Mozambique - Second and Third Rehabilitation Credit Projects

Docunint of The World Bank FOR OMCLAL USE ONLY MICROGRAPHICS Report No: 12128 RqotN. 12128 Type: PPAR PERPORMANCE AUDIT REPORT MDZAMBIQUE SECOND REHABILITATION CREDIT (CREDIT 1841-MDZ) AND THIRD REHABILITATION CREDIT (CREDIT 2021-MZ) JUNE 30, 1993 Operations Evaluation Department This docment has a restricted distribution and may be used by recipleats only In the performance of their official duties. its contents may not otherwise be disclosed withot World Bank authorization. CURRENCY EQUIVALENTS Currency Units Metical (pl. Meticais) (April 1, 1993) USD1.00 - MZN 3,100 (Secondary Msrket Exchange Rate) Special Exchange Rate for Tied Aids 8 percent discount ABBREVIATIONS AND ACRONYMS BCPI - Bureau for the Coordination ci Import Programs 80M - Bank of Mozambique CNP - National Planning Commission CREE - Commission for Economic and External Relation EAP - Economic Action Program ERC - Economic Recovery Credit ERP - Economic Recovery ?rogram ESAF - Extended Structural Adjustment Facility (IMF Program) ESW - Economic and Sector Work GCPI - Department for the Coordination of Import Programs PAR - Performance Audit Report PCR - Project Completion Report PFP - Policy Framework Paper SA - Structural Adjustment Facility (IMF Program) SPA - Special Program of Assistance for Africa SRC - Second Rehabilitation Credit TRC - Third Rehabilitation Credit FISCAL YEAR OF THE BORROWER January 1 - December 31 FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of DirecorwGeneral Operations Evaluation June 30, 1993 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report (PAR) to Mozambique - Second Rehabilitation Credit (Credit 1841*MOZ) ano Third Rehabilitation Credit (Credit 2021-MOZ) Attached is the Performance Audit Report (PAR) on Mozambique - Second Rehabilitation Credit (Credit 1841- MOZ) and Third Rehabilitation Credit Paraguay (Credit 2021-MOZ), prepared by the Operations Evaluation Department. These operations, undertaken at a time when the country was still suffering from a destructive civi war, aimed at backing an ambitious but gradual program of stabilization and liberalization adopted by the Govemment in 1987. The Second Rehabilitation Credit (SRC) specifically supported changes in the foreign trade regime, domestic price IIberalizatIon, elimination of monopolies, improvements in fiscal and exchange-rate policies and, more generally, a more eff9ctive system of resource allocatior The Govemment's approach was to make partial adjustments In each area, rather than dramatic shifts, t. evaluate the effect of changes before proceeding futher. The Third Rehabilitation Credit (TRC) carried these reforms forward and also contemplated a modest social program of poverty reduction. Notwithstanding the enormous difficulties of carrying out stabilization and structural adjustment programs in a situation of civil war compounded by a devastating drought, considerable progress was achieved towards the stated objectives of the programs. Thus, the Inflation rate abated significantly -although at 45 percent p.a. it still remains too high-, several monopoly situations have been corrected, domestic trade has been liberalized and rationing has practically disappeared, public finances have been strengthened, the system of foreign-exchange allocation has Improved, and some growth In exports, food-crop prodc-tion and Investment has taken place, although the levels are still much below pre-war flows. Much remains to be accomplished before Mozambique tums the comer. As pacificaton and democratization get consoildated, economic stabilization and restructuring must move forward. For this, private investment Incentives should be Improved, military expenditures neod to be curtailed to strengthen public finances and reduce the unsustainable dependence on foreign aid, export disincentives must be redressed, and the reform of the financial sector must be deepened, thus strengthening monetary control Instruments. Poverty alleviation is an equally urgent priority. The Bank is continuing to support these efforts by means of a fourth adjustment operation, the Economic Recovery Credit (Credit 2384-MOZ) approved in June, 1992, and other operations. The PAR concludes that, while more remains to be done, the outcome of both credits was satisfactory, because their limited but important objectives were substantially attained in spite of adverse political and natural disasters. In view of the shown commitment of the authorities and positive albeit partial results, the sustainablifty of the reforms is considered likely, and the Institutional development impact partial. The assessment presented in the PCR for the SRC is consistent with these findings. Attachment This documnent has a restricted distribution and mnay be used by recipients only in the performnance of their official duties. its contents may not otherwise be disclosed without World Bank authorization. FOR OFFICIAL USE ONLY PERFORMANCE AUDIT REPORT MOZAMBIQUE SECOND AND THIRD REHABILITATION CREDITS (Credits 1841-MOZ and 2021-MOZ) TABLE OF CONTENTS Page No. Preface* * * * * * * ** * * * * * * * ** ** * * * * . . . . Basic Data Sheet * * * * * * * * * * * * * * * * * * * * * . . . Evaluation Summary . . . . . . . . . . . . . . . . . . . . . . . . vii I. INTRODUCTION * * * * * * * * * * * * * * * * * * * * * * . 1 II. THE SECOND REHABILITATION CREDIT ............ . 3 III. THE THIRD REHABILITATION CREDIT . . . . . . . . . . . . . . 6 IV. ADJUSTMENT ACHIEVEMENTS . . . . . . . . . . . * . . . . .* 9 Adjustment Strategy . . . . . . . . . . . . . . . . . . . 9 Exchange Rate . .. . . . . . . . . . . . . . . . . . . . 9 Foreign Exchange Allocation . . . . . . .. 10 Revenues and Expenditures ***** * ..... 10 Trade Liberalization ......... . . .... 11 Privatization * * * * * * * * * * * * * * * * * * 11 Public Expenditure Review *.**.** ..* ..*** . 11 Financial Sector Reform ..* . * .. * * * . . 12 Programs to Address the Poverty Impact of Adjustment . . 12 V. IMPLEMENTATION . . . . . . . . . . . . .* * . . . . . . 14 Procurement . . . . . . . . . . . . . . , * * * . . . . . 14 Institutional Impact .i....... .. ..... 15 Supervision * * * * * * . . 15 IMF/Bank Relations . . ..... .*. . . . . . 16 Audits * * * * * . . . . 17 Aid Mobilization and Coordination . . . . . . . . . . . . 17 Bank Staff Performance *999999999 999999 17 VI. ECONOMIC IMPACT OF THE PROGRAM ............... 18 Impact of the War and Drought . . . . . . . . . . . . . . 18 GDP Growth Rate * i * * * * * * e* . . . . . . . . . 18 Export Earnings and the Trade Balance . . . . . . . . . . 19 Investment .. . . ... ... ., ... .. 19 Weaknesses in the Present Situation . . . . . . . . . . . 20 This document has a retricted distribution and may be used by recipients onLy Ia the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization. Table of Contents (cont'd) Pa1e No. VII. OVERALL ASSESSMENT AND SUSTAINABILITY . . . . . . . . . . . . 22 VIII. LESSONS LEARNE) *************.*... . . . .. . .. .. 23 ATTACHMENT I Comments Received from the Royal Ministry of Foreign Affairs, Oslo . ... ..... * . . . . . . . . . . . . . 25 PERFORMANCE AUDIT REPORT MOZAMBIQUE SECOND AND THIRD REHABILITATION CREDITS (Credits 1841-OZ and 2021-OZ) PREFACE 1. This is a Performance Audit Report (PAR) on the Mozambique Second Rehabilitation Credit (SRC) in an amount of SDR 54.5 million plus SDR 14.5 million from the IDA administered Special Facility for Africa, and the Third Rehabilitation Credit (TEC) in an amount of SDR 68.2 million, in support of the Government's Economic Rehabilitation Program. The SRC was approved on August 4, 1987 and became effective on October 22, 1987. It was closed on June 30, 1991, two and one-half years behind schedule. Cofinancing administered by IDA with the SRC funds included gran.s from the Swiss Special Joint Financing (SJF) of 16.9 million Swiss france and Swiss Bilateral Financing of 10.1 million Swiss francs signed in September-October 1987, and cofinancing provided by the Government of Norway of 30 million Norwegian kroner signed in March 1988, by the Danish International Development Agency (DANIDA) of US$2.8 million signed in March 1989, and by the Ministry of Development Cooperation of the Netherlands of 7.3 million Dutch guilders, also signed in March 1989. 2. The TRC was approved on May 18, 1989 and became effective on August 4, 1989. Cofinancing administered by IDA with the TRC included: (i) 20 million Swiss francs provided by Switzerland, signed on June 12, 1989; (ii) 40 million Finnish marks provided by Finland, signed on September 6, 1989; (iii) 5 million British pounds sterling provided by ODA, signed on February 22, 1991 and 7.5 million British pounds on February 24, 1992; and (iv) 50 million Norwegian kroner provided by the Government of Norway, signed on December 12, 1991 and June 24, 1992. In addition, cofinancing associated with the TRC but administered on a parallel-financed basis included: (i) 20 million marks by the Federal Republic of Germany; and (ii) 60 million Swedish kronor provided by the Swedish Government. 3. The PCR for the SRC was forwarded to the Board on April 12, 1993. The TRC is almost fully disbursed and is scheduled to close on August 31, 1993, but the Project Completion Report has not yet been prepared. "0wever, because of the close relationship between the SRC and the TRC, the PAR has been prepared to include a review of both Credits, based on the PCR for the SRC, the President's Reports, the Credit documents, a study of Bank files, and a field visit to Mozambique. 4. The SRC and TRC were preceded by a first Rehabilitation Credit (No. 1610-MOZ) approved in June 1985, and were followed by the Economic Recovery Credit (No. 2384-MOZ), approved on June 11, 1992. All four of these Credits were dedicated to supporting the gradual but steady transition of Mozambique from a centrally planned to a market economy. 5. The PCR for the SRC provides a good, but brief, account of the program experience, the strengths and weaknesses of its achievements, discusses the performance of the Borrower's executing agencies, and concludes that the Credit achieved most of its key objectives. The PAR includes an account of the experience of both the SRC and the TRC, outlines the achievements of the Governmentts adjustment program to date and its effectiveness in stimulating the economy, discusses the likelihood of sustaining these achievements, discusses the Bank staff's performance and concludes that the overall results of both Credits were satisfactory. Lessons applicable to other adjustment credits are set forth based on the Mozambique experience. 6. Comments on the PAR received from the Bank of Mozambique and the Ministry of Finance have been taken into account throughout the report. Comments made by a Norwegian consultant to the Royal Ministry of Foreign Affairs, Oslo, are included as Attachment 1. - iii - PERFORMANCE AUDIT REPORT MOZAMBIQUE SECOND REHABILITATION CREDIT (Credit 1841-MOZ) BASIC DATA SHEET CREDIT POSITION (Amounts in US$ Million) As of April 30, 1993 Credit Ori-inal Disbursed Canceled eaeyid Outstanding IDA Credit 70.0 72.74 0.1 0.0 77.10 SPA Financ. 18.6 18.77 0.1 0.0 19.99 Note: Small discrepancies between various ..aounts are due to fluctuations in the exchange rate of the US$ in relation with SDRs In which IDA Credit and SFA Finance were expressed. CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS (IDA and SPA) FY88 FY89 FY90 FY91 Appraisal Estimate (US$M) 67.1 88.6 88.6 88.6 Actual (US$1) 54.2 74.4 85.0 88.4 Actual as % of Appraisal (Z) 80.8 84.0 95.9 99.8 Date of Final Disbursement: September 30, 1991 PROJECT DATES Original Actual Initiating Memorandum 02/27/87 02/27/87 Letter of Development Policy 06/26/87 06/26/87 Negotiations 06/22/87 06/22/87 Board Approval 08/04/87 08/04/87 Signing 09/08/87 10/05/87 Effectiveness 10/22/87 10/22/87 Loan Closing 12/31/88 06/30/91 - iv - STAFF INPUTS (staffweeks) Pteappraisal Appraisal Negotiation Supervision Other Total 1986 14.1 0.1 14.2 1987 62.6 26.1 2.7 1.0 92.4 1988 5.9 28.* 34.1 1989 4.1 4.1 1990 2.2 2.3 1991 12.6 0.3 12.9 1992 3.6 3.6 Total 76.8 26.1 8.6 50.8 1.4 163.6 MISSION DATA No. of No. of Staff Date of Month/Year Weeks Persons Weeks Report Preparation 11/86 6 7 42 12/30/86 Appraisal 3/87 3 6 18 6/16/87 Supervision I 11/87 2 5 10 11/28/87 Supervision II 5/89 1 2 2 6/28/89 Supervision III 11/90 1 1 1 9/10/91 Completion OTHER PROJECT DATA Borrower: Republic of Nozambique Follow-on Projects Projects Third Rehabilitation Credit No.: 2021-MOZ Amount: US$90 million Board Date: may 18, 1989 PERFORMANCE AUDIT REPORT MOZAMBIQUE THIRD REHABILITATION CREDIT (Credit 2021-MOZ) BASIC DATA SHEET CREDIT POSITION (Amounts in US$ Million) As of April 30, 1993 Credit Oriuinal Disbursed Canceled Rapaid Outstanding IDA 90.0 90.45 (*) 0.0 94.77 (*) Still open. Note: Small discrepancies between various amounts are due to fluctuatons In the exchange rate of the US$ in relation with SDRs In which IDA Credit was expressed. CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS UY90 PY91 Y2 FY-93 Appraisal Estimate (US$M) 45.0 90.0 90.0 90.0 Actual (US$M) 28.0 84.0 87.1 88.2 Actual as % of Appraisal (%) 62.2 93.3 96.8 98.2 Date of Final Disbursement: PROJECT DATES Oritinal Actual Initiating Memorandum 06/09/88 06/09/88 Letter of Development Policy 03/17/89 03/17/89 Negotiations Board Approval 05/18/89 05/18/89 Signing 06/12/89 06/12/89 Effectiveness 08/04/89 Loan Closing (sti.ll open) - Vi - SAIF INPUT (etaffweeks) Preappraisal Appraisal Negotiation Supervision Other Total 1988 10.9 2.7 13.6 1989 21.8 7.2 0.8 29.7 1990 26.2 26.2 1991 18.6 1.5 20.1 1992 6.0 2.8 8.7 1993 3.5 3.1 6.6 Total 10.9 24.5 7.2 55.1 7.4 105.0 OTHER PROJECT DATA Borrowers Republic of Mozambjique Follow-on Prouect: Project: Economic Recovery Credit Credit No.: 2384-MOZ Amount: US$180 million Board Date: June 11, 1992 - vii - PERFORMANCE AUDIT REPORT k-.OZAMBIQUE SECOND AND THIRD REHt3ILITATION CREDITS (Credits 1841-MOZ and 2021-MOZ) EVALUATION SUmMARY 1. In 1983 the FRELIMO Party SAF agreement in June 1987, and the Congress, which controls economic Bank followed with the Second policy in Mozambique, took a decision Rehabilitation Credit (SRC) on August to shift away from the socialist 4, 1987. The objectives of the SRC policies of the past by putting were to support a series of policy increased emphasis on smallholder changes adopted in 1987, to provide production and private investment, and foreign exchange in support of the by giving priority to increasing the program, and to assist the Government efficiency of existing capacity rather to develop an agenda for future policy than to new investment. This decision changes. The measures supported by was prompted by tha obvious failure of the IMF and the Bank were incorporated past policies, which had resulted in in a Policy Framework Paper (PFP) sharp declines in GDP and severe agreed with the Government that shortages of consumer goods, including included exchange rate adjustments, basic foodstuffs. The Government increases in revenues, monetary and applied and was accepted for interest rate policy changes, membership in the IMF and the World improvements in external debt Bank in 1984, and the Bank made management, changes in the trade available the first Rehabilitation regime and in the foreign exchange Credit (No. 1610-MOZ) in June 1985. allocation system, more liberal This Credit had the limited objective pricing policies, and an improved of supporting the Government's first domestic resource allocation system. modest steps away from a centrally While the changes covered a wide range managed to a market economy through of issues, the Government's approach the provision of balance of payments was to make partial adjustments in support for rehabilitation and each area rather than dramatic shifts maintenance of existing investments. so that the effect of the changes The Government was encouraged to could be evaluated before proceeding continue its policy changes through further. the vigorous producer response that resulted from the liberalization of 3. The early policy changes, the fruits and vegetables market in supported by increases in donor May 1985, which demonstrated the assistance, helped to reverse the stimulative effect of price incentives decline in GDP that characterized the in a free market. pre-1987 period, and the economy expanded at a 5.0 percent average 2. The Bank and the IMF worked annual rate during 1987-89. This closely together to develop a more encouraged the Government to expand amb..ious, but still gradual, program its liberalization efforts, which in of stabilization and liberalization in turn were supported by a continuing 1987. The Fund entered into its first series of IMF agreements and, by the - viii - Bank, with the Third Rehabilitation 6. Achievements of the adjustment Credit (TRC) approved in April 1989. process have been substantial. The Government experimented on a Although carried out gradually over limited basis with the non- the eight-year period, the Government administrative allocation of foreign now has an exchange rate close to exchange, made further improvements in equilibrium, tax revenues as a its public Expet.iture Program based percentage of GDP have doubled, and on principles agreed upon with the exports have doubled, albeit from a Bank, reduced price controls on very low basis. Investment as a additional product groups, revised the percentage of GDP has increased more tariff structure, and privatized a than five times, foreign exchange significant number of small- and movements are virtually free, price medium-sized parastatal companies. controls have been effectively Further significant policy changes eliminated, Government regulation of were subsequently taken in connection the private sector has been reduced, with a fourth adjustment operation and the quality of public investments (the Economic Recovery Credit, No. has been improved. Progress has been 2384-MOZ) approved in June 1992. made on privatizing the parastatal companies and in strengthening the 4. The adjustment program can be financial sector, although more needs evaluated in three different ways: to be done in both areas as well as in (i) were the policy changes improving and strengthening the civil implemented as agreed; (ii) what service. On the negative side, results were achieved, both toward inflation remains at a high level (45 progress in converting to a market percent in 1992), Government economy and in terms of physical expenditures have increased results; and (iii) was the underlying substantially in real terms, the strategy valid. On the basis rf all fiscal deficit is unsustainable, and three measures, the progrim was the country is heavily dependent on successful. foreign aid for both budget and balance of payments support. The SRC 5. Implementation of the agreed and TRC did not include much provision policy changes by the Government for for institutional development, but all four of the adjustment credits was some strengthening was achieved in the good, with the exception of a six- creation of a procurement monitoring month delay in meeting one of the unit, in the agency that administers conditions for the second tranche the public expenditure program, and in release under the TRC relating to the the GovernmentIs institutional improvement of the Public Expenditure capacity to design and implement Program. Difficulty was also economic policy changes. experienced in meeting the Bank's audit requirements and in processing 7. The overall effect of the program procurement applications related to on economic output was positive in the the use of the Credits, reflecting the 1987-89 period, but lack of attention relatively weak Government to export promotion, increased institutional structure. The IM military activity, a severe drought requirements were consistently and curtailed aid from and exports to complied with during a continuous Eastern Europe have retarded the series of agreements from 1987 to the growth rate since 1989. A peace present, although leakages in the agreement was reached in mid-1992 and credit control system resulted in the rains have resumed in 1993 so that continued high levels of inflation, future growth prospects are better. - ix - The improved economic climate has its support increasingly to the lower stimulated considerable interest on income groups most in need. the part of foreign investors in tourism (hotels), mining, agro- 10. There is reason to expect that industry and banking, but a true test the changes associated with the of the effectiveness of the adjustment adjustment program will be sustained program will depend upon the economic since there is growing private sector results that can be achieved under investment, and the improved situation more normal conditions. is recognized by the public compared to the preceding period of shortages 8. The program design consisted of and economic decline. However, the modest changes at each phase in degree of economic benefit resulting deference to the Government's desire from the changes will depend on the to move at a gradual pace. However, maintenance of peace and on how the the changes that were agreed upon were transition to a peacetime economy and generally implemented on schedule and a popularly elected government is became the basis for further positive implemented. The country is still steps in the next phase, thus heavily dependent on donor aid, which, validating the appropriateness of the if reduced too rapidly, could derail strategy. Cooperation between the IMF the adjustment process. and the World Bank was good, although the early stabilization programs did 11. The most important lesson not manage to achieve an equilibrium emerging from the Mozambique exchange rate until early 1992 nor to adjustment experience is that a achieve the inflation targets set gradual adjustment process can be forth in the various PFPs, despite effective even under conditions of Government compliance with agreed war, if the Government is fully credit ceilings. IDA supervision was committed to it, and if it is adequate, although supervision reports supported by an adequate level of were not always filed as prescribed by donor assistance. Also, at a more Bank operating procedures. operational level, the program demonstrated that an equilibrium 9. There is no clear conclusion exchange rate is a precondition for a regarding the social impact of the market-based foreign exchange program. While poverty reduction was allocation system. Differing donor not an explicit objective of the SRC, procurement rules present a serious it became an objective of the TRC. It impediment to implementation of is apparent that shortages of basic program aid. This should be commodities, which were common in the anticipated and addressed through pre-adjustment period, no longer attempts to unify the procedures and exist. On the other hand there were through adequate levels of training sharp increases in basic food prices; and technical assistance in the early these did not affect a majority of the phases of the program. poor, who are concentrated in the informal rural sector. The number of 12. In summary, the PAR concludes urban poor did increase, but this is that, for both credits, the overall attributable to the war. The outcome was satisfactory, with likely Government has, with IDA support, sustainability, and partial provided safety nets for those most institutional development impact. adversely affected by the charges and This assessment is consistent with the has over time shifted the emphasis of analysis contained in the PCR for the SRC. PERFORMANCE AUDIT REPORT MOZAMBIQUE SECOND AND THIRD REHABILITATION CREDITS (Credlts 1841-OZ and 2021-MOZ) I. INTRODUCTION 1.1 Mozambique, with a population of about 15 million people, is one of the poorest countries of the world with an annual per capita income recorded at around US$70. Literacy and infant mortality rates, levels of malnutrition and life expectancy are among the worst in Sub-Saharan Africa. At the same time, Mozambique has a rich natural resource endowment, with good agricultural land and plentiful rainfall, extensive forest cover, natural gas reserves, hydropower potential and mineral resources. 1.2 Mozambique's colonial background under Portuguese rule did little to equip it for independence in 1975, leaving a poorly developed physical and social infrastructure. Prior to independence, most semi-skilled positions in the economy were filled by the 250,000 Portuguese who lived in Mozambique. The colonial authorities did not stress education or social development, and native Mozambicans were not trained for management or government positions except at the lowest levels. Therefore, when the new government in Portugal agreed to give Mozambique independence and 230,000 of the immigrant Portuguese returned to Portugal in 1975, the impact on the economy vas traumatic. 1.3 The new ruling party FRELIMD chose socialism as its development strategy. All productive enterprises, including agricultural estates, were taken over by the Government, agricultural cooperatives were created to organize small farmers, and both internal and external trade was put under state control. Foreign exchange was allocated by fourteen Government trading companies that specialized in product groups, resulting in administrative decisions that reflected non-economic considerations. This choice did stimulate some aid flows and technical assistance from Eastern Europe, but also generated animosity from rightist elements both within and outside of the country. An opposition group called RENAMO, supported by South Africa and Rhodesia, began a long and costly civil war that disrupted large portions of the country and cut off logistical linkagea both internally and to Mozambique's neighbors. At the same time, the Government's socialist policies stifled producer incentives and caused small producers and farmers to withhold goods from the controlled markets. By the early 1980s, production had declined perceptively, consumer goods had become scarce, Mozambique's external debt had increased excessively, and the ability to finance imports and service the debt had declined as exports dropped. By 1984 the exchange rate was officially 42.44 meticais per dollar but was trading on the black market at 1,500. - 2 - 1.4 During the early 1980s the Government became increasingly aware that its socialist policies were not producing the expected results. In a FRELIMO Party Congress in 1983, the Congress adopted economic policies aimed at stemming the drop in production. This included increased emphasis on smallholder production and private commercial farms, increased efficiency in the use of existing capacity rather than new investment, and an increased role for private investment. As a result of the Congress, in 1984 the Government adopted an Economic Action Program (RAP) based on the new policies, covering the period 1984-86. At the same time, it introduced an export retention scheme whereby selected export enterprises were allowed to retain a portion of their foreign exchange earnings. It also liberalized the prices and marketing of fruits and vegetables in May 1985, gave authority to enterprise managers to lay off redundant workers and allowed some agricultural export enterprises to trade directly abroad. 1.5 As part of its new strategy, the Government applied to become, and was accepted as, a member of the IMF and the World Bank in 1984. This financial assistance was complemented by a multilateral debt-rescheduling operation. The first Bank/Fund missions to Mozambique attempted to persuade the Government to adopt a comprehensive adjustment program, shifting emphasis from centralized state control to a market economy. However, while the Government was prepared to experiment with market-based policies under the EAP, it was not yet ready to abandon its socialist system entirely. At the same time, the IMF was stressing the need to realign the exchange rate and to reduce fiscal deficits and money expansion. 1.6 In view of the changes adopted under the EAP, the Bank agreed to make IDA resources available in support of the Government's program. The first Rehabilitation Credit (No. 1610-MOZ), approved in June 1985, had the modest objective of providing assistance to the Government for the rehabilitation and maintenance of existing investments that were expected to generate an immediate production response. The credit financed part of the Government's 1985/86 imports of equipment, spare parts and raw materials on a positive list basis, provided a limited amount of technical assistance for procurement, and financed studies of the industrial and transport sectors. A procurement unit (UCPI) was established in the Ministry of Commerce to handle procurement under the program in accordance with World Bank procurement procedures. 1.7 This cautious first operation, which was also intended to stimulate a dialogue that could lead to more comprehensive adjustment measures in the future, accompanied a significant turnaround in Mozambique's economic fortunes. Beginning in 1987 and continuing strongly through 1989, output expanded on average about 5 percent per year (see paragraph 6.4). More significantly, the freeing of controls on fruits and vegetables produced an immediate flow of produce into the market, demonstrating to the Government the power of incentives operating in free markets. Thus, while the first operation was primarily in support of emergency rehabilitation measures and had virtually no macro-economic policy conditionality, it was a critical first step toward the later, more significant, adjustment operations that followed. An evaluation of this Credit was carried out by OED and is included in a PPAR dated June 26, 1992. -3- II. THE SECOND REHABILITATIO1 CREDIT 2.1 Following the earlier EAP adopted in 1984, the Government adopted an Economic Rehabilitation Program (ERP) in 1987 covering the period 1987-89 with the objectives of stabilization, more efficient resource mobilization and expanding economic growth. It undertook a number of major reforms aimed at achieving these objectives, including the gradual reduction of centrally administered controls and encouragement of the private sector. Specifically, it undertook a significant devaluation of the metical (although still not attaining an equilibrium exchange rate), increasing agricultural and industrial prices (but retaining price controls), increasing prices on petroleum products and transport tariffs, and introducing new tax measures through a comprehensive revision of the tax structure. A second debt-rescheduling operation was concluded. In accordance with a program worked out with the IMF, further exchange rate adjustments were to be made periodically. The Government also agreed to increase progressively the number of imported products for which no administrative allocations would be needed, to allow unrestricted purchases of foreign exchange to be made through the banking system, and to reduce the number of product groups imported through state trading corporations on a monopoly basis. The export retention acheme was expanded to include 100 large producers that earned foreign exchange, and in January 1987 was further expanded to include all exporters of non-traditional products. The Government also expressed its intention to dismantle price controls gradually. 2.2 In response to these actions, and in recognition of a program agreed with the IMF to reduce the budget deficit, increase revenues, restrain credit expansion, move toward positive real interest rates, and adjust the exchange rate periodically, the Bank agreed to make an IDA Credit available with the following objectives: a) to support the policy and institutional reforms put into effect in 1987 and to prepare for subsequent adjustment measures in 1988; b) to provide foreign exchange to finance essential imports needed for the recovery of the economy; and C) to assist the Government to develop an agenda for longar term policy changes. The proposed IDA Credit was to be augmented by resources from the Special Facility for Africa and with cofinancing from other donors. 2.3 The program was incorporated into a Policy Framework Paper (PPP) worked out jointly with the IMHF and the Bank, with the IMF advising the Government on issues related to exchange rate adjustment, public finance management, monetary, credit and interest rate policy, and external debt management. The Bank emphasized the trade regime and foreign exchange allocation system, pricing and distribution policies, domestic resource allocation, agricultural marketing and producer prices, industrial pricing and efficiency, and transport sector efficiency. The discussions of these issues during the 4- formulation of the PFP resulted in a single program agreed to by both institutions and the Government. 2.4 The Credit was made available in two tranches, with the first half available for disbursement upon effectiveness in recognition of the changes already put in place. The release of the second tranche was tentatively planned for six months after Credit effectiveness, but was to be dependent on the Government's satisfactory progress on macroeconomic stabilization and on the completion of the following specific actions: a) reduction of the number of product groups subject to fixed pricing from 46 to 37, with five additional product groups agreed with IDA to be reduced by January 1988; b) improvements in the foreign exchange allocation system by basing quarterly allocations on realistic estimates of foreign exchange availability and by taking into account the operating efficiency of the users according to criteria agreed with IDA; c) completion of a study of the newly adopted trading measures described in para. 2.1, and a plan for implementing the recommendations agreed with IDA; d) reduction of the number of product groups which must be imported through the state trading monopolies from eleven to five and the number of export commodities from three to one; e) initiation of a study of the allocation system for domestic goods based on terms of reference and a schedule agreed with IDA; and f) completion of a study of the parastatal enterprises and an action program agreed with IDA. These conditions were substantially met on schedule, and the second tranche was released accordingly. 2.5 IDA funds and associated financing were utilized for the procurement of a broad range of imports on the basis of a negative list, rather than the more limited positive list used for the first Rehabilitation Credit. Procurement was gradually shifted to the private sector, supervised and assisted by a special procurement unit called the Bureau for Coordination of Import Programs (BCPI) set up for this purpose in the Ministry of Commerce, which was an enlarged version of the procurement unit set up under the first Credit. Disbursements were generally in line with appraisal estimates, but lagged somewhat because of delays in issuing import licenses and because most importers had to obtain credit from the commercial banks as a separate step after securing the import license. The Credit closing date had to be extended three times to allow all of the financing to be utilized. 2.6 In addition to satisfactory progress in implementing the policy changes agreed to for the SRC, the Government met the conditions of the IMF's - 5 - Structural Adjustment Facility (SAY) Agreements for 1987-89. However, the domestic credit ceilings of this program covered only a small proportion of the banking sector's assets (80 percent of the assets and liabilities were either "unclassified" or "items in transition"). As a result, the "domestic-source credit concept did not allow adequate control of credit expansion, and inflation remained disturbingly high (42.1 percent in 1989). The Government, the Bank and the IM also entered into updated Policy Framework Papers (PFPS) for 1988-90 and for 1989-91, guided by the underlying strategy outlined in the Government's Economic Rehabilitation Program (ERP). 2.7 The budget deficit, after taking into account donor budget support, was reduced from over 10 percent of GDP in 1985/86 to 6 percent in 1988. By April 1989 price controls had been eliminated or reduced for products accounting for 70 percent of GDP in the agricultural and industrial sectors and the remaining fixed prices were being adjusted regularly. The exchange rate was adjusted substantially, raising the official rate from 2-3 percent of the parallel rate in 1986 to around 50 percent in October 1988, but the remaining spread between the parallel and the official exchange rate indicated that equilibrium had not yet been achieved. The export retention scheme was expanded to cover both traditional and non-traditional exports, and while the import allocation system was still largely determined on an administered basis, the allocation and procurement process was improved by removing a substantial number of products from the monopoly trading companies to the BCPI (later renamed the GCPI) where donor procedures .3quiring competitive bidding were required. 2.8 Partly a result of the liberalization measures put in force from 1985 onward, and assisted by the infusion of increased donor import financing, the decline in GDP that characterized the 1984-86 period was reversed. GDP expanded 4.0 percent in 1987 and 5.5 percent in 1988 in spite of a continuation of the war, which disrupted trade between a substantial portion of the countryside and Government-controlled areas. - 6 - III. THE THIRD REHABILITATION CREDIT 3.1 Encouraged by the visible positive results of its earlier efforts, the Government proceeded on a gradual but steady basis to carry out the targets set by the ERP. The Bank agreed to continue its support for the ERP by providing financing through the Third Rehabilitation Credit (TRC), approved on April 24, 1989. The TRC had two principal objectivess (i) to consolidate the progress made in macroeconomic stabilization; an4 (ii) to initiate further reforms in key aspects of resource allocation required to sustain the recovery. 3.2 Specifically, the areas to be covered by the IRC included the following actions to be taken by the Government: (a) introduction of a mechanism for the non-administrative allocation of foreign exchange, with demand to be managed principally through exchange rate and tariff policies for an estimated US$25 million of imports to be covered by the new system during the first twelve months. Administrative safeguards would be left in place during the first year in the event that market demand was excessive, at which time a review would be carried out with the objective of removing the safeguards and expanding the system if it operated satisfactorily; (b) Improvements in the planning and executing of the Public Expenditure Program. A three-year rather than a one-year program was to be developed based on principles agreed with IDA, including giving priority to tha completion of the most productive ongoing projects, rehabilitation and maintenance rather than new investments, and to projects that appeared capable of quickly yielding or saving foreign exchange and showing high rates of economic return. In agriculture, priority would be given to family farms rather than the state sector, and irrigation would focus on small scale low cost methods rather than large scale projects; (c) reduction in the number of products subject to fixed pricing from 25 to 20, initiation of a minimum price support system for some agricultural products (groundnut, sunflower, mafurra, cashew, copra, and cotton), and introduction of import parity as a basis for setting prices of those products that remained subject to fixed pricing; (d) decontrol of the wholesale trade of a further 15 products in early 1989, with all enterprises permitted to trade directly with other enterprises; and -7- (e) sionlification of the tariff structure through the consolidation of produce categories and the reduction in the number and range of rates. 3.3 The Credit was to be released in two equal tranches and used %o finance a broad range of imports subject to a negative list, as vas the case for the SRC. The second tranche release was predicated on satisfactory progress in implementing the ERP and in meeting the following specific conditionst (a) approval and implementation of the system for non- administrative allocation of foreign exchange, including agreement on the dismantling of the first year safeguardes (b) adequate progress on improving the Public Expenditure Program, including the introduction of a three-year financial plan and a review and prioritization of all capital-intensive projects; (c) verification that the minimum pricing system for selected agricultural products was functioning, a review of its results carried out, and fixed prices adjusted taking into account international border prices; and (d) completion of the tariff review and measures for simplification agreed. 3.4 The Credit was approved on May 18, 1989 and the first tranche released upon effectiveness on August 4, 1989. There was a delay in meeting- the second tranche condition relating to the improvements to the Public Expenditure Program, which the Bank concluded was too large and did not adequately link the financing plan to the investment program. The authorities argued that the conditionality was rather vague, but they realized that the Expenditure Program was not feasible. Compliance was achieved after about a six-month delay and the second tranche vas released accordingly. Disbursements were somewhat delayed for the same reasons that affected the SRC (see para. 2.5), and Credit closing was extended from the original date of April 30, 1991 to August 31, 1993. As of April 30, 1993, 98.0 percent of the IDA Credit had been disbursed. The attempt to set up a limited non-administrative foreign exchange system, however, did not prove successful due to the lack of a steady supply of foreign exchange. This made it difficult to set an appropriate price for foreign exchange, with the result that the system could not rely on a market-based allocative process. 3.5 The TRC was in turn followed by a fourth Credit dedicated to moving the adjustment process along further. This Credit, called the Economic Recovery Credit (ERC), was approved on June 11, 1992. It provided for further improvements in the foreign exchange allocation system and export incentives by developing a consolidated market for foreign exchange, in place of the partial non-administrative allocation process tried under the TRC, liberalizing prices of manufactured products, and reforming the agricultural marketing system. The banking sector was reformed by clearly defining the lending and fiscal activities of the BOM and the Ministry of Finance, by separating the commercial banking functions from the BOM's central banking functions, and by passing new banking legislation that encourages more competition in the banking industry. It also -8- provided for measures to facilitate the privatization of several of the larger parastatal companies, fostered further improvements in the Public Expenditure Program review process, and required the expansion of budget expeaditures for health and education. This Credit was declared effective on August 3, 1992 and is now under implementation. - 9 - IV. ADJUSTMENT ACHIEVEMENTS Adjustment Strategy 4.1 By 1985 when the first adjustment operation was undertaken, the Government had both positive and negative reasons for undertaking an adjustment program. As mentioned earlier, the Government was aware that its existing policies were not working, and the first experiments with liberalization--most notably, the freeing up of fruit and vegetable production from state control-- provided a vivid demonst. ion of how the incentives associated with a market- based system could stimulate output. At the same time, Eastern European aid flows were slowing down, debt repayments were exceeding foreign exchange availability, and overall productive output was declining sharply. 4.2 However, the Government was not prepared to accept the drastic actions recommended by the first Bank/Fund missions, as mentioned in paragraph 1.5. The program eventually agreed to was one that the Government could endorse as its own and that the Bank could accept as a move in the right direction. It provided for gradual change that allowed the Government to experiment with price decontrol and other liberalization measures, taking a few product groups at a time, while the donor community cushioned the effect of the changes by substantial levels of balance of payments support and debt relief. This strategy was carried out over an eight-year period, with gradual but steady movement toward a market economy. Over this period, and continuing to the present, the Government generally met its commitments to the changes agreed at each stage, and the Bank and other donors provided financial support on a fairly continuous basis. 4.3 The changes can best be described in relation to the entire period (1985 to present), even though specific changes were associated with each of the Bank's four adjustment credits. Exchange Rate 4.4 At the beginning of the Bank/Fund relationship with Mozambique in 1984, the exchange rate was trading in the illegal parallel market at about 40 times the official rate. While the early stabilization programs provided for major devaluations, the parallel rate was still over two times the official rate from 1987 to 1991 (see graph below). This prevented the full reliance on a market-based system of foreign exchange allocation since whoever secured access to foreign exchange at the official rate did so on a highly subsidized basis. In October 1990 a legal "secondary market" was introduced, where a limited number of exchange transactions were permitted on a free-exchange basis. Initially, the secondary market rate was near the illegal parallel rate, but as more exchange transactions were liberalized, the size of the illegal market shrunk, and all the rates converged. Since 1991 the differential between the parallel and the official rate has been reduced to between 10 and 20 percent. The premium for any remaining illegal transactions, if any, is believed to be small. Thus the exchange system is now operating close to equilibrium, and is open and free for most foreign exchange transactions. - 10 Sgread Between Parallel and 9ficial ExchAee Rate 2A 2.4 2.2 2 a I 1. 1A Searcet Report ad Recommendation of the President for the Economic Recovery Program, May 18, 1992 (No. P-5775-NOZ) Foreig& Egghange Allocation 4.5 The foreign exchange allocation system vas gradually changed to a market-based svstem, as described in the earlier sections. Also, the monopoly enjoyed by the fourteen parastatal trading companies for the import and export of various product groups was gradually reduced, and most of these trading companies have either ceased to exist or are gradually fading away. It has only been in the last year and a half, however, that a market-based system of foreign exchange allocation could be achieved due to the over-valuation of the exchange rate until that time, as described above. At present, foreign exchange is readily available, although importers must follow the procurement guidelines required by donors if they are drawing on donor-financed imports. The secondary market exchange rate is determined daily by the various banks on the basis of supply and demand, and the official rate is then set by the Central Bank on the basis of movaments in the former rate. fevenues and Expenditures 4.6 Government current revenues have risen from 12.9 percent of GDP in 1986 to a projected 25.9 percent in 1992 through increases in transaction and income taxes and in customs duties as the result of the major revision of the tax structure in 1987. Even though the actual ratio may be overstated owing to some underestimation of GDP, this is a substantial increase, and represents a major achievement. This has, however, resulted in a relatively heavy tax burden by African standards, with a 50 percent corporate iucome tax rate for all but very small businesses, a 10 percent turnover tax, excise taxes, and an 18 percent - 11 - withholding tax on individuals. (By comparison, the World Development Report shows average total current revenues as a percent of GNP of 15.8 percent for the thirteen Low-Income African economies for which data was available in 1990.) As a result of widespread tax evasion, moreover, the burden falls mainly on a relatively small segment of the formal sector. 4.7 Expenditures have also risen sharply, from :?2.4 percent of GDP in 1986 to a projected 58.2 percent in 1992. This reflects a sharp increase in donor- financed capital investment, which rose from 5.6 percent of GDP in 1986 to 26.4 percent of GDP in 1992, and an increase in military spending from 5.4 percent of GDP in 1986 to 10.2 percent in 1992. Current expenditures, excluding military expenditures, remained flat at about 20 percent of GDP over the same period even though spending for education and health included in these figures increased from 9.2 percent to 13.1 percent of GDP. Both capital and recurrent expenditures are supported by donor grants, so that the net level of deficit spending was 6.7 percent of GDP in 1992. This is financed by a combination of Central Bank credit and a build-up of government arrears. Trade Liberalization 4.8 Price controls were gradually reduced over the eight-year period and exports and imports liberalized so that for most products, price controls and trade restrictions no longer apply, as described in the previous sections. Privatization 4.9 In 1988 the Government set up a Commission to manage the privatization of government-owned companies, along with the creation of an authority called the Enterprise Restructuring Unit (UTRE) to carry out the privatization of the larger parastatal companies. The Commission gave the ministries authority to privatise small and medium enterprises, and under this authority some 200 firms have now been turned over to private ownership, either as outright sales or on a lease basis. Only in mid-1991 has privatization become a significant objective of Government policy, however. Since that time, UTRE has carried out studies of several of the large parastatals and agreement has been reached to sell eight of them. The Government has stated that its intention is to sell off all of the remaining parastatals (about 400) except for the public utilities. 4.10 The Government's privatization efforts have been supported by the Bank through several separate lending operations (Industrial Enterprise Restructuring Credit, No. 2081-MOZ, approved on December 21, 1989, and the Small and Medium Enterprise Credit, No. 2082-MOZ, approved on the same date). Public Expenditure Review 4.11 The Government has developed a formAl review process for its capital expenditure budget whereby annual Public Expenditure Reviews (PER's) are to be carried out on the basis of criteria agreed with the Bank for project selection, as described in para. 3.2 (b). The investment program is prepared as a three- year program of "core projects," updated annually, with due regard for return on investment and the cost of operation and maintenance of the projects after completion. - 12 - 4.12 This process has been carried out successfully since its inception, and has now become a standard part of the Government's budgeting process. It has eliminated what some Government officials referred to as "white elephants," has reoriented the irrigation program away from large-scale projects to support for small farms, and has reduced investment in the weak parastatal companies. It has also led to a shift of resources toward the rural areas, called attention to the need for increased spending in the social sectors, and now includes all donor- financed projects. Financial Sector Reform 4.13 Reform of the financial sector was undertaken only late in the adjustment process, and the absence of a competitive private commercial banking sector is still an impediment to growth in Mozambique. However, several significant improvements have been made in this area during the past two years. A new central banking law and a general banking law were adopted in December 1991. The BOM's commercial banking activities were spun off from the central bank functions in 1992 and set up as a separate publicly owned commercial bank. The changes in the banking laws have encouraged investors to set up private commercial banks. One new bank began operations in March 1993 and a second Is expected to open in about two months. IDA is in the process of preparing a Financial Sector operation, which is tentatively scheduled for approval in December 1993. Programs to Address the Poverty Impact of Adjustment 4.14 There are differing views as to how severe an adverse impact the adjustment program has had on the lowest income groups. There is no doubt that the measures that reduced subsidies on basic foodstuffs and cut back the official rationing system placed a financial burden on those who had been able to obtain goods through these programs, which were principally urban populations and civil servants. At the same time, the persistent shortage of goods in the pre- adjustment period meant that these programs were not fully effective in meeting demand at subsidized prices, and consumer goods obtained outside of the official system were often only available at scarcity prices. Also, the urban population represents only about 25 percent of the total population. Thus, the majority of the poor, who are concentrated in rural areas, were not adversely affected by the increases in f-Adstuff prices. The number of urban poor did increase, however, as a consequence of the war. The adjustment program gradually shifted the terms of trade in favor of the rural sector, and so rural producers were generally better off after adjustment. Also, the increased level of donor aid provided in support of the adjustment program supported a higher overall consumption level than would otherwise have been possible (private savings have averaged a negative 16.8 percent over the past five years, giving some idea of the order of magnitude of this factor). Even more important, the improved GDP growth rate starting in 1987 helped ease the burden on all groups. 4.15 At the same time, the Government's socially conscious orientation has made it sensitive to the impact of the adjustment changes on the population, and it has consistently taken steps to mitigate any negative effects, especially in regard to the urban population. Starting in 1987, the Government introduced a "safety net" by continuing the old ration system in Maputo and Beira for a - 13 - limited number of basic commodities. The Government more recently started a targeted program of support for poor families identified through the health system, whereby families with malnourished children are given cash subsidies if they can demonstrate their lack of income. The new system is being expanded to cover twelve major urban centers (it now covers ten) and will replace the old rationing system, which will phase out in mid-1993. 4.16 The targeted program was a result of studies carried out under a Social Dimensions of Adjustment (SDA) program managed by the World Bank staff and financed through contributions from other donors on a grant basis. The SDA program also finances community development projects. To date only US$3 million of the US$12 million of available donor financing has been utilized, however. 4.17 Poverty reduction was not an explicit objective of the SRC, but was introduced through monitoring studies in the TRC and became a specific subject of conditionality in the ERC. The Bank carried out a study of poverty in Mozambique entitled "Poverty Policy Framework Paper," dated January 31, 1990, followed by another study ("Determinants of Poverty and Income Distribution in Maputo") completed in March 1993, which has helped to analyze the problems of the poor and to suggest targeted responses that are within Mozambique's financial capability to implement. In addition, the Government has agreed, as a condition of the second tranche release for the ERC, to increase budgetary allocations from domestic sources in real terms from 1992 to 1993 by at least 1 percent for education and 4.5 percent for health. These budget increase targets, which were met in 1992, evolved from the Public Expenditure Reviews and are considered by the Government and the Bank to have both development and anti-poverty objectives. - 14 - V. IMPLEMENTATION 5.1 This section reviews the implementation experience with the SRC and the TRC in respect to procurement, technical assistance, supervision, IW/Bank coordination, audits, donor aid coordination, and Bank staff performance. Procurement 5.2 A special procurement unit (UCPI) was set up under the first Rehabilitation Credit to handle procurement of the goods financed under the Credit. Three long-term technical assistance advisers were provided to work with the UCPI, and some Government employees were sent for training. 5.3 Under the SRC, the UCPI was renamed the GCPI and its functions were shifted from direct procurement to the role of advising and assisting the end users (government or private) in the application of the Bank's and other donors' procurement procedures. The long-term technical assistance advisers were terminated, as their services were not found to be satisfactory, and outside assistance financed by IDA was limited to short-term visits by the Bank's procurement advisers, who frequently conducted short in-country procurement seminars, and some training abroad, supplemented by a long-term procurement adviser financed by ODA. The SPA sponsored joint donor procurement missions led by Bank procurement personnel in September 1989, March 1990, and March 1991, which served as training sessions for the GCPI personnel. 5.4 GCPI's role was complicated by the multiplicity of donor procurement procedures. While the Bank attempted to achieve a degree of uniformity in these procedures, there still remained about a dozen different sets of rules applicable to donor financing. Even the Bank's rules changed over time in respect to the dollar value of purchases that could be handled through regular commercial practice rather than ICB, and in how and where procurement files were to be reviewed. 5.5 Also, problems arose in the coordination between GCPI and the 8O, which was responsible for disbursing the credits, and delays resulted from the fact that the license applicants usually waited until after securing an import license before applying to a commercial bank for credit, which then took additional time to process, as mentioned in paragraph 2.5. 5.6 As the exchange rate remained overvalued until early 1992, it was necessary to control the allocation of the available foreign exchange on an administered basis. This was done by the Commission for Economic and External Relations (CREE) on the basis of estimated need and priority within the economy. As the exchange rate became more realistic, the allocation system was gradually discarded, and market forces were used to allocate resources after 1991. Coordination between the GCPI and the BOM was gradually improved with the introduction of computers, and the excessive delays for importers seeking credit have been reduced by making the issuance of import licenses virtually automatic. Thus, by the end of 1992, the procedural problems that led to unnecessary delays in procurement and disbursements had been resolved. The need to comply with - 15 - multiple donor procurement procedures, however, is still burdensome to private importers. Institutional Impact 5.7 The SRC and TRC included financing for some technical assistance for procuroment, and for various studies to be carried out in connection with policy reforms. However, the TA for procurement was never utilized, and on the whole very little technical assistance was actually financed under these Credits. There was a separate Credit (Economic and Financial Management Technical Assistance, No.2066-MOZ) approved in October 1989 that made funds available for this purpose. This project is still under implementation; the Region reports that progress is slow and uneven. Other donors and the IMP also provided personnel for strengthening the Government's relatively weak institutions. Also, various Bank procurement missions and training sessions in connection with the Credits hUlped to strengthen the GCPI, which became an effective unit for managing and monitoring the procurement for donor-financed programs. 5.8 The TRC also had an impact on the training and operation of the National Planning Commission, which expanded its capacity to review and monitor the Public Expenditure Program. Perhaps most important, the Government developed the expertise to design and implement policy improvements on a multi-agency basis, using the PFP as an effective instrument for reaching agreement on Government policies, and for following up the implementation of those policies. Supervision 5.9 The Project Completion Report (PCR) for the SRC lists only a limited number of supervision missions over the life of this operation, and shows a gap between November 1987 and May 1989 where no missions occurred. However, the PAR for the first Rehabilitation Credit contains a much more comprehensive list of supervision missions, including three missions between November 1987 and May 1989. In actual fact, the Bank staff made frequent visits to Mozambique in connection with the adjustment program, even though formal supervision reports were not filed. Some of these visits were primarily to prepare follow-on projects or to work on related operations or ESW, but lank staff was frequently available in Mozambique to address problems in connection with these two Credits. The Bank established a Resident Mission in 1989, which also played an important role in monitoring progress after that date. The missions conducted by procurement advisers, including the three SPA missions mentioned in para. 5.3, also filled a supervision function but were not recorded as formal supervision missions. - 16 - 5.10 The ratings recorded on Supervision Form 590 were ps fpllows: SUPERVISION RATINGS (OVERALL) YA O TRC 88 2 89 2 1 90 2 3 91 2 2 92 2 2 The rating of 3 in fiscal year 89 for the TRC reflected the delay in meeting the conditions for the release of the second tranche, as described in paragraph 3.4. The ratings seem realistic in view of the generally satisfactory implementation performance accompanied by some disbursement delays related to procurement problems as well as difficulty in meeting the Bank's audit requirements (see para. 5.14). IMF/Bank Relations 5.11 The IMF's first SAF agreement with Mozambique was signed on June 8, 1987, just two months before Board approval of the SRC. The Bank and Fund staff worked closely together in defining the conditionality of these two agreements, and both organizations saw the agreements as interrelated and supportive of each other. While the Bank, as a matter of policy, did not have specific cross- conditionality with respect to the requirements of the SAP, one second tranche condition for the SRC and the TRC was "...continued satisfactory progress on macroeconomic stabilization," a phrase that encompassed the kinds of issues addressed in the SAP. The IMF entered into a series of programs each year thereafter, first in the form of SAP's and later as ESAF's, the most recent of which was on December 1, 1992. 5.12 Over this period, Bank staff regularly participated in Fund missions, and both organizations worked together on a series of PFP agreements negotiated with the Government. The Government met the criteria spelled out in the IMF agreements and PFP's with only minor exceptions over the entire six-year period. On the whole, relations between the Bank and the IMF appear to have been excellent, and the programs of each supportive of the other. 5.13 In terms of substance, the stabilization program did not meet the inflation objectives set forth in the PFPs, even though the Government met the credit and budget deficit targets designed to achieve the desired result. As was realized in 1990-91, substantial "credit leakages" were occurring in the sense that the IMf credit ceilings covered only small proportion of the banking sector's assets (80 percent of the assets and liabilities of the banking sector were either unclassified or "items in transition"). The operational implication was that the "domestic-source credit" concept did not allow adequate control of credit expansion. To address this issue and improve consistency between monetary targets and outcome, Mozambique's credit targets were changed to the Net Domestic - 17 - Asset concept. In 1992, the first year of full implementation of the NDA concept, actual and targeted inflation were quite close (45 percent versus 54 percent). Also, as mentioned in para. 4.4, it took four years after signing the first SAP for an equilibrium exchange rate to be reached. Audits 5.14 The Government has had difficulty carrying out satisfactory audits of Credit accounts on a timely basis, as required by the Credit Agreement. After experiencing difficulty with audits under the SRC, the BON hired a private consulting firm of auditors to do this work. Even so, audits continue to be a problem, reflecting the institutional weakness of the Government and the lack of qualified accountants in Mozambique. This situation might have been less troublesome if the Bank had identified this weakness at an earlier time and taken steps to assist the Government to overcome it. The problem is being tackled under the Economic and Financial Management Assistance Credit (cf. para. 5.7), which calls for steps to promote intensive accountancy training. Aid Mobilization and Coordination 5.15 The adjustment credits, combined with IMF agreements, annual Consultative Group meetings, and the SPA process have all played a catalytic role in mobilizing substantial amounts of external aid on a timely basis. Donor assistance has taken the form of balance of payments support, project assistance, and debt relief. The various agreements and the BanklFund monitoring of their conditions have given donors confidence that their support would be used in a constructive and coordinated manner. Total donor aid disbursed averaged US$666 million annually from 1988 to 1992 (see Annex A), which has financed intermediate goods for local production facilities, has cushioned the shock to consumers through the importation of consumer goods, and has financed virtually the entire Public Expenditure Program. Debt rescheduling has been negotiated every year since 1984, and will continue to be needed for the indefinite future. Bank Staff Performance 5.16 The performance of the Bank staff over the entire period appears to have been good. Supervision was adequate, although supervision reports should have been filed on a more regular basis. The Bank staff's Government counterparts expressed satisfaction with the cooperative attitude of the staff, and attributed the good working relationship in part to the fact that there was considerable continuity on the part of the Bank staff over the life of the program so that the staff could come tc understand Mozambique's problems. One official, however, felt that there was a lack of continuity among the Bank's procurement advisers, especially in the early years, which added to the problems in this area but spoke highly of the support provided by some of the Bank procurement staff. - 18 - VI. ECONOMIC IMPACT OF THE PROGRAM 6.1 The Government's BRP, the Bank's four adjustment operations, and the IMF*s various SAP's and ESAF's all contributed in an integrated way to the economic results achieved over the period 1985-1992, and it is not possible to disaggregate their individual contributions. A review of the behavior of the economy over this period does, however, provide a basis for assessing the achievements of the combined actions that were taken. Impact of the War and Drought 6.2 In assessing these results, it is necessary to take into account the effect of the civil war that was under way over the entire period until mid-1992 and the drought that impacted on all of Southern Africa in the early 1990s. The war made large parts of the country inaccessible to the Government and interrupted the land transport linkages between Maputo and other major urban centers within the country as well as with South Africa. Military activity increased during the 1990-92 period (shortly before a truce was achieved in September 1992), with a larger adverse impact than in the late 1980s. 6.3 The drought began in 1990 and intensified in each of the following two years in the 3outhern half of the country, having a negative impact on agricultural output in each year but especially in 1992. Thus the economic results for the 1990-92 period reflect the results of both intensified military activity and increasing drought, with the most serious effect occurring in 1992. Rains have resumed in 1993 at a normal level, and there is reason to hope that the drought is now over. GDP Growth Rate 6.4 Overall economic results reflect the changes made in economy policies as well as the other factors mentioned above, as follows: Table 1: GDP GROWTH RATE 1984 1985 1986 1987 1988 1989 1990 1991 1992 GDP % Change -2.2 -10.4 -2.0 4.0 5.5 5.4 1.3 2.7 -2.4 The positive results in the 1987-89 period, which coincided with the major disbursements from the SRC but which also reflected a rebound from the highly negative results of the previous three years, encouraged the Government to proceed with further policy changes. The results during 1990-92 were not as encouraging, in part because of the intensification of the war and the drought. Also affecting the 1990-92 results were the cessation of aid from the Soviet Union, a decline in workers' remittances from East Germany, and the loss of Soviet export markets. While the overall level of donor aid did not decline (see Table 2), the composition shifted to an increase in food aid (because of the - 19 - drought) and a decrease in intermediate goods, with a negative impact on domestic output. Export Earnins and the Trade Balance 6.5 Exports showed a significant improvement through 1991 from a very low base, rising in spite of the war and drought (shrimp exports, not affected by drought , were a major factor in the increase). They declined somewhat, however, in 1992 reflecting the loss of Soviet barter arrangements, war and drought, as well as insufficient incentives. Imports rose sharply during the period due to increased donor balance of payments financing. Thus, the trade imbalance increased (see Table 2). Table 2: EXPORTS, IMPORTS AND FOREIGN AID (US$ million) 1986 1987 1988 1989 1990 1991 1992 1_ (Proj.) Exports 79 97 103 105 126 162 139 Imports 543 625 736 808 877 899 887 Donor Aid Disbursed* 497 605 625 645 699 645 701 (Loans and Grants) (*) Includes food and non-food aid provided by the U.N. for war and drought relief. Investment 6.6 Non-Government investment (which includes private and some parastatal investment, although no breakdown is available) quadrupled in 1986-92, and government investment rose five-fold over the same period. However, non-government savingl' declined from 6.2 percent of GDP to -22.2 percent, reflecting an increase in balance of payments support flowing to consumption, while government savings increased from -12.1 percent to -4.0 percent over the same period. As "Non-government savings" includes the operations of public enterprises. - 20 - Table 3: SAVING AND INVESTMENT (Z of GDP) 1986 1987 1988 1989 1990 1991 1992 _ _(Proj.) Govt. Revenues 12.9 16.2 19.9 23.4 22.2 23.9 25.8 Govt. Expenditures 22.4 37.5 45.2 49.0 51.7 50.4 58.2 Non-Govt. Investment 4.1 8.0 10.8 12.0 14.0 17.7 20.1 Govt. Investment 5.1 16.0 22.6 23.5 24.1 24.4 26.9 Non-Govt. Savings 6.2 -18.6 -16.7 -21.4 -11.7 -12.8 -22.2 Govt. Savings -12.1 -5.2 -2.7 -2.0 -3.4 -0.6 -4.0 6.7 The increase in non-governmental investment was the result of an improved investment climate brought about by the policy changes described above. Foreign exchange became accessible, price controls were lifted, and investment rules were simplified. The exchange rate now reflects the realistic cost of foreign goods, profits can be repatriated, and export proceeds can be retained. There has been a visible increase in interest in new investment on the part of foreign investors since the end of the war, with frequent foreign business delegations exploring investment possibilities in tourism, mining and agriculture/fishing. At the same time, the continued high rate of inflation (45 percent in 1992), caused in part by the drought in 1992 (the IMF estimates that inflation in 1992 would have been about 31 percent if there had not been a drought), and the related high nominal interest costs (46 percent for most commercial borrowing), combined with relatively high tax rates, are sources of complaint by local entrepreneurs. Nevertheless, the overall investment climate is perceived by potential investors as favorable and improving, and is encouraging both local and foreign investors to expand their productive activities. There is a perception in the business community that future profit opportunities lie in productive investments rather than in speculative trading opportunities now that foreign exchange is readily available and freely convertible. Weaknesses in the Present Situation 6.8 There is no doubt that the policy changes achieved during v-e past eight years represent significant progress, even though the physical results have been somewhat masked by the effect of the war, drought and other factors described in para. 6.4. However, there are serious weaknesses in the present structure that will need to be addressed in the years ahead. Inflation remains at a high level, as mentioned above. Overall Government expenditures are extremely high for an economy of this size, and the negative personal savings rate reflects the fact that a substantial part of the donor aid to Mozambique is flowing to consumption, and is financing a significant part of the budget. These dependencies will be difficult to reduce, and can probably only be done gradually over a long time period in order to avoid a shock to the economy. The tax burden on those who pay is already high, and it will be difficult to further increase the tax ratio. Furthermore, donor aid finances about 80 percent of all imports, another dependency that will have to be reduced gradually. These reductions will add to inflationary - 21 - pressures on the economy, something that is already a problem, and finally, debt rescheduling will continue to be needed on an indefinite basis unless the stock of debt is reduced, although the current account financing gap after rescheduling is projected to be closed by about 1996. 6.9 On the agenda for further action needed by the Government is a faster pace of privatization of the larger parastatals and more vigorous civil service reform, vhere little progress has been made on reducing redundancies. Much remains to be accomplished before Mozambique turns the corner. The process of pacification and democratization needs to be consolidated, economic stabilization and restructuring must move forward. For this, decisive action on multiple fronts is imperative: private investment incentives should be improved, military expenditures need to be sharply curtailed to strengthen public finances and reduce the unsustainable dependence on foreign aid, export disincentives must be redressed, and the reform of the financial sector must be deepened, thus strengthening monetary control instruments. Poverty alleviation is an equally urgent priority. The Bank is continuing to support all these efforts by means of a fourth adjustment operation, the Economic Recovery Credit (Credit 2384-MOZ) approved in June, 1992, and other targeted operations. - 22 - VII. OVERALL ASSESSMENT AND SUSTAINABILITY 7.1 The adjustment process in Mosambique has brought significant improvements to the economy, in spite of war and drought. Specifically, the SRC and the TRC were successful in supporting gradual but important changes in the economic system. While not all of the measures undertaken were successful, such as the non-administrative allocation of foreign exchange tried under the TRC, they were generally carried out as agreed, and paved the way for the more significant measures to be taken as conditions for the ERC that followed. The most encouraging indications that these changes are producing the desired impact are the increases in investment that have occurred and the current high level of interest by potential investors. Therefore, both of these Credits deserve an overall rating of *satisfactory." 7.2 The SRC and TRC, as adjustment credits providing balance of payments support, are not inherently sustainable in themselves. Nevertheless, the actions taken following these operations indicate that the Government is, and has been, committed to the adjustment process and intends to continue in force the changes that have been made. As such, both Credits desire a rating for sustainability of "likely." Future economic progress will, of course, depend on the continued maintenance of the peace agreement achieved last year and the peaceful process of political change that is under way with a multi-party election planned for next year. 7.3 The Credits were designed with only limited objectives related to institutional impact. Nevertheless, they did achieve the establishment of a unit to supervise Government and private procurement, improved the ability of the National Commission of Planning to prepare and monitor the Public Expenditure Program, and strengthened the Government's ability to plan and execute policy reforms, thereby rating a "partial" for institutional impact. - 23 - VIII. LESSONS LEARNED 8.1 There are a number of useful lessons that emerge from a review of the adjustment experience in Mozambique: (i) A gradual adjustment process can be effective if the Government is fully committed to it, especially if the changes undertaken early in the process produce visible resuLts (not all gradual adjustment programs lead to successful results, of course, as in Sudan and Somalia), and if supported by an adequate level of donor program aid on a continuous basis. (ii) An equilibrium exchange rate is necessary for a market-based foreign exchange allocation system; it is also necessary as an incentive to shift investor interest from imports to production. (iii) Differing donor procurement rules represent a serious problem for programs requiring multi-donor balance of payments support; efforts should be made to harmonize these rules to the greatest possible extent, and to provide a well-planned and effective program of technical assistance and training to be put into effect at the beginning of the program in order to avoid procurement delays that can undermine the adjustment process. (iv) More generally, in designing adjustment programs the Bank should give early emphasis to local institutional capacity and the need for technical assistance and training. This need is likely to extend outside of the public sector--such as the need for trained accountants--particularly when adjustment programs rely on a strong private sector response. (v) Countries emerging from war situations can have a strong capacity to recover and resume economic growth. Such situations may present windows of opportunity to introduce quickly far- reaching structural reforms, and Bank staff should be alert to the emergence of such opportunities. - 25 - ATTACHMNT i (Comments Received fr-m the Royal Ministry of Foreign Affairs, Oslo) Persiadag~avd. g8 y493 Meriader1 Petrmance hAut Repot, Moamubtqun 1. The tapt has a mh tm posidvo y" of the eomo~må ohange *a W ~mMg*s has g ä åiamgh uines198 Accing 0 DP.ps tadk b 1 (pa 17) ta m glasa n ospat dud f1987-199m mo ba 1nd toh asdvs Saa in I=udw b *dnarm suppo duinag *es year, whdch laar leveUud af, the level af ODP in 1991 wa lowr tai the tly 19Gand ~DP.mr"É r capia as bm. ngpdie since 1989. (be ~dmcdoin 0DP b 1921s imaly du *s# dugt atnd mnu bo mlad tany mmn pocy,) The ~ balanu has shown increaing d.Bela n spim of aply sde* ama such a hug devmluatioas mnd llhemmMan0afUm. »i wall nowata otepetepeiagouær ha be diappoiMdag and 804 t he d 4pmd*nt of tho ad w w* abe dåd må a sustinablekalanes. To excus* theat ulow dow m" smethmm with the w ndds*ght isno aaicigwncoelooks bh ubopeseaciotaook p la*einth nk pheof t* war. Ta wom ao see.. weather candilua (daught o- yea isod by loods) th d y. 190's My viäw is e that the p ly changs that åäok plme dmdag PR hav bad negadw, s~om, bas tha t he ea s offt have ben mc 1 r ar ast 0ly wany p~cmve tal iss .n-f = he bpar m~ chanas Ca &ct h avudan) in pui.. Mhe taudusy ~ slu pts aasy phse masy pave w bo of Etde eWp Bo M ~mobtque in th paeset nn. 2, Monm~lqu. isa vy poo uouy with mst of iS citions Eving blo mW« amnanb evels. The policy chsages have creatd opostles for somi paaple and or psople with sm edaaednic i ular. Donr fma hav* b= an impu=somasofinanm for ee s"eksdag «lal and e d mil., Pom y du dw a rma inaa pMme bet y du 10 * n=ed 0 Banas0war,th eaathas ha ie upu oialequalby a Bmgar pli@yp gat.I smy beoms N say (u p k. pm a9. at dh 0 of dh pwo ~e bh by policies. Ifowevwe, i Ss somewkst sideppingth absda lse wh1ia 1belisvels the musuive inra i th a r trba por pmly a a oem e~ t war Tom sUm a an hb s gs whbm *a On ~dmda sMdtfor rgqdaglow due toth sal er problems. *3. Tse is becammach aik about an Oqullibotu schage rai theda Report. One has s hear inmind what eqdlbadmws mae mkdng aboustn ioambquatsta uomnt P52UIel an,th matat for fa~ia echug is dona~ by dh Snfow of mid #~y, ts tafluenc d by the type ofiapaseguplal and Other aguadn thu 0IS ad wo a ftr iong du ta %=4amk n x u Tidly, tis vey mach tariann by t* 6n umsub olical awpad la goth Ablca wbih Ss bomWqu lbguc trading prmer. An ovrvulued Rand bad o a ovaulued Mediullagsly hrugh th de liian unwd. FGm~*ly, as long cdvs admt lmitndiia me baekng Ud di celinp am imposed too wag~sy, dh mk~ fr tk ma Sexcungp esinc s pwn pzopedy. My view is that i us ot sound m-hea a ffin the exchngp -n have ss 4gus folly ro ths circumaanes. A Si Iaon has II giv. a faily onvincing nalysi fwhydtsisso