Mozambique - Restoring rural production and trade (Vol. 1 of 2) : Main report

Report No. 8370-MOZ I Mozambique Restoring Rural Production and Trade (In Two Volumes) Volume 1: Main Report October 23, 1990 Southern Africa Department Country Operations Division FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS Meticais/US$ 1975 27.24 1980 32.40 1981 35.35 1982 37.77 1983 40.18 1984 42.44 1985 43.18 1986 40.43 1987 (average) 289.44 1988 (average) 528.60 1989 (average) 747.10 SOURCE: Goverment of Mozambique.  PREFACE The report presents the findings of two missions which visited Hozambique during April and September 1989. The missions were comprised of Andrew Goudie (Mission Leader and Principal Author, World Bank); Jorge Rebelo (Senior Transport Planner, World Bank), Daniela Gressani (Economist, World Bank); Althea Hill (Demographer, World Bank); Rene Bonnel (Senior Economist, World Bank); Maria Teresa Benito (Research Assistant, World Bank); Baudouin Duvieusart (Educatior, Sector, Consultant); Norman Rask (Agricultural Credit, Consultant); Tom Kennedy (Transport Sector, Consultant). Hajor contributions were also made by Roger Grawe, David Phillips, Jacomina de Regt, Evelyn Gruenberg-@ievert, and Ligia Murphy. Staff from the Banco de Mocambique, the Banco Popular de Desenvolvimento, the Ministries of Education, Finance, Trade and Transport, and AGRICOM worked particularly closely with the mission and made major contributions to the report. 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.  NOZANBIQUK RXSTORING RURAL PRODUCTION AND TRADE VOLU0m I TABLE OF CONTENTS Pare No. EEMCTI sVE BUuIAY . . . . . . . . . . . . . . . . . Progress under the Economic Rehabilitation Program, 1987-89 . i The Strategy of the Economic and Social Rehabilitation Program . ii The Incentive Frameork . .......... ...... . . iv The Promotion of Rural Trade and Production . . . . . . . . . vii The Efficiency of Resource Allocation .. . . . . . . . . . . . viii Macroeconomic Polcy . ....... . . ..... . .. x Demographic Trends . .............. . xii The Role of the Donor Commmity ......... . . . . .. . xiii Poverty and the Evolution of Living Standards . . . . . . . . xiii MIN REPORT PART 1 INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 CHAPTE WII . . .. . . . * . ...... . . 4 MACROECONOMIC POLICY AND PERFORMANCE UNDER THE WRP, 1987-89 . . . 4 A. The Objectives and Strategy for Development . . . . . . . . . 6 B. The Evolution of the Real Economy . . . . . . . . . . . . . . 8 C. The Evolution of Macroeconomic Adjustment . . . . . . . . . . 14 D. The Evolution of the Economic Structure . . . . . . . . . . . 33  - The Incentive Framework .................. 33 - The Allocation of Resources . ............... 42 S. The Evolution of External Assistance and the External Account . ................. 53 F. The Ezternal Dependence of the Economy . . . . . . . . . . . . 58 CRAPTER III . . . . . . . . . . . ..................................66 THE IMPACT OF THE INSECURITY PROBLEH ON ECONOMIC DEVELOPMENT . . . 66 PAXT 2 CuAPTIz IV . . . . . . . . . . . . . . . 9 73 THE DEVELOPMENT OF THE ECONOMIC AND SOCIAL INFRASTRUCTURE . . . . 73 A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 73 B. Indicators of Infrastructural Decline . . . . . . . . . . . . 74 C. Basic Issues of Infrastructural Development . . . . . . . . . 75 D. The Macroeconomic Significance of Infrastructural Development 77 CRAPTER V . . . . . . . . . . . . . . . . . . . . . . . . . 80 THE DEVELOPMENT OF THE TRANSPORTATION INFRASTRUCTURE . . . . . . . 80 A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 80 3. The Objectives of Trarsport Sector Policy . . . . . . . . . 84 C. The Framework for the Transport Sector Strategy . . . . . . . 87 - The Framework . . . . . . . . . . . . . . . . . . . . . . . 87 - Underlying Assumptions . . . . . . . . . . . . . . . . . . 88 - The Principal Policy Issues ... . . . . .............. . 89 D. The Development of the Road Sub-sector . . . . . . . . . . . . . 90 - The Development of the Road Infrastructure . . . . . . . . 90 - The Structure, Ownership and Utilization and of the Fleet .... . . .*. . . * . * . .... . * 95 - The Need for New Capacity . . . ........... .. .... 102 - The Allocation of Trucking Capacity . . . . . . . . . . . 103 - The Tariff Structure . . . . . . . . . . . . . . . . . . . 105 E. The Development of the Coastal Shipping Sub-sector . . . . . . 107  THE DEVELOPMENT OF THE FINANCIAL INFRASTRUCTURE . . . . . . . . . 111 A. Reforms and Developments in the Credit Sector under the ERP . 111 - The Structure of the Banking Sector . . . . . . . . . . 112 - The Operations of the Banking System . . . . . . . . . . . 113 - Relations between the Public Sector and the Banking System .... . . . . . . . . . . . . . . . . . *. 117 - The St.imulation of the Agricultural Sector . . . . . . . 118 - SunA.ary .... . . . . . . . . . . . . . . . . . . . . . 122 B. Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . 123 - The Development of Prudential Regulations and Instruments for Credit Management ... . ............. 123 - The Access to the Banking System . . . . . . . . . . . . . 125 - The Availability of Long Term Credit . . . . . . . . . . . 126 - The Mobilization of Domestic Savings . . . . . . . . . . . 128 - The Role of Subsidized Credit . . . . . . . . . . . . . . 129 * The Problem of Targeting Agricultural Credit . . . . . 129 * The Prospects of the CCADR .#. 0 . . . . . . . . . . . 132 C. Credit Needs of the Family Sector . . . . . . . . . . . . . . 133 _ CHAPTE VII ............. . . . . . . . . . . . ..135 TE DVELOPMENT OF THE MARKETING INFRASTRUCTURE . . . . . . . . . 135 A. Introduction ..... . . . . . . . . . . . . . . . .. . . . . 135 B. The Major Issues of Recent Marketirg Studies . . . . . . . . . 135 C. The Prospective Role of AGRICOM . . . . . . . . . . . . . . . 140 D. The Storage Infrastructure . . . . . . . . . . . . . . . . . . 144 E. The Determination of Marketing Margins . . . . . . . . . . . . 150 CHAPTER ViIl. ...... . . . . 0 . . . . . . . . . . . . .. 153 THE IMPLICATIONS OF FUTURE DEMOGRAPHIC TRENDS ... . . . . . . 153 A. National Population Issues in the Long Term: Rapid Population Growth . . . . . . . . . . . . . . .. . . . . 153 - Demographic Patterns and Trends . . . . . . . . . . . . . 153 - Future Demographic Trends . . . . . . . . . 154 - Implications of Future Demographic Trends . . . . . . . . 158 - Population Policies and Programs for the Long Term . . . . 162 B. Population Issues in the Short to Medium Terms Displacement and Resettlement . . . . . . . . . . . . . . . . 163 -CurrentPatterns ..... . . . . . ........ . . . 163 - Current Issues . ......... . . . . . . . .. . . .. 167 - Future Trends . . . . ............ . . 168 - Future Issues . . . # . . . . . . . . . . . . . . . . . . 170  - Population Distribution Policy for the Short, Medium, and Long Term . . . . . . . . . . ....... . . . . . .. . . 173 CRAPTEM IX . . . . . . . . . . . . . .. . . . . .. . . . . . 175 TE DEVELOPMENT OF HUAN RESOURCES . . . . . . . . . . . . . . . . 175 A. Current State of the Sector . . ... .. .. 9* 175 - General Overview . . . . . . . . . . . . . . . . . . . . . 175 - Sector Organization and Structure.. . . . . 177 - General Education System ..177 - Adult Education . . ...180 - Vocational and Technical Training . . . . . . . . . . . . . 182 - Higher Education ...183 - Public Expenditures ..184 B. The Role of the Education System . . . . . . . .. . 187 - Occupational Structure ................ . 187 - Contribution of Education and Training . . . . . . . . . . 188 C. Sectoral Response and Issues .190 - Managerial Reasons for the Inadequacy of the Sectoral Response 190 - MINED's Long Term Development Plan . . . . . . . . . . . . 191 - Adult Education..99.999. 9 194 - Vocational and Technical Training . . . . . . . . . . . . . 195 - University Plan to 2000 ..196 - Higher Pedagogical Institute . . . . . . . . . . . . . . . 197 - Investment Policy .... . . . . . . . . . . . . . . . . . 197 - Balance between Expenditures and Resources .. .. . . . . 198 - The Impact of Improved Security . . . . . . . . . . . . . . 199 D. Conclusions. . . .......... 200 PART 3 CATZaX .. . . . . . . . . . . ... 202 THEDEVELOPENT OF MEDItUM-TERM POLICY . ............. 202 A. The Economic and Social Rehabilitation Program . . . . . . . 202 B. The Development of Macroeconomic Policy . . . . . . . . . . . 205 - The Hacroeconomic Framework . . . . . . . . . . . . . . . 205 - Exchange Rate Policy .... . . . . . . . . . . . . . . . 207 - FiscalPolicy ....... ......... 209 - Monetary Policy . .............. .213 - Debt Policy . . . . . . .......... 215 C. The Development of Structural Policy . . . . . . . . . . . . . 219  - The Price Incentive Framework . . . . . . . . . . . . ... 220 - The Structure of Fiscal Revenues and Expenditures . . . . . 222 - The Trade System . . . . . . . . . . . . . . . . . . . . . 227 - The Provision of Rural Support Services . . . . . . . . . 230 - Industrial Policy .... . . . . . . . . . ........ . 231 - The Alleviation and Reduction of Poverty . . . . . . . . 234 D. The Policy Alternatives . . . . . . . . . . . . . . . . . . . 238 - The Central Scenario . . . . . . . . . . . . . . . . . . . 239 - The Impact of Improved Security . . . . . . . . . . . . . . 241 The Decline of Real External Aid . . . . . . . . . . . . . 243 - Summary .... . . . . . . . . . . . . . . . . ... . . . 244 E. Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . 245 BIBLIOGRAPHY . . . .. ...... . 247 TABLES AMD FIGURES USED IN TEXT Chapter II Table 1 The Evolution of Real Growth, 1974-89 . . . . . . . . . . . . 9 Table 2 Evolution of Production and Export Volumes ... . . . . . . 11 Table 3 The Evolution of Commodity Exports, 1980-1989.. . 12 Table 4 Macroeconomic Adjustment: Targets and Outturns, 1987-90 . 19 Table 5 The Evolution of the Macroeconomic Balances, 1980-89 . . . 21 Table 6 The Evolution of the Exchange Rate, 1980-89. . 23 Table 7 Government Revenues, 1986-90... . .24 Table 8 Consum.ir and Enterprise Subsidies, and Enterprise Credit, 1986-90. . .... . . .. ... . 26 Table 9 Degree of Subsidy given through the Ration System ..... . 27 Table 10 Evolution of Wages and Prices 1986-90 . . . . . . . . . . . . 29 Table 11 Products distributed through the Ration System: Volumes and Prices 1986-89 . .... . . . . . . . . . 31 Table 12 The Evolution of Producer Prices . . . . . . . . . . . . . . 36 Table 13 The Evolution of the External Terms of Trade . . . . . . . . 41 Table 14 The Evolution of Imports and External Assistance . . . . . . 54 Table 15 The Evolution of the Debt Burden . . . . . . . . . . . . . . 56 Table 16 The Evolution of the External Accounts . . . . . . . . . . . 58 Table 17 Selected Indicators for Sub-Saharan African Countries - 1988. 59 Table 18 Estimated Aggregate Import and Grant Flows, including the Emergency Program . . ..62 Table 19 The Cash Flow Problem .......... ..64  chagter III Table 1 Impact of Insecurity of Population Distribution . . . . . . . 67 Table 2 The Evolution of Railway Transportation . . . . . . . . . . . 69 Chanter VI Table 1 Evolution of Credit by Bank and Economic Usage . . . . . . 115 Table 2 CCADR - Credit by Borrower, 1988 ....... . . . . . . 120 Chanter VII Table 1 Commercial Network for Agricultural Marketing . . . . . . . 142 Table 2 ACRICOM Marketing Share of Aggregate Agricultural Production (1988) . . . . . . . . . . . . . . . . . . . . 142 Table 3 AGRICOM Storage Capacity by Province as of May 1988 . . . . 146 Table 4 AGRICOM Storage Capacity and Marketable Surplus by District, in Province of Cabo Delgado, Jan.-Sep. 1988 . . .147 Table 5 Estimated Present and Future Storage Capacity for AGRICOM 149 Chapter VIII Table 1 Projected Size and Growth of the Mozambican Population, 1990-2020 .... . . . . . . . . . . . . . . 156 Table 2 Projected Population Structure of the Mozambique Population, 1990-2020 .... . . . . . . . . . . . . . . 157 Table 3 Projected Working-Age Population of Mozambicans, 1990-2020 . 158 Table 4 Projected Numbers of School-Age Children and MCH Clients, 1990-2000 . . . . . . . . . . . . . . . . . . . . 160 Table 5 Estimated Number of Internal Refugees and War-Affected Persons in Mozambique, 1989 . . . . . . . . . . . . . . . 165 Table 6 Projected Mid-year Population of Internal and External Refugees . . . . . . . . . . . .170 Table 7 Projected Costs of Refugee Resettlement, 1995 onwards with Given Percent of Internal Refugees Remaining in Peri-urban Areas ................. 172 Chanter rX Figure 1 Internal Efficiency, Primary Education . . . . . . . . . . 181 Figure 2 Internal Efficiency, Secondary Education . . . . . . . . . 181 Table 1 Offer and Demand for Graduates from Technical Training . . 183 Table 2 Budgetary Expenditure in Education . . . . . . . . . . . . 185 Table 3 Budgetary Expenditure by levels and types of Education (1985; Z) . ............ . . . .. 185  Chauter X Table 1 Financial Impact of Debt Service Cancellation compared to Debt Rescheduling, 1990-2000 . . . . . . . . 218 Table 2 Composition of Budgetary Investment, 1975-90 . . . . . . . 226 Table 3 Key Macroeconomic Indicators (Scenario 1) . . . . . . . . 240 Table 4 Key Macroeconomic indicators (Scenario 2) . . . . . . . . 242 Table 5 Key Macroeconomic Indicators (Scenario 3) . . . . . . . . 244 ABBREVIATIONS AND ACRONYMS AGRICOM State Enterprise for Agricultural Marketing AIDS Acquired Immune Deficiency Syndrome BM Bank of Mozambique BPD Banco Popular de Desenvolvimento (People's Development Bank) BSTM Banco Standard Totta de Mozambique BTN Brussels Trade Nomenclature CCADR Caixa de Credito Agraria para Desenvolvimento Rural (Fund for Agricultural Credit) CENE National Executive Committee for the Emergency C_M Mozambique Railways CNSP National Commission for Salaries and Prices CPI Consumer Price Index CREE Commission for External Economic Relations DIHAC State-owned Enterprise for Distribution of Construction Materials DNTR National Directorate of Road Transport DNEP National Directorate of Roads and Bridges DNPCF National Directorate of Ports and Railways DPCCN Departamento de Prevencao e Combate das Calamidades Natur4as (Department for the Prevention and Control of Natural calamities) ECMEP Provincial Road and Bridge Construction and Maintenance Enterprises  EDM Mozambique Electric Company EEC European Economik Community EMOSE State-owned Insurance Enterprise EP Emergency Prograi ERP Economic Rehabilitation Program ERS Export Retention Scheme ESRP Economic and Social Rehabilitation Program FAO Food and Agricultural Organization FP Family Planning GDP Gross Domestic Product GSP Global Social Product GWH Gigawatt hours IDA International Development Association IMBEC State-owned Enterprise to Import Consumer Goods IMF International Monetary Fund PFP Policy Framework Paper MCH Maternal and Child Health MF Market Fund MINED Ministry of Education MTL Medium- and Long-Term Loans MNR Mozambique National Resistance MUV Manufacturing Unit Value NAVIQUE State-owned CoasLal Shipping Enterprise NORAD Norwegian Aid Development Agency RENAMO Mr'zambique National Resistance PDP Priorit .:istricts Program PER Public Expenditure Review  SDA Social Dimensions of Adjustment SIDA Swedish International Development Agency SMEF Small and Medium Enterprise Fund SNAAD System for the Non-Administrative Allocation of Foreign Exchange TFR Total Fertility Rate TIRS Truck "Insurance-Replacement" Scheme UCPI Unit to Coordinate Import Programmes UNFPA United Nations Fund for Population Activities UNDP/IL0 United Nations Development Program/International Labor Organization UNHCR United National High Commission for Refugees USAID United States Agency for International Development WFP World Food Programme  MOZAIMAOUE: RESTORING RURAL PRODUCTION AND TRADE EXECUTIVE SUMMNARY 1. The central theme of this report is the critical role of economic growth over the next decade in Mozambique. While growth is necessary to all economic development, its importance in the current context of economic crisis in Mozambique is exceptional. The Government should therefore make the recovery of production the primary focus of economic and social policy. The achievement of rapid growth will, however, rest heavily on three major elementss the development of the economic and social infrastructure in the rural areas; prolonged and substantial external capital inflows; and the continuing commitment of the Government to economic policy reform. This report gives a particular emphasis to these elements, and highlights their integral role in the agricultural and rural strategy of the 1990s. The report, furthermore, draws attention to the constraining reality of the Mozambican economic environment and its impact on the formul. tion of economic and social policy. It specifically focusses on the pressing problems of extreme poverty and of the major weaknesses in the institutional capacity and manpower resources of the country. The impact of the on-going insecurity problem is necessarily highlighted with regard to the formulation of short-term policy. Progress under the Economic Rehabilitation Program, 1987-89 2. Since the initiation of the Economic Rehabilitation Program in early 1987, impressive progress has been made in the development of economic policy and in the rehabilitation of the economic structure. Indeed, despite the continuing difficulties created by the rural insecurity problem, the commitment of the Government to the reform program has been exemplary. Not only has there been a very close adherence to the strategy as originally designed, but the rate of adjustment has exceeded expectations in many areas of policy. 3. Major structural changes have been effected over the ERP period. The comprehensive administrative controls over pricing and distribution, that characterized the early 19809, have been largely dismantled, except in those areas of the economy still most seriously affected by che emergency. Centrally-administered trading patterns have been substantially displaced, with enterprises generally being free to determine their own trading partners and their own production and distribution patterns. The pressure to restore commercial practices and market-based systems of economic activ!ty has, moreover, been reinforced by the adherence to strict monetary and fiscal policies. Enterprise subsidies now play a very minor role in enterprise activity, and bank credit is restricted to supporting only enterprise investment. 4. Substantive steps to improve resource allocation have also been implemented, notably in the allocation of foreign exchange and of public expenditures. The initiation of the SNAAD (system for the non- administrative allocation of foreign axchange) in 1989 was a major step towards introducing a more appropriate trade regime, and the move to establish a more effective institutional structure to evaluate and control  - ii - public expenditures was urgently required. In both these two areas, considerable adjustment remains to be undertaken. The necessity of pursuing an appropriately sequenced reform program precluded any rapid steps towards trade liberalization in the 1987-89 period, given the inadequacies of the exchange rate, the dominance of tied external aid, and the domestic price controls. Equally, the weaknesses of the public sector's institutional capacity presented a major obstacle to increasing the efficiency of resource allocations. In the coming years, both trade reform and enhanced resource utilization should be accelerated as these constraints are lifted. 5. The restoration of an appropriate incentive structure has been a key focus of the ERP strategy, given the emphasis on the agricultural sector, and especially on the family sector producers. Consequently, the conduct of exchange rate and pricing policy have been critical. In general, substantial progress has been achieved, with the massive price and exchange rate distortions of 1986 being drastically diminished. Nonetheless, exchange rate adjustment remains a key policy element for the future, with continued real depreciation being crucial to facilitate the transmission of the maximum incentives to the producer level. The further adjustment of official prices should reflect the exchange rate realignment, and additionally diminish the differcntial between international and domestic prices. 6. In view of the fundamental strategy of the Government, major improvements in the magnitude of the macroeconomic imbalances, and, in particular, the degree of external dependence were not anticipated. The responsiveness of exports to the modest growth of the economy has, however, been disappointing: exports have grown erratically, and a sustained growth path has not been established. On the other hand, macroeconomic adjustment has been especially impressive in the area of fiscal stabilization, where Government dissavings have been drastically reduced and domestic bank financing of the fiscal accounts has been virtually eliminated. In 1986, both these two indicators were equivalent to around 122 of GDP. As noted above, the reduction of subsidies has been striking, as has been the sharp increase in revenues. 7. After three years of reform, several policy areas have clearly emerged as requiring greater attention over the forthcoming period in the context of the broad themes highlighted in paragraph 1. The remainder of this section provides greater detail of the principal issues and recommendations that should dominate economic and social policy making in the 1990s. The StrateRy of the Economic and Social Rehabilitation Proaram 8. The priority focus of the Economic and Social Rehabilitation Program (ESRP) should be on the recovery of production, and notably the recovery of the agricultural sector. The strategy of the ESRP has three key elements in order to atCtain this objective: (i) the mobilization of substantial external capital resources.  - iii - (ii) the development of the rural infrastructure to facilitate rural trade and production. (iii) the continued reform of the economic policy environment. In addition, economic and social policy must, firstly, be directed towards overcoming the long term obstacles to development by creating a greater institutional capacity and supply of skilled manpower, and, secondly, must be tailored to take account of the extreme degree of poverty that may be expected to persist throughout the 1990s. 9. The primary objective of the 1990s must be the establishment of sustainable economic growth. Without the recovery of production, it will not be possible to resolve the most pressing problems that Mozambique currently faces: this relates particularly to the problems of poverty, the major degree of macroeconomic imbalance in both the internal and external accounts, the debt problem, and the balance between public and private sector activity. With regard to macroeconomic policy, it is a major conclusion that macroeconomic balance depends on the restoration of the productive base, rather than on fuirther reductions in expenditures and living standards. Consequently, for the growth strategy of the Economic 3ind Social Rehabilitation Program (ESRP) to be effective, continued high levels of external capital assistance will be critical. Otherwise, the existing per capita consumption level of between US$80-l00 will not be sustainable, and the modest growth that is anticipated will prove impossible. Indeed, further declines in living standards would seriously jeopardize the viability of the program. 10. The prime short-term determinant of growth remains the evolution of the insecurity situation. S'lch is its pervasiveness and its far- reaching impact on all aspects of rural life that the productive response to the policy adjustments will necessarily be contingent on this factor. Not only is production hampered by the displacement of the population and by the disruption of traditional working practices, but the incentive that derives from an efficiently operating trading structure is severely weakened. Moreover, until more stable conditions return, the development of the rural infrastructure will be significantly delayed. with the possibility of further deterioration in the worst affected regions of the country. Nonetheless, insecurity should not prevent further steps towards establishing a more appropriate economic structure which can induce a rapid recovery when conditions are more favorable. Neither should it delay the rehabilitation and development of rural infrastructure in those areas which can be safely accessed. 11. The report concludes that continued economic policy reform will be essential, both at the macroeconomic and sectoral levels, but that the process of infrastructural restoration and development are necessary complementary elements in the strategy. Impressive progress has already been achieved in the Economic Rehabilitation Program (ERP) period with respect to policy reform, and, although further policy steps will be essential, the report seeks to emphasize the equally crucial role of the infrastructural issues. The focus of the strategy should continue to be upon the agricultural sector, and this requires a greater emphasis on  - iv - supporting rural production and trade. Both these elements are affected by the physical infrastructure and by the economic and institutional policy of the transport, financial and marketing sectors. Equally, rural economic activity is determined by the provision of services to sustain rural communitiest namely, the provision of basic education, health and water services. Agricultural development must therefore embrace a cross-sectoral approach if a sustainable rural trading and production structure is to be developed. 12. Institutional development and capacity-buildina will be priorities in instituting a stronger framework within which economic development can occur. The underlying scarcity of human resources is exemplified by the fact that less than 3Z of the civil servants in the core economic ministries have a university degree. The weaknesses are, moreover, exacerbated by the substant5ve structural change that the economy is undergoing, which necessitates the rapid development of important new skills that were little demanded in the past. The Government is requiring greater accountability in all sectors of the economy, and the lack of management and financial skills is a serious constraint to the operation of a more commercially oriented economic environment. 13. Only with substantive investment in educational and manpower training will growth be sustainable in the medium term. Moreover, with the considerable lead times that are involved, these investments should be undertaken rapidly. Consequently, the report conducts a sub-sectoral analysis of the education sector, and identifies many areas in which progress is required. In addition, while the report supports the current emphasis of the sector on the provision of the basic primary education skills of literacy and numeracy, it strongly recommends that the link between primary education and the economic, social and cultural development program be more fully developed. Moreover, the limited capacity of the education sector is itself a major concern, particularly with regard to the adequacy of the skilled staff to implement the sub-secteral recommendations. The Incentive Framework. 14. The priority concerns in establishing a more appropriate incentive framework, centered on improvements to the rural terms of trade, should be: Mi) reductions of the differential between official (minimum and fixed) prices and international prices; (ii) efforts to overcome the weaknesses of the market structures by encouraging greater private sector participation, and by supporting AGRICOM in the short-term; and (iii) the promotion of improved efficiency and rehabilitation of enterprises, and the maintenance f the flow of consumer products to the rural areas.  - v - 15. The improvement of the rural terms of trade (measured by the relative costs of a basket of goods consumed by rural versus urban households) has been one of the key elements of the ERP strategy to promote a more appropriate incentive framework. Major progress has been effected in the realignment of domestic producer prices towards those prevailing on international markets. However, it is concluded that the failure fully to realign domestic prices to international prices at a sustainable exchange rate, and, indeed, at the prevailing official exchange rate in the case of the export crops, constitutes the major explanation for nct improving the agricultural terms of trade as much as expected. At an indicative sustainable exchange rate, domestic food crops in 1989 were priced at the producer level at around 80X of the international price, but the export crops were still considerably undervalued at around 50Z of the i.tarnational price. It is strongly recommended therefore that, especially with respect to the export crops, a greater price incentive be passed through to the producer level. 16. The report recommends that the medium term objective should be to facilitate this process through further price decontrol, but it acknowledges that, in the short-term, selective controls continue to have a place in preserving producer incentives in a period of massive food aid, and significant scarcity. It is most important, however, that the rationale for controls be kept under review, and that further steps be taken as conditions permit. In the industrial sector, a more transparent definition is required of the essential products for which conditioned pricing is necessary, with a rapid move to decontrol those products not regarded as essential. 17. It is clear, however, that the fundamental weaknesses of the marketing structure are themselves a prime obstacle to the effective transmission of price incentives from the international markets to the domestic producer level. Despite the intention to pursue policies of fixed pricing and minimum pricing at the producer level for agricultural products, it is concluded that the pervasive problem of rural insecurity, combined with a lack of capacity within the state enterprises, has prevented the effective implementation of the price legislation. Notably, the enforcement and monitoring of the stipulated official prices has not been possible on a consistent and comprehensive basis, and, in particular, AGRICOM had not been able to fulfill its obligation to act as buyer of last resort. Moreover, the prevalence of monopsonistic trading and an high cost, inefficient processing sector have led to relatively modest increases in agricultural producer prices, which have mitigated the impact on the rural terms of trade. 18. The report reiterates the importance of maximizing rural price incentives, and the long term goal of effective minimum producer Prices for selected products. Given the immediate problems of implementing an effective producer level minimum price policy, the report supports the interim policy of additionally establishing minimum prices at the district wholesaling level, at which enforcement is possible. Moreover, the report proposes that more detailed study should be conducted of the minimum price systemt notably with respect to, firstly, the methodology and assumptions underlying the price setting procedure; secondly, the financial  - vi - implications and contingency plans for supporting the buyer of last resort; anLd, thirdly, the potential budgetary and/or monetary implications of this support. These latter considerations have the potential to become extremely important and highly disruptive of macroeconomic management if the buyer of last resort were to incur substantial financing costs that required the support of either the budget or banking system. They therefore warrant close study. 19. In addition, the report recommends the progressive promotion of private sector activitv in order to enhance the operation of the rural trading structure. It does, however, strongly, recommend that the state continue to play a major role in the short term in order to sustair, the functioning of the weak market structure, notably through reinforcing the key trading enterprise, AGRICOM. In the medium to long term, the objective should be to diminish progressively AGRICOM's operations except at the wholesaling level. But, in the current emergency, AGRICOM is critical to economic recovery, thereby warranting further support. This highlights a dilemma of institutional policy over the immediate future: while the emergency dictates the strengthening of some institutions, this support may not be justified once security is restored. Nonetheless, to ignore the critical role that such institutions play now would endanger the productive response that the reform program has so far elicited. Moreover, the reporc highlights the need for increased institutional coordination between those agents concerned with the emergency and those operating in the normal market structures. Th%.s, it is recommended that the supply and distribution of emergency food by DPCCN should be undertaken in close consultation with AGRICOM both to avoid eroding producer incentives, and to avoid unnecessary costs being incurred in transportation and storage. 20. Fostering the private sector should be achieved through the establishment of an economic environment in which there is neutrality between sectors with respect to the access to resources, and in the degree of financial autonomy and accountability that is required. The relative efficiency of the respective operation of the private and public sectors would then determine the relative role that each plays. A substantially reduced dependence on centrally administered allocation procedures is the key element in this respect. 21. Moreover, the report recommends that the restructuring and rehabilitation of the agro-processins sector of the economy should be a top priority in order that the maximum benefit may be passed to the producer. 22. While improving price incentives are central and necessary to enhancing the productive incentive, they are not sufficient. It is concluded that the non-price incentives play an equally essential role: these include the supply of incentive goods, and the provision of the necessary rural economic and social infrastructure. It is concluded in the report that the substantial improvement in the rural supply of consumer goods during the ERP period is probably the major factor in the improved terms of trade, since, prior to 1987, few, if any, consumer goods were available and then only at extremely high prices. In consequence of this conclusion, the report recommends that, firstly, the rural supply of  - vii - consumer goods should be maintained at a high level, and, secondly, that efficient import substitution should be fostered to reduce the import requirement, and the consequent impact on the terms of trade. Measures to promote industrial development are detailed in the report. The Promotion of Rural Trade and Production. 23. In addition to those factors identified in the previous section as critical to improving the rural terms of trade, the priority concerns in promoting rural trade and production should be: (i) the development of multi-sectoral contingency plans for the development of rural infrastructure to be implemented as security, financial and capacity constraints allow. (ii) an increased emphasis and the dedication of more resources to, firstly, the development of the rural feeder road network and to the rehabilitation of small ports, and secondly, the provision of rural health, education and water services. 24. It is a fundamental assumption of the macroeconomic framework that the provision of economic and social services can respond in parallel with the productive response and therefore pose no serious constraint to growth. It was noted in paragraph 11, however, that the report concludes that agricultural growth will be severely constrained without rural infrastructural development, especially with the restoration of peace. The report argues, furthermore, that rural infrastructure should be seen as an additional incentive to production. However, unlike the provision of price incentives which require relatively little administrative and financial capacity, rural infrastructure rehabilitation and development require very substantial institutional capacity and finance. Moreover, development implies substantial lead times before the benefits accrue. 25. Consequently, the report concludes that urgent multi-sectoral development-in which growth in the key agricultural sector is supported by concurrent development of rural transportation, marketing and financial infrastructure-is critical for medium to long term growth to be sustainable, subject to the obvious constraints imposed by the insecurity. The report gives support to the present initiative of the Government in introducing the Priority Districts Program (PDP), since it correctly focusses attention on the critical need to support agricultural development. However, as is noted in paragraph 34, it is strongly recommended that the PDP continue to be seen as an integral element of the aggregate public expenditure planning process. 26. One key feature of the PDP should be the development of contineency plans for all districts of economic and social importance even in the absence of local security. The reality of the economy's implementation constraints and security problem, however, calls for a very clear analysis of the priority programmes and of the rate at which development should be attempted. This will necessarily entail short-term discrimination in favor of specific localities and sectors, but such an approach would facilitate the establishment of a sustainable rural  - viii - structure more rapidly than an overly ambitious program that ignores the real problems of capacity and security. 27. In this respect, several general conclusions can be derived from the sectoral analysis of the report. The priority concern is the current condition of the rural transportation infrastructure and of the capacity to provide adequate transport, particular in response to growing production. The report calls for greater attention to be given to the development of an integrated transport sector strategy, which combines the short term emergency needs with the longer term requirements of the market structure, and which places greater emphasis on the rural feeder road network, and on the use of the smaller coastal ports. Reducing the fragmentation of the economy and the isolation of many communities should be a top priority in order to reintegrate rural producers within the commercial market system, and thus the development of the roads and sea networks should be strongly promoted. Indeed, there is a strong case for placing this development above that of the other urgent rural needs, since these latter needs are themselves heavily dependent on adequate communications. 28. In contrast, the development of rural credit and other financial facilities appears to demand less priority in the immediate future. The report concludes that the family sector - the prime focus of the economic strategy - has little need at present for extensive access to credit. The present technological production base demands few capital inputs, and until progress is made on national research and extension, the financial needs of the sector will remain very low indeed. To the extent that credit is required at all, the report recommends that the formal banking network should establish lending mechanisms lo traders to facilitate on-lending on an informal basis and usually in very small amounts to the family producer. The report also analyses the question of subsidized credit as an appropriate instrument for promoting agricultural development. It is strongly concluded that subsidized agricultural credit is not economically justified, and particularly at the heavily subsidized rates at which credit from the newly established CCADR is made available. The objective should be to phase out the CCADR and to reduce substantially the differential between other agricultural commercial credit and the commercial credit available to other sectors. 29. The development of rural social services must form an integral part of the PDP. The impact of such service provision on production may be difficult to quantify, but is nonetheless considerable. Moreover, with the return of secure rural conditions, resettlement will be directly related to the standard of living that is anticipated in the rural areas. Provision of health, education and water services will therefore be critical to alleviate the pressure on the urban areas and the green zones. Furthermore, these services should be the primary instrument in the Government's drive to achieve a more sustainable population growth rate. The Efficiency of Resource Allocation 30. The priority concerns in establishing more appropriate mechanisms for the allocation of resources should be:  - ix - (i) trade reform, with the focus on the rapid expansion of the SNAAD (system for the non-administrative allocation of foreign exchange). (ii) the restructuring of the financial sector to establish a commercially oriented and viable sector, in which indirect instruments of control can be operated. (iii)the continuation of the present efforts to establish an appropriate institutional structure to evaluate and control public expenditure. 31. The basic development strategy calls for a heavy reliance on external capital throughout the 1990s. The report supports the economic case invoked to underpin this policy, since without major economic and social rehabilitation and without the critical irflows of both consumer goods and productive inputs, the basis for a sustained recovery will not be created. It is, however, a major conclusion that such levels of external aid are only economically justifiable, and, moreover, likely to be sustained by the donors, if they are utilized efficiently. Thus, there is a strong emphasis on three primary aspects of resource allocations foreign exchange, credit and public expenditures. 32. To date, progress in these areas has been slow, reflecting the need for appropriate sequencing of the reform process. For example, trade reform necessarily was contingent on the prior establishment of a more appropriate exchange rate, of greater decontrol in the domestic pricing structure, of progress in the untying of external assistance, and of reform and restructuring of the tariff structure to replace the prevailing quantitative controls. Substantial progress has been made with respect to most of these elements, and therefore a major move towards trade reform is proposed. The report, however, makes it clear that constraints to this process still exist, and action on the constraints themselves is simultaneously essential. Specifically, more rapid progress on untying aid is urgent: it would be ironic if the major bottleneck to external trade liberalization was attributable to the external donor community. It is strongly recommended that the SNAAD should form the core of the trade reform process: other competing funds should be integrated within the SNAAD both to promote transparency and simplicity in the system and to avoid undermining the SNAAD mechanism. Subject to the constraints noted above, the progressive enlargement of the system to encompass a wider range of products should be a feature of reform for many years. 33. The reasons for the continued controls over credit allocation are largely related to the need for institutional development in the sector. Fundamentally, a less restrictive allocation mechanism must await the restructuring of the financial system, and the restoration of a more appropriate interest rate structure. The completion of the separation of the commercial and central banking functions of the Banco de Mozambique should be the top priority in this regard. This would not only facilitate the establishment of autonomous financial institutions, thereby allowing them to operate in a commercial environment, but it would pave the way for the introduction of indirect controls over the system using minimum reserve  - x - requirements rather than the current quotas. The beneficial impact on the efficiency of credit allocation should be significant. 34. The enhanced allocation of public exDenditures is necessarily a prime concern, given that they currently constitute 60Z of GDP. In addition to stressing the findings of the recently completed public expenditure review, the report makes two further recommendations. Firstly, greater emphasis should be given to the recurrent cost implications of the investment program, and, secondly, while the designation of specific expenditure programs such as the Priority Districts Program (PDP) and the programs to alleviate poverty is valuablp in order to attract donor aid and to promote these priority concerns, it should not lead to the establishment of a fragmented budgetary process. The integration of all expenditures within the budgetary planning process and focussed on the sectoral ministries should remain the key means by which prioritization is ensured. Moreover, there is an urgent need to improve the planning and control of public expenditures. Without the development of basic institutional capacity and operating procedures, it will be impossible to implement the necessary measures to enhance the efficiency of resource allocation, in general, and to utilize the appropriate decision-making criteria. Macroeconomic Policy 35. The priority concerns of macroeconomic policy should be: Mi) the continued strict adherence to the fiscal and monetary strategy of the ERP period, notably the elimination of the domestic bank financing of the budget. (ii) the continued realignment of the real effective exchange rate to a sustainable level. (iii) the negotiation of debt cancellation agreements with both official and commercial creditors. 36. It is the conclusion of this report that the macroeconomic framework established over the ERP period will require little fundamental change in the early 1990s. The defined framework for macroeconomic adjustment embodies a substantial degree of disequilibrium throughout the 1990s, but it is this disequilibrium that has been identified as necessary to the restoration of growth and macroeconomic balance in the medium to long term. The report reiterates the appropriateness of this premise, and, while acknowledging the long term nature of the adjustment process and the need for a continuing and sustained commitment on the part of the Government to policy reform and adjustment, it recommends that the basic strategy should be retained. 37. As was highlighted in paragraph 9, the restoration of macroeconomic balance will be accelerated by the promotion of rapid growth and by the enhancement of external aid, and, on the contrary, will be rendered more difficult by the curtailment of aid flows and by deflationary demand management policies that lower growth.  - xi - 38. One area of concern that requires further study is highlighted in the report; namely, the implications of the persistent macroeconomic imbalance for the non-Government sector. Already, major adjustment has been effected in the Government current account. However, the strategy entails, firstly, a considerable redistribution of the savings imbalance from the Government to the non-Government sector; secondly, the persistenc2 of major imbalances in non-Government dissaving and foreign saving; and, thirdly, substantial Government and non-Government investment finance. The consistency of this macroeconomic policy with the microeconomic realities of the enterprise sector should be a prime concern, particularly given the need for major enterprise rehabilitation and investment and for enhancing the financial stability of the sector. 39. The key macroeconomic policy instrument will continue to be exchange rate policy. Despite the substantial adjustments that have occurred, the report concludes that there is a need for significant additional real depreciation of the currency in order to attain a sustainable rate. However, it is recommended that adjustment should be phased, since substantive step-changes could prove counterproductive given the severity of the structural constraints within the economy. It is argued that the immediate impact on urban living standards and on inflation of a step change would have a high cost, while the agricultural productive response to the change would be very protracted. Thus, the report recommends that exchange rate adjustment be made progressively, and accompanied by major efforts to remove the structural bottlenecks that inhibit the critical supply response. The prime indicator of exchange rate sustainability should progressively be assumed by the SNAAD (the system for the non-administrative allocation of foreign exchange). 40. The analysis of debt policy concludes that neither export growth nor debt rescheduling will be able to restore an adequate debt servicing capacity. Even the most favorable debt-rescheduling terms, that are likely to be attainable, fail to restore external financial viability in the medium term. The necessity of debt cancellation of at least part of the outstanding debt burden and/or debt service payments will be essential, both with respect to commercial debt, which forms only about 6.5S of the aggregate debt, and official debt. Without debt cancellation, extraordinarily restrictive fiscal policy would be necessitated for external financial viability to be attainable. The report strongly rejects this policy option since it would undercut the emphasis on growth and would prove to be self-defeating. 41. As was noted above, fiscal adjustment has made impressive progress with, for example, enterprise subsidies being reduced from 8.5Z of GDP in 1986 to around 1? in 1990; revenues increasing from 13S of GDP to almost 23Z over the same period; and domestic bank financing of the budget being almost eliminated after being 12? of GDP in 1986. The report concludes that many specific problems render the adherence to traditional budgetary targets highly problematic. These problems include the dependence on concessional loan finance, the problems of budgetary coverage, the current definition of the capital account to include many recurrent expenditure items, and the impact of counterpart funds. The report recommends that for the short to medium term the key target and  - xii - indicator of fiscal adjustment should be the domestic bank financing ef the budget. This should be coupled with a major effort to modify the budgetary accounts to incorporate all expenditures and revenues, and through improving the classification of expenditures. 42. The report also identifies the primary determinants of savinas in the medium term, and again concludes that growth and increased incomes are the principal mechanism by which domestic savings can be generated and in time displace the massive level of foreign savings. Presently, the report finds little evidence that savings are interest-elastic, or that the weaknesses of the financial network are a specific obstacle to savings mobilization. However, it is evident that the long term level cf savings will be a direct function of an appropriate interest rate structure and of an adequate institutional framework. Both will be important to tap the savings from the growing agricultural. durplus once incomes have recovered markedly. Demographic Trends 43. The demographic priorities should be focused on: (i) the strengthening of the health and family planning programs to facilitate a less rapid growth of the population; and (ii) the design of expenditure programs, especially in the rural areas, that take account of the actual and potential resettlement patterns. 44. Despite the massive displacement of the population caused by the persistent insecurity problem and the necessity of discussing issues of population with great sensitivity in the present environment, Mozambique must address the same issues of rapid population arowth that are faced by other African countries. At the present population growth rate of around 2.7?, the population would double in the next 25 years. Indeed, even with a growth rate that declines to half the current figure, the population of Mozambique would be around 32 million by the year 2020. The report therefore recommends that the initial steps taken by the Government over recent years to confront the problem should be reinforced despite the on- going security conditions. This is especially urgent in view of the very long delay before an impact would be felt from any immediate stepo. A sample census should be undertaken to raise the awareness of population issues, and further strengthening of the health and family planning programmes should be given a high priority. 45. A profound short-term disturbance to traditional settlement patterns has been produced by the insecurity, and, with the restoration of peace, a further major demographic upheaval will occur as resettlement is undertaken. Not only da these movements tend to mask the underlying pattern of rapid population growth and high dependency, but they greatly complicate the process of economic and social development. The programmes of rural development must give a high priority to ensuring that the infrastructural development is compatible with the longer term settlement patterns.  - xiii - The Role of the Donor Community. 46. The priority concerns should be: (1) the continuation of substantial external capital flows throughout the 1990s; and (ii) the closer adherence of the donors to the detailed macroeconomic and sectoral strategy of the Government, especially through untying aid and directing resources to only the priority needs of the Government. 47. The report concludes strongly that given the continued appropriateness of the ESRP strategy, substantial levels of external capital assistance will be essential throughout the 1990s. Without these flows, growth would be very weak, with per capita consumption stagnating, if not declining, and little improvement in the degree of macroeconomic imbalance being attained. only the restoration of the productive base can create the conditions for external assistance to decline if living standards are not to be disastrously affected. , 48. As noted above, an adequate flow of external assistance will be contingent upon efficient utilization of the resources, but a strong recommendation is included in the report that the donors themselves have a pivotal role to play in this regard. Firstly, as was noted in paragraph 32, untying ai. is a key determinant of the rate at which trade reform can proceed, and, secondly, for the Government to adhere to the public expenditure priorities that it has determined, requires donors to provide the Government with flexibi.ity in the manner in which resources are allocated - both in the selection of investment projects and in the use of counterpart funds. Poverty and The Evolution of Living Standards 49. Although, ultimately, the augmentation of living standards is the primary objective of the economic development program, making inferences about the evolution of real per capita incomes is highly problematic, and analyzing non-earned income is almost impossible. In Mozambique, these statistical and data problems are extreme, and only tentative conclusions are feasible. In particular, given the income data, the central problem is the selection of an appropriate price index. It is striking, however, that per capita income in Mozambique in 1989 is estimated to be only around US$100, making It one of the poorest countries in the world. The analysis of the report additionally concludes that those on or near minimum wages approximately maintained their real incomes over the 1987-90 period, but those on average incomes suffered a substantial decline in 1987, and, despite significant improvements since then, real income levels in 1990 remain well below those of 1987, and particularly, 1980-82.  - xiv - 50. To these findings may be added the conclusions of the recent Green Report 1/ that identified around 60S of the population as living in ,absolute poverty': where a household is defined to be in absolute poverty when having expenditure on food amounting to in excess of 602 of its total income. 51. The report concludes that a long term commitment to the strategy of the ESRP is the most effective way of reducing poverty over the long term. It does, however, support the view that the immediate alleviation of the worst instances of poverty in a systematic and targeted manner is necessary, both for humanitarian reasons and because it is required for the political sustainability of the process of adjustment and economic restructuring. Moreover, the report reiterates the importance of the targeted food security polices currently being implemented by the Government. 21 52. The analysis of the report, and especially the discussion of the various policy options and scenarios, concludes that, even with the achievement of stable, sustained growth over the 1990s, Mozambique will still be a desperately poor country in the year 2000. After collapsing by more than 251 over the 1982-85 period, real per capita consumption has increased modestly by about 12 per annum over the 1987-89 period. However, even with the most optimistic scenario (scenario 2 in the report), which assumes GDP growth rates of almost 6.02 over the entire 1990s, real per capita incomes in 2.,' 0 would still only be a little above 90? of the 1982 levels. The report concludes therefore that acceptable living standards remain a 'ong term objective, even with the restoration of peace, the on- going support of the external community and a continuing adherence to economic policy reform and to economic and social infrastructural development. * * * * * * * * * 11 'Estudo SDA: Social Dimensions of Adjustment', Reginald Green (February 1989). 2/ 'Mozambique: Food Security Study", World Bank (October 1989).  PART 1 CHAPTER I INTRODUCTION 1.01. The attainment of an acceptable standard of living in Mozambique remains a fundamental but distant objective of economic policy. Prior to the collapse of domestic production in the first half of the 19808, the previous peak level of real per capita GDP was estimated in 1980 at around $180. At the present rate of growth of real GDP of 42 per annum, and with a population growth rate of 2.62 per annum, it would take another 25 years to recover this earlier, albeit grossly inadequate, peak. 1.02. This perspective illustrates the magnitude of the economic problem in Mozambique. While a major reveraal of the earlier economic decline has been realized and replaced by significant growth, the recovery to acceptable levels of real income will be painfully slow. Indeed, this is unsurprising since Mozambique is exceptional in the depth and comprehensiveness of the current crisis, even in the context of Africa. This is starkly reflected in many of the available indicators. Firstly, it is now estimated that at least 60Z of the population in 1990 are living in "absolute poverty", defined as having an inadequate nutritional standard even when spending in excess of 60Z of total income on food. Moreover, the average annual per capita income in 1989 is estimated at around US$100. Secondly, gross production in 2989 was only around 752 of the peak production level of 1981: with the production of cashew, cotton, copra, citrus and rice, all being only 50? of their levels in the early 1980s; with tea, sugar and sisal being between 5-15? of their 1980 levels; and only maize comparing favorably with 1980. Thirdly, the prevailing degree of macroeconomic imbalance is extreme. External savings in 1989 were almost 60? of GDP, and national dissavings were around 25? of GDP. Fourthly, the massive import dependence is reflected in the trade account, with imports being more than seven times the value of exports in 1989, and around 60? of GDP, and with aid-financed grain imports being between 85- 90X of the aggregate marketed grain supply. Fifthly, the debt problem is one of the most serious in Africa, with a debt stock to GDP ratio in 1988 of 358.3?, and a debt stock to export ratio of 4530?. The 1989 debt service ratio before debt relief was almost 175?. Moreover, external aid continues to be in excess of 80? of the aggregate foreign exchange inflow. Finally, the cost of the rural insecurity has been massive: 50? of the stock of primary schools have been destroyed during the 1980s; one third of the health units have been destroyed; foreign exchange revenues from rail transportation fell by 1989 to 25Z of the 1980 levels; and 35-40? of the entire population has been seriously affected or displaced. 1.03. Given these extraordinary indicators, the nature of the recovery task facing Mozambique is clearly immense. At present, the principal determinant of growth in Mozambique is the perceived danger and risk induced by the insecurlty problem. Rural production and distribution are comprehensively affected by the cumulative impact of the destruction on all aspects of the economic and social infrastructure, and by the continuing  - 2 - threat and reality of personal attack. In this context, economic activity is fragile and highly volatile, and a stable and consistent pattern of recovery will be difficult to attain. 1.04. While economic policy will necessarily be circumscribed and constrained by the security situation, it is a basic premise of Government policy and of this report that the establishment of an appropriate economic policy framework is a prerequisite for development. Although the economic response to reform will be seriously impeded by the insecurity, both the initiation of the recovery and the preparation of the economy for the time when the insecurity is less pervasive and less intrusive on economic activity depend on such reform. Indeed, the first three years of the Economic Rehabilitation Program substantiate this assumption, as annual GDP growth has improved by 11 percentage Fjint.. on average. Moreover, the restoration of growth is itself likely to be an important factor in determining the course of the insecurity problem. Reform, however, can not be conducted in isolation and without regard to the prevailing disturbance. Defining the constraints to reform and the needs of a quasi-war economy will remain integral to the difficult task of recovery. 1.05. Irrespective of the security situation, economic policy reform is by no means a sufficient condition for economic recovery. It is a central tenet of this report that in the absence of complementary measures to stimulate and support production and trade, policy reform will be relatively ineffective, and potentially counter-productive. Consequently, the provision and maintenance of an adequate economic infrastructure is given a high priority, especially in the fields of transportation, finance and credit, and marketing. Moreover, the provision of the necessary social infrastructure in the form of education and manpower development programs, and of population and health programs must play a central role if longer- term constraints are to be effectively surmounted. Furthermore, the supply of adequate incentive products and the rehabilitation of capital is seen as an integral element of the overall economic program. 1.06. Despite the serious constraints under which the economy currently operates, a coherent and comprehensive program was deemed necessary to overcome the dramatic economic collapse of the early 1980s. The Economic Rehabilitation Program was consequently initiated in January 1987, and has since been consistently pursued by the Government. Indeed, the Government has displayed an impressive commitment to the program with the fourth rolling three-year program, covering 1990-92, being finalized in early 1990. The ERP has already given considerable emphasis to two elements of the program: (a) the reform of the economic policy environment, which has appropriately been the priority concern given the nature of the prevailing distortions in 1986. (b) the mobilization of considerable external and internal resources to finance the capital investment and rehabilitation program, and to finance the required flow of consumer incentive goods to complement the policy reform.  - 3 - 1.07. This report discusses the evolution and continuing importance of these elements, but has an additional objective of seeking to establish the significance and complementarity of a third key element of the ERPs namely, the basic economic infrastructural support services. 1/ Consequently, the report devotes considerable attention to identifying the means by which the infrastructure can be developed to facilitate and provide an incentive to both the productive and distributive sectors. 1.08. The general objective of this report is to analyze the course of economic development over the first three years of the ERP, 1987-89, with a view to identifying the principal opportunities for future growth and to defining a more directed program for the medium term. The report has four major components2 (a) the review and analysis of economic development under the Economic Rehabilitation Program, 1986-89 (chapters II to III); (b) the analysis of the development constraints in three key areas of the economic infrastructure - ;.ransportation, financial, and marketing infrastructure (chapters V to VII); (c) the analysis of the development constraints in two key areas crucial to longer term development - issues of demographic and human resource development (chapters VIII to IX); (d) the medium term policy and prospects for growth (chapter X). I 1/ Some investment projects have had an impact on the support services, but there has been little systematic programming of the priority needs.  I CaPATER II MACROECONOMIC POLICY AND PERFORMANCE UNDER TEE ECONOMIC REHABILITATION PROGRAM (ERP). 1987-89 2.01 Background. The numerous factors that led to the introduction of the Economic Rehabilitation Program (ERP) have been reviewed and analyzed in detail elsewhere. 1/ Here, we briefly summarize the causes of the economic collapse of the first half of the 1980s, and the factors that led to the introduction of the ERP. In addition, in later sections of this report, comparisons are drawn with the earlier period wherever this facilitates the economic analysis of the ERP period. 2.02 The extraordinary and extreme nature of Mozambique's current crisis is attributable to the coincidence of a series of adverse forces, both economic and non-economic. One set of determinants of the economic collapse was exogenous: the successive years of severe climatic disruption, with alternating drought and flood; the intensification of the regional insecurity problem in the early 1980s; the expulsion of many Mozambican workers from South Africa; and the serious weaknesses inherited from the colonial era, together with the disruption and destruction of the Independence period itself. The second set of determinants was endogenous, comprising the many aspects of economic policy that were inadvisedly pursuedt including the reliance on a highly centralized and controlled system of economic planning, under which direct physical controls over production and allocation were maintained 2/; the gradual erosion of the market structures and the economic incentive framework, especially the isolation of both production and distribution from the international competitive environment; and the decline in financial and budgetary control and discipline. This policy stance was, moreover, instrumental in provoking a sharp decline in external assistance, which further exacerbated the emerging crisis. The specific nature of the economic crisis is elaborated below. 2.03 Although the importance of economic reform was apparent at the Fourth Party Congress in 1984, it was not until 1986 that the pressure for / Refer to "Mozambique: An Introductory Survey", June 6, 1985, World Bank. 2/ Although this was, in part, a necessary response to the serious loss of skilled manpower and the desertion of enterprises at Independence.  - 5 - a comprehensive and far-reaching program gained momentum. 31 At this time, it was clear that the more marginal reforms of the Economic Action Program 4/ were failing to reverse the economic collapse, and urgent steps were necessary. In response, the Government introduced the Economic Rehabilitation Program in early 1987. 51 2.04 The objective of the chapter is to present an analytical evaluation of the reform program to provide a foundation for the formulation of future economic policy. Four elements of the ERP over the 1987-89 period are highlighted: the broad objectives and strategy for development; the evolution of the real economy; the evolution of economic policy, including both the macroeconomic adjustment program and the process of economic restructuring; and the evolution of external assistance. Chapter X then summarizes the conclusions of both chapters II and III, and addresses the questions of whether the ERP is achieving its objectives, what are the outstanding weaknesses and problems that are emerging; and, most importantly, what direction should the program now take. The fundamental objectives, strategy and policies of the Economic Rehabilitation Program have been presented in detail elsewhere 6/. In this chapter, only selected aspects are discussed in detail insofar as they relate to the major issues identified. 3/ In July 1986, the Government produced an outline of the program, "Economic Rehabilitation Program, 1987-90', which formed the basis of the later strategy papers. 4/ The Economic Action Program was introduced in 1984 following the Fourth Party Congress, with the goal of decontrolling some areas of the economy and giving greater emphasis to private commercial and family sector interests. (Refer to "Mozambique; An Introductory Surveyg, June 6, 1985, World Bank). 5/ The initial phase of reform was implemented prior to any program being formalized with either the IMF or World Bank. 6/ In particular, refer to the papers 'Economic Policy Framework, 1987-89', (dated May 5, 1987), 'Economic Policy Framework, 1988-90' (dated March 3, 1988), 'Economic Policy Framework, 1989-91' (dated February 21, 1989), and 'Economic Policy Framework, 1990-92 (dated May 1, 1990). These papers were all prepared jointly by the Government, the World Bank and the International Monetary Fund.  -6- A. The Obiectives and Strategy for Development 2.05 The global obiectives of the Economic Rehabilitation Program 1,ave remained unchanged since the inception of the program in January 1987. .aey are: (a) to reverse the decline in production, and restore a minimum level of consumption and income for all the population, particularly in the rural areas; (b) to reduce substantially the domestic financial imbalances and strengthen the external accounts and reserves; (c) to enhance efficiency and establish the conditions for a return to higher levels of economic growth once the security situation and other exogenous constraints have eased; (d) to reduce the gap between the official and parallel markets; and (e) to restore orderly financial relationships with trading partners and creditors. 2.06 The broad strategy of the ERP. The Government has adopted an integrated and comprehensive program despite the impelling problems of insecurity and limited administrative and absorptive capacity. As the objectives indicate, the Economic Rehabilitation Program is not a narrowly defined rehabilitation program. On the contrary, it embodies two primary components. The first is focussed on economic policy reform, and comprises two key elements: the macroeconomic adjustment of the economy, and the establishment of an economic structure that is better suited to the attainment of the objectives. 7/ The second is concerned with the mobilization of adequate resources to support the policy reform through the financing of capital rehabilitation, essential consumer incentive products, and productive inputs. An even broader interpretation of the ERP would 7/ The identification of these two elements certainly involves a degree of artificiality, not least because of their inter-relationships. For instance, the macroeconomic adjustment program is a pre-requisite for many of the changes that are being effected in the incentive structure. Equallj, the policies designed to bring financial stability to the macro economy are leading to the initiation and operation of new mechanisms and criteria for economic management, which are themselves structural in nature.  encapsulate the Emergency Program as a third component. 81 Although this program has the principal objective of sustaining life in the most hard- hit areas of the country, it also embraces wider concerns related to the - incentive structure and the logistical requirements of the distribution system. 2.07 This integrated strategy is seeking to implement a major reorientation of the economy, and create an economic structure that differs fundamentally from that which had prevailed since Independence, and, indeed, prior to Independence. Thus, while the global objectives of paragraph 2.05 are unexceptional, tte intermediate objectives for the economic structure and operation of the economy mark a discrete break with the historical character of the system. Even though the basic nature of the prospective medium-term structure is described here only in general terms, it contrasts strikingly with the pre-ERP economic structure (paragraph 2.02). The structure may be characterized as follows: (a) it is based primarily on the development of the agricultural and agro-industrial sectors of the economy. The historical dominance of these sectors 9/ is indisputable, and this provides prima facie support for the appropriateness of this strategy. The detailed strategy, however, differs markedly from the earlier period of development, with the focus on the family and private sectors displacing the previous emphasis on the state sector. The development of the industrial sector is accorded an imDr,rtant secondary role, given its complementary significance to agricultural recovery, and, particularly, to the enhancement of agricultural production incentives; (b) it aims to diminish the degree of administrative control over economic activity and create a more market-based economy, in which the international and domestic market mechanisms provide the principal signals to economic agents. This structure would provide the incentive to both public and private entities to increase production and productivity. Moreover, it redefines the role of the State Plan and the central administration of the economy, with the direct control of physical quantities and prices in production and distribution being displaced by a 81 The Emergency Program was initiated in 1985, and has subsequently taken the form of annual appeals to the donor community primarily for grains, but more recently with an increased emphasis on the logistical support. The Program is analyzed further in chapters II (section F) and III. 91 During the ERP, the agricultural sector has accounted for 40-502 of GDP, and for around 802 of employment; the agricultural and agro- industrial sector accounted for 902 of aggregate exports.  reliance on indirect levers of control through the market mechanism; (c) it seeks to enhance the role of the private sector in the mixed economy while retaining the public sector's role in strategic areas of the economy. Continued state control cver some areas of both production and distribution would, in part, be determined by the prevailing emergency circumstaaces, but not exclusively so. Three areas of continuing state participation can be identified irrespective of the developmentt of the emergency situation. Firstly, Government policy is to retain a monopoly in the ownership of several fields of activity, including the public utilities,and the provision of health and education services. Secondly, the state sector will continue to participate in selected areas of agricultural and industrial production and distribution alongside the private sector, subject to the state enterprises being able to compete efficiently. Thirdly, state participation will be maintained in selected areas even if it entails loss-making activities, when such activities have been designated as essential for non- economic reasons, notably on equity grounds. In particular, AGRICOM will continue acting as buyer of last resort, and, in some circumstances and regions of the country, this may entail uneconomic activity. B. The Evolution of the Real Economy lO/ 2.08 Back2round. The most striking feature of Mozambique's economic development in the post-Independence era has been the dramatic collapse of production in the 1982-85 period. Over these years, real GDP fell at an annual average rate of around 6Z, and real per capita consumption declined at a similar rate. Investment also collapsed at almost 20Z per annum over the 1982-85 period, reflecting the fall in external assistance, although it is estimated to have jumped by 502 in 1986 as external capital inflows increased markedly. At the sectoral level, the data for gross social product suggest that the most substantial declines occurred in the 10/ The data limitations are particularly serious in the field of national accounts with no Government estimates of GDP being made from production. The absence of value added data precludes the accurate analysis of sectoral growth, and the existing Global Social Product (GSP) data can only be used as a rough indicator. Data in this section need therefore to be handled with extreme care, and with the appropriate qualifications.  industrial and transportation sectors, iith agricultural sector experiencing a more modest, albeit sustained, decline. 11l T3ble 1. The Evolution OT Real Orowth, 1974-89 Ainual average growth rate(S) 1974-76 1977-01 198245 1986 1987 1988 1989 Aggregte OMP -9.5 2.1 -5.9 1.8 8.8 8.6 4.0 Aggregte asp n.a. 2.8 -10.6 2.2 8.1 6.1 8.8 Agriculture n.e. 2.1 -87 -0.6 7.0 7.2 2.0 Induetry n.m. 8.8~~~~a -18.4 -48 8. 7.a 7.0 Construrtion n.m. 8.7 -2.2 44.6 -16.0 0.1 0.0 Transport n.. a. -15.9 1.7 -9.8 8.8 4.2 Other n.a. 0.5 -1.8 -0.7 8.8 4.8 s.5 Con=uptlon n.. n.m. -4.d -0.6 8.4 8.6 4.6 Consusption per capita n.e. n.m. -6.9 I.4 o.8 1.0 2.0 Groes Investent n.s. n.m. -17.8 81.4 18.6 20.6 2.6 Export goods volume n. n.. 84.0 -8.0 9.4 11.4 4.2 Impot goods voluse n.e. n.. -19.7 12.4 1.8 6.8 4.0 It ehold be noted that the national accounting date are genrally Inadequate. neu ntly. only Ore Socil Product it reported here et the ectoral level. The gregate stimate or o DP are baed on *wxend iture dXat. Xe yet, no volvo added date exist to allew analyss of CDP from the production ide to be undertaken. Source: Oovernmont of lbxambi quo 2.09 At the disaggregate level, the gross marketed production of the principal agricultural crops showed the same trend (Table 2). At the extreme, cotton and sugar production collapsed to 92 and 16S respectively of their 1980 levels by 1985, but the general impact of the crisis was little better. The other key export crops of tea and cashew, which contributed one third of total exports in 1980, fell to around 30S of the 1980 production levels. The contrast with the production levels of the immediate pre-Independence years is even more stark. Marketed food production followed a highly volatile trend through the 19809, but by 1986, maize production had fallen to almost half of its 1980 production level, and rice production fell by 1983 to under half of its 1980 level, although it subsequently recovered. In the early 1970s, domestic marketed production of maize and rice had ranged between 150,000 and 230,000 tons a ill There is considerable uncertainty surrounding the agricultural estimates, not least because the insecurity has seriously hampered the data collection process. In contrast to the official data presented in table 1, estimates made in the context of the 'Agricultural Sector Surveya (World Bank, 1988) suggest a greater decline in agriculture over the 1980-86 period. For example, between 1980 and 1986, the total gross agricultural output valued at 1980 official producer prices is estimated to have fallen by about one third, with agricultural GDP estimated to have fallen by 25? over the same period. These data suggest a far greater decline of around 5S per annum over the 1980-86 period. In particular, the trend in agricultural subsistence production is unknown, but it would be presumed that the impact of substantial rural dislocation would be a significant decline in this component, and hence in aggregate production given the weight of subsistence production.  - 10 - yeart over the 1985-88 period, this had dropped to between 40,000 and 75,000 tons per annum. The absence of data on domestic food production in the family sector makes any assessment of trends in subsistence agriculture highly problematic. However, the deterioration of the security situation and the climatic problems have led to significant numbers of displaced and affected persons (chapter III), and in these circumstances it is almost inevitable that subsistence production has declined significantly. 12/ Estimates suggest that between 1980-86 the per capita production of the family sector of cassava, maize, rice and sorghum iell respectively by 252, 45Z, 25Z and 40?. 13/ These trends are reflected in the role assumed by the Emergency Program. In 1980, external aid and commercial imports accounted for around 20X and 55Z respectively of the aggregate cereal supply, with domestic marketed production accounting for the residual. By 1983-85, external aid accounted for 65-70? of the aggregate supply, commercial imports for around 13?, and domestic marketed production for barely 20X. 2.10 Industrial production displayed a similar collapse between 1980 and 1986, with both the indices of gross industrial production and of manufacturing output falling by around 50-60X. Most notably, electric power generation fell from 11.3 GWH in 1980 to 0.4 GWM in 1986 due to the sabotage of the transmission lines; petroleum refining was halted in 1985; and cement production in 1986 fell to barely 302 of the 1980 level. In consequence, capacity utilization fell sharply to less than 30Z in 1986 in many industries. 14/ 12/ 'Affected' persons are defined to be those whose traditional communities and whose traditional production activities have been disrupted by the insecurity problem, but who have not fled from their homelands. This disruption may take the form of localized displacement, with the local population effectively living in the area surrounding their villages in order to minimize the personal danger, and only returning in daylight hours to undertake the traditional production activities. It will also include those whose local economic and social infrastructure has been destroyed by attacks, but who remain in the villages. 13/ Refer to "Agricultural Sector Survey', (World Bank, 1988). 141 At the extreme, capacity utilization fell to 62 in sugar, and 10? in cashew processing, oils and soaps. These industrial issues are enlarged in the wBusiness Environment Study' (dated June 20, 1989; No. 7705-MOZ).  - 11 - Table 2. Evolution of UIarketd Production and Export Volume 1980 a 100. 1s9 1975 1978 1980 1981 1982 1988 1984 1985 1980 1987 1988w199 (m Obteted Production Volume E1] Cash.. 228.7 1892. 102.7 100.0 102.9 8e.1 20.7 28.9 88.8 48.9 42.8 51.4 87.6 Cotton 221.9 80.1 111.6 100.0 113.6 98.8 8s.1 80.4 9.8 16.6 48.8 29.6 48.8 Capt. 18.8 1881.8 181.7 100.0 187.7 98.7 82.8 84.0 84.7 77.1 68.4 65.9 42.0 Citrus 107.1 91.1 108.4 100.0 98.2 102.1 89.6 67.6 84.1 84.0 48.6 48.7 68.4 Too 88.6 78.0 100.0 110.1 121.7 58.7 66.4 27.8 7.1 2.0 4.8 9.7 Sugar cane 100.0 106.2 98.2 56.5 80.5 16.2 22.6 18.8 12.9 18.2 steel 114.1 128 . 100.0 78.6 48.9 41.1 48.8 8s.8 0.8 1.8 1.8 4.8 Noise 184.6 148.2 10?.7 100.0 128.1 158.8 102.0 140.9 105.4 81.4 68.9 92.4 119.9 Rice 275.2 215.6 100.9 100.0 70.8 88.9 47.6 82.4 67.0 87.2 s8.2 62.7 58.7 Export Volume Prawn 48.0 84.0 60.0 100.0 151.4 118.4 96.1 88.1 100.0 109.8 97.8 99.0 08.8 Cashew 189.7 185.9 117.9 100.0 88.8 100.7 87.1 26.2 20.0 19.8 38.2 43.8 as.0 Cotton 857.9 812.8 224.8 100.0 281.5 280.1 221.6 ee_o 78.8 18.8 68.7 74.8 61.7 Capra 248.5 157.2 177.8 100.0 62.7 es.1 88.9 21.6 68.5 60.4 76.8 70.8 26.9 Citrs 180.0 100.7 84.8 100.0 117.6 82.9 57.0 78.8 73.9 59.1 54.8 48.5 s8.8 Too 88.3 6.7 45.0 100.0 SS.4 88.7 44.4 25.7 6.0 4.9 2.2 0.0 0.8 Sugar 280.4 79.8 s.6 I100.0 98.9 44.6 89.2 25.7 28.4 30.8 16.2 18.1 20.2 In alud the output of the enterprise aector and the arketted output of the fmil y sector. IQ Eate d. Sorce: Government of oambique. 2.11 The broad evolution of domestic production is predictably mirrored in the evolution of aggregate export volumes, which collapsed at an estimated average annual rate of around 34? between 1982-85, before falling by about 3? in 1986 (Table 1). Only prawn export volumes were sustained, being impervious to both the climatic and security problems of the period. Tea and sisal exports were almost eliminated. Cashew exports reflected the trend in production, falling to around 20? of the 1980 level in 1985 and 1986. On the other hand, cotton exports displayed a surprising resilience to the production trend, and increased for much of the period, although they fell back in 1985 to around 80 of the 1980 level before collapsing in 1986. The 1980-86 period therefore saw a considerable change in the composition of exports (Table 3). In the early 1980s, no export product accounted for more than 20? of total revenue, although cashew and prawn together accounted for around 35Z. By 1986, however, 70? of total revenue was attributable to these two products, with no other product accounting for more than 5Z except sugar. Moreover, by 1985, exports were totally dominated by agricultural products. In 1980, non-agricultural exports (principally petroleum products, tantalum, timber and coal) had accounted for over 35? of revenue, but, by 1986, these exports had been almost eliminated with the exception of timber. 15/ 15/ An indication of the potential for growth is given by a comparison with the levels of earlier years. For example, cashew export volumes in 1985 were only 10? of the 1973 level and 15? of their 1975 level. Cotton export volumes stood at only 10? of their 1973 level in 1985, and 25? of their 1975 level.  - 12 _ Table 8. The Evolutton of Commodlty Expoote. 101W89 (Percentage Ober"s) 1980 198l 1982 1983 1o"4 1158 1986 1907 1980 1989 Prawn 11.8 18.7 16.8 28.? 29.5 43.6 48.4 s9.5 42.0 39.0 Cahew 28.1 19.0 19.0 12.2 16.0 13.0 21.1 81.1 25.7 18.7 Cottn 2.9 0.9 7.5 12.9 8.4 7.0 0 7 5.6 4.7 7.8 Mrpsa 8.8 1.7 1.8 .8 1 6.6ef 2.8 8.4 4.4 1.9 Citru 0.9 1.7 1.2 1 8.4 4.0 2.8 2.6 1.8 8.6 Sugar 8.8 8.9 8.8 6.6 8.0 8.9 10.2 4.5 4.8 5.2 Tea lO.a 8.1 11.2 11.2 11.8 8.2 16 0.4 0.0 0.1 Wood 2.1 2.6 1.4 0.6 1.8 1.1 1.2 1.2 0 7 0.8 Coal 1.8 8.8 1.8 0.4 0o. 0.4 0.8 0.6 0.4 0.8 Labster 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.4 2.8 1.6 Petrol products 22.6 18.6 16.4 18.6 8.7 8.1 6.1 2.6 4.8 9.4 Other [13 13.4 11.8 19.4 12.8 16.0 5.1 8.9 5.8 7.8 12.2 TOTAL EXPORTS 100.0 100.0 99.9 100.0 100.0 100.0 100.0 100.0 100.0 100.0 [1] Other osnds includes molt,aee. caahea oil, tntalna, cement, sisal, copr oil, clinker. Source: Government of NoZabique. 2.12 The Economic Rehabilitation Program. 1987-89. In the first three years of the ERP the economic collapse that dominated the first half of the 1980s was arrested. The rate of recovery of GDP averaged almost 5Z per annum, and gross social product averaged over 42 per annum. Relative to the earlier decline, this reversal was a major achievement, but, given the depth to which real incomes and production had fallen, this growth rate represents only a modest upturn. Real GDP in 1986 was about 80Z of its 1980 level. In consequence, at a 42 growth rate, it would take over six years to regain the 1980 real GDP level, and, most strikingly, it would take over 25 years to regain the 1980 real per capita GDP level. 16/ The upturn in real GDP, coupled with the major inflows of consumer goods, facilitated a critical reversal of the collapse of per capita consumption. Over the 1982-85 period, per capita consumption fell at around 7Z per annum, and, although only a modest growth of a little over 1.02 per annum has been attained over the 1987-89 period, the collapse has been halted. 17/ Real investment has followed a highly erratic course, and 16/ Assuming a constant population growth rate of 2.61 per annum. 17/ The following GDM and GNP per capita data reflects these trends 12]: 1980 1981 1982 l198 194 l5 1988 1987 1988 1989 CDP [cur, Mt. bn] 78.2 80.7 92.7 91 . 108.0 148.6 166.9 428.1 6n.9 984.9 CDP [cur l, a] 2413.6 222.9 a 484 227.8 254.4 8 3. 41.1 1S2O.9 1248.4 1278. (at afficin l exchange rate) 12.29 12.61 12.94 18.28 13.63 1S.9 14.88 14.74 13.13 18.80 iesident IwP4ltion p1] (S) 12.13 12.30 12.46 12.64 12.81 12.98 13.16 13.34 18.82 18.88 0DP per capia (resident ppulation) ecurret At official exchange rate 199.0 108.7 196.9 180.2 198.7 261.5 818.7 114.0 92.8 92.1 a yer ingl average c/rate 181.8 186.1 211.8 191.8 210.1 269.8 801.8 299.1 180.7 132.6 0CP per capia (aggregate population) [current At official exchange rate 198.4 181.0 189.7 171.5 1t8.7 242.7 287.8 108.2 82.8 82.5 8r ,9 wa/ro t 179.4 181.ti 28.7 182.4 197.8 249.9 276.6 270.7 lt6.8 118.7 Ibrld bank Atlas thod (P n.m. n.m. 208.8 162.6 178.0 198.9 190.7 179.4 98.8 eo.0 Wt: (] Population adjuse to exclude refugee living outside Mxaabiqux. [23 It heuld also be noted that the saries *re highly sensitive to the choice of exchange rate. Oiver the distortions to the official rate, this rats clearly ha& majer shortcmings. Sour: aovernuat of lbt ique and Niesion estim_tee.  _ 13 - having declined at an average annual rate of almost 201 between 1982-85, it jumped in 1986 by over 50?, and has since continued to grow strongly in real terms. This again reflects the rapid growth of external resource flows since 1985. At the sectoral level, gross agricultural, production responded strongly, growing at around 72 in 1987 and 1988, although it fell back in 1989 to between 2Z and 3?. 2.13 Underlying the recovery of the agricultural sector in aggregate, however, has been a more unstable and volatile experience at the disaggregate level (Table 2). Domestic food crops g-.ew rapidly, with maize production increasing at an annual average of 32X over the 1987-89 period. Rice production moved more erratically. Nonetheless, aid still contributed between 85-902 of the total grain supply in 1987 and 1988, with commercial imports of grain being almost entirely displaced by the emergency imports. In aggregate, the grain supply has risen significantly, and the declining share of domestic marketed production has masked the modest improvements made under the ERP. On the other hand, tea and sisal production continue only at very low levels, while sugar remains at only 15? of its 1980 production level. Of the export crops, cashew production has recovered steadily at an average of 8Z per annum over 1986-89, while cotton has responded vigorously and tripled its production over the same period. On the other hand, copra and citrus have moved erratically. One indicator of the fragility of the agricultural recovery is provided by the gross marketed output data for specific crops, recorded on a provincial basis. The 1988 data revealed a mean growth of around 4?, but with a massive variance, indicative of an highly unstable and, as yet, unsustained recovery path. 2.14 Industrial growth was also fragile. Production remains highly sensitive to the flow of industrial inputs and ultimately to the availability of external finance. However, despite the difficulties encountered with donor funding in 1987 and in the first half of 1988, gross industrial production followed a stable path, growing at an annual average of almost 8? over the 1987-89 period. The available data suggest an erratic recovery of the other sectors of the economy. Construction output fell sharply in 1987, before flattening out in 1988 and 1989. Transport, also declined sharply in 1987, but has since grown steadily. 2.15 The recovery of the export sector reflects this extremely fragile recovery of production. Thus, export volumes have moved erratically, and have failed to establish a stable growth path. In 1987, the volume of goods exports grew rapidly at 9Z, albeit reflecting the extremely low base to which both production and exports had dropped. In 1988, growth accelerated to exceed 11?, but then fell to the more sustainable level of 4? in 1989. As Table 2 reflects, cashew exports increased by more than 100? between 1986-87, while cotton increased bj 360Z. In 1988, cashew exports again increased by 13?, but then fell back by 17? in 1989. On the other hand, cotton displayed a less volatile trend, continuing to grow steadily at 13Z per annum over 1988-89. In general, export recovery has been volatile, despite the strong overall trend. Most importantly. prawn export volumes continued at around the 1980 level of production over the 1987-89 period, albeit somewhat below the 1985-86 level and significantly less than the peak of 1981. Copra fell heavily in 1989  - 14 - after recovering from the trough of 1984, while the decline in citrus since 1981 continued unabated until 1989 when exports rose sharply. The plantation crops of tea and sugar also continued their slump, with tea exports being almost eliminated and sugar continuing over the 1987-89 period at barely 20X of the 1980 level. It is striking, however, that export valies barely rose over 1987-89, as export prices fell sharply; most notably for prawn by 102 between 1988-89, and for cashew by 372 over 1986- 89. 2.16 These trends are reflected in the composition of exports (Table 3). Pra.n dominated exports in 1986, accounting for almost 502 of foreign exchange revenues. Since then, this share has dropped to 392 in 1989, with cashew first increasing to around a 302 share, and then falling to 191 in 1989. Nonetheless, these two products still accounted for almost 602 of export revenues in 1989. With tea and sugar failing to regain their earlier importance, no other product in 1989 accounted for more than 72 of revenue except for the group of petrol products. Aggregate non- agricultural exports remain a small share of the total, although there have been instances of individual industrial products establishing a stronger, albeit still very small, export base. C. The Evoluition of the Macroeconomic Adiustment 2.17 The defined framework for macroeconomic adjustment embodies a substantial degree of disequilibrium for many years, but it is this disequilibrium that has been identified as necessary to the restoration of growth and macroeconomic balance in the medium to long term. However, the likely success of such a macroeconomic strategy rests on several central questions. These are, firstly, whether the extraordinary degree of imbalance in the internal and external accounts is an appropriate and necessary element of the development strategy; secondly, whether this strategy is adequate to elicit the expected supply response in a situation of constrained demand; thirdly, whether a strategy that will be dependent on such imbalances for the medium term is sustainable; and, fourthly, whether the imbalances are being appropriately managed to preclude potential adverse repercussions. 2.18 The Framework for Adjustment. Macroeconomic policy has three principal objectives in the short to medium terms the promotion of production; the creation of a sustainable financial environment; and the mobilization and management of increased external resources. (a) the primary objective is the reactivation of agricultural production and marketing. This depends most fundamentally on the re-establishment of economic incentives, and particularly of price incentives. In turn, this necessitates the reintegration of the domestic economy within the international economy and a significant reduction in the price differential between the official controlled price structure and the uncontrolled price structure (including both the unofficial parallel markets and the uncontrolled official markets);  - 15 - (b) the second objective is the reduction of both internal and external financial imbalances. As will be expanded in detail later, this is a longer term objective in many respects given the nature of the existing imbalance. The utilization of only non-inflationary fiscal finance and the control of credit extended to the non-Government sector are the baFis of the internal strategy. On the external side, the objective is three-fold: firstly, to effect a major realignment of the exchange rate to lay the foundation for the restoration of domestic incentives and, thereby, production; secondly, to negotiate appropriate agreements with external creditors that embody a serviceable debt burden; thirdly, to finance the external imbalances that the economic strategy implies by contracting additional debt only on concessional terms; (c) thirdly, the strategy aims both to minimize the reduction in existing living standards and stimulate the recovery through the deployment of significant external resources. The appropriate flow of real goods to -estore the capital structure and to provide the necessary incentive goods are critical to complement and support the policy program. In view of the limitations in meeting this need from domestic production, imports, financed by external assistance, are accorded a fundamental role in ensuring the coherence of the overall strategy. 2.19 It is in this context and with these objectives that the Government strategy under the ERP defines a program of macroeconomic adjustment. Alternative strategies will be further discussed in chapter X, but it can be noted immediately that the principal constraint is the exceptionally low level of per capita consumption, which effectively precludes additional reductions in aggregate consumption if the strategy is to be sustainable. 2.20 The combination of the existing degree of macroeconomic imbalance and the recovery stratagy being pursued imply that adjustment will be a protracted process. It will also be far from uniform in its impact on the substantial macroeconomic imbalances that characterized the econory in '986. In particular, the Government strategy necessitates the persistence of major macroeconomic imbalances in some sectors of the economy for the medium term, together with a redistribution of the savings imbalance from the Government to the non-Government sector. Continued imbalance is therefore particularly apparent in the degree of non- Government dissaving and foreign saving. On a sectoral basis, the following adjustment paths are planned: (a) in the central Government accounts, major progress in the restoration of balance is possible, on the one hand, wit% Government dissaving being rapidly diminished and domestic bank financing of the budget being vigorously curtailed. On the other hand, Government investment is programmed to remain a substantial proportion of GDP, and this will be financed directly through foreign saving.  - 16 - (b) in the non-Government sector, macroeconomic adjustment will be considerably protracted. The substantial increases in the effective demand for consumption and, to a lesser degree, investment products are heavily financed by the non-Government sector, and, especially, the enterprise sector. As a consequence of the limited domestic resources of this sector, the consumption component will necessitate significant dissaving within the sector, and the investment component will be predominantly financed by foreign savings. (c) in the external sector, substantial savings will continue to be required to finance the Government investment program, and to finance both the consumption and investment needs of the non- Government sector. From a different perspective, the massive external saving may be seen as the necessary counterpart of the critical foreign exchange constraint and the domestic expenditure strategy. 2.21 The persistence of this pattern of financial imbalance is therefore anticipated, with balance only being slowly restored as domestic production responds to the ERP. The Evolution of the Adiustment 2.22 In this section, the adjustment process is reviewed, and an analysis of the principal policy developments over the course of the ERP is presented. A more detailed description of the policy program is documented elsewhere (refer footnote 6). 2.23 The Macroeconomic Adjustment. The period immediately preceding the ERP saw major changes in the macroeconomic balances. In the early 1980s, national savings were insignificant, and investment, which averaged around 20X of GDP, was financed almost exactly through foreign saving. At this time, there were in fact small savings being made on the Government current account, which were roughly offset by the dissaving of the non- Government sector. In the years immediately preceding the ERP, Government dissaving 181 increased sharply to exceed 102 of GDP, and only severe reductions in Government capital expenditure from 162 of GDP in 1984 to 5% in 1985-86 prevented the Government financing requirement from increasing 18/ Enterprises losses were financed through the banking system until 1987, when the Government assumed responsibility for such finance. The budgetary data for the 1982-86 period has, however, been adjusted to include the finance received by enterprises to finance losses to allow comparability with the later period. It is noteworthy that these subsidies rose from 22 of GDP in 1982 to reach 8.5Z of GDP by 1986, and this was a major component in the increase of Government dissaving over this period. Furthermore, transfers to enterprises are treated here as components of Government expenditure and as contributors to Government dissaving, rather than as enterprise dissaving in order to avoid double-counting.  - 17 - rapidly. This collapse in investment was reflected in the drastic fall in imports and in the consequent decline in foreign savings, both of which fell to barely 502 of their 1982 levels by 1985. In 1986, there was a modest reversal of the downward trend in investment and foreign savings, but Government savings continued to deteriorate. 2.24 Since the initiation of the ERP, the Government has designed economic policy to adjust progressively the distribution and magnitude of the macroeconomic imbalances, and has succeeded in adhering closely to the original macroeconomic framework. The most striking feature is the rate at which fiscal and monetary adjustment has been achieved and the degree to which the Government has accelerated the process in some areas and exceeded the annual targets. 191 2.25 On the fiscal side, five aspects require highlighting: (a) aggregate revenues as a proportion of GDP were increased from 13.32 in 1986 to around 222 in 1989 and 1990. Despite a shortfall in 1987 relative to the target, revenues subsequently exceeded the target by a substantial amount; 201 (b) subsidies to enterprises as a proportion of GDP were decreased from 8.52 in 1986 to 1.5Z in 1989 and are targeted at 1.02 in 1990; (c) the current deficit declined from 122 of GDP in 1986 to 1.42 in 1989. This reflects the combined impact of the rapid increase in revenues and the tight containment of recurrent expenditures; 19/ These targets are in general set at the end of the year preceding the year to which they relate. 20/ Tie revenue shortfall in 1987 was of little macroeconomic importance since it was entirely compensated for by the substantial undershooting of the expenditure on enterprise subsidies. Equally, although it was necessary for consumption subsidies in 1988-89 to exceeded the objectives, the buoyancy of revenues again implied a minor net macroeconomic impact.  - 18 - (d) the overall deficit after grants as a proportion of GDP has been contracted from 15.32 in 1986 to a targeted 9.8? in 1990, if a consistent basis is adopted; 21/ (e) domestic bank financing of the Government budget has diminished from 12Z of GDP in 1986 to 0.1X in 1989 and a targeted 0.2Z in 1990. The rate of adjustment in this respect far exceeded the objectives, particularly in 1988. The principal determinant of this trend has been the substantial decline in Government dissavings, combined with the external financing of the investment programme. 2.26 In summary, while a degree of deviation from target would be anticipated due to the impact of exogenous disturbances during the year, the data in Table 4 reflects no significant departure from the planned evolution of fiscal policy. 2.27 The measurement of the trends in the macroeconomic imbalances is complicated by the immense distortions of the period up to 1986. Traditional indicators which measure financial balances as a ratio of GDP are grossly misleading when the implicit price deflators in the numerator and denominator diverge very substantially. Here, the cumulative devaluation over the 1986-89 period was almost 1750? in local currency terms, and this is instrumental in causing the ratios to GDP to record a dramatic deterioration over this period (Table 5). In consequence, a more accurate understanding of the dynamics of the evolution of the real degree of macroeconomic imbalance is given by the evolution of the real economy. 21/ Note the reservations in the text to the appropriateness of this indicator in measuring the adjustment towards financial balance. The other deviation of interest is that of the overall deficit in 1988. While the extent to which the target was exceeded is of little consequence, it is a good example of the difficulty of defining meaningful target variables for the aggregate fiscal account in Mozambique. While the overall deficit after grants defines the addition to the stock of external debt that must be contracted if domestic bank finance is to be avoided, targeting this variable discriminates against concessional debt with a high grant element (including IDA). The problem of defining aggregate fiscal targets is reflected in the inconsistency with which they have been set: a target was initially set for the overall deficit in 1987, then left unset in 1988, and again set for 1989.  - 19 - Table 4. Uacro.eonomlc Adlustment: Targets and Outturn.. 1987-90 1986(1] 1987 l9w 1989 1990 (proJ.) l ~~~~~~~~Old bel- Ne baa- Actual Target Ctutturn Target Outturn Target Outturn Target Target Fital Policy: Current deficit (a S of cur. *ap) S2.0 28.0 24.8 22.6 12.2 R as S of OP) 12.1 8.2 S.1 4.7 2.7 4.7 1.4 8.8 8.8 Revenue (m S af QDP) 18.8 19.9 16.0 1S.1 19.8 21.9 28.8 22.8 22.8 Enterprise subsidies ffit. bn) 14.2 14.0 9.0 12.0 11.1 12.0 12.0 12.0 12.0 mS of GOW) 8.8 8.8 2.1 1.8 1.7 1.8 1.S 1.0 1.0 Consumer subsid ie Mt. bn) 0.8 6.0 8.9 8.8 7.2 8.8 8.4 9.9 9.9 m, S of COP) 0.8 1.6 1.4 0.8 1.1 0.4 0.9 0.6 0.8 Investent (S of GDP) 6.6 19.4 15.9 22.4 21.2 26.8 22.4 21.5 82.8 Overall deficit pre-granta, S of total eap) 61.0 88.0 86.8 (p g t-grants; # otf CP) 18.8 9.9 11.8 12.5 10.0 10.2 7.1 9.8 18.2 Credit to Government (23 (t. bn) 20.1 2S.0 14.4 20.0 9.6 15.0 1.2 8.0 8.0 (asoliop) 12.0 5.9 8.4 8.2 1.8 1.8 '.l 0.2 0.2 MOnetary Policy: ES] Credit to Non-Governmeent (2] (Mt. bn) 4.7 18.0 19.1 84.0 S9.9 88.0 66.8 78.0 78.0 Total credit sapansion (Mt bn) 24.8 40.0 88.8 74.0 69.8 60.0 67.9 78.0 78.0 S of opening yar broad ney stock) 19.6 . 17.1 48.0 88.1 22.6 26.8 21.6 21.6 Money supp ly growth C5 change) 18.4 44.7 47.8 48.4 80.2 29.5 84.4 20.0 20.0 El] 1988 overall deficit (pre-granta, as X of total expenditure) aubsequently corrected to 87.2 of tota I expenditure; and 1 current deficit (a U of current expenditure) corrected to 47.68. (2] Enterprise finance in 198 wes _t through the banking ayiate. The figure here Is therefore an estimate for c rative purpoee. (8] Credit is defined here to be dommatically-aourced credit. Sourc:s Government of Moxabique. Nonetheless, in view of the considerable progress that has been made towards the elimination of the previous distortions, particularly in the exchange rate, the data for 1989 in Table 5 do more accurately reflect the current degree of imbalance. 22/ 2.28 With respect to the adjustment of the aggregate macroeconomic imbalance, the principal adjustment has been seen in the fiscal accounts, as observed above. In consequence, a major reduction in Government dissaving from 122 of GDP in 1986 to under 3S in 1988 and 1989 has been effected. On the other hand, Government investment has been significantly increased in real terms over the 1987 to 1989 period, and accounted for around 22S of GDP in 1989. The Central Government financing requirement has consequently increased to 242 of GDP. Equally, the increased availability of consumer and rehabilitation goods to the non-Government sector has encouraged considerable dissaving of around 24Z of GDP in 22/ To the extent that the remaining distortions are progressively removed, the imbalances as reflected in these ratios to GDP will continue to deteriorate (see chapter X).  - 20 - 1989. 23/ With non-Government investment growing to almost lIz of GDP, the residual financing requirement of the non-Government sector has attained 352 of GDP. The external counterpart of these trends is apparent in the imbalance in the trade account, and in the very high level of foreign savings. which attained almost 601 of GDP in 1989. Once more, the observed trend requires a major qualification (see previous paragraph), but the degree of imbalance in 1989 alone is an accurate reflection of the extreme situation that prevails. 2.29 Thus, as was envisaged in the macroeconomic framework, considerable progress has been made in eradicating the fiscal current imbalance, while the imbalances in the overall Government fiscal stance, and in the non-Government and external balances remain extremely large. 2.30 The level of capital investment is probably overstated both in the Government and non-Government sectors. In many cases it records the value of projects financed directly from external assistance which are known to incorporate significant allocations for conventional recurrent expenditure, including technical assistance, rehabilitation and spares. The Government capital account, in particular, is more accurately considered as a development budget for this reason. Not only does this have implications for the fiscal indicators, but it has the further implications that national investment is overstated, national saving is overstated, and consumption is understated. The final column of Table 5 illustrates the potential impact of the existing misclassification of recurrent expenditures as capital expenditures in the Government budget. In 1989, for instance, if one third of Government investment were misclassified, its ratio to GDP would fall by 7.5 percentage points and would be compensated for by a similar rise in Government dissaving. In consequence, national dissavings would be higher, and national investment lower, by the same amount. 23/ The sources of finance for the non-Government sector are not fully known, but it would appear that some diversion of bank credit is occurring to finance enterprise current account losses, and that there may still be some reserves of excess liquidity that the sector is able to draw upon and finance the current expenditures.  - 21 - Table 5. The Evolution ot the Macroeconomic Belances. 1O9-S9 __ ~~~~~~~~~~~~~~~~~~~~~~~Unadjuatad fijAdjuate As a S of M0P 1980 1981 1982 e198 1984 198S 1988 1987 1988 1-89 1989 Foreign Savings Current Account Deficit 17.58 20.88 23.48 22.17 18.71 12.96 1S.07 48.70 80.598 68.83 88.83 Non-Government Sector Oroe Domestic Inveetment 7.80 8.45 2.59 -6.86 -4. 9 2.82 4.11 7.88 11.29 10.92 10.92 National Savings -0.18 -2.87 -8.86 -8.62 -2.88 8.84 6.74 -16.22 -15.78 -24.11 -24.11 Savings - InvatAnt -7.94 -8.88 -10.95 -2.06 2.11 1.02 2.68 -24.08 -27.07 -38.08 -85.08 Centrol Governeern Sector Cross Domstic Inv.teet 11.18 14.78 16.72 18.80 15.55 4.87 5.60 18.98 21.17 22.44 14.96 National Saving. 1.58 2.78 4.21 -4.61 -8.28 -9.41 -12.10 -5.70 -2.74 -1.88 -8.83 Savings - Investment -9.89 -12.02 -12.81 -20.11 -20.82 -18.98 -17.70 -21.63 -2S.91 -28.79 -28.79 Aggregate National EconoM Cross Domietic Invetmnt 18.98 20.20 19.81 9.98 10.56 6.89 9.71 28.78 82.48 88.98 25.88 National Savings 1.40 -0.15 -4.16 -12.2S -4.16 -6.07 -5.87 -21.92 -18.82 -25.46 -82.94 Savings - Investment -17.88 -20.35 -28.46 -22.17 -18.71 -12.96 -18.07 -45.70 -80.98 .1 .8S -68.83 Noto: [E] The two sets of data for 1989 represnt (i) the aunadjusteda data from the Government account. and (ii) the *djustada doats where an indietive 83.S of the Governmnt invetment budget is reclassified as recurrent axpenditure. Source: Government of Ho ebique and Mieeson eatimate. 2.31 Despite the potentially destabilizing impact of these imbalances, Government policy has adhered closely to the original strategy in attempting to minimize this problem, particularly with regard to the implementation of monetary policy. On the monetary side, three observations may be made from Table 4: (a) aggregate credit expansion has remained within the targeted limits throughout the period, and, indeed, has more than fulfilled the goals in the 1987-88 period; (b) credit to Government declined rapidly and fell well below the specified objectives, as noted above, allowing credit to the non-Government sector to exceed the targets by a small amount and, nonetheless, permitting the aggregate objectives to be maintained; (c) monetary growth in 1987 and 1988 exceeded the target due to the unexpected temporary accumulation of external reserves, but was nonetheless well within the acceptable range given the annual growth in consumer prices. 2.32 Thus, despite the substantial financial imbalances in the non- Government sector, credit expansion to this sector was maintained broadly in line with the target, and sufficiently to ensure the attainment of the aggregate monetary objectives. Moreover, while there is little prima facie support for the view that the central Government crowded out the non- Government sector prior to the ERP, the trend over the 1987-89 period clearly reflects a marked decline in the share of aggregate credit extended  - 22 - to the Government. The Government share in domestically-sourced credit fell from 431 in 1987 to under 22 in 1989. There is, however, an outstanding issue regarding the crowding out of the private sector by the public sector inclusive of the public enterprises and state farms. 2.33 External AdiuRtment. Macroeconomic adjustment on the external side has focussed on the realignment of the exchange rate. The misalignment in 1986 was clearly demonstrated by the official rate being around 2.5? of the parallel market rate, and by the fact that the real effective rate had risen from an index of 100 in 1980 to 331 in 1986 (Table 6). 24/ By the end of 1989, the cumulative depreciation of the metical since 1986 stood at 95Z in foreign currency terms (1942Z in local currency terms), and the real effective rate had fallen well below the 1980 level: the effective rate at the end of 1989 was 70.0 [1980=100]. By the end of 1987, the cumulative adjustments had reduced the official rate to about 502 of the parallel rate, and this relationship was roughly maintained throughout 1988. In 7989, the policy objective of small, frequent declines in the real ef,.ective rate was pursued through monthly adjustments of the nominal rate vis-a-vis the dollar. The parallel rate, however, depreciated more rap4 iy, leaving the official rate at around 45X of the parallel rate at the e