Document of The World Bank FOR OFFICIAL USE ONLY C to ?z m 024 Report No. 7987-MOZ STAFF APPRAISAL REPORT MOZAMBIQUE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT NOVEMBER 21, 1989 Industry and Energy Operations Southern Africa Department lbis document has a resicted dIstbutio and may be u_d by recipiens only In the peaformaace of their officrl duties. its contents may not otherwise be diosed wit Wodld Bsnk authizaon. C UVA,SY EQVALES (OCTOBER 1989) USS 1 - 813 Meticais (MT) - October 1989 US$1 . 682 Meticais (NT) - at time of appraisal (March 1989). MT 1000 - US$1.47 ABBREVIATIONS AND ACRONYMS AEPRIMO Association of Mozambican Private Entrepreneurs LM, Banco de Mocambique BPD Banco Popular de Desenvolvimento 3STM Banco Standard Totta de Mocambique ,CADR Caixa de Credito Agrario e Desenvolvimento Rural EFC Enterprise Financing Component ERP Economic Rehabilitation Program FB Final Beneficiaries QAPI Gabinete de Consultoria Dos Projectos da Pequena Industria IDIL Instituto Nacional da Desenvolvimento de Industria Local MCA Ministry of Construction and Water MIE Ministry of Industry and Energy PFI Participating Financial Institution PPF Project Preparation Facility SEILA Secretariat of State for Light Industry (now part of HIE) SME Small and Medium Enterprise UCPI Coordination Unit for Industry Import Programs UGP Apex Unit (Unidade de Gestao de Projecto) FISCAL YEAR Government and Public Enterprises: Calendar Year FOR OMCIL USE ONLY MOZAMBIQUE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS CREDIT AND PROJECT SUMMARY ..................... . i-v I. INTRODUCTION .... . . . . . . . . . . . . . . . . . . . . . . 1 II. THE INDUSTRIAL SECTOR .... . . . . .. 2 The Economic Background .... . . . ... . . . . . . . . 2 Industrial Development .... . . . . . 3 The Structure of Industry . . . . . . . . . . . . . . . . . 5 Post Independence Industrial Stra.tegy and Planning . . . . . 6 The Role of Small and Medium Faterprises . . 7 The Current Business Climate . . . . . . . . . . . . . . . . 8 Current Industrial Output and Employment . . . . . . . . . . 9 The Market for Industrial Products . . . . . . . . . . . . . 10 The Reform of Industrial Policy . . . . . . . . . . . . . . 11 The Economic Efficiency of Industry . . . . . . . . . . . . 13 Industrial Strategy and Implications for Small and Medium Enterprisu Development ..14 Institutional Structure for Small Enterprise Promotion . . . 15 Instituto Nacional da Desenvolvimento de Industria Local. (IDIL) . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 III. THE DEVELOPMENT OF THE FINANCIAL SECTOR AND THE DEMAND FOR INDUSTRIAL CREDIT .17 Financial System, Institutions and Background . . . . . . . 17 The Strategy For Financial Sector Reform. . . . . . . . . . 18 Banking System Arrears .... . . . . . . . . . . . . . . . 21 Organization and Operation of the Banks . . . . . . . . . . 22 Bank of Mozambique .22 Banco Popular de Desenvolvimento (BPD) .25 Banco Standard Totta de Mocambique (BSTM) . . . . . . . 27 The Financial Sector: Summary and Conclusions . . . . . . . 28 The Role o.i the Small and Medium Enterprise Development Project in the Financial Sector Reform Strategy . . . . . . . 29 The Demand for Industrial Credit . . . . . . . . . . . . . . 29 IV. THE PROJECT ..31 Project Objectives ..31 The Role of IDA and the Rationale for Assistance. . . . . . 31 Project Concept ... . . . . . . . . . . . . . . . . . . . . 32 Project Description . . . . . . . . . . . . . . . . . . . . 33 The Enterprise Financing Component . . . . . . . . . . . . . 33 Technical Assistance and Training . . . . . . . . . . . . . 34 Project Costs and Financing Plan ..35 V. ANALYSIS OF THE ENTERPRISE FINANCING COMPONENT . . . . . . . . . . 37 The Enterprise Financing Component and its Rationale . . . . 37 The Apex Unit and Institutional Arrangements . .38 Participating Financial Intermediaries . . . . . . . . . . . 39 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Operating Mechanism and Credit Management Process . . . . . 40 Subproject Eligibility and Selection Criteria . . . . . . . 42 Accounting, Auditing and Reporting . . . . . . . . . . . 44 VI. THE TECHNICAL ASSISTANCE AND TRAINGNG PROGRAM . . . . . . . . . . 44 Technical assistance . . . . ...... . 44 Training Program . . . . . . . . . . . . . . . . . . . . . . 46 VII. DISBURSEMENT, PROCUREMENT AND IMPLEMENTATION . . . . . . . . . . . 47 Disbursement . . . . . . . . . . . . . . . . . . . . . . . . 47 Procurement . . . . . . . . . . . . . . . . . . . . . * * 48 VIII.SPECIAL ISSUES . . . . . . . . . . . . . . . . . . . . . . . . 48 The Role of Women in Industry .. . . . . . . . . .. 48 Environmental Considerations ... . ...... 49 IX. PROJECT BENEFITS AND RISKS ........ ...... ...... 49 X. RECOMMENDATIONS. AGREEMENTS AND UNDERSTANDINGS TO BE REACHED . . . .50 Conditions of Credit Effectiveness . . . . . . . . . . . . 50 Conditions of Disbursement......... co Assurances received from the Government . . . . . . . . . 51 kAnexes: Annex 2.01 Structure of Manufacturing Industry Annex 2.02 Scale Distribution of Industry Annex 2.03 Enterprises So14 bv the State Annex 2.04 1988 Production Data (HIE Heavy Industry) Annex 2.05 Department of Planning, Production Table Annex 2.06 Financing of Enterprises under the Small Medium Enterprise Fund Annex 2.07 Import Tariff Rates - 1989 Annex 2.08 Short Run Domestic Resource Cost Analysis Annex 2.09 Small Enterprise Credit Scheme Annex 2.10 Decree No. 6188 Instituto Nacional de Desenvolvimento da Industria Local (IDIL) Annex 2.11 IDIL - Organization Chart Annex 2.12 IDIL - Provisional 1989 Budget Summary Annex 2.13 External Donor Financing of IDIL Inv.stments Annex 2.14 Legal Status of Enterprises Annex 2.15 UNIDO Study - Main problems affecting the firms Annex 2.16 Export Retention Rates, 1986-88 Annex 2.17 Fixed Consumer Prices, 1980-April 1988 Annex 3.01 Structure of Interest Rates, September 1989 Annex 3.02 Distribution of Bank Credit to the Economy !.nex 3.03 Estimated Subsidies to State Enterprises Annex 3.04 Bank Branch Networks - June 1986 Annex 3.05 Distribution of Deposits by bank and terms 1980-1988 Annex 3.06 Evolution of Lean Asset Structure and Rationalisation of Arrears - BM Annex 3.07 Subsectoral Breakdown of Bank Credit Annex 3.08 Banco Popular de Desenvolvimento - Organization Chart Annex 3.09 Structure of Loan Authorization Responsibility (BPD) Annex 3.10 Summary Accounts of Banks Annex 3.11 BPD Provisional Balance Sneet Annex 3.12 Proposal for the Financial Rehabilitation of BPD's Loan Portfolio Annex 3.13 Lending Arrears: BST, BPD Annex 3.14 Industrial Credit Survey: Summary of Credit Responses Annex 3.15 Mo-etary and Credit Developments - 1984-88 Annex 3.16 Baak of Mozambique - Organization Chart Annex 4.01 Project Cost Estimates and Financing Plan Annex 5.01 Participation Agreement - Draft Annex 5.02 Operating Policies and Procedures for the Financing Component Annex 5.03 Instructions for Preparation of Subproject Appraisal Report Annex 5.04 Instructions for Rediscount Request and Appraisal Framework Annex 5.05 Terms of Reference for Interdepartmental Commission (CI) Annex 5.06 Preliminary Operating Budget - UGP Annex 5.07 Information Requirements for Project Completion Reports and Supervisions Annex 6.01 Terms of Reference - Adviser to UGP Annex 6.02 Terms of Reference - Technical Assistance for upgrading of accounts of the commercial banks Technical Assistance for the Study of the Restructuring of the Banking System Annex 6.03 Terms of Reference - IDIL *^mall Business Advisory Service Annex 6.04 Proposed Small Business Lovisory Service (IDIL) - Terms of Reference and Provisional Budget Annex 7.01 Approximate Projected IDA Disbursements Annex 7.02 Disbursement Arrangements Annex 7.03 Procurement Arrangements Annex 8 Selected Documents Available in the Project File HOZANBIQUE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT CREDIT AND PROJECT SMI4ARY Borrower: People's Republic of Mozambique. Beneficiaries: Ba'! of Mozambique, Ministry of Industry and Energy Institutc Nacional da Desenvolvimento de Industria Local (IDIL), participating banks, and eligtble small to medium scale business enterprises. Amounts SDRs 25.1 million (US$32 million equivalent) Terms: Standard IDA terms, with 40 years maturity Onlendina terms From the IDA funds of US$32.0 million equivalent, the Bank of Mozambique (BM), acting as executing agent, would make available approximately US$28.5 million to the participating financial institutions MPFIs), for onlending on the basis of actual loan approvals and agreed eligibility criteria. The remaining total of about US$3.5 million would be retained by BM (Central) for technical a. sistance to the banks and the industrial promotion organization (IDIL), and for training. The PFIs would onlend the credit proceeds in local currency to beneficiary enterprises at adjustable interest rates based on the structure of rates prevailing in Mozambique. The onlending credit risk would be borne by the PFIs who would receive a spread as determined within the banking system. The foreign exchange risk would be borne by the BM (Central) on behalf of the Government, and would be covered by the interest yield on funds onlent, net of the service charge on the IDA credit, the administration costs, and the spreads of the PFIs on onlending. Subloans under the Credit would have a maturity of 3 to 12 years with 1 to 4 years grace period. The onlending terms and conditions are to be reviewed annually. Prolect Obiectives and Description: The aims of this project are: (a) to promote the rehabilitation and development of manufacturing, processing, and a range of service industries by providing foreign exchange financing to small an! medium enterprises capable of efficient operation within the reformed business environment; (b) to restore the capacity of the banking system for the delivery and management of credit to enterprises; and (c) to assist the Government in the formulation of industrial policy. - li - There are two components, nanely (a) financing, and (b) technical assistance and training. The financing component is to be based on an apex line of credit which will be made available to BM (Central) through a Subsidiary Administration Agreament and onlent to the commercial arm of BM, the Banco Popular de Desenvolvimento (BPD), and the private sector Banco Standard Totta (BST). The project as a whole, including the line of credit, will be supervised by an apex unit in BM and there will be a project steering committee. Subject to meeting efficiency (including environmental) criteria, subloans will be available for fixed investment, permanent working capital, and sub*-oject preparation service. Technical assistance will finance consultancy inputs to set up the apex unit and the initial operations of the Credit, to advise on upgrading the accounting capabilities of the commercial banks, and to carry out policy advisory studies in the industrial and financial sector. There would also ba support to the IDIL to set up a small business advisory service, part of whose role would be to support subloan applications. A training program for bank employees, initiated with UNDP financing, will be completed under the Project. A Business Environment Study has been completed which provides the policy basis for the project. Proiect Benefits and risks Subprojects using the line of credit would be expected to earn a rate of return above the opportunity cost of capital. For subloans of over US$250,000, the economic rate of return would be expected to exceed 122. For all subprojects the required financial rate of return would also exceed 12Z. Thus the total financing component would be expected to earn a return of over 12X. Significant economic benefits would arise from the startup and rehabilitation of SMEs which are efficient earners or savers of foreign exchange, and capable of yielding substantive employment and income. In addition, benefits would flow from improvements in financial infrastructure. - tit - There are three main areas of risks (a) problems in the banking reorganization, the lack of credit experience of the banks themselves, and the need to resolve entorprise financing problems, could result in delays in implementation; these potential problems would be addressed through technical assistance and training; (b) social or political pressures might cause a slow-down in the price reform under the ERP; however the commitment shown by Government suggests that these risks are amall; finally, (c) there is the risk of deterioration of the security situation; however because of t.heir small capacity and because the large majority are urban-based (and these are likely to comprise the bulk of subloan applications), SMEs are likely to be less vulnerable to disruption of rural infrastructure, supplies and markets. - iv - PROJECT COST ESTIMATES (US$ Million or equivalent) Item Local Foreign Total Z Cost Cost Cost of Total (1) Enterprise Financing Component Civil works, machinery, equipment, spares, materials 10.00 34.07 44.07 Consultants services 0.50 1.50 2.00 Sub Total 10.50 35.57 46.07 01.8 (2) Institutional Strengthenilng Component IDIL Advisers - 0.36 0.36 Equipment. facilities 0.05 0.07 0.12 Apex Unit/UGP Adviser - 0.36 0.36 Equipment, facilities 0.05 0.20 0.25 Materials, operating costs 0.05 0.10 0.15 Consultants Services Studies (finar.ciallindus) - 0.24 0.24 Training 0.05 0.48 0.53 PFI accounts upgrading - 2.00 2.00 Policy Study (Business environment) 0-12 0.12 SUB TOTAL 0.20 3.93 4.13 8.2 (3) TOTAL 10.70 39.50 50.20 100.0 - V - PROPOSED FINANCING PLAN (US$ Million or equivalent) Local Foreign Total z Cost Cost Cost of Total (1) Enterprise Financina CauuDonent IDA - 28.57 28.57 European Investment Bank - 7.00 7.00 Enterprises 5.50 - 5.50 Participating Banks 3.00 - 3.00 Government 2.00 - 2.00 Sub Total 10.50 35.57 46.07 91.80 (2) Ihstitutional Strengthen1np Component IDA - 3.43 3.43 UNDP - 0.50 0.50 Government 0.20 - 0.20 Sub Total 0.20 3.93 4.13 8.20 (3) Totals 10.70 39.505 0.20 100.00 of which: Total IDA - 32.00 32.00 63.70 Total Cofinancing (EIB, UNDP) - 7.50 7.50 15.00 Total Banks and Enterpriset 1.50 - 8.50 16.90 Total Government 2.20 - 2.20 4.40 Total Cost 10.70 39.50 50.20 100.00 APPROXIMATE PROJECTED IDA DISBURSEMENTS (US$ million or equivalent) Fiscal Year 1990 1991 1992 1993 1994 1995 1996 Total Enterprise financing - 2.00 4.00 6.00 6.00 7.00 3.57 28.57 Equipment - 2.58 0.50 - - - - 3.08 Training - 0.10 - - - - - 0.10 Refund of PPF 0.25 - - - - - - 1.00 Totals 0.25 4.68 4.50 6.00 6.00 7.00 3.57 32.00 Cumulative disbursements Z 0.80 15.40 29.50 48.20 67.00 88.80 100.00 MOZAMBIQUF SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT STAFF APPRAISAL REPORT 1. INTRODUCTION 1.01 The Government of the People's Republic of Mozambique has requested an IDA Credit of US$32 million for a Small and Medium Enterprise Development Project (the Project). The Project comprises two principal components - an enterpr.se financing component (EFC), and an institutional strengthening component. The EFC consists of a line of credit to be onlent through the banking svstem. The institutional strengthening component consists of technical assistance and training, designed to upgrade the lending capability of the banks and the industrial promotional infrastructure, and to support industrial policy formulation. 1.02 This Project supports and complements the Government's ongoing Economic Rehabilitation Program (ERP) launched in 1987, by assisting with the rehabilitation of the industrial and financial sectors. The ERP has had a significant impact on industry through changes in exchange rate policy and foreign exchange allocation, interest rate reform and credit control, reform of public expenditure and its financing, and by decontrol of enterprise pricing, output and distribution, previously under the control of the central planning authorities. The private sector, both in industry and banking, has been accorded a revitalized role, and the Government is actively seeking ways to introduce private sector participation into the state and 'intervened' companies. Aid flows which have supported the ERP have also been used to provide short-term import support for industrial enterprises, permitting production to continue during the adjustment phase. 1.03 The Project builds on the short-term import support assistance which has up to now been the main focus of external aid efforts to industry in Mozambique, and starts to address the longer term issue of industrial investment and rehabilitation, focussing upon the smaller enterprise sector, which has shown potential as an important source of future growth. At the same time the Project is concerned to stimulate the recovery of the banking sector and the revival of prudent investment lending to enterprises, which has in recent years all but ceased as a result of inter alia shortage of foreign exchange, and the need to support short term enterprise operating deficits. 1.04 The Government of Mozambique, over the period 1987 to 1989, has demonstrated clearly its commitment to reform of the financial sector, in order to restore the position of the banks as mobilizers of savings for efficient investment. Of most significanci have been reform of interest rates and credit controls, carried out in conjunction with the IMF, cessation of lending to finance enterprise operating deficits, enterprise asset revaluation and debt clearance, and the reemergence of private banking along with a major reduction in the lending share of the Central Bank and progress towards separation of its commercial from its central banking functions. The latter measures, also supported by the IMF, are aimed at the revival of the Central Bank's regulatory and policy making role. -2- 1.05 Total cost of the Project would be about US$50.2 million including approximately US$39.5 million in foreign exchange. The proposed IDA credit would amount to US$32.0 million, 64S of the total Project costs. Cofinancing of US$0.5 million has been provided by UNDP for project preparation; US$7.0 million has been provisionally proposed by the European Investment Bank. 11. THE INDUSTRIAL SECTOR The Economic Backsround 2.01 At independence the economy of Mozambique was built up around four main activities - subsistence agriculture, processing of agricultural commodities for export, migrant labor, and transititourism services. The external account depended on merchandise exports (principally cashew nuts, prawns, cotton and tea), transit trade (from South Africa, Zimbabwe and Malawi), tourism, and mine workers remittances, (largely from the South African coal mines). The revenue from remittances and services was usually sufficient to offset deficits on the merchandise trade account, which ranged between 20? and 352 of import value over 1960 to 1973. The industrial sector expanded rapidly from a low base in the five years preceding independence, following the opening up of the economy to private foreign investment. 2.02 Following independence a series of major setbacks occurred. These included the departure of 90? of the settler population, and virtually all skilled manpower over 1974-77, which forced the Government to take over control of numerous industrial enterprises. The emigration also had particularly savere effects on plantation agriculture, rural distribution and the railways and ports. In 1974, foreign exchange reserves were almost fully depleted. The overall situation was aggravated by the diversion of transit trade to South Africa, reductions in mine labor remittances, and fall off in tourism earnings. 2.03 In 1980 serious problems arose with the intensified attacks by armed bandits. Inter alia this led to a 602 reduction in exports over 1980 to 1984. In addition, the central c-ntrol of prices and production resulted in major exchange rate and price distortions in the production and banking sectors, with diversion of goods on to parallel markets. The shrinking of the tax base as a result of the departure of the settlers, and the subsidies to enterprises assisted the growth of the fiscal deficit which grew to 30? of GDP. In addition by 1987 external debt exceeded US$3.0 billion and the debt service requirements exceeded 200? of exports of goods and services. The balance of payments gap was met by donor assistance amounting to 80 - 85? of Mozambique's foreign exchange inflows. As a result of the fundamental problems facing the economy GDP per capita is estimated to have declined by 50? in real terms between 1973 and 1983. 2.04 In January 1987 the Economic Rehabilitation Program (ERP) was initiated. The ERP introduced major macroeconomic changes with respect to the exchange rate, credit controls, public expenditure, pricing, trade and distribution of goods, taxes and tariffs, and a series of other measures related to these. The state Central Plan, in force since 1978, has been reduced in scope to more of a review function. As a result of the ERP - 3- measures, and major international financial support, including foreign debt service renegotiation, real GDP is estimated to have risen by about 42 in 1987 and 1988. 2.05 The major source of growth has been the family and private commercial farm sector, which responded to improved price incentives and probably also to the increased availability of consumer (incentive) goods. In addition industrial production rose by about 7? (see below) in 1987, after six years of decline, and the rise seems to have continued in 1988. A recovery in merchandise exports occurred from a low point of US$79.0 million in 1986 to an estimated US$105 million in 1988. Inflation and fiscal deficit targets have been met, and the exchange rate is now around 40 to 502 of the parallel rate, implying a considerable realignment of internal and external prices. The impact of the ERP has to be seen in context, however; production still remains well below 1980 levels and the serious problems of security remain, along with those of inadequate skilled manpower and rundown capital stock. Industrial Development 1, 2.06 Pre-independence. Apart from a few agroprocessing plants such as sugar and sisal, industrial development began in Mozambique in the 1930's, when Portugal turned its attention to its colony as a source of raw materials. From about 1930, smaller scale manufacturing started partly to supply the settler community. At the same time certain industries were curtailed in the colony, in order to ensure that markets were open to Portuguese exports, (as in the case of the Portuguese textile industry, Which was based on Mozambican cotton exports). After 1946, the emerging industrial sector diversified away from primary processing into consumer and intermediate manufacturing. The first textile factory was permitted to start production in 1952, and cement productiox expanded rapidly. The domestic market was boosted by a sharp rise in the settler population to about 240,000 by 1970. The most rapidly growing industry was metals and enginecring, which recorded an increase of 302 per annum from 1964 to 1970). Import substitution manufacture increased its share of total industrial output steadily, from approximately 372 in 1955 to 612 in 1972, while the share of export processing activities declined proportionately. Nevertheless the most important subsector (in terms of employment and investment) remained primary processing, i.e. cashews, tea, sugar, sisal fibre, cotton ginning, and edible oil. There was extensive South African investment in cashew processing, which by 1973 comprised about 252 of organized industrial employment, and was a major world supplier. 2.07 Over the period 1957 to 1970 the rate of growth of industrial output averaged between 6 and 72 per annum, with an acceleration to over 102 during the period 1965 to 1969, as Portugal opened up the economy to foreign investment, particularly from South Africa. The 'open door' policy for foreign investment included a series of incentives such as tax holidays, and profit repatriation entitlement; previous regulataons requiring financial 11 The discussion of this chapter is elaborated in the Business Environment Study, IDA May 1989, Chapters 2 and 3. - 4 - participation by Portuguese firms were dropped. In one sense the legacy of this period has been helpful to industrial viability, because the need to face foreign competition probably resulted in the establishment of economically efficient operations. However, the new enterprises also tended to be highly dependent on imports, and were often equipped with second hand machinery; their reliance on foreign managemhent and technicians was also a potential weakness. Summary data on enterprises and employment in manufacturing and processing over the period prior to independence in 1974 are as follows. Table 2.1 Bnterprises and employment 1962 - 73 1962 1967 1969 1970 1972 1973 Number of enterprises 1283 1602 1802 1904 1488 1418 Employment 59090 68653 73044 85050 95810 99503 Sources Estatisticas Industriais; various years; Instituto Nacional de Estatistica 1973. 2.08 The post independence decline. Following independence in 1974 the exodus of 200,000 Portugiese settlers caused a serious disruption in production since the settler community had all but monopolized managerial and skilled jobs. This situation necessitated the 'intervention' by the Government in numerous enterprises, many of which were by then in a state of neglect, and in some cases with heavy debt arrears. The coal mines were taken over after two serious accidents. Formal nationalization however only occurred in the case of petroleum refining and a shipping company. A series of closures and amalgamations of foreign owned banks took place to create the state controlled central bank (the Bank of Mozambique) and the Banco Popular De Desenvolvimento. The Banco Standard Totta remained private. The state also took over commercial operations necessitated by closure of Portuguese firms. In 1975 criteria were established for intervention, including a 60 day delay following the publication of a statutory notice during which owners of abandoned units or their representatives could oppose. A total of about 300 enterprises were intervened initially: including many small distribution outlets which were after 1980 returned to the private sector. In 1987, a total of 140 manufacturing and processing enterprises were listed as intervened. It appears that the Government has returned the majority of enterprises to private ownership, largely in the small-scale distribution sector, but increasingly in manufacturing. 2.09 Table 2.2 shows a partial index of industrial production for the recent periods - 5 - Table 2.2 21 Index of Industrial rroduction (1980 - 100) al 1973 1975 1980 1982 1983 1984 1985 1986 1987 1988 Total manufac- turing output 139 87 100 90 70 56 43 42 45 50 est. a/ The index applies to nationally registered enterprises (approximately 50 workers and above), and excludes certain industries. 2.10 The rapid decline in output immediately after independence was partly reversed by 1981. In 1981 however sabotage of infrastructure by armed bandits bugan. 1986 output fell to less than half its 1980 level in manufacturing and agroindustry, and 302 of the pre-independence peak production. Sabotage was responsible for the decline of electric power generation from 11.3 GWH in 1980 to 0.4 GWH in 1986. Petroleum refining was halted in 1985. The centralized control of production, distribution and pricing probably also reduced the ability of enterprises to adapt to adverse conditions. Capacity utilization of industrial plant fell to 302 or less in 1986 in many industries. The most seriously affected industries were sugar (6Z utilization), cashew, oils and soaps (10Z), because of their reliance on domestic materials and transport subject to sabotage. In manufacturing the most seriously affected were containers and paints (both estimated at 82), while only batteries and radio assembly recorded higher than 50X. In 1987, however, there was an increase in industrial output, the first for six years, as a result mainly of increased material provision through donor import support; it is expected that this increase would have been maintained in 1988. The Structure of Industry 2.11 The composition of industrial output. Annex 2.01 shows the structure of employment and output, for 1973 and 1987 over all manufacturing and processing enterprises. Despite its externally dependent situation, in 1973 industry was relatively diversified, with a relatively high level of internal linkages. In particular metals and engineering had a significant share of output. The traditional colonial industries, represented mainly by the food, beverages and tobacco sector, comprised 44Z. The largest single industry in terms of value added contribution was sugar, and the largest in terms of employment was cashew processing. The split between consumer, and producer (intermediate and capital) goods production was approximately 67 t 33 in terms of value added. The direct export sector comprised about 202. In 1987 the structure of industrial production shifted towards textile and garments subsector, as a result of investments in the 1970's; there has been a major decline in the case of nonmetallic mineral products partly due to the security constraints on particularly the cement industry, which is producing 21 Source: UNIDO Informacao Estatistica, Commi8sao Nacional de Plano (CNP) 1987, and provisional MIE estimates. Based on gross output. -6- at less than 30X of its 1981 level. The preindependence engineering base is still largely intact, but in great need of refurbishment. 2.12 Industrial location. In 1973, Maputo (Lourenco Marques) province accounted for 44Z of employment, and 51S of industrial value added. Beira and Maputo together accounted for 60Z of employment, and 71. of value added. The most widely distributed industries were cereals milling, cotton ginning, sisal, and timber which were located largely outside Lourenco Marques/Maputo province. In general the food and fibre processing industries, as expected, were widely distributed, while manufactured goods such as rubber, plastics, chemicals, paints, and metals and engineering were heavily concentrated in the two major towns. By 1987 the recorded pattern was altered with a considerable increase in the share of Maputo province. Maputo and Beira continue to dominate the sector in terms of employment and output. There are advantages in this in terms of economies of concentration and secAtrity considerations for those enterprises not dependent on materials srom upcountry. However, against this in the longer term is the issue of income distribution and regional balance. 2.13 Ownership structure. As stated, following independence the ownership of industry changed radically as a result of the decision by the state in 1975 to 'intervene' abandoned or commercially sabotaged enterprises. After an initial intervention in about 300 enterprises the 1977 law 31 permitted various changes, including full state ownership or reversion to private ownership, depending on the circumstances. In 1984 the structure of ownership of 575 nationally registered enterprises was as follows: state 114; intervened 140; private 294; mixed and cooperative 27 (see Annex 2.14). The extent of public ownership is a constraint on industrial rehabilitation and mechanisms for expanding private sector involvement are being discussed 4/. Post Independence Industrial Strategy and PlannIng 2.14 The rapidly developing economic difficulties of the country in the early 1980's obliged the Government to set aside long term plans that had been drawn up previously which had laid emphasis on large scale basic industries such as iron and steel, aluminum, and chemicals. In 1983 the 4th party congress adopted a new policy emphasizing the increase in utilization of existing capacity, rehabilitation, and a new focus on small scale industry and the private sector. The role of the central plan, which had set targets for pricing, production and distribution since 1979 for about 575 nationally registered enterprises, started to be reduced. By 1983 it was accepted by Goverrment that a greater degree of flexibility had to be introducee into the system. The current situation is that the plan is now based on 'tottom up' submissions of production price and shipment figures rather than the 'top down' instructions of the Planning Commission. Nevertheless, business behavior in the industrial sector is still constrained by the effects of past controls - e.g. there is little procurement or marketing experience, nor 3/ Decree Law No. 18177 4/ Some options are also examined in the Business Environment Study; op cit. - 7 - experience of actively seeking opportunities for profit making. This applies to both the public and the private sector enterprises. The Role of Small and Medium EnterDrises 2.15 As stated the role of small and medium enterprises in the economy has only become a focus of Government concern relatively recently. Available statistics for the scale distribution of industry in 1973 and 1987 are at Annex 2.02. Bearing in mind omissions and under-reporting, the scale structure has shifted towards microenterprises (under 10 workers), which comprised 11Z of 1987 employment compared with 2? of 1973 employment in industry. The 1987 employment in microenterprises is shown to have doubled over 1973. The total micro and small scale sector, defined as enterprises with 1 to 100 workers, comprised 25Z of total employment in 1973 and 31? in 1987. The small tO medium scale category in 1987 (all enterprises of 1 to 200 workers) would include over 90Z of enterprises with 46Z of total employment. At the other end of the scale, for large enterprises of over 500 employees, the 1973 share of 402 of employment has fallen to 29Z, largely because of the semi-closure of industries such as cement, cashew processing and sugar. By subsector the cmallest average scale is in the wood products and textile (garment) industries (average 15 workers). The food sector also has a relatively large number of micro and small enterprises but also contains the largest (e.g. sugar). 2.16 The overall 1973 estimate of 252 of employment in all recorded enterprises of under 100 workers appears comparatively low; this could be accounted for by the known history of rural Mozambique before independence where a combination of migrant labor and plantation agriculture may have distorted downwards the contribution of rural industry. The 31? estimate for 1987 however also reflects the low capacity utilization of larger enterprises as well as a switch towards the smallest scale of production. 2.17 In the case of Maputo province alone the employment figures show an increase in employment between 1973 and 1987, from 43,000 to 46,400 (see Annex 2.02). The Maputo results confirm that the only sector to exhibit significant growth, contrary to the overall trend, has been microenterprises with under 10 employees. There is also an increase in employment in the largest scale categories, which is principally explained by the establishment of textiles in Maputo province during the early 1970's. The structure of microenterprises in Maputo in 1987 was dominated by the garment industry, (consisting of 210 separate enterprises with 42? of total microenterprise employment). The next most important activities were engineering and metal products (small repair shops), and wood products. 2.18 Enterprises in the range of 10 to 200 workers have not fared better than the rest of industry; however, those employing less than 10 workers, largely metalwork and small mechanical workshops, wood products, and garment producers, seem to have countered the decline over the sector as a whole. The evidence of relative dynamism in the smallest firms is not easy to interpret; given the highly protected post independence environment and severe lack of foreign exchange and skills, it is possible for the small enterprise sector with lower dependence on imports and technical skills to earn profits even with high pricellow quality products. Nevertheless, the apparent fact of -8- solid growth in this sector is consistent with international experience and it is likely that small scale enterprises are potentially economic as a result of their ability to utilize capacity more fully, and their more appropriate pattern of factor utilization, including use of indigenous skills and managerial know-how. 2.19 In terms of the reestablishment of longer term investment lending in Mozambique, there is therefore an a priori justification for identifying a target group of more managerially and technically progressive enterprises within these subsectors which are looking to expand capacity from workshop scale. The Current Business Climate 2.20 Security. An inescapable issue is that of the security situation which has effectively isolated the rural economy and population. This constraint affects industry both in terms of procurement of raw materials and the sale of finished products. There is however some optimism in the business community that the situation will be alleviated as the economic reforms assist in the reintegration of the rural economy through price incentives to commercialized agricultural production. 2.21 The role of the Government, while still predominant, has shifted towards policy setting and away from detailed decision making. Its main function is now perceived by business to be its role in taxation and allocation of foreign exchange, and therefore must be conceived in terms of its ability to provide the right type of incentive framework. State enterprises are in principle expected to rationalize their production and costs based on their ability to sell at competitive prices in the market. Government policy is now openly discussed with the business community. This change is reflected in the creation of the Association of Mozambican Private Entrepreneurs (AEPRITO) and the Industrial Association AEPRIHO in 1988. Two industrial conferences were held in 1987 and 1988, and Government statements showed strong support for increasing the role of the private sector. 2.22 New investment and company formation. Industrial investment since independence has been limited, and concentrated in cereals processing, ship repair, bus assembly, timber processing, farm implements, vegetable oil, and textiles. Industrial investment financed by the state reached a peak in nominal and real terms of 251 of total public investment expenditure over the period 1981-83, averaging about Mt 4.0 bn per annum. However, there was a decline to a 1986 nominal level of Mt 1.30 bn. Indications of an upturn ir. activity may be seen in renewed investor interest. Foreign investment proposals increased significantly in 1988, with over 20 being approved, compared to 15 over the period 1985 to 1987. As of January 1989 approximately 20 further proposals were under investigation, mainly tourism and trade related; processing industry proposals included fish, cashew nuts, and tobacco. 2.23 A number of company sales to private entrepreneurs at the national level have occurred over the past few years. A total of 45 company sales are reported over the period 1983 - 88 (Annex 2.03). These included principally wood products manufacturers and electrical equipment agencies, as well as -9- food, beverages, oil and soap, garments, leather, plastic products, and metalvorks. Sell offs have increased over the period, with a bunching in 1987 and 1988. At the local level (defined by the Government as the group of enterprises with less than about 50 workers), 40 company privatizations were recorded over 1985-88. Of these 26 were in Haputo, 4 in Nampula, and 12 in Beira, largely in small wood-working and metal-working units. There have been very few new company registrations at the national level in recent years. At the 'local' level new company registrations in Haputo amounted to about 150 over 1985 - 88 of which 50 were bunched over the period Tanuary to October 1988. The products included largely food processing (including milling), wood and metal work, and to a lesser extent garments and pottery. 2.24 Pricing and distribution. Prior to 1987 all costs and prices of finished products of nationally registered enterprises were strictly controlled. Companies generating losses due to price control were given automatic access to credit from the banking system. Three categories of prices now exist: (a) controlled, which apply to about 7 industrial products, including milled grain, oil, and soap (see Annex 2.17); (b) conditional, which permit enterprises to set prices on a cost plus markup basis, and to submit for ex post approval which is generally given; and (c) free prices. The conditional category is transitional between controlled and free prices. Initially the new process for approving price increases was slow and cumbersome, both within the fixed price and conditional price category, but by the end of 1988 it had been reportedly speeded up. In those few cases where industrial products are still price controlled, official prices are also being regularly adjusted to reflect real costs. The number of products subject to price control will be reduced progressively. 51 2.25 Prior to 1987, all industrial goods from nationally registered enterprises were supposed to be sold to government designated buyers. For producers with low quality products the system of designated buyers was a major benefit as all production was guaranteed to be sold. This meant that producers were not accountable for poor quality, which in turn led to a breakdown in the quality control functions, and labor efficiency. The reforms of January 1987 began to eliminate designated buyers, and firms have become more conscious of normal marketing considerations such as price and quality. Additionally, the concept of cost accounting has become more important, particularly in the area of raw material costs. Current Industrial Output and Emplo7ment 2.26 In 1987 industrial production expanded for the first time since 1981. The index of production (Table 2.2) was about 6-7Z above that of 1986; this was mainly due to the effects of donor import support programmes, including two IDA Rehabilitation Credits which allocated about US$60 million to industry. The recovery was however spread unevenly between branches. In 1987 the major increases were in textiles (21Z), wood products (46Z), chemicals and plastics (161), and basic metals (136X). However tobacco, and leather registered declines. Provisional data for HIE enterprises (over 50 workers) in 1988 show an overall increase of about 20? in real terms (Annexes 5/ See Hozambique; Policy Framework Paper, 1988-90 - 10 - 2.04 and 2.05). covering both increases and declines. The available statistics show a continued recovery from the low point of 1986. although production has not yet approached the level of 1980. It would be expected that the poor state of plant and equipment in many enterprises would act as a constraint on further significant increases, prior to more major renovations of plant and equipment. There is also the problem of a possible market constraint, discussed below. 2.27 Several estimates of current employment are available. A 1987 labor survey shows employment of 66,500 in manufacturing, (with 17,700 in construction, and 3,700 in public utilities), covering all enterprises. The National Planning Commission estimates 87,800 in manufacturing for nationally registered enterprises alone (22,100 in construction and 4,600 in public utilities), which would give an adjusted estimate of total industrial employment in manufacturing and processing enterprise of about 110,000. UNIDO 6/ estimated a total of 150,000 employees in the organized sector, plus 30,000 in locally registered units and a further 20,000 in microenterprises. Given the difficulties that have faced industry since 1973, when industrial employment was estimated at 99,500, combined with the relaxation of laws related to security of employment in 1985, the current organized sector total is likely to be in the range 80,000 to 100,000. The Market for Industrial Products 2.28 There is no certainty that either the short or long-term level of demand within the economy is sufficient to justify the retention of all existing industrial capacity. Aggregate demand for industrial goods may be considered to have been influenced by longer term demographic changes, and the more immediate impact of devaluation on the pattern of urban/rural demand. There have also been transitional problems resulting from uncoordinated imports (e.g. garments), and donor aid goods such as blankets, soap, cooking oil, and agricultural tools which have constrained the market available to local producers. 2.29 Demand in the long run. The level and pattern of demard have been influenced principally by the settler exodus in the 1970's, partly offset by the arrival of the foreign aid community, and internal and external migration caused by sabotage and dislocation. Consumption shows a 11Z reduction over five years since 1982, and an estimated reduction of around 212 since 1973. The Business Environment Study estimated that, without the effects of the dislocation and refugee problem, aggregate consumption would have increased by 15 to 202 since 1973 given zero growth in consumption per capita. However, the market for higher value manufactures would not have risen as much, since the departure of the settlers would have affected this sector disproportionately. Thus it is possible' that the market for manufactures would have expanded little if at all over 1973 to 1987, even without the dislkcation. Demand for some industrial products (particularly consumer durables) could take several years to regain its 1973 level, even with reestablishment of peace. 6/ UNIDO Industrial Situation in Mozambique' May 1987. - 11 - 2.30 lmpact of devaluation on purchasing power. The impact of devaluation on the market has more immediate implications for the industrial sector. Relative costs have fallen, but urban real wages and purchasing power ! would be expected to have fallen as well; at the same time the rural market, which would have been expected to have gained from changes in domestic relative prices, is partly inaccessible because of disruption of distribution infrastructure. The indications of the trend in urban real wages are ambiguous; however, if there has been a significant reduction in urban real income tnen discretionary purchases would be severely cut back, while essentials such as food would be cut but to a lesser extent. The first types of expenditure to be cut back would be for consumer durables such as electrical goods (e.g. radios) and bicycles, as well as clothing, beverages and cigarettes, and certain nonessential processed/packaged foods. Certain industries have in fact noted a decline in production from 1986 levels due primarily to a retraction in demand. These include oils and soaps, footwear, mattresses, cardboard containers, car tires, bicycles. and PVC pipes. 2.31 Problems related to the security situation. In terms of marketing and distribution the security problem had made the delivery of goods to (and from) rural areas difficult and in some cases impossible with a severe reduction in the accessible market. In addition farms unable to get commercial crops to market because of disrupted transport would havc suffered a significant reduction in ircome, and reduced purchasing power. Increased producer prices would in this situation be unable to increase effective purchasing power. It is notable that smaller scale production of manufactured goods generally would be less vulnerable to security problems to the extent that it draws supplies and delivers to markets within neighboring areas. The Reform of Industrial Policy 2.32 The most important reforms related to industry that have taken place or are in process under the Economic Rehabilitation Program are the following. 2.33 Exchange rate and foreign exchange allocation. Currency devaluation has tended to lower the real value of domestic factor payments, particularly real wages, and has improved the medium/long term competitive position of labor intensive and domestic resource based industry. A phased opening up of the foreign exchange market is in process through the new system for nonadministrative allocation of foreign exchange, under the IDA Third Rehabilitation Credit, and through mechanisms such as special funds - the 'market fund' for trading companies, and the 'small medium e_terprise fund' for producers. In 1988 a total of US$6.0 million was disbursed under both funds (SME fund financing is at Annex 2.06). The fund allocatiun for 1989 is expected to total US$25 million. In addition an export exchange retention scheme was introduced in 1984 (see Annex 2.16). 2.34 Pricing and distribution. Since January 1987 price policy has aimed at reducing the number of products with fixed prices and allowing prices to be more related to costs of production and market demand. Distribution policy is expected to continue to change alongside pricing, with a reduction in the number of final products subject to administrative - 12 - allocation to 15 in 1989. All enterprises are now permitt-ed to trade directly rather than through a trading company; state trading companies are expected to compete with the private sector. However, control on foreign procurement is still partly exercised through foreign exchange allocation and import licencing, with control of some internal trade through rationing. Recommendations on reform in foreign exchange allocation and import licencing have been made to the Government in the Businesa Environment Study, and special arrangements have been made regarding import licenses for equipment financed by the present project (see para. 5.19). 2.35 Investment incentives. Positive efforts to attract foreign and domestic private investors are being made through the establishment of trade essociations, and through privatization and joint ventures. The 1984 and 1987 foreign and local investment laws relating to tax exemptions and !'centives and foreign exchange retention included tax holidays, depreciation and capital allowances, and exemptions from labor income tax, turnover tax, and import and export duties. In 1988 a debt-equity swap law was passed setting out conditions under which foreign investors could acquire local assets. The export retention scheme, despite limitations, is a particularly important inducement to foreign and local investors. However, the actual impact of the system is difficult to judge in current conditions where investment is constrained by numerous other factors (summarised in Annex 2.15). Proposals for refinement of the incentive framework in a number of areas have been made in the Business Environment Study. 2.36 Tariff and tax reform. From 1987 to 1989, partly as a result of discussion with business, reforms have been instituted to rationalize and simplify the system of company taxes, and trade tariffs, and to introduce the concept of limited tariff protection as opposed to quantitative controls. Among the main changes has been the abolition of dividend taxation. Under the Business Environment Study simplification and increased transparency of the system is recommended, in order to improve the incentive framework. The IMF has also proposed certain modifications to the system 71. The current structure of tariff rates is shown in Annex 2.07. 2.37 Enterprise financial restructuring and financial services capacity. Restructuring is required because of the effects of devaluation and accumulated debt on enterprise balance sheets. These effects distort tax liabilities and discourage bank lending. By December 1988 the Government had taken steps to transfer about Mts 8.0 billion of the debt of 10 state and intervened companies to the Central Budget, where revised terms and conditions of repayment will be worked out. Transfers up to now have been confined to public sector companies. Some individual debt reschedulings have also been arranged through the Bank of Mozambique, on easier terms. A decree has been issued requiring revaluation of assets of enterprises within 1988 balance sheets. The regularization of bank lending and the establishment of an accountable private sector also require auditing capacity to be set up, and some progress is being made in this regard. A system of standard accounts was instituted in 1984; however, there is an acute shortage of accountants and the Government is considering allowing foreign accountancy firms to open 7/ 'Memorandum on the tax system of Mozambique' IMP January 1988. - 13 - offices. Currently, capacity for external auditing of enterprise accounts is not sufficient; internal auditing is carried out and auditing for tax purposes is undertaken by the Ministry of Finance. 2.38 Campamy sales and ownirship. The overall question of company formation and ownership has been addressed by the Government through legislation relating to the intervened companies. Most recently (1989) there has been a move to transfer some intervened companies to the state sector as a possible precondition for eventual company sale. The Government has sold off assets abandoned by previous owners under the original legislation, and has come to specific agreements with new owners. Sales are dealt with on a case by case basis, and no general clarification of the legal position of intervened companies has been made. Proposals for mechanisms for sell off of state assets are made in the Business Environment Study, and ownership and other corporate legal issues are being examined by a Government working group under the Minister of Industry. 2.39 Labor. In January 1987 decree law 5187 set 20 grade ranges in industry, specifying new pay levels and allowing supplementary payments sucb as performance linked and seniority bonuses. After the decree, a series of interim increases were permitted to offset part of the effects of devaluation induced price increases. The aim is to increase flexibility in employment, in terms of rewards for efficiency and ability of enterprises to lay off workers. It is intended that these measures will allow wage costs to more accurately reflect operating conditions. Industrial costs have fallen in real terms due to devaluation; however, where overmanning still exists the longer run competitive position of the industries may be adversely affected. The Economic Efficiency of Industry 2.40 The economic efficiency of the industrial sector has been improved by the series of devaluations that have taken place. The devaluation has generally lowered wage costs as a proportion of total costs so that enterprises are more competitive vis a via international prices. According to the results of an industrial efficiency analysis carried out under the Business Environment Study (Annex 2.08), in the short run, ignoring plant replacement costs, most industries are able to operate efficiently in economic terms. This means that they are earning or saving foreign exchange efficiently enough to justify the commitment of domestic resources. 2.41 The results imply that, treating plant and equipment as a sunk cost, it is economically justifiable to supply working capital and carry out organizational improvements, repairs and minor replacements over a range of consumer, intermediate and capital goods industries. There is some doubt however about industries such as textiles, certain footwear products, glass, and edible oil given the present state of their operations, and the sugar industry which at the moment is unable to cover variable costs at world prices. However, the efficiency study could only give approximate guidelines and is no substitute for case-by-case feasibility studies which would be carried out under the Project. 2.42 The long run viability of many enterprises (after taking account of costs of equipment replacement) can only be determined after detailed - 14 - analysis at the enterprise level because the current situation is distorted by excess capacity, low efficiency and possible market constraints. For many industries complete refurbishment is required which would involve not only plant -eplacement but reorganizationlreduction of the labor force and radical improvements in productivity through for example reducing material wastage if economic efficiency is to be restored. 2.43 The efficiency study included a group of small enterprises; however, the results did not suggest that this category showed a systematically different level of efficiency than the total sample; again, case-by-case analysis would be essential for determination of the specific prospects for the smaller enterprises. Industrial Strategy and Implications for Small and Medium Enterprise Development 2.44 The stagnation of industrial investment and production over the past few years, and the price distortions in the industrial sector resulting from centralized control, do not permit a clear view of the impact of the reforms on SHE. Unlike other countries there is no experience of systematic disadvantages facing SME, vis-a-vis larger enterprises, in areas such as foreign exchange allocation, fiscal incentives, access to credit, or public investment planning since the reforms of 1983, when a number of small enterprise development units were set up. In addition, foreign exchange funds were created for small enterprises and a microenterprise credit program. (see below and chapter 3). However, it would be expected that administrative allocation would tend to favor large enterprises. 2.45 In general, the reform process should favor domestic resource using, labor intensive production; these are characteristics of smaller enterprise production; in addition the SMEs would benefit from greater flexibility of production and ability to utilize capacity more fully in the context of continuing uncertainty of input supply and markets. It is in this sector that an earlier supply response may be expected while larger enterprises attempt to rehabilitate their rundown plant and. equipment, and disused marketing and distribution systems. 2.46 The strategy for rehabilitation of industry involves the creation of an environment in which industrial ent.epreneurship can be fostered; this requires a difficult transition frum a supply-oriented planned industrial sector to a market-oriented environment in which production and investment respond to market and price signals. It is likely that smaller enterprises are in a better position to make the transition. The process of price (and wage) adjustment must continue in order to allow costs and prices to vary according to domestic market conditions, and secondly in order to permit domestic prices to converge over time with international prices, so that an efficient distribution of production between domestic and international markets is attained. This requires continued action in main policy areas of the ERP. - 15 - Institutional Structure for Small Interprise Promotion 2.47 The Govern.-nt decision to switch policy in favor of small-scale enterprise resulted in the rapid creation of small industries units under several Government Institutions - Ministries of Industry and Energy (MIE), Agriculture, Fisheries, Construction, and Labor. The Banco Popular de Desenvolvimento (BPD) set up a department specializing in small enterprise credit. n January 1988, Instituto Nacional da Desenvolvimento de Industria Local (IDIL) was formed from the Department of Local Industry as an independent agency under the Secretariat of State for Light Industries (SEILA). In 1988 MIE and SEILA were merged, and IDIL became an agency of MIE. 2.48 In addition, in 1984 the Gabinete de Consultoria dos Projectos da Pequena Industria (GAPI) was founded as a technical assistance unit for small enterprise mainly in rural areas (supported by the F. Ebert Fcundation of the German Federal Ripublic). GAPI has approved a total of about US$1.2 million to about 90 projects over four years and also arranges technical assis_ance. The disbursed loans (to about 50 projects) have averaged about US$18,000. The modal range of loans has been US$6,000 to US$25,000, and they are largely directed to small rural units, such as grain mills, vegetable oil, soap, woodworking and pottery. The actual geographical dispersal has been restricted largely to Cabo Delgado, Niassa, and Maputo provinces. Recently a number of loans have been approved in Tete province (see Annex 2.09). 2.49 The coordination of SHE promotion is complicated by the fact that the Provincial Directorates of Industry and Energy have responsibility for registration, licencing and promotion of industry in their region, and have a dual reporting function, to both the MIE and the Provincial Governor. However, the situation is being clarified as the agency which has been oificial.y designated the role of promoting small scale enterprise is IDIL, and IDIL delegations are to be attached to existing provincial directorates. Instituto Nacional da Desenvolvimento de Industria Local (IDIL) 2.50 IDIL is a technical advisory agency, legally established in 1988 under decree No 6188 (Arnex 2.10). The president of IDIL now reports directly to the Minister of Industry and Energy. The decree states that IDIL would have the following main areas of activity: (a) appropriate technology development and transfer; (b) technical support and consultancy assistance; (c) arranging of local and external financing, and mobilization of external cooperation; (d) training; (e) provision of advice on industrial protection; (f) registration and data collection; and (g) promotion of industrial activity based on local resources and needs. 2.51 IDIL (and its predecessor DIL) collaborated with GAPI in the processing of mos. of the projects financed by the Ebert foundation and a few additional projects sponsored by other bilateral donors. Of 100 projects proposed about 50 have been approved, of which 36 were under the GAPI program (see para 2.48). The level of investment averaged about US$10,000. The main types of activity financed were, as in the case of the GAPI program, wood products, vegetable oil pressing and soap, and cereal milling, plus a small number of other activities, including repair units, pottery, tanning, - 16 - vegetable and fish preservation. The actual role of IDIL in these projects has been mainly one of checking proposals which may have been forwarded by BPD, and in working with GAPI to arrange technical support and loans. On occasions IDIL has also despatched its own technician or arranged one from elsewhere (e.g. through the Sector Ministries) to assist in appraisal or repair/installation of equipment. IDIL's in house technical staff currently consists of technicians (chemicals and leather', supported on occasions by teci.nicians from its technology development a iliate, PRODIL. The latter company has produced and installed a number of village oil presses, and some prototypes of other equipment, along with its main commercial production of metal furniture. 2.52 The provisional staffing target of IDIL is 28 in 1989, and in the medium term 44. Of these latter about 19 may be categorized as professional or semi professional staff, and 25 as administrative and support. These exclude provincial delegation staff. Five departments would be set up, - administration (including economics and accounts), technical, training, management, and external relations (see Annex 2.11). IDIL delegations are being set up in the provinces of Sofala, Cabo Delgado, Niassa, Inhambane, Zambezia, Tete and Nampula. 2.53 The most recent 1989 IDIL budget requires expenditure of Hts 62.9 million against estimated receipts of Hts 21 3 million. (Annex 2.12), excluding the proposed IDA Project. All expatr-iate assistance costs are assumed to be financed outside the budget. Sources of local finance for operating expenditure are deficient by about Mts 41.6 million, or 601 of administrative and personnel costs, but this deficit is expected to be met out of the Government budget. The proposed 1989 equipment investment budget of Mt 242.8 million is financed largely (861) by four foreign aid projects, totalling approximately US$306,000 (Annex 2.13). The potential for making IDIL self supporting will be improved by the proposed Small Business Advisory Service (para 2.57). 2.54 From the point of view of the SME Project, there are limitations to the extent that technical assistance is likely to be effective for IDIL in the short run. This is (i) because IDIL's experience up to now has been with mainly micro-enterprises in rural areas; and (ii) because of its currently very small size and reliance on Government budgetary resources (which the mission were informed have now been committed). In addition, the number of external donors interested in assisting IDIL inevitably creates pressure on its internal administrative capacity. Nevertheless, the Government has made it clear that IDIL will be the principal vehicle for promotion of the smaller enterprise sector in general. Proposals for other external assistance received by IDIL, which are either ongoing or are under serious consideration, have come from UNIDO, ILO, Swedish and US Governments and non-government organizations from Holland, Italy and the Eduardo Mondlane foundation. Assistance includes technical personnel, vehicles and office equipment. 2.55 An alternative approach to assisting IDIL under the Project was examined; this involved a skills exchange, to be set up with a local currency budget to subcontract technicians from existing larger industrial enterprises for provision of assistance to smaller enterprises, avoiding build up of IDIL - 17 - in-house technical staff, but at the same time allowing expansion of technical capacity. However, the Government felt that any approach taken at this stage should be more cautious, and should consist of advisory assistance targeted at areas not covered by other resources, primarily in support of the effective use of the proposed line of credit. 2.56 IDIL's future program also includes a proposal for setting up a small industry development fund (Fundo de Fomento a Pequena Industria). It is proposed that this would be a fund managed by the BPD, and would be a development of the existing GAPI system. 2.57 The proposed IDA assistauce program under the Project would be limited in scope because it is not considered that the IDIL organization is sufficiently strong as yet to absorb larger external inputs. It would, therefore, be confined to provision of a pilot small business advisory service designed to provide financial, management and marketing advice to business in Maputo and Beira areas. The limited size of the assistance program is justified because it is not considered that the IDIL organisation is not sufficiently strong as yet to effectively use a larger input. This project component is elaborated in Chapter 6. Ill. THE DEVELOPMENT OF THE FINANCIAL SECTOR AND THE -DEMAND FOR INDUSlRlAL CREDIT. Financial System, Institutions and Background 3.01 Mozambique's financial sector currently consists principally of three banks, and one insurance company. In addition, there is an Agricultural Credit Fund and two development funds - for agricultural and irrigation projects - which are administered by, but not strictly part of, the banking sector. The following analysis is restricted to the banking system, which attained its current configuration after a restructuring in 1978, involving closures and the amalgamation of a number of foreign banks under the control of the state sector. Of the three banks currently operating, one, the Bank of Mozambique (BM), acts both as Central Bank and as the leading commercial bank. A second fully state owned bank is the Banco Popular de Desenvolvimento (BPD). The third bank, Banco Standard Totta de Mocambique (BSTM), is a foreign-owned private bank. 3.02 Over the period 1980 to 1986, the banking system acted as a conduit for financing the production plans of the economy. A rapid expansion of domestic credit occurred so that while GDP fell in real terms by 8Z per annum over this period, domestic credit expanded rapidly, and serious arrears were built up amounting to over 50Z of lending by 1986. Interest rates on lending and borrowing were not used for rationing of credit and were controlled at negative real rates. Bank deposits were very largely non-interest-bearing demand deposits. The situation was not conducive to mobilization of real savings and would normally have led to excess demand for investment funds, even in the highly adverse investment environment. However, the nonavailability of foreign exchange for import of investment goods constrained investment, so that liquid reserves were accumulated. Lending tended to be concentrated in BM, partly financed by deposits from the other - 18 - banks. Deposits in the commercial banking sector were predominantly short term in character (including refinancea overdrafts). The dual role of the BM was not conducive to the development of its regulatory and policy making responsibility. Commercial banks were able to maintain financial stability because of the high levels of liquidity, and lack of alternative outlets for savings within the underdeveloped financial mLrket; book earnings were apparently positive because of high yield margins over the average cost of deposited funds (and also possibly because of the accrual of unpaid interest). However, even with nonperforming loans accounted for at full value, combined capitalization was not adequate. 3.03 As stated in chapter 2, public investment fell by about two thirds in nominal terms between 1980 and 1986; data on private investment are not available but it fell to a negative net level where enterprises were not maintaining their capital. Thus the foreign exchange shortage, repression of interest rates, and the other problems facing the banking system resulted in a situation whereby over the period 1980-86 the banks virtually ceased financing longer-term borrowing for investment, especially in industry. (Finance of enterprise operating deficits was entered in bank balance sheets as long term debt, but this was not related to investment). To address this situation, the Government since 1987 has adopted a series of relatively radical measures for the banking sector under its Economic Rehabilitation Program (ERP), with the objective of restoring capability for efficient mobilization of savings and allocation of investment. The pace of chsage implies a high level of commitment. The measures taken have been included in agreements between the Government, IDA and the IMF. The Strateay For Financial Sector Reform 3.04 Process of financial reform. The task which the Government has embarked on since 1987 is complex and lengthy, requiring that the financial sector undergo a transition from a system whose main purpose was the administrative allocation of public funds according to the requirements of the central plan, to one in which private savings can be effectively mobilised and channelled to economic investment outlets via a market determined price (interest rate) system, and which can be monitored and regulated through monetary instruments by the central bank. Under the previous system the main instrument of monetary control was the annual credit plan, which complemented the annual production plans; the interest rate was effectively redundant and monetary and regulatory control of the banks was impracticable. In order to rehabilitate the financial sector, the reform process has had to address the following basic areas: (a) interest rates; (b) institutional development; (c) financial restructuring of the banks, ld) establishment of performance guidelines. The combined effect of reforms ia all these areas would be to raise domestic savings and ration credit via the price system to more profitable outlets, allow necessary specialisation of the functions of the central bank, and permit a fresh start to be made in the commercial banking system. 3.05 The ERP, reflected in the Government's Policy Framework Paper, has initially addressed (a) and (b) above. Under the program agreed with the IMF, nominal interest rates have teen increased in successive steps toward positive real levels as the rate of price inflation declines, with a target - 19 - of achieving positive real rates in 1990. The interaction between the fiscal and monetary policy has been addressed by setting targets (ceilings) for the fiscal deficit in combination with bank credit ceilings, whereby Government financing by the banking system has been significantly reduced in real terms; in addition, banking system financing of operating losses of enterprises has been curtailed and a portion of doubtful loans transferred from the banking system to the Ministry of Finance. These measures have in turn permitted progress under (c) above, in terms of the restructuring of the balance sheets of the commercial banks by the removal of a portion of nonperforming assets. In the institutional area, the complex task of separating the Bank of Mozambique (BM) into its central and commercial functions has been initiated. This separation is a necessary step towards the restoration of the central bank's regulatory and monetary control functions, and its role as financier of central government. In addition, some initial progress has been made on diversification of instrumeits of Government Finance and prudential regulatory controls. 3.06 The no-xt stages of the rehabilitation of the financial system will require continued progress on interest rate reform and on institution building and reorganization. The financial restructuring area is relatively less advanced, and the reintroduction of an effective regulatory system for the commercial banks will to some extent require inter alia the prior achievement of progress in restructuring and the final clearance of lending arrears, which, up to now, has been confined to those of BM (see paras. 3.15 and 3.16). The regulatory powers of the BM have not been utilised because, for example, reserve requirements have not been effective due to excess derosits in the commercial banks and, in consequence, the central bank re iscount facility has been redundant 8/. In addition, regulations concerning financial performance and prudent lending have not been effective because of the financing of enterprise deficits during the period of central planning. The pace at which improvements can be made in these areas depends to a large extent on the progress of institutional reform, in terms both of organization (of the BM), and in terms of capacity (skilled manpower) of all the banks. In particular, manpower constraints in the commercial banks in the area of accounting, financial management and credit analysis will take time to resolve, as well as skill shortages in central banking functions. The proposed project will provide technical assistance and conditionality related to the next stages of the financial sector rehabilitation (para. 3.42). 3.07 Structure of interest rates. The structure of lending rates of interest in Mozambique is shown in Annex 3.01. Rates in effect from 1981 to 1986 were very low in nominal terms, ranging from 0 to 62 for deposits, and 3 to 102 for lending. and negative in real terms. The structure of interest rates was revised with effect from January 1987 according to Mozambique's agreements with the IMP for a Structural Adi1!<ment Facility (SAP), with rates ranging from 31 on demand deposits and 121 to 201 on time deposits, and 54 different lending rates ranging from 12X to 35X. Provision was also made for a rediscount rate of 101, applicable on amounts up to 61 of demand deposits, and rising to 121 on amounts up to an additional 61 of demand deposits. The most recent revision of rates came into effect in September 8/ These powers are codified under the Organic Law, decree 2/75. - 20 - 1989, with the number of lending rates now reduced to 16, ranging from 152 to 35?. The number of term lending rates (over one year) has declined from 27 to 7, and the range contracted from 18-35Z to 22-35Z. Time deposit rates are in the range 14? to 222 and the Central Bank rediscount rate is now unified at 122. These interest rates remain negative in real terms. Nevertheless, the higher interest rate structure will have a positive impact, with credit demand shifting to firms that have better prospects in the current business environment. Under the terms of Mozambique's agreement with the IMF, they should continue under review and be revised progressively with a view to achieving positive real interest rates by 1990. This is likely to be achieved on the basis of current projected inflation rates. Under its Policy Framework Paper Government has committed itself to reduce over time the differential between subsidised and commercial rates of interest. Annual reviews of progress on achieving positive (weighted average) real interest rates would also take place under the proposed project (see para. 5.13). 3.08 Credit control and lending shares. Mozambique had no active formal credit allocation policy until 1987, when a ceiling on domestic credit expansion was introduced of Mt 40 billion. Of this amount, Mt 25 billion were allocated to lending to the state, with the remaining Mt 15 billion being allocated amongst the three banks for lending to the economy, according to their share in lending. Additional credit expansion was allowed under agreement with the IMF to the extent of the countervalue in meticais of certain foreign exchange resources, such as World Bank loans. For 1988, the ceiling was raised to Mt 74 billion, of which Mt 20 billion for lending to the State, and Mt 54 billion for lending to the economy (including state enterprises). There was thus a very significant decline in 1988 in real terms in the level of banking system financing to be made available to the State. This shift partly reflects changes in the channelling of financial resources to state enterprises, in the context of rationalization of their operations, as well as increasingly tight controls on the Government's budget and the desire to prevent 'crowding out' of the private sector. 3.09 Data for 1988 show a below-ceiling Mt 64.9 billion expansion in domestic credit, and a distinct shift in the allocation of funds had become apparent 9/. In 1986, BM accounted for 792 of total bank lending, BPD for about 182, and BSTM for about 32; by end 1988 these figures were 69.5X, 23.62 and 4.3? respectively, with the remaining 2.62 lent by the newly established Caixa de Credito Agrario de Desenvolvimento (CCADR). More significant are the shares in incremental lending in 1988 (i.e. out of the additional Mt 64.9 billion): BM lent less than 482 of this amount, with BPD accounting for almost 37?, BSTM for close to 7Z, and CCADR for almost 9?. Along with the opening up of foreign exchange transactions (para. 3.11), competition between the three banks is beginning to strengthen, although progress is constrained by shortages of skilled staff. Once the banks have addressed their urgent training needs, promotion of fuller competition will be critical to the development of an efficient financial sector. Under the Project assurances were received that the Government would formulate a program, by June 30, 9/ The relending of reimbursements from the Government to BM however effectively increased new lending outside the ceiling by about 10? (see para 3.15). - 21 - 1992, for the continued extension of competition within the banking sector, to be implemented promptly thereafter. 3.10 At present, there are no established guidelines for the sectoral distribution of credit, although they are under consideration. In recent ye&rs, agriculture has accounted for around half of total bank lending; of the remainder, industry accounts for about 172 (39-422 if primary transformation of agricultural products is tncluded). while construction accounts for about 5-72, transport and communications around 12-14Z, domestic trade some 7-9? and foreign trade 6Z. These shares have not changed significantly over the period 1986-88, except for an increase in domestic trade credit. Data for BM suggest that manufacturing industry receives some 11? of total lending. As of end 1988, BH accounted for 702 of total lending to industry, down from 85Z in 1986, while BPD and BLZM accounted for 13.5Z and 12.92 respectively, and the newly established CCADR accounted for 3.5Z (see Annex 3.07). 3.11 Foreign exchange operations. When the banking system was restructured in 1978, it was also decided that BM would have a monopoly on foreign exchange operations (handled through the commercial department of BM). The Government is now moving towards a loosening of this monopoly; in particular, the private sector bank, BSTM, has recently been granted a limited foreign exchange license. 3.12 Deposit regulations. A further constraint on competition in the banking system has been the restriction of firms to holding an account at only one bank. An exception has been made for firms that have their account with either BPD or BSTM and subsequently require a foreign exchange account, for example for export activities, which must be held at BM. The lifting of .his restriction is under consideration by the Government, in order to encourage greater competition between the banks. BM is also considering introducing compulsory deposits with the Central Bank, which could potentially facilitate monetary regulation. Provision might be made for remunerating any deposits over and above the compulsory level. 3.13 Government fimnance. Treasury bonds were introduced in a very limited way in 1988 (Mt 10 billion, on which interest is paid in US dollars at an annual rate of $1.30 per Mt 10,000 bill), and a secondary bond market has been initiated, under the responsibility of the recently established Sociedade de Investimentos e Estudos Financeiros (SOCIEF). The more widespread use of Treasury bonds is expected to provide an alternative investment for both institutions and individuals, thus reducing the liquidity of the banking system and pulling interest rates on bank deposits up to a level reflecting the opportunity cost of Government resources. Extending the use of Treasury bonds could have significant positive affects on the allocation of funds in the economy. Banking System Arrears 3.14 Despite the indications of positive progress, the banking system still faces a serious arrears problem, which has arisen from several sources (see Annexes 3.06 and 3.13). A significant portion of the arrears dates back to independence, when many Portuguese firm owners left the country; a number - 22 - of these firms were subsequently intervened by the Government. The bulk of the arrears of the private bank, BSTM, date from this period. The largest share of arrears, however, has stemmed from lending, largely to state enterprises and intervened firms, by the banks (mainly BM and BPD) at the Government's request. Much of this lending was to cover operating deficits (up to 1986 inclusive) considered to be due to price controls and the difficult economic environment facing the firms. Total figures for this type of lending, and for arrears arising from it, are not currently available. Since 1987, the Government has covered such deficits through direct fiscal subsidy and has reduced their level substantially; in 1987, such subsidies totalled Mt 9.1 billion, most of which went to the agricultural sector, with the total declining to Mt 6.8 billion in 1988 (Annex 3.03). 3.15 The Government has decided to address this aspect of the arrears problem by assuming much of this type of debt itself. Since 1988, BM tLas been holding negotiations on these measures with the Government; it also held a great part of these arrears, exceeding Mt 40 billion (see Annex 3.06). The other two banks are now undertaking similar negotiations with the Government; this will be especially significant for BPD which faces major arrears from the state farm sector (see Annex 3.13). As yet, the total amount of debt the state will assume is not clear, although a mechanism has been found to provide the necessary resources: i.e. the metical countervalue of funds made available under the first two IDA Rehabilitation Credits has been (at least partially) earmarked for this purpose. 3.16 If the banks had to recognize the full extent of their current arrears as a loss, they would all have highly negative net worth. Whether or not write-offs are necessary, however, the current capital base of the banking system is no longer adequate in view of the greatly increased asset base. The capital to assets ratio was about 4? for BM in December 1987 after an 82? capital increase 10/, 2.32 for BPD, and 1.12 for BSTM. Under the technical assistance component of the proposed Project these aspects would be reviewed and the need for capital reconstruction evaluated. In order to reestablish a viable banking sector it is important that current negotiations between the Government and BM for the clearing of lending arrears be also extended to BPD and BSTM. Assurances were received that the Government through BM would, on the basis of agreements with all commercial banks, formulate an action program to settle lending arrears of the commercial banking institutions (including BM (Commercial), by December 31, 1991, and an action program for the rehabilitation of the banking system, by June 30, 1992, for prompt implementation, to include performance benchmarks in terms of capitalization ratios and arrears ratios. Organization and Operation of the Banks Bank of Mozambique 3.17 BM is by far the largest of the three banks, and the one with the broadest mandate. It was created in 1975 to take over the central banking 10/ Based on the ratio equity to gross assets applicable to BM's commercial banking activities. _ 23 - role previously played by Portugal's Banco Nacional Ultramarino, and in 1978 absorbed the Mozambican operations of four Portuguese-owned banks. 3.18 Branch structure and lending responsibilities. As Annex 3.04 indicates, DM has 10 filiais (provincial head offices), 17 agencias (district branches) and 13 delegacoes (deposit offices). The limits attributed to each branch for credit approval are currently under review. Loans above the approval limit of the manager of a filial are referred to headquarters for approval. The loan request will be reviewed by the relevant lending directorate (industry, agro-industry, or trade, transport and others) for submission to the Director, the department General Manager or, if necessary, the Governor for approval. Each directorate has three or four credit analyst staff, including on average one university graduate, with the rest either high school or vocational training graduates. 3.19 BM is concerned to improve the quality of analysis in its branches, in order to be able to delegate more approval authority to that level. This would free the headquarters' analysts to put together new types of credit operations and focus more on overall coordination. Among the constraints are the number of qualified personnel; the problem is a national one, and BM as a whole has only some 20 university graduates. The lack of data processing and transport equipment is a further constraint. These problems are being addressed under this project through the training program and technical assistance (Chapter 6), and are also the subject of bilateral donor aid. 3.20 Lending share. Annex 3.07 shows the distribution of credit by sector and bank. BM lending between 1987 and 1988 rose strongly in trade and Lransport sectors, while lending to agriculture, industry and construction fell in relative terms. This resulted in an overall lending decline in the relative share of agriculture from about 42? to 39Z of total lending, while industry's share declined slightly from 172 to 162. The overall share of domestic trade increased from 8? to almost 14?, construction and foreign trade each accounting for about 7-82, and transport and communications for the remaining 17-18Z. 3.21 The separation of central and commercial banking functions. The two functions of PM, as Central Bank and commercial bank, have been clearly distinguished in the bank's Organic Law of 1975. However, in practice, AM has not distinguished these functions for accounting or operations. A new organizational structure was introduced in BM in 1987 in order to help define the lines along which the central and commercial banking roles should be separated (see Annex 3.16) 11/. Of the eight departments, two have purely central banking functions (Planning and Economic Studies, and Banking Inspection), two have purely commercial banking functions and the remaining four serve both parts of the bank. The separation of activities within three of the remaining four departments poses no major conceptual problem, since 11/ The Bank of Mozambique's Board of Directors is entirely internally constituted, comprising the Governor and the eight department Administradores (General Managers). - 24 - they are support departments 12/. The Department of International Relatioas and its directorates are responsible for negotiating all foreign loans/assistance to BM and to the Government. This involves issues of institutional responsibility for foreign exchange risk. It is expected that it may take some two to three years fully to resolve this and other control issues and to reflect the results in BM's accounts. To this end a new accoanting framework has been under implementation with IMf assistance in all the banks since July 1989. 3.22 The separation of accounts of BM will permit all aspects of operations to be clearly identified as pertaining to either the central banking or the commercial banking function of BM. A full separation of accounts along these lines is not expected to be available before 1992, however, for reasons explained above. The establishment of a new commercial bank, and the transfer of BM's commercial activities to it, is also a possible option for the Government. Under the project assurances were received from the Government that a phased program for the separation of BM's central and commercial banking functions would be provided to IDA by June 30, 1991, leading to its prompt implementation thereafter. 3.23 The Government's desire to introduce greater competition within the financial sector is constrained in practice by the lack of development of BH's central banking role (particularly its regulatory functions). While the other banks also face constraints with respect to their operational capabilities, these can be most effectively resolved by allowing, and indeed encouraging, them to compete effectively. The etrengthening of BM's central banking role will thus continue to be of considerable importance. The recent shifts in new credit allocation show positive progress in decentralization of the system, and under the Project an action program for extension of competition would be formulated (see para 3.09). 3M's Financial Situation 3.24 Foreign exchange liabilities. The financial situation of the commercial banking area of BM is sensitive to the decision about whether it should retain foreign exchange liabilities on its balance sheet. Foreign medium-to long-term debt booked at Mt 37 billion at year-end 1986 rose by end-1987 to Mt 413 billion, and Mt 612 billion by end-1988, due to devaluation. The difference constitutes as yet unrealized foreign exchange losses. If foreign borrowing were accounted for as a commercial liability, then the separate commercial BM would clearly be insolvent (see Annex 3.10). 3.25 Because of the lack of an accounting division between central and commercial functions, the allocation of overall responsibility for individual borrowings, and for associated profits and losses, will have to be clarified on a case-by-case basis. It will then be possible to reflect this status in accounting terms using the new accounting framework. Given that in many cases foreign loans were contracted on the instructions of the authorities in order to finance the deficits of primarily state-owned and intervened 12/ These are the Departments of Legal Affairs and Financial Participations, Staff and Administration. - 25 - enterprises, it may be considered appropriate for most foreign exchange liabilities to be placed on the Central Bank's balance sheet. These issues are currently being addressed with the assistance of an IMF-financed advisor. 3.26 Deposits. Annex 3.05 shows the evolution of banking system deposits since 1980. BM's demand deposits were Mt 36.3 billion for a lending portfolio of Mt 108.3 billion in December 1986: some of BM's lending was financed by the other banks through their deposits with the Central Bank (Mt 16 billion in 1986), as well as through foreign borrowing. In order to make BM's commercial banking activities more self-financing, BM started to accept term deposits in 1987 and to stimulate sight deposits. BM's share in total deposits rose from 46S in 1986 to 592 by December 1988, capturing 69Z of incremental deposits over that period. As a result, deposits rose to 752 of lending portfolio (excluding Government), as opposed to only 48Z in 1986 (Annex 3.10). 3.27 Lending arrears. As stated in paragraph 3.15, the Government has agreed to take over responsibility for about Mt 40 billion in BM loans to state and intervened enterprises, which are in arrears and unlikely to be collectible. This amount represents only the principal in arrears, since BM does not accrue interest on doubtful loans. Annex 3.06 shows the evolution of the different components of BM's loan portfolio. Of the Mt 40 billion that the Government has agreed to assume, Mt 8.8 billion has been paid (out of countervalue paymeuts from firms receiving foreign exchange under the first two IDA rehabilitation operations), while another Mt 10 billion has been rescheduled. As a result, the proportion of these arrears to BM's overall portfolio is declining quite rapidly, dropping to 152 by December 1988 from 342 in December 1987 and 411 in December 1986. 3.28 Other arrears considered capable of rescheduling have declined from 422 of portfolio to 21Z over the same two years, while rescheduled amounts now constitute 252 of portfolio, and doubtful debts remain fairly steady at about 62. In the meantime, the satisfactory component of the portfolio has increased from 132 to 332, or to 582 if rescheduled amounts are included, or to 732 if the amounts the State has now agreed to assume are also included. BM's equity and reserves also increased substantially in the last quarter of 1987, to Mt 25.9 billion; the adequacy of this is currently difficult to judge, because of uncertainty as to the extent of the as yet unrealized foreign exchange losses that may be allocated to the commer--ial banking area of BM. However, BM is addressing the problem both from the point of view of asset quality and capitalization, and its asset position has been strengthened. Banco Popular de Desenvolvimento (BPD) 3.29 Banco Popular de Desenvolvimento (BPD) was formed in 1977, integrating the Instituto de Credito de Mocambique and Montepio de Mocambique. It has traditionally been responsible for the financing of agriculture (and, by extension, the rural sector), housing and construction, and for domestic savings mobilization. However, it is also empowered under its charter to invest in equity, new ventures, and take up commercial paper. This latter role has not been fulfilled, but recently a share capital - 26 - participation department was set up for the purpose. It also holds equity in a few enterprises, notably textiles, inherited from nationalized banks. 3.30 Bran4.h structure and capacity. BPD is 10O2 state-owned, with 10 regional and 22 district branches, 46 deposit offices and 70 savings collection posts. It thus has by far the largest branch network in the country, with 148 offices as opposed to BM's 40 (see Annex 3.04). Banco Popular de Desenvolvimento's current organizational structure is given in Annex 3.08. 3.31 The credit approval limits for BPD branches are given in Annex 3.09; loans for amounts above the General Manager's limits are submitted to BPD's President for approval. At headquarters, the lending operations directorate is made up of four sections, three of which are responsible for lending by area (northern, central, and southern zones of the country). The numbers of staff and educational levels of credit analysts both in headquarters and in the regions are very similar to those of BM. In 1987, BPD held a training course for credit analysts and is also receiving technical assistance from the Friedrich Ebert Foundation, and an AfDB loan is under preparation that would finance training and technical assistance. BPD's Financial Situation 3.32 Liquidity. BPD's balance sheet (Annexes 3.10 and 3.11) shows considerable excess liquidity, largely because its savings mobilization role has combined with the lack of lending opportunities, due to, inter alia, shortage of foreign exchange. In December 1987, over 90Z of BPD's lending portfolio consisted of nominally short term working capital loans, although it is understood that the proportion was reduced during 1988. According to BM figures, which exclude interbank deposits, in 1986 BPD had Mt 35 billion in deposits, but only Mt 22 billion in its loan portfolio (excluding loans to the State). By June 1988, deposits had increased to Mt 53.7 billion and loan portfolio to Mt 35.3 billion. According to BPD's own figures, deposits were Mt 61.8 billion in 1986, and Mt 102.3 billion by November 1988, of which Mt 39.5 billion were deposits by the State. Lending totalled Mt 29.8 billion in 1986, Mt 34.7 billion in June 1988 and Mt 53.4 billion in November 1988. Thus in November 1988 liquid assets were about 402 of total assets. 3.33 Arrears. BPD has severe arrears problems. Including lending to the state and state farms, Mt 33.9 billion of BPD's Mt 35.3 billion portfolio were in arrears by June 1988. BPD considers that, with some rescheduling,it could collect about Mt 6.0 billion of its arrears, but that it may not be possible to reschedule a further Mt 27.9 billion (see Annexes 3.11 to 3.13). A large proporti^n of the arrears are old, with Mt 10 billion corresponding to loans granted before independence, and recent arrears increases have been largely due to interest accruals on old loans. Almost 93Z of BPD's lending to the economy was to the state-owned sector, with about 1.6Z going to cooperatives, and 5.7Z to the private sector. Loans to the state sector accounted for 97?Z of BPD's arrears in late 1987 (91.5Z of state portfolio in arrears), while cooperatives accornt for 0.62 (35.72 in arrears), and the private sector for 2.6? (39.62 in arrears). A start has been made in resolving state sector arrears and it is understood that in 1988 arrears were reduced to about 502 of total portfolio, while the proportion of lending to _ 27 - the state sector was reduced to 67Z. BPD is negotiating with the Government on a more comprehensive resolution of its arrears problem, based on detailed analysis of individual loans (see para 3.16). 3.34 Earnings and capital base. As noted above, the overhang on BPD's deposits relative to lending has increased since 1986, as lending dropped from 702 of deposits in 1986 to 572 in 1987. However, the increased interest rates introduced in 1987 more than compensated for potential earnings loases because of the increased average spread over borrowing rates. This effect has been reduced however from 1988, when CCADR started borrowing from BPD at a lower rate than BPD would lend directly to the agricultural sector. (See para 3.36). Despite the higher expected net income, BPD's capital base, at about 2.32 of total liabilities, needs to be strengthened. 3.35 Future role. At present, BPD is trying to define its possible future role in Mozambique's evolving financial sector. BPD would like to offer a full range of development banking services, as allowed in its charter, lending more to indistry and the service sectors, with a significant role in financing long term investment, as well as possible equity financing. BPD has also established a small but apparently successful microenterprise credit program with the Ebert Foundation which has disbursed about US$1.2 million to 60 units, largely agro-processing in rural areas (see para 2.48). Under the IDA Urban Rehabilitation Project BPD is also responsible for managing credit to small and micro-enterprises in the building materials industry. 3.36 Caixa de Credito Agrario e Desenvolvimento Rural (CCADR). The agricultural credit fund, CCADR, was established in 1988 as a mechanism to channel credit to the rural sector. It is managed on behalf of the Government by BPD. It started operations in the second quarter of 1988, lending Mt 5.6 billion in 1988, mainly to agriculture and industrial processing activities. The CCADR provides subsidised credit (at a current interest rate of 62). Significant growth of the fund would not be consistent with rationalization of the financial sector. Its principal rationale is to channel donor finance to contractually agreed uses, and it is a fund rather than a bank insofar as it does not intermediate private or commercial deposits. Provided that CCADR retains a small share of the market, and involves a transparent form of subsidy financed by resources outside the banking system, it should not in principle adversely affect the financial reform program. Banco Standard Totta de Mocambique (BSTM) 3.37 Branch structure. BSTM is the only private bank remaining in the country. The number of branches has declined, however, from 44 before independence to 7 today. The bank's ownership is made up as follows: Standard Chartered UK, 302; Standard RSA, 52; Totta e Acores Portugal, 302; Fonsecas e Burney Portugal, 102; Anglo American RSA, 52, and others 201. BSTM lost its foreign exchange license after the restructuring of the banking sector at independence, which contributed significantly to the decline in the bank's operations. However, in 1988 BM granted BSTM a lUn'ted foreign exchange license, for personal transactions, and BSTH is planning to open two new branches in 1989. This is a positive development, which - 28 - complements the increased share of lending by BSTM. Assurances have been received from the Government that an action program for the extension of competition would be undertaken (see para 3.09). In addition capitalization and arrears targets will be required (see par& 3.16). BSTM can be expected to continue to rehabilitate traditional commercial banking activities in the future, and has recently started discounting bills. BSTH Financial Situation 3.38 Liquidity. Although it has operated on a much smaller scale than the other two banks, BSTM has had the same type of deposit overhang as BPD, with 1986 deposits totalling Mt 7.6 billion while its loan portfolio amounted to Mt 3.8 billion (Annexes 3.10 and 3.13). By August 1988, portfolio totalled Mt 6.7 billion vhile deposits reached Mt 18 billion ( Mt 11.7 billion according to BM figures for Sept 1988). Almost all lending has been short-term, to urban commercial enterprises. For a number of reasons, including portfolio arrears, deposit overhang, and the fact that BSTM deposits at the Central Bank are not remunerated, BSTM is not currently paying interest on current accounts nor accepting time deposits. 3.39 Arrears. BSTM also suffers from a serious arrears situation, with close to Mt 1.8 billion (about 40X) of portfolio classified as doubtful in 1988, most of which stems from the period just after independence. Again, however, this amount is dwindling quite rapidly as a proportion of total portfolio. BSTM has constituted provisions against some of its bad loans, and adds to them each year. However, BSTM's capital base of 1.1 of liabilities is inadequate and declining in relation to the increase in nominal value of assets. Once BSTM has defined capital adequacy requirements, BSTM's shareholders would be expected to inject new equity into the bank. TV- Financial Sector: Summary and Conclusions 3.40 Mozambique's financial sector is underdeveloped and not on a sound financial footing at present, with serious arreaL-s and toe small a capital base. However, a good start has been made in the complex transition from a centrally planned environment to a market economy. The separation of BEWs two banking functions is inevitably quite a lengthy process, and could probably not be speeded up significantly since the principal binding constraint is management time. Timely provision of the institutional support already planned under other IDA projects in Mozambique will also be important. Interest rate reform has maintained progress and positive real interest rates should be achieved in 1990 given the current decline in inflatic.n and increase in nominal rates. The arrears situation is being addressed progressively by the Government. The banks' capital base is an area that will perhaps take longer to address, in BM's case because a final evaluation of the needs can only be made when the two functions are fully separate in accounting terms; in addition, the shortage of Government resources may delay equity increases for BM (Com.ercial) and BPD -- assuming that they are both to remain fully state-owned. - 29 - 3.41 In the meantime, the policy measures that DM has taken have involved cautious but sustained steps towards revival of commercial banking. In addition, the financial sector is reflecting the changes in the real economy, with the recent shifts in the sectoral distribution of credit, as well as an increasing share of lending being channelled through the other financial institutions. These are all strong indicators both of BM's intent to continue liberalizing the system and of the syst3m's basic capacity to adapt to the changing environment. The Role of the Small and Medium Enterprise Develoment Prolect in the Financial Reform Stratea 3.42 The Project is designed to support the Government's strategy for financial sector reform. The proposed apex line of credit would be a multibank instrument which would assist in the extension of competition, and reintroduction of longer term investment lending and appraisal skills. Under the Project a series of formal action programs would be prepared and implemented, for the separation of the commercial and central banking functions of EM, the clearance of lending arrears and financial restructuring of the commercial banks, the introduction of performance guidelines, the continued extension of competition within the banking s ctor, and the upgrading of the accounting capabilities of the commercial banks. The Project therefore focuses particularly on the micro aspects of banking system reform, while also addressing issues such as institutional change. Under an annual project implementation review interest rates will also be monitored. Finally, the Project addresses the real economy issues of improving the efficiency of industry through lending to viable enterprises, and fills a supply gap in medium-to long-term credit during the continuing financial reform process. The Demand for Industrial Credit 3.43 The market for longer term indurtrial credit is difficult to assess because of the disruption on both the supply and demand side over the past few years. Supply of longer term credit has, as discussed above, been constrained by a series of interlinked problems, including interest rate repression, contraction in banking capacity, shortage of foreign exchange, and emphasis on short-term lending and financing of enterprise deficits on Government instruction. More recently, domestic credit ceilings have also been imposed, partly in order to reduce or eliminate bank financing of enterprise deficits. Supply conditions have started to improve with interest rate reform, institutional reorganization and reactivation of the private sector. On the demand side, credit requirement projections cannot be meaningfully based on past trends because of the disruption of lending. In order to gain an initial estimate of likely financing requirements, a credit survey was carried out as part of the preparation of the project, 3.44 The industrial credit survey was designed to obtain some indicative information about the appropriate size of the proposed lending program. A total of 200 questionnaires were di.stributed by the Government to enterprises, and 120 responses were received. A summary analysis of the results is given in Annex 3.14. The survey has a number of limitations, notably the fact that estimated financing requirements of a number of firms - 30 - were highly tentative, and also because it could not be ascertained a priori whether the enterprises responding would qualify for loans on profitability or economic efficiency grounds, especially given the uncertainty of demand. Finally, it should 'Js noted that demand for foreign exchange does not necessarily imply a need for credit as such. However, given the depreciated value of metical savings balances, a requirement for long-term credit is likely to account for the bulk of stated foreign exchange needs for equipment and inventories. The results of the survey may be regarded as a starting point. 3.45 The total estimated requirement for 119 enterprises was US$61 million, excluding a single proposal of US$10 million for one enterprise. 75 enterprises were at national level (roughly above 50 workers), and 44 at local level (below 50 workers) of which all were in the Maputo area. Total requirement at larger scale (excluding the largest proposal), was US$55 million, and at small scale was US$6.0 million. Average loan size for the larger scale group was US$822,000, of which US$420,000 was for fixed and US$402,000 for working capital. For the smaller scale group average loan size was US$127,000, of which US$78,000 was for fixed and US$49,000 for working capital. 3.46 Direct extrapolation of the sample of 75 national level enterprises for the sector as a whole (580 enterprises) is inadvisable due to the degree of uncertainty of the sample estimate. If it is assumed that 25Z of the sample estimate of $55 million were economically viable enterprises, then extrapolation would lead to a total requirement of about US$110 million for fixed and working capital. Given the time period needed to implement major replacements,or new investments, the phasing of such a requirement would probably be realistically over a three year period. Extrapolating from the 44 local enterprises to the national estimate of about 600 enterprises in the size range 10 to 50 workers is even more hazardous since the sample is considerably less representative. A lower bound estimate of US$20 million is probably a conservative starting point for smaller enterprises. The target group for the present project (enterprises of up to about 200 workers) consists of approximately 502 of the total requirement in the larger scale group of enterprises surveyed and the whole requirement of the smaller scale group, amounting to approximately US$75 million over about a three year period, at an average investment of about US$ 250,000. At an average subloan size of $250,000, the total number of subloans under the proposed IDA Credit would be about 110. 3.47 The scale of the proposed IDA enterprise Financing Component (US$28.5 million equivalent) may be regarded as conservative in relation to the requirements estimated through the survey. There is clearly a pent up demand for credit in the industrial sector, although it cannot be ascertained, a priori, whether this is from viable and bankable applicants. Under the SHE Project viability would be established prior to the granting of any loans to enterprises. _ 31 - IV. THE PROJECT. Project Objectives 4.01 The aims of this project are as followst l X (a) to promote the development of the industrial sector by providing medium to long-term foreign exchange financing focussing on notentially efficient small to medium-scale enterprises in the industrial, mining, agricultural-related, transport, construction, and other commercial subsectors, capable of efficient operation within the reformed business environment. (b) to promote institution rebuilding by restoring the capability of the public and private sector financial institutions of the country, and to facilitate the development or rehabilitation of an effective medium to long-term finaucing capability for enterprises. (c) to assist in the formulation of Government policy for industrial and financial development with emphasis on small and medium enterprises. The Role of IDA and The Rationale for Assistance 4.02 General IDA involvement In Mozambique. Eleven credits have been made to Mozambique up to November 1989, including both general balance of payments assistance and project related investment credits. The principal macroeconomic support has been through three rehabilitation credits which have been designed to support economic policy changes in particular relating to pricing and exchange rates, and to decontrol of production and distribution. The objective of sector investment credits has been to support supply responses in directly productive activities, to take advantage of improvements in the macroeconomic environment, and to support rehabilitation of social and economic infrastructure. The present project would complement the existing IDA assistance strategy, and the Government's Economic Rehabilitation Program (ERP), by strengthening the industry and finance sectors tiarough the finance of potentially efficient industrial enterprises and by strengthening the financial institutions. 4.03 IDA's role in the Industry and finance sector. Since the start of the ERP in January 1987 external assistance to the industrial sector has concentrated on balance of payments support to finance recurrent imports of materials and spares for a range of consumer and intermediate goods, notably food products, textiles and tires, and also for technical assistance. Under the First Rehabilitation Credit (1610-MOZ) US$37 million went mainly to light industries, and approximately US$25 million has so far been allocated to industry under the Second Rehabilitation Credit (1841-MOZ). The result of these inputs has been to assist industrial production to increase by 6-72 in 1987, the first increase after six years of rapid decline in output. However, this type of assistance does not address the longer term issues of the viability and structure of the industrial sector as a whole, nor the creation - 32 - of an environment in which efficient industries are encouraged to expand. It is this need which is addressed through the present project. In addition IDA is considering a credit under the proposed Industrial Enterprise Restructuring Project, which will focus on selected larger scale enterprises. 4.04 Restructuring the financial system is of particular importance for industry. The banking sector has contracted significantly and is currently unable to perform adequately the functions of mobilizing savings and intermediating credit. The banks need strengthening in order to effectively provide medium to long ter-m loans for industrial investment. Given the series of measures for financial reform already taken by the Government, and outlined in Chapter 3, and the clear resolve of the Government to revitalize the sector as central planning is phased out, this is an opportune time to assist in maintaining the momentum of revival, and at the same time strengthen portfolios, ensuring that the banks develop the capability for prudent investment lending. The project would fill a supply gap in medium- to long-term financing within the ongoing reform process. Proiect Concept 4.05 Efficient allocation of medium to long-term credit requires lending based on assessments of profitability, both in financial and in economic terms, as well as the reestablishment of conventional banking criteria. Economic analysis is important given the changing but still protected industrial environment, and continuing need to adjust relative prices. 4.06 The Project focuses on the small and medium enterprise sector; this is defined approximately as including enterprises with less than 200 workers. The importance of the sector is reflected in the fact that small and medium- scale industrial enterprises, as defined, currently account for a significant proportion (46Z) of industrial employment. The Credit is directed to a wide range of subsectors, with a focus on manufacturing, but with the expectation that subprojects will also materialize in subsectors such as mining, agribusiness, construction (including building materials), transportation, distribution and commercial services. A directed credit of this type is justified by its relatively broad focus, and by the likelihood that sources of indigenous entrepreneurship, skill formation and growth would originate across the broad spectrum of efficient smaller enterprises. Moreover, given the large number of enterprises within the sector, there is a need to create an effective decentralized institutional framework to appraise and finance project proposals. The microenterprise sector (under 10 workers) has exhibited particular resilience to the economic difficulties of the country and it is intended that the Credit would be available for enterprises at this scale as well as those in the formal economy. 4.07 The proposed lending operation is a means of rehabilitating the financial system by reintroducing the techniques and criteria for term lending, so that investment funds reach enterprises which are likely to have relatively favorable long-term prospects, and bank lending portfolios can begin to be strengthened. In order to achieve its objectives the Project focusses on the environment for efficient industrial investment and bank lending. - 33 - Proiect Description 4.08 The Project is divided into two main components: (i) an enterprise financing component (EFC), and (ii) an institutional strengthening component. The EFC consists of a line of credit to be onlent through the banking system. The institutional strengthening component consists ofs (a) technical assistance; and (b) training, the latter two components being designed to upgrade the lending capability and financial management of the banks and the industrial promotional infrastructure. The proposed IDA Credit would be made available by the Government to BM through a Subsidiary Administration Agreement. Formalization of the Subsidiary Administration Agreement, under terms and conditions approved by IDA, would be a condition of Credit effectiveness. The Enterprise Financing Component 4.09 The EFC would involve a line of credit to finance fixed asset investment, associated incremental permanent working capital and project preparation services. The EFC would be managed by an apex unit (Unidade de Gestao de Projecto -- UGP) within the central banking area of BM, established with its own operating policies and procedures. Funds would be onlent through the participating financial intermediaries (PFIs), which are expected to comprise all three commercial banks. 13/ 4.10 Approximately US$28.5 million of the IDA funds would be made available through the Subsidiary Administration Agreement to finance the EFC. In addition, cofinancing of US$7.5 million has been proposed by other donors. The PFIs and Government are expected to contribute about USS million in complementary financing in local currency, with a further minimum US$5 million equivalent expected as equity participation from enterprises. It is expected that the line of credit would be committed within a four to five year period after Credit effectiveness. There would be no pre- established allocation of credit funds between the PFIs, although it is likely that the commercial area of BM would account for the largest share due to its predominance in the finan-ial system. The foreign exchange risk would be borne by the Bank of Mozambique on behalf of the Government, while the commercial risk would be borne by the PFIs. The finance of eligible enterprises would be on the basis of prior apprais&.L. 4.11 The UGP would be responsible for the management and supervision of the EFC, and would review the aporaisals and would have to approve subloan applications above the free limit granted to the PFIs. It would also morLitor subproject eligibility, terms and conditions of onlending, approval limits, select'ic. criteria and procurement, and be responsible for disbursements, munitoring and reporting, and other issues. 13/ The role of the Central Bank in the channelling of funds is addressed in paragraph 5.01. - 34 - Technical Assistance and Training 4.12 The technical assistance will consist of: (a) the provision of expertise to assist in the implementation and operation of the line of credit, (b) assistance in the strengthening of banking capacity and industrial policy formulation; (c) strengthening of the Instituto Nacional da Desenvolvimento de Industria Local (IDIL) and (d) subproject preparation. Technical assistance for policy analysis has also been provided through the Business Environment Study, funded by UNDP. 4.13 The proposed assistance to DM would take the form of the provision of an adviser to the apex unit and a provision for consultancy assistance to address problems connected with the upgrading of the accounts of the participating banks, and the development of the financial sector. Assistance to IDIL would be in the form of the provision of two advisers to establish a small business advisory service in Maputo and Beira. A further provision is for subproject preparation and appraisal services, and for required studies of banking and industrial development issues. 4.14 The training program for credit and project analysts began in February 1989 and is due to be completed prior to the effectiveness of the Credit; it is financed by UNDP. It consists of a series of seminars and workshops, designed to provide required analytical skills in project appraisal for about 50 members of staff of the BM and PFIs, and some additional participants from IDIL and the Ministry of Industry. The program is designed to upgrade the skills required to operate the credit line as well as more general bank lending skills. Additional IDA funding is proposed for follow up training after the completion of the program. The Demand for Credit 4.15 Projections of past bank lending as indicators of credit demand are not meaningful because of the virtual halt in investment lending over the past few years, and the abandonment of normal bank lending criteria. A credit survey of 120 responding enterprises is reported on in paragraph 3.44 and following. A preliminary indication of the scale of financing that might be required for the sector as a whole, including both fixed and working capital, on the basis of survey and other estimates, is at least US$130 million from potentially economically viable enterprises. The proposed Credit would meet part of this need. 4.16 The proposed total IDA Credit is expected to be onlent at an average rate of about US$5 million per annum, which would amount to approximately 1OZ of total 1988 domestic disbursements by the banking system to the economy 14/. 14/ At the exchange rate of Mt 813 - US$1.00. _ 35 - Project Costs and Fimaucina Plan 4.17 Project costs and financing are presented in Table 4.1 and in Annex 4.01. Total project cost is estimated at about US$50.2 million equivalent of which US$39.5 million would be in foreign exchange. The IDA j component of U$ 32 million would therefore finance about 641 of the total. 4.18 The Project cost breakdown has a number of implications. First of all, the contribution of the participating banks is expected to be relatively small; this reflects a relatively low share of the financial costs of investments in local currency in the case of rehabilitation projects where infrastructure and civil works are already in place. Secondly, a minimum assumption is made that 10 of the subproject's financing requirements will be met through local equity investment. The main contribution of the Government is in terms of a share of operating costs of the apex unit, support to the training program, administrative support to the IDIL advisers, and some equity type participation, based on existing assets. TABLE 4.1(a) PROJECT COST ESTIMATES Local Foreign Total Z of Cost Cost Cost Total (USSmillion) (1) Enterprise Financing Comnonent Civil works, machinery, equipment, spares, materials 10.00 34.07 44.07 Consultants services 0.50 1.50 2.00 Sub Total 10.50 35.57 46.07 91.8 (2) InstitutioDal Strengthening Compoaent IDIL Advisers - 0.36 0.36 Equipment, facilities 0.05 0.07 0.12 Apex UnitIBM Adviser - 0.36 0.36 Equipment, facilities 0.05 0.20 0.25 Materials, operating costs 0.05 0.10 0.15 Consultants Services Studies (financial/indus) - 0.24 0.24 Training 0.05 0.48 0.53 PFI accounts upgrading - 2.00 2.00 Policy Study (Business environment) - 0.12 k.12 Sub Total 0.20 3.93 4.13 8.2 (3) TOTAL 10.70 39.50 50.20 100.0 - 36 - TABLE 4.1(b) PROPOSED TINKCING PLAN Local Foreign Total 2 of Cost Cost Cost Total (USMmillion) (1) Eaterprise Financina Component IDA - 28.57 28.57 European Investment Bank - 7.00 7.00 Enterprises 5.50 - 5.50 Participating Banks 3.00 - 3.00 Government 2.00 - 2.00 Sub Total 10.50 35.57 46.07 91.8 (2) Institutional Strengthenn Component IDA - 3.43 3.43 UNDP - 0.50 0.50 Government 0.20 - 0.20 Sub Total 0.20 3.93 4.13 8.2 (3) Totals 10.70 39.50 50.20 100.0 of which: Total IDA - 32.0 32.0 63.7 Total Cofinancing (EIB, UNDP) - 7.5 7.5 15.0 Total Banks and Enterprises 8.5 - 8.5 16.9 Total Government 2.2 - 2.2 4.4 Total 10.7 39.5 50.2 100.0 4.19 Parallel cofinancing of ECU 6.0 million (about US$7.0 million) has been provisionally proposed by the European Investment Bank. UNDP cofinancing of US$0.5 million for project preparation and training has been committed. Given the apparent substantial unrealized demand for credit by industry. discussions are taking place with other possible sources of cofinancing, which may be included during project implementation. The terms of the onlending of external funds would be as detailed for the IDA Credit in Chapter 5, according to prevailing interest rates for term lending, and commercial bank spreads of a proportion of the onlending interest rate. The review and development of cofinancing activity would be addressed in the annual project implementation review (see para 10.03(e). - 37 - V. ANALYSIS OF THE ENTERPRISE FINANCING COMPONENT. The EnterDrise Financing Component and its Rationale 5.01 The enterprise financing component (EFC) would be administered by the Central Bank, under a Subsidiary Administration Agreement between the Government and the Central Bank, through an apex unit (Unidade de Gestao de Projecto - UGP). The apex unit has been formally established within the BM (Zentral) in order to permit it to operate independently of the other functions of BM (Central), with a specific statement of operating policies and procedures and a participation agreement with the commercial banks (see Annexes 5.01 to 5.04). It is expected that this would help to prevent possible conflicts of interest in the approval of loans and the management of the credit in general. In this respect it should be noted that the UGP would be independent of the regulatory and control functions of the central bank, and that all credit risk would be borne by the commercial banks. Therefore the UGP would not interfere with the process of separation of the central vis a vis commercial banking. The credit would be channelled through participating fV'ancial intermediaries (PFIs) to the final beneficiary (FB) enterprises. It is intended that all three commercial banks (viz: the commercial banking area of BM, the BPD, and BSTM) would operate as PFIs. The line of credit would finance medium to long-term lending for fixed asset investment and associated incremurntal permanent working capital needs through subloans made by the commercial banks and refinanced up to 90Z by the Central Bank. 5.02 The need for the financing component derives from the aim of rehabilitating the financial system. As stated in chapter 3, almost all non- agricultural lending is short-term and principally for working capital purposes, and a series of factors have constrained supply, related to the institutional structure and interest rates. What long-term lending exists is generally linked to assistance from foreign donors (recipient firms are now expected to pay over a period of time the local currency cost of donor inputs, including both technical assistance and equipment). Provision is made under the prevailing interest rate structure for longer term lending by commercial banks but longer term lending has largely ceased, inter-alia because the premium of long-term over short-term rates does not adequately offset the perceived additional risk to the banks. The commercial banks are also financed primarily, and increasingly, by sight deposits, further discouraging longer term lending. The Project would fill a gap in the supply of medium-to long-term financing during the period of financial reform. 5.03 The proposed apex line of credit for long-term investment lending would be a new type of financial instrument for Mozambique. It would introduce a structure (apex unit and channelling mechanivm) that can be used as a general financing instrument for future IDA or other external lines of credit through the central bank, in addition to its immediate role in the revival of long term investment lending. The principal advantage of an apex operation lies in its ability to involve the banking sector as a whole in the proposed project, including the private bank which has been marginalised over the past few years, with resulting broad-based improvement in appraisal capability and portfolio quality. _ 38 - The Apez Unit CUGP) and Institutional arranmente 5.04 The enterprise financing component would be channelled through the (UGP) in BM (Central) , vith funds being onlent through the PPIs. The UGP has been set up as a unit within the International Relations Department under the central banking function of BM. 5.05 In addition to its manager who has been appointed, the staff of the UGP would consist of two senior level project analysts, at least one of whom would have an accounting background, two administrative officers, and support staff. The Central Bank and UGP are receiving assistance from an expatriate technical advisor in setting up the line of credit mechanism and in the operations of the UGP for a total of 36 months, initially financed under a PPF. The project analysts to staff the UGP may be selected in part on the basis of achievement under the training programs (para. 6.09). The UGP would be fully staffed, with an adviser, two project analysts, two administrative officers and support staff, and operational, as a condition of Credit effectiveness. 5.06 i project steering committee (Comissao Interdepartamental -CI) has been set -.p to oversee the implementation of the project. The CI would be chaired B 3M (Central), and membership would comprise Ministries of Finance, IndustrJ and Energy, Commerce and Trade, and the National Planning Commission, plus, at BM's discretion representatives of other relevant subsector Ministries, PFIs, and the private sector (e.g. the Chamber of Commerce). Once the proposed project becomes effective, CI members would be kept informed on a regular basis as to progress of operations under the line of credit and the project as a whole, and would organize formal meetings as required (see Annex 5.05). 5.07 The UGP would receive a spread of 0.5Z per annum on the outstanding value of subloans to cover its administrative expenses. While expenses during the start-up period may exceed initial receipts, revenues when the proposed project is underway should compensate for this (see Annex 5.06). The principal functions of the UGP would be to: (i) ensure adherence of PFIs to established procedures in selecting eligible subprojects and ensure application of appropriate standards for subloan appraisals; (ii) review the eligibility and authorize financing under the line of credit for subprojects submitted by PFIs, subject to IDA approval where appropriate. For subloans of up to US$100,000 equivalent, the UGP would only ensure that the requests meet the eligibility criteria (paras 5.23 and 5.24) and would give its clearance, confirming the rediscount request, within ten working days of submission. For subloans between US$100,000 and US$250,000 equivalent, the UGP would, within ten working days, review the requests in more detail, make any comments on the quality of the appraisal to the PFI, and ensure that the eligibility criteria were met. For subloans above US$250,000 equivalent, the UGP would - 39 - undertake the above steps prior to submitting the subproject to IDA for approval; (iii) through the CI, facilitate issuance of import licenses for enterprises receiving subloans (see para 5.19). (iv) administer the Special Account (para. 7.02), ensuring proper disbursement of funds, and supervise and centralize the collection and forwarding of supporting documentation; (v) monitor the PFIs' compliance with their various obligations under the Project (para. 5.08); (vi) supervise, on a sample basis, SME subprojects; (vii) ensure liaison between IDA and the PFIs on matters relating to SME subprojects, and maintain records required for supervision and project completion reports by IDA (see Annex 5.07). (viii) act as Secretary to the CI (project steering committee). A model form of agreement is at Annex 5.01. Participating Financial Intermediaries 5.08 All three commercial banks operating in Mozambique will be eligible to participate as financial intermediaries under the proposed project, providing the commercial bank has entered into a participation agreement with the Central Bank, under terms and conditions satisfactory to IDA. This agreement would, inter alia, specify that the PFIs shouldt (i) designate qualified staff to manage the loans financed by the proposed project; (ii) perform satisfactory subproject appraisals and submit required appraisal reports to the UGP; (iii) ensure that resources are used by the final borrowers for the purposes intended and that procurement procedures acceptable to IDA are followed; (iv) supervise subprojects according to required schedules and provide the UGP with periodic reports on the status of subprojects; (v) adhere to terms of lending and repayment of loans; and (vi) provide the UGP and IDA with such information as they may reasonably request. - 40 - 5.09 Receipt by IDA of satisfactory signed and authorized participation agreements between the Central Bank and at least two commercial banks would be a condition of Credit effectiveness. Receipt by IDA of a satisfactory model subloan agreement between each participating bank and beneficiary enterprises would be a condition of first disbursement by each particpating bank. 5.10 BM will be acting in both its capacities, namely as the Central Bank and as the leading commercial bank, with no legal separation of the two functions. While work is underway to achieve a clear separation between these functions, BM does not expect that a full separation of accounts would be available before 1992. However, the new accounting framework, which has been introduced, will enable BM to distinguish between central and commercial banking roles for any given operation (see para 3.22). 5.11 It is expected that all three commercial banks would participate under the EFC of the proposed project, although it is likely that the commercial bank'rig area of BR will account for the largest share of operations, reflecting its general predominance. Operating Mechanism and Credit Hanagement Process 5.12 The IDA Credit would be made to BM (Central), acting as the Government's agent, which would onlend funds under the line of credit to the PFIs in local currency, which in turn would onlend it to beneficiary SMEs. The foreign exchange risk would be borne by EM (Central) on behalf of Government. A residual spread, estimated to average around 'II at current interest rates, would be retained by the Government through Bh .o cover the costs of administering the line of credit through the apex unit and to offset the foreign exchange risk. 5.13 The interest rate to beneficiary SMEs would be in line with the currently prevailing interest rate structure in Mozambique, and would be variable with changes in thi' structure (paras 3.07 and Annex 3.01 detail the existing rate structure). 'he present interest rate structure has been established by the Government according to a Despacho of September 1989. This structure is in accordance with a program agreed between the Government and the IMF in which the level of interest rates will evolve so that they become positive in real terms by 1990. The revised interest rate structure introduced in January 1989 raised lending rates for terms over one year to between 22Z and 342 (and 22-352 in September 1989), and was also considerably simplified. To the extent that these areas may cease to be coveredc by agreements with the DMF, assurances were received that an annual proiect implementation review by the Government and IDA would take place, in order to review onlending terms and cenditions, and progress on the achievement of positive weighted average real onlending interest rates. 5.14 The PFIs would pay interest on funds onlent by the Central Bank such that they would receive a spread of a percentage of the onlending interest rate which would be higher for longer maturity subloans with maturities over 7 years. The onlending interest rate would be based on the rate determined jointly by the Ministry of Finance and BM. The spread formula has been determined as a result of consultations within the banking - 41 - system, and is based on current bank'ng conditions. It reflects the relatively high administrative costs of such projects, and the need to ensure that the spreads are realistic by comparison to those on other funds in Mozambique at the present time. The perceived risk on lending, and especially on medium to long-term lending for investment purposes, is currently high. Provisionally, BM (Central) has proposed that it would retain a 73Z 3f the final onlending rate for subloans of up to a seven year term, and 651 for subloans of more than a seven year term; this is approximately equivalent at current rates to a spread range of 7 to 9? (see Annex 5.01). 5.15 Funds under the line of credit would be onlent to the PFIs in local currency, with tte same maturities as the individual subloans to final beneficiaries. Subloan terms to beneficiaries wouid range from a minimum of three to a maximum of twelve years, inclusive of grace periods of one to four years. The Central Bank may subsequently relend repaid amounts to PFIs for similar purposes in line with the objectives of the project, through its rediscounting mechanism, for a period of up to 20 years from the date of Credit effectiveness. 5.16 Subloans granted under the line of credit could finance up to 90Z of the total project cost for rehabilitation/extension subprojects and up to 80Z for subprojects carried out by tLew enterprises to limit the debt to equity ratio of new projects. Thus, entrepreneurs would be required to finance a minimum of 102 and 202 of subproject costs for existing and new firms respectively. However, in exceptional cases, and only if the relevant PFI agrees, the 20? minimum participation for new projects could be temporarily reduced to 10 at the beginning of a project if all generated profits are applied to reach 20X as quickly as possible. 5.17 Subloan processing under the line of credit would be coordinated by the UGP, which would serve as the principal link between IDA, the PFIs and the beneficiaries of the proposed project's enterprise financing component. The UGP would send subprojects for approval to IDA, according to the laid down approval criteria (see para 5.24). 5.18 Initial preparation of subprojects will be undertaken by potential beneficia.y firms, which may seek assistance from IDIL or private consultants if necessary, and presented to the PFI of the firms' choice. The PFIs would review the subprojects in accordance with their own loan analysis procedures and with operating requirements defined under the EFC (Annexes 5.01 to 5.03). PFIs would then prepare for submission to the UGP an appraisal report according to a standard format, which would vary in depth and detail depending on the size and nature of subprojects. The report would cover relevant information about the enterprise and the proposed investment, including its technical soundness, financial viability, economic efficiency and managerial capacity. The report would also set down loan security requirements. Financial rate of return (FRR) calculatioDs would be required for all subloans, on the basis of cash flow analysis, with balance sheet analysis also required for subloans above US$100,000 equivalent. An economic rate of return (ERR) calculation would also be required for subloans above US$250,000 equivalent. - 42 - 5.19 The UGP would review the appraisal reports to verify that all eligibility conditions are adequately met. This review would be carried out through a checklist of these conditions, which would be supplemented for subprojects above the PFIs' free limit by a more thorough process to review the viability of the firm and the subproject (Annex 5.03). If the subproject is eligible for financing and viable, the UGP would authorize (subject to prior IDA approval for the largest subprojects) the corresponding rediscount. With a view to accelerating subproject implementation, it was agreed that, through the CI, the issuance of import licences to enterprises receiving subloans for imported goods would be facilitated y the Ministry of Commerce and Trade, and a supplemental letter to that effect would be included. 5.20 Mozambique's foreign exchange position is expected to move towards equilibrium and to permit phased liberalization, inter alia, through extension of the system introduced under the IDA Third Rehabilitation Credit 15/. However, there is a likelihood of foreign exchange bottlenecks which could cause problems for enterprises which require replenishment of imported supplies beyond the period allowed for working capital under the credit (maximum one year). These bottlenecks may occur as a result of the transitional excess demand for foreign exchange and the segmented nature of the foreign exchange market. Consequently, it was agreed that a supplemental letter would be included confirming that, for subprojects financed under the line of credit, the Government would facilitate allocation of foreign exchange for imported inventory replenishment. 5.21 Because this is the first project of its kind in Mozambique, the first three subprojects from each PFI, as well as the first three subprojects requiring UGP approval, would be subject to prior IDA review and approval. Thereafter, with the exception of subprojects over US$250,000 equivalent, which would require prior IDA approval, IDA would review a sample of subprojects on an ex-post basis during supervision missions. 5.22 PFIs would be responsible for making supervision visits to SMEs receiving Project funds, for maintaining adequate records to monitor the evolution of subprojects, and for reporting to the UGP on the progress of each subproject and the status of the corresponding subloan. For this purpose, trar -portation equipment is provided for under the technical assistance subcomponent of the Credit. Supervision reports, ir. a standard format prescribed by the UGP, would be required from the PFIs at least twice a year until the loans are repaid. These supervision responsibilities of the PFIs are specified in the Participating Agreement which the PFIs would sign with the Central Bank (see Annex 5.01 for the draft agreement). In addition, the UGP would conduct its own selective supervision of SME subprojects in order to monitor the performance of intermediaries' supervision activities. 15/ This is the 'system for non-administered allocation of foreign exchange' which currently covers about 5Z of imports but is expected to be expanded. - 43 - Subproiect Eligibility and Selection Criteria 5.23 Beneficiary SMEs would be enterprises with up to 200 employees that are legally constituted in Mozambique according to local regulations and procedures. However, subprojects with a high expected rate of return and meeting the objectives of the proposed Project, in the case of enterprises of over 200 employees, may be considered on a case-by-case basis. No more than 25Z of overall funds available under the EFC are available to such 'high merit' larger enterprises. Subsectors eligible for financing would include agribusiness, mining and quarrying, all manufacturing and processing. construction, transport and commercial services. Given the increasingly important role of microenterprises (detailed in Chapter 2) there would be no required lower limit to the scale of enterprises eligible for financing under the Credit. The line of credit would finance fixed assets and associated incremental permanent working capital and consultants' costs. for rehabilitations, extensioaw and new operations. 5.24 In order to receive financing under the line of credit, the following aspects of each subproject would ),ave to prove satisfactory: (i) subloans for any subproject for a nesi or existing enterprise should not exceed US$1.0 million equivalent; (ii) for all subprojects, technical viability, including market analysis, would be required as well as an opinion on the managerial capacity of the firm, and an assessment of any significant adverse environmental impact or hazard; (iii) for all subloans, cash flow analysis on an incremental basis would be required, leading to a financial internal rate of return (FRR) calculation with a 12 percent real rate of return hurdle; in addition, summary cash flow analysis would be required for the firm as a whole, to ensure its overall viability and ability to service its debt; (iv) for subloans above US$100,000 equivalent, current and projected balance sheets and income statements would also be required, along with financial ratio analyses, including liquidity, debt service coverage, leverage, and earnings ratios. (v) for subloans above US$250,000 equivalent, economic analysis would also be required including an economic internal rate of return (ERR) analysis with a 12 percent hurdle. (vi) for all enterprises financed, an overall equity/asset ratio of 25Z for the total company would normally be desirable. But equity asset ratios of a minimum IOZ will be acceptable. Where, in an otherwise viable enterprise applying for a sub loan, financial ratios are unsatisfactory due to the effects of debt accumulated as a result of price and distribution controls prior to 1987, the UGP would require the PFI to - 44 - submit a satisfactory financial restructuring plan before approving a subloan. Accounting. Auditing and Reportu 5.25 The UGP would maintain separate accounts for each part of the proposed project. These accounts, including the Special Account, would be audited annually by independent auditors acceptable to IDA, and the audit reports would be submitted to IDA no later than six months after the end of each fiscal year, including an opinion regarding the adequacy of supporting documentation for disbursement of IDA Credit funds based on statements of expenditure. Subproject supervision reports would be prepared by the PFIs on a quarterly basis during implementation, and twice yearly thereafter until the subloan has been fully paid off. These would be submitted to the UGP. 5.26 The UGP would submit to IDA quarterly reports on the status of the portfolio, transactions relating to the Special Account, collections of PFI subloans, and pipeline of PFI subloan applications. It would submit semi- annual reports on its overall financial situation and operations. The UGP is also responsible for coordinating the data required for supervision reports and project completion report by IDA (see Annex 5.07). Monthly submissions for replenishment of the Special Account are discussed in paragraph 7.02. 5.27 BM, through the UGP, would be responsible for coordinating provision of audited financial statements of the PF1's, submitted not later than nine months after the end of the relevant fiscal year, to be considered at the proposed annual project implementation reviews (see para. 5.13). VI. THE TECHNICAL ASSISTANCE AND TRWNING PROGRAM. Technical Assistance 6.01 The objective of the technical assistance input iss (a) to improve the effectiveness of the credit operation; (b) to upgrade bank accounting capability; and (c) to establish generalizable skills in investment lending and industrial consultancy assietance. In order to achieve this, technical assistance is proposed to BM and participating financial institutions, and to the Instituto Nacional da Desenvolvimento de Industria Local (IDIL). 6.02 Technical assistance to the banking system would consist oft (a) the provision of an adviser and operating support for the apex unit; (b) the provision of consultancy/advisory assistance for the participating banks in order to upgrade financial statements to international auditing standards, and to carry out studies of the banking system required by the Government; and; (c) continued training of loan officers and credit analysts. Associated office and transportation equipment would also be provided. The UGP advisory post is proposed to be of up to 36 months duration, and its initial financing has been covered through a Project Preparation Facility. The adviser- designate also participated in the appraisal mission for the Project, and the Government has been closely involved in preparations. - 45 - 6.03 The terms of reference for the proposed UGP adviser are at Annex 6.01. The main function of the adviser is to assist in the establishment and initial operations of the apex unit. This vili involve advice on staffing, setting up a work program, finaliting operating procedures, and preparing documentation, including the implementation of memoranda of agreement betveen BM and the participating banks. The initial work program of the unit will include inter alia establishing the operational procedures for monitoring of the credit operation, supervising appraisal standards, maintaining approval limits and advising on approvals, referring to the IDA proposals above the threshold for local approvals, and liaising with the interdepartmental steering committee on lending policy. 6.04 The terms of reference for consultancy assistance for the upgrading of the accounts of the PPIs are at Annex 6.02. The objective will be to upgrade the financial statements of the PFIs so that they meet international auditing standards, suitable for submission to IDA. Under the Project, a supplemental letter would be included confirming that the BM (Central) would carry out a review of the PFIs' accounting capabilities and would prepare an action program, by March 31, 1991, for their strengthening, to be implemented promptly thereafter. In addition, draft terms of reference for possible consultancy assistance for the restructuring and recapitalization of the banking system are at Annex 6.02. 6.05 The terms of reference for advisory assistance to the IDIL are at Annex 6.03. The objective of this input is to set up a capability within IDIL for providing business advice to enterprises, especially in financial management and project preparation for bank financing. A small business advisory unit of two advisors would initially focus on assisting enterprises to make proposals for financing under the line of credit, in order to increase the effectiveness of the lending operation. Later the work program would be broadened to include a wider range of business consultancy. The advisory unit would need to emphasize training and skill transfer to local professional staff of IDIL. Office and transportation equipment would also be provided. 6.06 The small business advisory service woild be set up in Maputo and Beira, at IDIL delegation offices. The location for this pilot scheme is justified by the fact that these two towns account for well over 502 of industrial employment and output (see Chapter 2). However, future expansion of the scheme could incorporate other centers. Each adviser would have two local counterparts, and the duration of the advisory post would be for 18 months. Charges would be made for advisory services which could be financed through the eventual subloan, if granted. A revenue projection has been made by IDIL based on fee income from preparation of loan applications and general advice. From a market survey of the existing private consultancies in Maputo IDIL considered that a fee of 1.52 of the value of successful loan applications would be appropriate. For other work a range of other fees is to be charged. An updated terms of reference and income/expenditure statement for the proposed unit is set out at Annex 6.04, based on IDIL's own estimates. 6.07 After the first year the service is expected to be able to cover its local costs, including training, but not the costs of foreign advisers. - 46 - This assumes the ability to handle over 200 separate items of assistance, of varying degrees of complexity, in year three, with eight consultants. (After the departure of the advisers it is intended that a further four local consultants would be recruited, making a total of eight in Maputo and Beira). If revenue is only 502 of the assumed amount, it would cover about two thirds of costs. If training is covered from other sources then the service would cover its costs at 50? of projected revenue. There is thus some safety margin for the revenue projections. 6.08 The Business Environment Study, with funding by UNDP of US$0.12 million, which is a component of the overall technical assistance, has been completed and sent to the Government. Its purpose is to provide initial industrial policy recommendations on a broad range of areas, including the foreign exchange regime, trade tariffs, the fiscal system, industrial efficiency and methods of industrial finance and enterprise restructuring. A follow up study is also under way which will make recommendations for the development of the legal regulatory system for the enterprise sector. This study will provids policy support to the IDA lending program for industry, and an additional I-)A provision of US$0.24 million is included for followup- studies relating to the industry and f4nance sectors. The progress of industrial policy reform will be a4.ressed in the annual proiject implementation review, based on the recommendation of the Business Environment Study. The TraininR Program 6.09 The training program started in February lS39. It consists of a series of two principal six week courses and a further three workshops lasting for two weeks. These are phased to be comp'eted prior to the date of effectiveness of the credit. The objective of the program is to develop capability within the banks to carry out project appraisals and to process subprojects under the credit. This is an essential component of an effective lending operation in view of the lack of experience in medium to long-term lending to enterprises. 6.10 A total of about 50 staff of the participating banks, and some representatives from the Ministry of Industry, and IDIL attended the first courses and evaluation comments were positive. The program is funded by UNDP to the extent of US$0.38 million, which includes training, office equipment (including computers) and a vehicle. The first part of the program was pitched at: (a) an elementary; and (b) a more advanced level, and covered financial, technical, market, and economic analysis, and bank lending practice; computer based models for project appraisal at differing levels of sophistication, conforming with the proposed approval mechanism of the line of credit are being developed. The second phase of training started on June 19, 1989. 6.11 An additional IDA provision of US$0.1 million is included under the Project for followup training assistance after the conclusion of the current program. In addition, cofinancing of further training through the UNDP and other sources will be discussed - 47 - VII. DISBURSEMEN. PRCREMENT AD IMPLEMENTATION Disbursement 7.01 A Project Preparation Facility advance of US$250,000 was approved by IDA on January 26, 1989. This provided financing for (a) hiring of an adviser to the UGP (apex unit); (b) provision of consultancy services to the banking system; and (c) equipment. 7.02 The disbursement schedule for the IDA Credit is given in Annex 7.01, and disbursement arrangements are shown in Annex 7.02. The Central Bank would serve as disbursement and collection agent for the refinancing granted to the PFIs. To expedite disbursements under the proposed line of credit, a Special Account would be established in a commercial bank satisfactory to IDA and managed by the UGP. IDA would make an initial deposit of US$2.5 million, representing about four months of disbursement requirements. Applications for replenishment of the Special Account, accompanied by appropriate supporting documents including reconciled bank statements, would be submitted on a regular monthly basis. 7.03 Withdrawal applications would be submitted with full supporting documentation, except for payments against contracts with a total value of less than US$100,000 for which reimbursement could be claimed on the basis of statements of expenditure (SOEs). Documents in support of SOEs would be retained by the UGP, and would be available to IDA for inspection during supervision missions. 7.04 Funds under the line of credit would finance 10O? of foreign expenditures of directly imported goods and 70? of the local expenditures. It would finance up to 100? of civil and engineering works undertaken as part of an investment project, and 1002 of expenditures for consultants' services and training costs. Other costs, including any taxes and tariffs imposed on imports, would be financed either by the entrepreneur or the PFIs under their domestic credit ceiling. 7.05 The final date for submission of subloan proposals for IDA's approval would be December 31, 1995. The expected project completion date would be June 30, 1996, and the closing date for disbursements would be December 31, 1996, in accordance with the expected disbursement profile. However, faster disbursement of the line of credit component seems quite possible. Subject to annual review, IDA would disburse for expenditures incurred up to 90 days prior to the approval of the subproject by IDA, or receipt by IDA of the information required in the case of a free-limit subproject. - 48 - Procurement 7.06 Under a line of credit project intermediated through the banking system regular commercial procurement by private enterprises is usually regarded as efficient and economic. However, since this is the first such project in Mozambique procedures for procurement of goods and services purchased with credit funds under the Project would be specified in each subproject proposal appraised by PFIs, according to IDA's procurement guidelines. Aggregate amounts under each type of procurement are not known a priori for subprojects. For items over US$100,000 and below US$500,000, at least three quotations would be obtained, using the method of International and Local Shopping (ILS) or Local Competitive Bidding (LCB). Any projects involving a civil works component would require LCB with public bid opening for contracts of between $100,000 and $500,000. International Competitive Bidding (ICB) would be required on contracts of above $500,000. For items of below $100,000, PFIs would assure themselves that sub-borrowers had canvassed the main sources of supply and had chosen appropriately. PFI appraisals would, inter alia, cover the procurement procedures used, and PFIs would maintain records of the procurement process during subproject implementation. The UGP would be responsible for ensuring that the PFIs comply with these guidelines. The procurement arrangements are shown in Annex 7.03. VHIL SPECIAL ISSUES The Role of Women in Industry 8.01 During the appraisal of the Project efforts were made to identify special issues affecting women in Mozambique, in relation to such matters as opportunity for industrial jobs and training, access to credit, and property/enterprise ownership, Under the constitution of the People's Republic of Mozambique, the rights of women are explicitly safeguarded in a number of areas. Article 7 states "Work is the right and duty of every citizen of either sex, and it is the criterion for the distribution of national wealth.' Article 17 states 'The emancipation of women is one of the state's essential tasks. In the People's Republic of Mozambique women and men have equal rights and duties, this equality extending to the political, economic, social and cultural spheres.' Article 26 states; many acts aimed at jeopardizing social harmony, or creating divisions based on color, sex, ethnic origin, place of birth, level of education, social position or occupation are punishable by law.' Further safeguards of a similar nature are in Articles 29 and 30. The Organization of Mozambican Women (OMW) is relatively strong and well supported. 8.02 In a recent employment survey (1989) of Maputo Province it was found that literacy (ability to read), although very low overall, was higher for women than for men. Nevertheless, only 22Z of the active female population was employed compared to 73Z of men, with a high concentration in commerce, including distributive trades and in self-employment, while the open unemployment rate (defined as those actively seeking work) was 21Z for women compared to 7.6Z among men. - 49 - 8.03 Credit under this project would be available for workshoplmicro scale enterprises (as well as larger enterprises), such as cereal and oil milling and other food processing, garment manufacture, pottery and ceramics, in which women are likely to be active. Under the onlending appraisal criteria the focus will be on financial and economic viability and managerial competence, without any prior stipulation concerning gender or nitionality (provided that an applicant firm is registered according to Mozambique law). No legal barriers exist to the set up of enterprises by women. Female representation in governing assemblies is modest but not insignificant. Environmental Considerations 8.04 This Project is designed to finance smaller enterprises across a range of industries. Within the industrial sector environmental considerations are important; this applies to for example industries which (a) extract natural resources (e.g. timber); (b) cause particular pollution problems (e.g. paper, chemical products, cement); (c) create special hazards for workers (e.g. coal mining, chemical products, hot processing of metal); or (d) create risks for consumers (e.g. processed foods). Mozambique is fortunate in having natural resources which would continue to support without difficulty significant increases in population, particularly in the North. However, the South is more vulnerable due to higher population density and more fragile drought prone soils. Similarly in the South deforestation has reduced over 40Z of woodland to scrub. This is largely the result of demand for fuelwood, which increased significantly as a result of the Government's relaxation of controls in 1981 in an attempt to switch away from imported kerosene and LPG. (The IDA Urban Household Energy Project is designed to introduce fuel efficient household stoves using coal, accelerate electrification of urban households and introduce other fuels). 8.05 Data are not available, but in terms of international experience the large majority of economy-wide timber usage would be for fuel, and a small minority for furniture and other timber products. It is likely that the timber demand from small scale furniture and wood products manufacturing enterprises would not involve a significant impact on resources, given the underdeveloped state of industry in general. For this reason type b) problems may also not be very important. In the case of type c) and d) some protection is given under current Mozambican law on safety at work and through public health regulations regarding food processing. However, in order to address possible environmental hazards, appraisals of subprojects, in industries specified under the IDA Environmental Directive, would be checked for environmental effects, in particular pollution and nonrenewable resource consumption, and that supervision of subprojects financed under the Credit would provide for the monitoring of these issues. DL PROJECT BENEFfTS AD RISIS 9.01 Economic benefits under the proposed project would arise from the startup and expansion of productive enterprises which are efficient earners or savers of foreign exchange, capable of economic provision of substantive employment and income benefits. In addition benefits would flow from improvements in financial infrastructure. This would include in particular - 50 - the strengthening of bank portfolios, the upgrading of bank staff capability in project appraisal and monitoring, and the reorganization of the bank system as a whole. It is expected that 100 to 120 enterprises would be financed under the IDA Enterprise Financing Component. Rehabilitation of these enterprises would be expected to provide or secure productive employment for about 6,000 workers, and increase the supply of goods and services. 9.02 All subprojects would go through an appraisal process (including environmental assessment), and those requiring subloans of more than US$250,000 would receive an economic appraisal. The hurdle rate proposed would be 122 economic rate of return, while all enterprises would be expected to earn a financial rate of return in real terms of 122. Thus the financing component of the Credit would earn a rate of return of over 122. 9.03 The main areas of risk include: (a) implementation delays due to delays in reorganization of the banks, the lack of long term lending experience of the banks, (to be addressed through technical assistance and training), and unresolved financial problems of enterprises; and (b) slowdown of ELP reforms due to social or political pressures; however, the commitment shown by Government suggests that the latter risks are manageable; thirdly, (c) deterioration of the security situation, which could adversely effect industry; this problem is however under control in the most likely urban locations for subprojects, and small-scale producers tend to be less vulnerable to disruption of sales and supplies. K. RECOMMENDATIONS AGREEMENTS AND UNDERSTADINGS TO BE. REACHE. Conditions of Credit Effectiveness 10.01 Before the Credit is declared effective the Government woulds (a) enter into a Subsidiary Administration Agreement with BM (Central) under terms and conditions approved by IDA (para. 4.08); (b) finalize the staffing of the UGP and make it fully operational (para. 5.05); and (c) provide to IDA the signed and authorised participation agreements between at least two PFIs and BM (Central) (para. 5.09). Conditions for Disbursement 10.02 (a) Before first disbursement by each PFI, provide to IDA a satisfactory model sub-loan agreement between the PFI and beneficiary enterprises (para. 5.09); and - 51 - (b) Before disbursement under each sub-loan ensure that -he sub- loan has been made in accordance with the procedures, terms and conditions agreed with the Association. Assurances Received from the Government 10.03 During the implementation of the Project the Government would: (a) through BM (Central), carry out no later than March 31, 1991, an action program to strengthen the accounting capabilities of the PFIs. to be implemented during project execution; (para. 6.04 and supplemental letter); (b) make available to IDA for its approval a phased program, by June 30, 1991, for the separation of the central and commercial banking functions of BM, leading to its prompt implementation thereafter (para 3.22); (c) based on agreements between BM (Central) and the commercial banks, including BM (Commercial), (i) formulate an action program, by December 31, 1991, to settle lending arrears of the commercial banks; and (ii) by June 30, 1992, formulate an action program for the rehabilitation of the banking system, including a plan for its recapitalization and the setting of performance benchmarks (para. 3.16) and a program for the continued extension of competition in the banking sector (para 3.09), for prompt implementation; (d) through the CI, facilitate the issuance of import licenses to enterprises receiving subloans, and, through BM (Central) facilitate the allocation of foreign exchange for replenishment of imported inventories by subprojects; (paras 5.19 and 5.20, and supplemental letter); (e) through BM, carry out an annual project implementation review with IDA starting not later than March 31, 1991 to: (i) monitor progress made in achieving project objectives; (ii) review progress on the implementation of the action programs for settling lending arrears, restructuring, and extension of competition within the banking sector (para 3.16); (iii) review progress on achieving positive (weighted average) real onlending interest rates, their terms and conditions (para 5.13); (iv) at the first annual review, consider proposals for industrial policy reform, based on the Business Environment Study (para 6.08); (v) review audited financial statements of the PFIs, which would be submitted not more than nine months after the end of the relevant fiscal year (para 5.27), and; (vi) review and develop the ongoing cofinancing of the Project (para. 4.19). 10.04 Subject to the above assurances and conditions the Project is suitable for an IDA Credit of US$32.0 million to the Government of Mozambique. STATISTICAL ANNEXES 1973 1987 */ Number of 1978 Velu Added Employmnt output Food Product. Estabilishents Percentage Employmnt Percentage (Eec Million) Percentage U I Food Product. 772.0 64.8 41648.0 42.1 1616.4 29.6 26.0 of which: Vegetabl- Oil 9.0 1687.0 180.6 Flour Mille J81.0 1909.0 61.6 Supgr 6.0 6298.0 650.2 Cshew Processing 16.0 20860.0 264.4 TOO 19.0 8078.0 67.6 Bakery, Contectionary 265.0 4804.0 88.6 Bev rmg e, Tobscco 24.0 1.7 4111.0 4.2 782.0 14.8 80.0 b/ 11.0 TetilIm, arments Leather Fibre 111.0 7.9 16679.0 16.9 606.5 16.6 24.0 26.0 of which: Cotten clning 21.0 2964.0 106.6 Splining, WUsle 8.0 4461.0 266.9 ramnts 26.0 4211.0 164.2 Wood, Paper, Priatiog 227.0 16.1 16707.0 16.0 626.5 10.8 14.0 10.0 c of which:#1 L4ging, samillitng 76.0 7665.0 148.0 Carpentry, furittre 91.0 850.0 102.6 Printing 45.0 8268.0 199.9 Petroleum Cmicals o Rubber, Plcatic 06.0 4.6 4066.0 4.1 449.9 8.6 8.0 11.0 u of which: w Rubber Products 2.0 774.0 66.6 Pluttc Products 12.0 742.0 54.2 Paint, Varnish 4.0 898.0 129.7 Nonmetal, Mineral Products 62.0 4.4 4804.0 4.7 U80.8 7.0 8.0 2.0 c of which: X Glas Products 1.0 047.0 8.1 Cement 8.0 898.0 164.0 Metals and engineering 189.0 9.9 11464.0 11.6 6092.9 18.6 19.0 14.0 ot *hich: t Struct. MLotl Prods. 40.0 2107.0 101.4 CIA Baglc Iron A Steel 8.0 1181.0 67.0 Met l Furniture 16.0 1618.0 69.0 Shipbldg, Ropirs 6.0 1486.0 110.6 _ Other Industries 9.0 0.6 860.0 0.4 28.2 0.5 2.0 TOTAL 1409.0 100.0 96068.0 100.0 5114.8 100.0 100.0 100.0 -----------------------------------------------------------------__----------__------------------------------------------------------------- Source: Based an Estatisticais Industrials 1973 and 1987. Note: a/ Based on gross output at 1906 prices, VA figures are not available for 1987; however 1978 and 1987 output shares appear comparable. X b/ Includs food products and beverages, tobacco, textiles ond garment.. o - 53 - ANNEX 2.02 MOIDUIQUE SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT Scale Distribution of Industry - 1973 and 1987 Size category. Number of workers per enterprise. Total 1- 9 10-49 50-99 100-199 200-499 500-999 1000- 1973 Number of enterprises 1418 583 480 133 134 56 20 18 Total employment by size category (000) 99.5 2.1 12.4 9.5 18.4 18.0 13.0 26.5 100? 1.8? 13.0Z 10.OZ 18.0Z 18.0Z 13.0Z 26.5? Total 1- 9 10-49 50-99 100-199 200-499 500 - 1987 Number of enterprises 2020 1145 551 134 98 64 28 Total employment by size category (000). 57.5 6.3 5.2 6.0 9.1 14.1 16.8 100X 11.02 9.0? 10.62 15.8? 24.6C 29.2Z Scale Distribution of Industry: Maputo province - 1973 and 1987. Enterprise size by employment category. No employed Total 1-9 10-49 50-100 100-199 200-499 500+ 1973 No of enterprises 498 97 226 68 61 36 10 Approx employment 43350 450 6100 4700 8100 10800 13200 Z of employment 100 1.2 14.1 10.8 18.7 24.9 30.4 1987 No of enterprises 823 445 229 58 48 30 13 Approx employment 46400 2400 5430 4690 7560 11230 15080 Z of employment 100 5.2 11.7 10.1 16.3 24.2 32.5 Sourcest based on Estatisticas Industrials 1973 and Ministry of Labor 1987 (unpublished, and excludes Zambezia province). 5 54 - ANNEX 2.03 Page 1 of 2 SMALL AND NEDIUDINTRPRISE DEVLOPMENT RJECT Enterprises Sold by the State (Empresas Tresgassados) Sectors/Subsectors Company Date of Sale A. Light Industry 1. Agro-industries Limari 1988 Palmar 1988 Jacaranda 1988 2. Food industry Fasebel 1983 Imeal 1987 3. Salt Empresas Estatzados Salina de Zambezia Salina Mieze 4. Textiles Fabrica investro Hotex 1987 5. Leather Calcado Zambezia Incala 1988 6. Wood, furniture Falcao e Ferreira 1986 A. Ferreira 1986 Gobomar 1986 Pandora Industrial 1987 Moveis Ribeiro 1987 Decorama Mobiliario Manica Mobiliario Sofala Mobiliario Nampula 1988 Mobiliario Cabo Delgado 1988 Mobiliario Niassa 7. Oils, soaps Corol 1985 Soboes/de Maio 1987 8. Light engineering Femol (Joint ownership) Enterprises Partially Sold Nets, mesh Malhas de Hoc Other Farbeira Other Irmaos Unido Other Famma ANNEX 2.03 - 55 - Page 2 of 2 B. Heavy Industrg 1. Paper products Sacoes de Papel 2. Non-metallic minerals Fabrica de Calcoes Ted 3. Engineering Cofusel Fabrica de Radiadores 4. Electrical goods a/ Marca (distibutors) Olivetti Adler IBM NCR Olympia Phillips + 3 others 5. Other PTL (Industrial) Telarame al Previously part of 'Empresa Nacional de Equipamentos Materiais de Escritorio (Eneme) Source: Based on handwritten notes provided by Ministry of Industry & Energy, Maputo, March 1989 - 56 - ANNEX 2.04 MOZAMBIQUE SMALL AND MEDTIM ENTERPRISE DEVELOPMENT PROJECT Production Data Ministry of Industry and Energy (heavy industry) (constant 1988 prices) million metic&ls 1987 1988 1989 (plai Tyres 4102 2978 5528 Mechanical engineering 3490 5132 7896 of which: agriculture tools 355 549 1171 bicycles 777 1074 1110 Electrical Engineering 1288 1401 2039 Refrigeration 1798 2533 3311 Heavy Engineering 1256 2007 2149 Metal processing/products 3809 3419 5515 Paper products 327 313 396 Petroleum products 1434 1893 1578 Chemical products and allied 4956 5916 7928 of which: paints 2119 1804 2156 cardboard cartons 1528 1471 3249 Glass products 1402 2197 1200 Electricity Generation 7180 6999 6358 Total heavy industry & energy 31042 34789 43891 Source: Ministry of Industry and Energy, Department of Planning Maputo, November 1988 Note: Data as in original document. MOZAMBlUE SMALL ND MEDS U ENTERPRISE DEVELOPMENT PROJECT S.crenUia de Estado de Industnit Limir. e Alimanter Deprtment of Plonning Prodbctioe Table UnidaWd de Direccao Controlo do Plan Jan-o.c 1967 Controlo do Pleno Jan-Dec, 198 C.C. Volue of Main Vafue of Otner TOTAL Vlue of- Min V Tlue of Oth-r TOTAL Preduction ProductTon Production Productton U Textile 1,289,219 6S9,8S9 1,849,078 1,720,992 1,203,726 2,924,71n 1S8
Группа Всемирного банка · Staff Appraisal Report
Mozambique - Small and Medium Enterprise Development Project
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