The new Commercial Code, approved in 2005, and the new Code for Registry of Legal Entities, approved in March, simplified the procedures for business registration. Furthermore, my Government approved a decree in September 2006, whereby registration becomes effective as soon as it is published on the government's official website. As result of this reforms it is now possible to open a business in 30 days, compared to 153 days in 2005. g) Growth in agricultural production in 2005 was around l.8%, partly due to C L a t i c problems, affecting the central and southern regions 5 1  of the ,country on a large scale. This indicates a slow down in comparison to 2004 when the rate of growth was 9%.. The impact of the droughts and floods in combination with outbreak of plague and disease combined with other factors resulted in the loss of 7% of the overall sown area. Around 265,000 families were affected, out of a total of around 3.5 million. The 1.8% growth was due to the recorded increase in cash crops, especially cashew nut (142.7%), tobacco (33.9%) and sugar cane (190/). 11. My Government will continue with implementation of the new procurement system, budget allocation to priority sectors in line with the CFMP, decentralization by increasing budget execution in provinces and districts, expand coverage and efficiency of internal and external audit bodies, complete the actuarial study of the INSS and develop its investment strategy as mechanism to improve the insurance and social protection. 12. The policy framework, which aims at consolidating macroeconomic stability, is consistent with the medium-term goal of sustaining poverty reduction through strong broad-based economic growth. The Government is commited to continue to implement measures to strengthen revenue mobilization and the transparency and monitoring of the budget execution. Conclusion 13. My Government remains committed to the overall objective of poverty reduction through sustainable economic growth. It is, therefore, the Government's hope that IDA will grant the requested Credit to assist inthe implementationof the proposedprogramme. With highest consideration, 2006 To: Mr. PaulWolfowitz President The World Bank 1818HStreet, N.W. Washington, D.C. 20433 U.8.A Av. Ahmed Bekou TourA no.'21 W.Andpr .C. PosW 4087. Tel.: 21493268 Fax.:Z1495463 Maputo - - 5 2  Annex 5: Mozambique Selected Economicand FinancialIndicators - Actual Estimated Projected Indicators 2000 2001 2002 2003 2004 2005 2006 Output, income, and prices (growth rates) RealGDP 1.9 13.1 8.2 7.9 7.5 7.7 7.9 Nominal GDP (Mt.trillion) 58.4 76.5 96.9 113.8 133.5 153.0 180.8 Nominal GDP (US$billion) 3.7 3.7 4. I 4.8 5.9 6.6 6.9 RealGDP per capita -0.2 10.7 6.0 5.8 5.4 5.7 5.9 Inflation(period average) 12.7 9.0 16.8 13.4 12.6 6.4 9.5 External sector (In terms of US$) Imports(c.1.f.) at current prices 1,163 1,063 1,543 1,741 2,035 2,467 2,725 Exports (f,o.b.) at current prices 364 703 810 1,044 1,504 1,745 2,101 Terms of trade (decline - ) 9.I -2.9 -3.4 -2. I 12.7 9.4 4.7 Money (as % of GDP) Money and quasi-money(M2) 28.8 29.2 28.0 28.3 25.6 28.3 27.2 Domestic Credit 10.6 12.6 11.2 9.5 6.9 9.3 10.3 M2growth rate 42.4 33.2 21.5 18.7 5.9 22.1 18.5 Public flnances (as % of GDP) Generalgovernmentrevenue (excluding grants) 12.9 12.4 12.4 12.9 12.6 14.0 14.4 Tax revenue 11.8 11.0 11.0 12.0 11.7 12.1 12.7 Nontaxrevenue 1.2 1.4 1.5 I.o 0.9 1.9 1.7 Expenditure 26.6 32. I 30.0 26.5 24.4 22.6 27.8 Current expenditure 13.1 13.5 13.9 14.3 14.2 13.8 14.8 Capitalexpenditure 13.5 18.6 16.1 12.2 10.2 8.8 13.0 Unallocatedrevenue or expenditure 0.0 -0.1 0.2 -0.4 -0.2 -0.3 0.0 Overall deficit before grants(-) -13.7 -19.9 -17.3 -14.0 -12.0 -8.9 -13.4 Overall deficit after grants(-) -5.8 -6.0 -7.2 -4.5 -4.5 -2.3 -2.4 Savings and investment (as % of GDP) Gross domestic savings 11.6 8.0 11.0 11.7 14.3 10.7 18.6 Gross domestic fixed capital formation 33.5 25.9 29.8 22.6 20.4 24.9 Externalcurrentaccount balance (before grants) -27.2 -26.1 -23. I -27.4 19.9 -14.1 -17.0 -17.4 AidGDP I/ 19.7 7.2 24.9 14.6 11.8 10.3 13.2 Other Indicators Gross official resewes In millions of US$ 745.3 727.0 824.8 947.2 1159.2 1104.6 1073.7 In months of importsof goods,sewices and income 5.8 5.1 5.4 6.0 5. I 4. I 3.4 Exchange rate-periodavg(local currency US$) 15227.2 20703.6 23678.0 23782.3 22581.3 23061.0 16085.7 Net present value of external debt as percent of 3 year moving averageof exports 2/ 177.1 109.8 91.7 102.0 83.8 83.6 32.3 I! Definedas net loandisbursements (excludingIMF) plus grants, over GDP. 21Historical NPV estimates are basedon previous debt sustainabilityanalysis. 2006 NPV projectedbasedon May, 2006 DSA. Source: Local Data Base, in tun from Mozambique authorities, IMFand staffcalculations. - 53 -  Annex 6: Mozambique at a Glance Mozambique at a glance 6/12/06 Sub- Key Development Indicators Saharan Low Mozambique Africa income Age dlstrlbutlon, 2005 (2005) Male Female Population,mid-year(millions) 19.8 741 2,353 70.74 Surface area (thousandsq. km) 802 24,265 29,265 Populationgrowth (%) 1.9 2.1 1.8 KO& Urbanpopulation(% of total population) 38 37 31 50-5) 4 O - u GNI (Atlas method. US$ billions) 6.2 552 1,364 30-34 GNI per capita (Atlas method, US$) 310 745 580 20-24 GNI per capita (PPP, international$) 1,270 1,981 2,486 10-14 O d GDP growth (%) 7.7 5.3 7.5 20 10 0 10 20 GDP per capita growth (%) 5.7 3.1 5.6 Dement (most recent estlmafe, 2000-2005) Poverty headcount ratioat $1 a day (PPP. %) 38 a 44 Povertyheadcount ratioat $2 a day (PPP. %) 78 ' 75 Under-5 mortality rate (per 1,000) Life expectancyat birth (years) 42 46 59 infant mortality (per 1,000 live births) 104 100 80 250 Chiid malnutrition(% of children under 5) 24 29 39 2w Adult literacy.male (% of ages 15 and older) 73 150 Adult literacy,female (% of ages 15and older) 50 Gross primaryenrollment, male (% of age group) 121 99 110 I W Gross primaryenrollment.female (% of age group) 100 87 99 L 50 Access to an improvedwater source (% of population) 43 56 75 0 Access to improvedsanitationfacilities (% of population) 32 37 38 OMozambique 0 Sub-SaharanAfrica Net Aid Flows 1980 1990 2000 2005 (US$ millions) Net ODA and official aid 169 1,003 877 1,228 3rowth of GDP and GDP per capita ("4 Top 3 donors (in 2004): Aid (% of GNI) 4.8 43.2 24.7 22.0 Lo 1 Aid per capita (US$) 14 75 49 83 Long-Term Economlc Trends Consumerprices (annual% change) 47.0 12.7 6.4 GDP implicit deflator (annual % change) 4.1 34.1 10.3 6.4 LO -- w 0 Exchangerate (annual average, local per US$) 85 W 32.4 947.5 15,447.1 23,081.0 Terms of trade index(2000 = 100) 86 111 100 113 +GDP - -- .--- - GDP per capita (average annualgrowth %) Population.mid-year(millions) 12.0 13.4 17.9 19.8 1.1 2.9 2.0 GDP (US$ millions) 3,528 2,483 3,778 8,836 -0.1 5.9 8.6 (% of GDP) Agriculture 37.1 37.1 28.1 22.3 6.6 4.9 8.3 Industry 34.4 18.4 26.6 29.8 -4.5 12.8 10.3 Manufacturing 10.2 13.3 14.2 10.2 14.5 Services 28.5 44.5 47.3 47.9 6.7 3.6 7.8 Householdfinal consumptionexpenditure 96.7 92.3 78.3 79.1 -1.7 3.7 8.6 General gov't final consumptionexpenditure 12.2 13.5 10.1 10.3 -1.1 3.1 8.5 Gross capital formation 7.6 22.1 33.5 20.4 4.1 11.4 5.1 Exportsof goods and services 10.9 8.2 19.7 32.6 -6.8 11.0 20.0 Importsof goods and services 27.4 36.1 41.6 42.3 -3.8 8.3 10.1 Gross savings -6.9 2.1 5.5 4.4 15.9 Note: Figures in italics are for years other than those specified. 2005 data are preliminaryestimates. ,. indicates data are not available. a. Countrypoverty estimate is for 1997. b. Aid data are for 2004. DevelopmentEconomics,DevelopmentData Group (DECDG). - 54 -  Mozambique Balance of Payments and Trade 2000 2005 (US$ millions) IGovernsnceIndicators,2000 and 2004 Total merchandiseexports (fob) 364 1,745 Total merchandiseimports (cif) 1,163 2,467 Voice and accountability I Net trade in goods and services -815 -642 Politicalstability ` I Workers' remittances and compensationof employees (receipts) 37 58 Regulatoryquality Current account balance -1,042 -1,058 Rule of law as a % of GDP -27.6 -15.9 Controlof corruption Reserves,including gold 742 1,103 0 25 so 75 100 Central Government Finance 1j 02004 Country'spercentilerank (0-100) 02000 htgher YSlYBs lmph bettermlmgr (% of GDP) Revenue 12.9 14.0 ISource Kaufmann.Krasv-Maslmru worn Bank Tax revenue 11.8 12.1 Expense 13.1 13.8 Technology and Infrastructure 2000 2004 Cash surplus/deficit -5.6 -2.3 Paved roads (% of total) 18.7 Highestmarginaltax rate (X) Fixed line and mobile phone Individual 20 32 subscribers (per 1,000 people) 8 27 Corporate 35 32 High technology exports (% of manufactured exports) 9.2 9.4 External Debt and Resource Flows 2000 2004 Environment (US$ millions) Total debt outstanding and disbursed 7,000 4,651 Agricultural land (%of land area) 61 62 Total debt service 96 83 Forest area (% of land area, 2000 and 2005) 24.9 24.6 HlPC and MDRl debt relief (expected:flow) 4,300 Nationally protected areas ("/aof land area) .. 8.4 Total debt (% of GDP) 185 3 78 7 Freshwater resources per capita (cu. meters) 5,164 Total debt service (% of exports) 12.5 4.4 Freshwaterwithdrawal (% of internal resources) .... 0.6 Foreigndirect investment (net inflows) 139 245 C02 emissions per capita (mt) 0.07 0.08 Portfolioequity (net inflows) 0 0 GDP per unit of energy use 2.2 2.5 Compositionof total external debt, 2004 (2000 PPP 8 per kg of oil equivalent) Energy use per capita (kg of oil equivalent) 401 430 (US$ millions) IBRD Total debt outstanding and disbursed 0 0 Disbursements 0 0 Principal repayments 0 0 othermuiu Interest payments 0 1 iaimi, 883 JSS millions IDA Total debt outstanding and disbursed 760 1,575 Disbursements 98 227 Private Sector Development 2000 2005 Total debt sewice 6 27 Tlme required lo start a business (days) 153 iFC (fiscal year) Cost to start a business (% of GNI per capita) 95.0 Total disbursed and outstanding portfolio 99 116 Time required to register property (days) --- 42 of which IFC own account 99 116 Disbursementsfor IFC own account 49 0 Ranked as a major constraint to business Portfolio sales, prepayments and (% of managers surveyedwho agreed) repaymentsfor IFC own account 3 5 Cost of financing .. 83.8 Electricity .. 64.0 MlGA Gross extosure 114 299 Stock market capitalization (% of GDP) Bank branches (per 100,000 people) Note: Figures in italics are for years other than those specified. 2005 data are preliminary estimates. ..indicates 8/12/06 data are not available. -indicates Observation 1s not applicable. 11Revenues refer to current revenues excluding current grants: expensesrefer to current expenditures; and, deficit refers to deficit after total grants. DevelopmentEconomics, Development Data Group (DECDG). - 55 -  Annex 7: MillenniumDevelopmentGoals for Mozambique Millennium Development Goals Mozarnbique With selected targetsto achieve between 7990 and 2075 (estimate closest to date shown, +/- 2 years) Goal 1:Eradicate extreme poverty and hunger 1990 I995 1998 2004 Income share held by lowest 20% 6.0 Malnutnbon prevalence, weight for age (% of children under 5) 27 0 26.0 24.0 Povertygap at $1 a day (PPP) (%) 120 12.0 Povertyheadcount ratio at $1 a day (PPP) (% of population) 36 36 Povertyheadcount ratio at national poverty line (% of population) 69 54 ' Prevalence of undernourishment (% of population) 56 45 Goal 2: Achieve universal primary education Literacy rate, youth total (% of people ages 15-24) 49 Persistence to grade 5, total (%of cohort) 34 46 Primary completion rate, total (% of relevant age group) 27 13 29 School enrollment, primary (% net) 43 49 71 Goal 3: Promote gender equality and empower women Proportion of seats held by women in national parliament (%) 16 25 30 Ratio of girls to boys in pnmary and secondary education (Oh) 72 74 62 Ratio of young literate females to males (% ages 15-24) 48 Share of women employed in the nonagricultural sector (% of total nonagricultural ernployrr 11 Goal 4: Reduce child mortality Immunization, measles (% of children ages 12-23months) 59 71 64 77 Mortality rate, infant (per 1,000 live births) 156 145 104 Mortality rate, under-5 (per 1,000) 235 212 152 Goal 5: Improve maternal health Births attended by skilled health staff (% of total) 44 46 Maternal mortality ratio (modeled estimate, per 100,000live births) ., 1,000 Goal 6: Combat HIV/AIDS, malaria, and other diseases Contraceptive prevalence (% of women ages 15-49) 6 17 Incidence of tuberculosis (per 100,000people) 167 460 Prevalence of HIV, female (Oh ages 15-24) 11 Prevalence of HIV. total (X of population ages 15-49) 16 Tuberculosis cases detected under DOTS (%) 54 47 46 Goal 7: Ensure envlronmental sustainability C02 emissions (metnc tons per capita) 0 0 0 Forest area (% of land area) 1.o 26 25 GDP per unit of energy use (constant 2000 PPP $ per kg of oil equivalent) 2.0 2.0 2.0 Improved sanitation facilities (% of populabonwith access) 20.0 32 0 Improved water source (% of populationwith access) 36 0 43 0 Nationally protected areas (% of total land area) 6.4 Goal 8: develop a global partnership for development Fixed line and mobile phone subscribers (per 1,000 people) 4 4 5 27 Internet users (per 1,000people) 0 0 0 7 Personal computers (per 1,000 people) 1 2 6 Youth unemployment (% of total labor force ages 15-24) 'ilk Education indicators (%) Measles Irnrnunizatlon (%of I-year olds) IC1indicators (per 1,000 people) 100 30 15 20 50 50 I O 25 25 1888 2wo 2w2 2004 0 -+-Primary net enmllmentratio 1880 1995 2000 2OW 2000 2002 2004 -"Ratio of gldr to boys in primary& 0 Fixed + mobilesubscnben secnndalyeducation OMozambique OSubSaharanAfnca 0 Internetusen Note: Figures in italics are for years other than those specified...indicatesdata are not available. 1/ Refers to 2003. Deve,opment Economics. Developmenl Data GroLp (DECDG). - 56 -  FinanceProject I infrastructureinvestments. Total Agricultureand RuralDevelopment 99.70 64.13 Market Led to Small Holders I The developmentobjectiveof the project is to increasethe income of smallholder 30.00 30.00 03120113 farmersin selecteddistrictsof the Zambezi Valley region of central Mozambique. Increasedincomeswill be achieved TransfrontierConversationAreas To achievegrowth in community-pnvatesector ledenvironmentallyand socially 20.00 19.60 06130113 sustainabletourism in TFCA GEF- Transfrontier Conservation To increaseh e area, connectivity,and effectivenessof biodiversityconservationin 10.00 9.60 06130113 Areas lhree TFCAs Coastal 8 Marine Biodiversity The Coastal and Marine Biodiversity ManagementProjectin Mozambique,will test, 5.60 0.90 06/30107 Mgmt and refine an approachto sustainableeconomicdevelopmentof coastalzone resources,througha strategicdevelopmentplanningprocess, to balanceecological, social,and physicalvalues In the coastalzone, GEF Coastal &Marine Biodiversity The Coastaland MarineBiodiversity ManagementProjectin Mozambique, will test, 4.10 1.39 06130107 Project and refine an approachto sustainableeconomicdevelopmentof coastalzone resources,through a strategicdevelopmentplanningprocess,to balanceecological, social,and physicalvalues in the coastalzone. AgricultureSector Expenditure To improvepublic expenditurein the agriculturesector 30.00 2.64 12131/06 Program I securesustainableand equitablesector growthand improvefwd security,while protectingthe environment. Total Agriculture and Environment Energy Reformand Access Proiect I To expanduse of electricity thus improvingwell-being in unservedand underserved 517.16 244.47 40.26 40.00 12/31/07 - I pen-urbanand rural areas-and strengthencapacity t i increaseaccess to modern 1 I I I - 57 -  I co v-l I  LzL I  (e I-  Annex 10: Mozambique: Relations with the Fund (As of October 31,2006) I. Membership Status:Joined 9/24/84; Article XIV 11. General Resources Account SDR Million % Quota Quota 113.6 100.0 Fund holdings of currency 113.6 100.0 Reserve position in Fund 0.01 0.01 111. SDR Department SDR Million %Allocation Holdings 0.17 n.a. IV. Outstanding Purchases and Loans SDR Million % Quota Poverty Reduction and Growth Facility (PRGF) arrangements 6.48 5.70 V. Latest Financial Arrangements Amount Amount Approval Expiration Approved Drawn Type Date Date (SDR million) (SDR million) PRGF 07/06/04 07/05/07 11.36 8.10 PRGF 06/28/99 06/28/03 87.20 78.80 ESAF 06121/96 06/27/99 75.60 75.60 VI. Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): Forthcoming 2006 2007 2008 2009 2010 Principal 0.16 Charges/Interest 0.02 0.03 0.03 0.03 0.03 Total 0.02 0.03 0.03 0.03 0.19  VII. Implementation of HIPC Initiative: Original Enhanced framework framework Total Commitment of HIPC Initiative assistance Decision point date 4/7/98 4/7/2000 Assistance committed (end-1998NPV terms) Total assistance (US$ million) 1,716.0 306.0 2,022.0 Of which:Fund assistance (US$ million) 124.6 18.5 143.1 Completion point date 6/29/99 9/20/01 Delivery of Fund assistance (SDR million) Amount disbursed 93.2 13.7 106.9 Interim assistance ... 2.3 2.3 Completion point 93.2 11.4 104.6 Additional disbursements of interest income ... 1.1 1.1 Total disbursements 93.2 14.8 108.0 VIII. Implementation of MDRI Assistance: Total Debt Relief (SDR ill ion)" Of Which: MDRI HIPC Debt Relief by Facility (SDR Million) Eligible Debt Deliverv Date GRA PRGF - Total January 2006 N/A 106.56 106.56 "The MultilateralDebt Relief Initiative (MDIU)provides 100percent debt relief to eligible member countries that are qualified for the assistance. The debt relief covers the full stock of debt owed to the Fund as of end-2004 which remains outstanding at the time the member qualifies for such debt relief. The MDRI is financed by bilateral contributions and the Fund's own resources, as well as the resources already disbursed to the member under the HIPC Initiative (see Section VII above).  Safeguards Assessment Under the Fund's safeguards assessment policy, the Banco de Moqambique (BM) is subject to safeguards assessment with respect to the PRGF Arrangement approved on July 6,2004. The assessment,which was completed on August 18,2004,identified weaknesses in the areas of financial reporting, internal audit, and the system of internal controls and proposed specific measures to address weaknesses. The implementation of these measures is being monitored by staff under the PRGF arrangement. Exchange Arrangements Mozambique's exchange system is a managed float. Commercialbanks may buy and sell foreign exchange to individual customers on a fully negotiable basis. The Bank of Mozambique introduced a foreign exchange auction system in January 2005. Auctions are held bi-weekly. Mozambique still avails itself of the transitional arrangements under Article XIV of the Fund Articles of Agreement, but has eliminated all Article XIV restrictions. It maintains, however, restrictions on the making of payments and transfers for current international transactions subject to Fund approval under Article VIII, as evidencedby (i) the discretionary prior approval for remittances of family living expenses; (ii) the authorization for the purchase of foreign exchange in excess of US$5,000 for certain transactions; (iii) the prohibition for the conversion of balances of nonresidents' domestic currency accounts into foreign currency or transfer abroad; and (iv) the need of proof of performance of a service prior to authorizingits payment. At the authorities' request, an Article VIII mission was conducted by LEG and PDR in March 2004. The mission encouraged the authoritiesto remove all existing the exchange restrictions. The authorities indicatedtheir intention to accept their obligations under Article VIII sections 2, 3, and 4 of the Fund's Articles of Agreement after the approval of the new foreign exchange law which is scheduledto be submitted to the assemblyby March 2007. Article IV Consultation In accordancewith Decision No 12794-(02176),as amended by Decision No 12854-(02196), Mozambique is on a 24-month Article IV cycle due to the approval of a new PRGF arrangement in July 2004. The 2005 Article IV consultationwas completed by the Executive Board on June 22,2005 (Country Report No. 051318). In concluding the 2005 Article IVconsultation,Executive Directors welcomed the substantialreduction in poverty realized over the past decade. At the same time, they stressed that stepped-up efforts are needed to further reduce poverty and, with the necessary financial assistanceof the international community,reach the Millennium Development Goals. In  particular, they looked forward to the new poverty reduction strategy paper for 2006-1 0. They noted, however, that a second wave of reforms is needed to deepen and accelerate structural changes to sustain high and broad-based growth. Directors emphasized that efforts should aim at (i) increasing tax revenues; (ii) strengthening public sector operations; (iii) reducing the costs of doing business; (iv) promoting labor intensive sectors; and (v) implementing a rural development strategy. FSAP Participation and ROSCs A Financial Sector Assessment Program (FSAP) for Mozambique was undertaken during the first quarter of 2003. The related Financial Sector Stability Assessment was circulated to the Executive Board on November 19,2003 (Country Report No. 04/52). A ROSC on fiscal transparency was issued on February 22,2001. This ROSC was updated in the context of the 2002 Article IV consultation (Country Report No. 02/140) and the 2003 Article IV consultation (Country Report No. 04/50). A Report on the Observance of Standards and Codes (ROSC) data module was prepared in June 2002 and issued on March 5,2003. This data module was updated in August 2005. Management Recent Visit At the invitation of the authorities, Mr. Kato, Deputy Managing Director, visited Maputo, Mozambique in July 2005.  EXTERNAL DEPARTMENT Press Release No. 061289 International Monetary Fund FOR IMMEDIATE RELEASE Washington, D.C. 20431USA December 18,2006 IMF Executive Board Completes Fifth Review Under the Three-Year PRGF Arrangement for Mozambique and Approves USS2.4 million Disbursement The Executive Board of the International Monetary Fund (IMF) today completed the fifth review of Mozambique's economic performance under the Poverty Reduction and Growth Facility (PRGF) arrangement for Mozambique in an amount equivalent to SDR11.36 million (about US$17.0 million), see Press Release No. 041153. The completion of the review enables the release of an amount equivalent to SDR 1.62 million (about US$2.4 million), which will bring total disbursements under the PRGF arrangement to an amount equivalent to SDR 9.7 million (about US$14.6 million). The Executive Board also accepted, as part of the financing assurances review, that adequate safeguards remain in place for further use of Fund resources. Following the Executive Board's discussion on Mozambique's economic performance, Mr. Murilo Portugal, Deputy Managing Director and Acting Chair, stated: "Mozambique's prudent macroeconomic policies, together with a first wave of structural reforms under its PRGF-supported program, have yielded strong economic growth, moderating inflation, and solid progress towards the objectives set out in its poverty reduction strategy. Continued solid policy implementation will play a pivotal role in consolidating macroeconomic stability, sustaining economic growth, reducing inflation, and enabling the efficient absorption of scaled- up foreign assistance, under the second wave of reforms envisaged in the PIano de Ac@o para Redup70 da Pobreza Absoluta II (PARPA 11) for 2006-09. Donor-financed projects should be integrated into the Treasury Single Account and e-SISTAFE with the help of the donors while clear guidelines on the use of national systems for the disbursement of aid could be disseminated. Over the medium term, the links between PARPA I1targets and the budget should be strengthened to reflect comprehensive fiscal planning and costing of programs and policies. "The achievement of these objectives will require strengthened fiscal policy and an investment climate enhanced by lowering the cost of doing business and continuing to squarely address governance issues. While the new draft labor law represents an improvement on the current law, the authorities are encouraged to take steps to address the remaining rigidities to labor market flexibility. The authorities are also encouraged to adopt a new laws on the mining and petroleum Washington, D.C.20431 r Telephone 202423-7100 Fax 2024236772 www.irnf.org  fiscal regimes. Adherence to the core principles of the Extractive Industries Transparency Initiative should strengthen the transparency of natural resource management and megaprojects. "In the context of scaled-up aid and acceleration of reforms, the 2007 budget envisages a 0.5 percent of GDP rise in domestic revenue with the share of priority expenditures exceeding 65 percent of total spending. The impending rollout of the new e-SISTAFE (public financial administration system) should also ensure a better monitoring of priority expenditures. A cautious approach is warranted in devolving resources to subnational levels, with proper sequencing, supported by sufficient administrative capacity-particularly at the district level. "The reinvigoration of the public sector reform program under a new public service authority is welcome. In particular, the installation of a clean, integrated payroll database based on a civil service census should help rightsize the civil service in line with more comprehensive sectoral strategies. The anti-corruption and judicial sector reform should be accelerated, in order to improve public perceptions and strengthen the constituency for reform. "The authorities' commitment to seek non-recourse financing for the transfer of majority ownership of the Cahora Bassa hydropower plant from Portugal to Mozambique will avoid an increase in the government's liabilities to commercial creditors, and to ensure transparency and accountability. "The Bank of Mozambique's stated policy of pursuing base money targeting in conjunction with a flexible exchange rate regime is welcome. This framework will help keep inflation under control, and cushion against exogenous shocks. In this regard, a more consistent monetary policy stance will be supported by greater exchange rate flexibility, when conditions permit. Parliamentary approval of the new foreign exchange law will allow Mozambique to establish full current account convertibility. "The Fund stands ready to remain engaged with Mozambique as it builds on its track record of strong macroeconomic performance and program implementation," Mr. Portugal said.