Mozambique - Economic Management Reform Operation Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No.: 20504 IMPLEMENTATION COMPLETION REPORT REPUBLIC OF MOZAMBIQUE ECONOMIC MANAGEMENT REFORM OPERATION (EMRO) (Grant No. H-002-MOZ) June 30, 2000 Macroeconomics 1 Africa Region 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 EQUIVALENTS Currency Unit: Metical (Mt); plural: Meticais US$1 = Mt 16,400 (June 20, 2000) FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy CFM Caminhos de Ferro de Mo9ambique EMRO Economic Management Reform Operation ESAF Extended Structural Adjustment Facility ESW Economic and Sector Work FIAS Foreign Investment Advisory Services FMR Fiscal Management Review GDP Gross Domestic Product GNP Gross National Product HIPC Heavily Indebted Poor Country ICR Implementation Completion Report IDA International Development Association IMF International Monetary Fund MPF Ministry of Planning and Finance MTEF Medium Term Expenditure Framework NPV Net Present Value PARPA Action Plan for the Reduction of Absolute Poverty PFP Policy Framework Paper PRGF Poverty Reduction and Growth Facility PRSP Poverty Reduction Strategy Paper SPA Special Program of Assistance SWAP Sector-Wide Approach TERC Third Economic Recovery Credit VAT Value Added Tax Vice President: Callisto Madavo Country Director: Michael Sarris Sector Manager: Philippe Le Houerou Task Manager: Jose Leandro  FOR OFFICL41 USE ONLY MOZAMBIQUE ECONOMIC MANAGEMENT REFORM OPERATION (EMRO) (Grant No. H-002-MOZ) Table of Contents PREFACE EVALUATION SUMMARY ...............................................I PART I: PROGRAM IMPLEMENTATION ASSESSMENT ...................................1 A. BACKGROUND ..........................1.......,,.,,,,,................1 B. STATEMENT AND EVALUATION OF OBJECTIVES .......................................2 Statement of objectives ...........................................2 Evaluation of objectives ...........................................4 C. ACHIEVEMENT OF OBJECTIVES ...........................................5 Revenue mobilization and the incentive regime ...................... .....................8 Expenditure management and budgetary reform .......................................... 10 D. WORLD BANK PERFORMANCE ................................... ...... 12 E. BORROWER PERFORMANCE .......................................... 13 F. PROGRAM SUSTAINABILITY .......................................... 14 G. FUTURE OPERATIONS .............................,,.,,,,.,,.,. 14 H. KEY LESSONS LEARNED ........................... 15 PART II. STATISTICAL ANNEXES ........................... 16 TABLES Table 1: Summary of Assessments Table 2: Related Bank Operations Table 3: Project Timetable Table 4: Credit Disbursements: Cumulative Estimated and Actual Table 5: Key Indicators, Actual and Projected, 1998-2001 Table 6: Updated Matrix of Actions Supported by the EMRO Table 7: Status of Legal Covenants Table 8: Bank Resources APPENDICES A. ICR MISSION AIDE-MEMOIRE B. BORROWER'S AGREEMENT WITH THE ICR This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.   MOZAMBIQUE ECONOMIC MANAGEMENT REFORM OPERATION (EMRO) (Grant No.: H-002-MOZ) IMPLEMENTATION COMPLETION REPORT PREFACE This is the Implementation Completion Report (ICR) for the Economic Management Reform Operation (EMRO) in Mozambique for which a IDA grant (H-002- MOZ), in the amount of SDR 109.5 million (US$150 million equivalent), was approved on December 10, 1998 as part of HIPC Interim Measures and made effective on February 17, 1999. The grant was a two tranche operation. The first tranche was disbursed on March 23, 1999. The second tranche was released on June 15, 1999 upon full compliance with prior conditions. The program closed on December 31, 1999 as initially envisaged. This ICR was prepared by Jose Leandro, Senior Economist and task team leader, AFTM 1, with the collaboration of Maria Teresa Benito-Spinetto, Research Analyst, AFTMI. It was reviewed by Philippe Le Houerou, Sector Manager, AFTMI, and Michael Sarris, Acting Country Director for Mozambique. The Borrower contributed to the preparation of the ICR through information provided during a preparation mission and agreed to the content of the report. Preparation of this ICR began in April 2000. It is based on discussions with Bank staff, Government officials, private sector representatives and other donors.   MOZAMBIQUE ECONOMIC MANAGEMENT REFORM OPERATION (EMRO) (Grant No.: H-002-MOZ) EVALUATION SUMMARY i. Background. In 1987 Mozambique launched a program of economic reforms involving a shift toward market-oriented policies, macroeconomic stabilization and structural reforms, in an effort to reduce acute fiscal and external imbalances and restore economic activity after a period of central planning and civil war. A peace agreement with the armed opposition was signed in 1992 and multi-party democracy was introduced, followed by the first free elections in 1994. The economy reacted well and growth averaged 5.5 percent in the period 1987-96 and accelerated to 10 percent in 1996- 98. Growth was broad based and GNP per capita increased by around 14.5 percent on average during 1996-98. Stabilization remained elusive until 1996, when inflation reached around 47 percent, but it fell sharply to 0.6 percent on average in 1998 following the restructuring of the financial sector and the implementation of prudent fiscal and monetary policies. ii. Program Design and Objectives. The EMRO was the fifth IDA adjustment operation to support the reform process. Four previous programs focused on price decontrols, liberalization of the foreign exchange market, budgetary reallocations in favor of the social sectors, privatization, financial sector reform and trade liberalization. The EMRO was designed at a time when macroeconomic stability had been achieved, economic growth was strong and the Government was moving into a new stage in its reform agenda aimed at sustaining growth, enlarging the circle of its benefits and gradually reducing dependency on external aid. iii. As Mozambique became eligible for debt reduction under the HIPC initiative and reached the decision point in April 1998, EMRO was conceived as part of the IDA's interim debt relief under HIPC -- hence answering a specific request from the Bank's Board of Directors -- and took the form of a grant. This fact had a great influence in the design of the program and had two direct implications: (i) the operation had to be prepared quickly and (ii) had to select measures that would both be substantive and could be implemented prior to the HIPC completion point, planned for June 1999. iv. In addition to supporting macroeconomic stability and the implementation of the reform program spelled out in the 1998-2000 PFP, thereby complementing the third annual ESAF program approved by the IME in 1998, the EMRO concentrated on: (i) revenue mobilization and the incentive regime, encompassing indirect tax reforms, trade liberalization and rationalization and simplification of import procedures; (ii) improved budgetary management and more effective expenditure planning. Support to human development and poverty reduction would result from the emphasis on ensuring the sustained financing of social sector expenditures, such as health and education.  - ii - v. Achievement of Objectives. The nature of the reforms supported by the EMIRO, as well as the timing for their implementation, reinforced the combined effects of sound fiscal and monetary discipline, the increased Government focus on poverty reduction and the continuation of the privatization process, and when combined with the generally favorable external environment and generous external assistance, have contributed to consolidate macroeconomic stability, sustain a strong supply response, and improve social indicators. vi. Performance in the areas supported by the EMRO was generally satisfactory, and all conditions for second tranche release were met. vii. Mozambique's macroeconomic performance in 1999, the period of implementation of EM:RO, remained strong, marked by rapid growth, low inflation and high private investment. Real GDP expanded by 9 percent, and inflation remained subdued, reaching 2 percent on average. However, higher than programmed monetary expansion in the second half of the year led to fears of increased inflationary pressures. For 2000 and 2001, macroeconomic projections were revised following the floods and cyclone that affected the country in February and March 2000. viii. Regarding indirect tax reform, the cascading turnover tax and the consumption tax were replaced in June 1999 with a VAT and excise taxes, respectively. Despite higher than projected VAT revenue on domestic operations, total VAT revenue for the remaining six months of 1999 was below projections due to lower VAT revenue on imports, but was accompanied by a sharp increase in the number of taxpayers between June 1999 and January 2000. VAT refunds to exporters, a key measure to stimulate export growth, are being paid within an average period of two months according to the authorities. A review of the tax system, including an assessment of the costs and benefits of special tax and customs exemptions, will be completed in August 2000 (against an initial target of March 2000), although the initial plan was to undertake a more comprehensive study, encompassing the whole tax system and covering distributional, equity and incidence issues. ix. The top import duty rate was reduced from 35 to 30 percent in April 1999, lowering the trade-weighted import duty average to 10 percent. A further reduction of the top duty rate to 25 percent is planned in early 2002. However, trade protection in the cashew and sugar sectors was increased toward the end of 1999, which may have adverse effects on economic efficiency and on the welfare of peasants whose cash income depends on the sale of raw cashew. In an effort to assess the impact of these measures and provide a basis for its policies, the Government agreed to conduct a study for each sector. x. The Government continued implementing the program of customs reforms initiated in 1996, and before the program was presented for Board discussion, import procedures were simplified. A new simplified importers registration system was adopted, and the previous cumbersome import documentation (Boletim de Registo de ImportaVdo, Clean Report of Findings and customs clearing document) was replaced with a Single Administrative Document. As a result, the elapsed time for processing of import  - iii - documentation was reduced from the previous three to four weeks to a maximum of 48 hours, lowering transaction costs and increasing the transparency of the import process. Thanks to efficiency gains, import tax collection rates have improved even in the context of declining statutory import duties. The Government intends to continue to reform customs administration by engaging in a new three-year phase aimed at consolidating the results achieved so far, and progressively transfer customs management from the specialized private company to Mozambican managers. Despite of this progress, however, corruption is still a worrying feature, that will continue to necessitate special Government attention and that will require measures in areas other than customs, such as in the police, the legal and the judicial systems. xi. Regarding budget management, a report on off-budget flows was prepared based on the 1998 fiscal year. The 2000 budget launched the first steps in the coverage of off- budget revenues, by including privatization revenue and profits of public enterprises. Given the urgent need to accelerate the process of inclusion of off-budget flows, the authorities intend to request each sector to define a strategy to achieve full budget coverage in the short run. xii. An exercise consisting in identifying recurrent expenditures misclassified as capital and included in the investment budget was undertaken. A report based on the 1999 budget identified these expenditures, but their reclassification has not yet been undertaken. xiii. As part of the efforts to improve the link between specific multi-annual sector policy objectives, the necessary resources to achieve them and the overall medium-term resource envelope compatible with the macroeconomic framework, a Medium Term Expenditure Framework (MTEF) was prepared in September 1998 and used in the preparation of the 1999 budget, both to set the sectoral expenditure limits and to serve as a framework for inter-sectoral resource allocations with a medium-term perspective. A new MTEF was developed in June 1999 and used in the preparation of the 2000 budget after being discussed and approved by a ministerial committee. xiv. Assessment of Outcomes and Program Sustainability. The need to adapt to the HIPC timetable represented a heavy constraint in the design of the program and resulted in a hasty identification process. Notwithstanding this constraint, the nature and the timing of the specific reforms supported by the EMRO were particularly appropriate. The simultaneous emphasis on trade liberalization and indirect tax reform, combined with customs reform, shielded the budget from the potential adverse revenue effects of tariff reductions that could have jeopardized the necessary fiscal adjustment, at the same time as they contributed to improve the allocation of resources and sustain a strong supply response. Also, the development of a MTEF and its use for the preparation of the budget in 1999 and 2000 is an important reform, but which needs to be institutionalized as part of the normal annual budget process if it is to contribute to fiscal sustainability, and systematically combined with the actions included in the PARPA (Action Plan for the Reduction of Absolute Poverty) in order to help increasing the poverty focus of public expenditures over time. The identification of off-budget flows and recurrent expenditures included in the capital budget are important steps that need to be followed by concrete  - Iv - actions in the short run in order to improve budget transparency, as the Government, in partnership with external donors, intends to move toward direct budget support in the context of sector-wide programs. Trade liberalization suffered a setback with the increase in protection in the cashew and sugar sectors, which may hinder economic efficiency and have a negative poverty impact. xv. The authorities' good track record in terms of economic stabilization and structural reforms, and their demonstrated commitment to the reform agenda, combined with strong ownership of the reform process, bodes well for the sustainability of reforms implemented under the EMRO. However, as the reform process deepens and moves into new areas that increasingly affect income distribution and resource allocation, governance and institutional issues, there are risks of a slow-down in the pace of change. This is particularly true in the case of trade liberalization and market deregulation. Therefore, the sustainability of the reforms implemented and the continuation of the good results achieved so far in terms of high growth, low inflation and improving social indicators, will depend to a large extent on the Government's capacity to steer the process to avoid these risks at the same time as it engages decisively on a new generation of reforms. These should include the strengthening of the macroeconomic environment, improving access to and tenure of land and facilitating higher agricultural productivity, removing impediments to private sector growth, investing in human capital and improving governance. The successful implementation of this reform agenda will require, inter alia, greater attention to distributional issues and the need to mobilize more actively the winners from reform in order to support continued change. xvi. Lessons Learned. The following are among the most important lessons learned: * Borrower ownership and commitment to the reform program is a key factor of success. The fact that the EMRO supported reforms that were clearly defined, previously agreed upon and fully owned by the authorities facilitated implementation and contribute to program sustainability. * Appropriate sequencing and complementarity between macroeconomic policies and structural reforms reinforce program outcomes. The simultaneous implementation of indirect tax reform, gradual trade liberalization and rationalization and simplification of import procedures, shielded the budget from a potential decline in revenue that could have endangered fiscal adjustment, at the same time as it reduced distortions in the allocation of resources and supported a strong supply response. When combined with prudent fiscal and monetary policies, a favorable external environment and the high level of foreign assistance, this resulted in strong GDP growth, low inflation, and high private investment. * Faced with capacity constraints, a smaller number of selective reforms results in greater impact. The focused nature of the operation, which concentrated on a limited number of areas, enabled the Government to concentrate on actions considered critical for the success of the overall reform process, and helped implementation in face of acute capacity constraints.  PART I: PROGRAM IMPLEMENTATION ASSESSMENT A. BACKGROUND 1. Since 1987, when the first phase of economic reforms was launched after a failed experiment with central planning, Mozambique has experienced a deep change. A shift toward market-oriented policies and a reduction of the role of the state in the economy was undertaken. A peace agreement was signed in 1992 with the armed opposition that opened the way to national reconciliation and democracy. The economy responded well and a period of rapid economic expansion followed. GDP growth averaged 5.5 percent during the period 1987-96, and accelerated to 10 percent during 1996-98. Growth was broad based, with agriculture, transportation and industry all showing strong results, and GNP per capita increased by around 14.5 percent on average during 1996-98. Inflation remained high until mid-90's, but fell sharply from 47 percent in 1996 to 0.6 percent on average in 1998, following privatization in the banking sector. 2. Underpinning this high-growth and low-inflation performance were prudent fiscal and monetary policies, accompanied by substantial external aid and a sound program of structural reforms based on privatization, financial sector reform and trade liberalization. Fiscal adjustment was accompanied by a shift of resources to the social sectors, and the implementation of better policy strategies in health and education led to improved social indicators. 3. In spite of these good results, Mozambique remained one of the most indebted countries in the world, suffering from acute internal and external imbalances and extremely dependent on foreign assistance for the delivery of basic social services. External public debt at end-1998, taking into account debt relief under traditional mechanisms (Naples terms with 67 percent debt reduction), was estimated at US$ 6 billion in nominal terms (US$ 2.7 in NPV terms), or about 538 percent of exports. As a result of the good stabilization and adjustment record as well as the Government's reform agenda, Mozambique reached the HIPC decision point in April 1998 (the completion point was successfully reached in June 1999). 4. It was against this background that the preparation and implementation of the Economic Management Reform Operation (EMRO) took place. It was conceived as part of the IDA's interim debt relief under the HIPC Initiative - hence answering a specific request by the Bank's Board of Executive Directors -- and took the form of a grant. This fact had a great influence on the design of the operation and had two direct effects: (i) the operation had to be prepared quickly and (ii) had to select measures that would both be substantive and could be implemented prior to the HIPC completion point, planned for June 1999. The EMRO followed and built on the progress made during the implementation of five previous adjustment credits in terms of stabilizing and jump- starting the economy. 5. The first two adjustment operations were approved in 1988 and 1989, and focused on rehabilitation measures. The third operation, the Economic Recovery Credit (1992),  - 2 - supported the early phase of financial sector reform, particularly the separation of central bank functions from the Banco Comercial de Mogambique, and the liberalization of the exchange rate. The fourth operation, Second Economic Recovery Credit (1995), promoted macroeconomic stability, financial sector reform, privatization and improved public expenditures management. The fifth operation, Third Economic Recovery Credit (1997), focused on the privatization of the two state-owned banks, a necessary step toward better monetary control, adoption of a budget reform program, limits to indirect subsidies to public enterprises, as well as the rationalization of the tariff and indirect tax regime, monitoring of the impact of the liberalization of the cashew sector, and the restructuring of the state ports and railway company (CFM). 6. The design of EMRO benefited from work undertaken under the Fiscal Management Review, as well as close co-ordination with the IMF, which provided support to the reform process through successive ESAF arrangements. B. STATEMENT AND EVALUATION OF OBJECTIVES Statement of objectives 7. The EMRO aimed to assist in the implementation (i) of key reforms agreed to in the Policy Framework Paper for 1998-2000 and (ii) of the measures outlined in the Final HIIPC Document for Mozambique approved by the Board in April 1998. In doing so, it would complement the third annual ESAF program approved by the IMF Board in August 1998. In addition to supporting the implementation of a stable macroeconomic framework, the operation would focus specifically on improving the sustainability and efficiency of public sector operations, with particular attention to fiscal reform, and improving the business environment for sustained, private-sector-led growth. 8. The operation included actions in four areas: tax and trade policy, customs reform and import administration, budgetary management and sustainability of expenditures. 9. Tax and Trade Policy: the main goals in this area were three-fold: (i) to reduce the tax-induced distortions that interfere with the allocation of resources; (ii) to improve the efficiency of taxation; and (iii) to support institutional changes that would improve the quality of tax administration. The operation would also support the Government's plans to undertake an overall assessment of the tax system, including the role of a set of tax incentives for new investments, namely those provided under the Investment Law, the Industrial Free-Zone Law and the Zambezi Valley Regime. The specific measures that the operation supported included: * define VAT coverage, adopt the VAT rate, and issue a Council of Minister's decree creating the VAT code. All measures were completed by negotiations. * replace the turnover tax with a VAT. Condition for the release of the second tranche.  - 3 - * replace the consumption tax with a narrower set of excises ("Imposto Sobre Consumos Especificos"). Condition for the release of the second tranche. * reduce the top import duty rate for finished consumer goods from 35 to 30 percent. Condition for the release of the second tranche. 10. Customs Reform and Import Administration: the program measures in this area would support the continuation of the Government's efforts to strengthen customs administration and to simplify the import process, increasing transparency and reducing the time and "transaction costs" associated with the existing system. These measures were: * adopt a streamlined registration mechanism for importers. Condition for Board presentation. * replace the existing import documentation (import licence, "Boletim de Registo de Importacao", Clean Report of Findings and customs clearing document, "Despacho Aduaneiro") with a single administrative document. Conditionfor Board presentation. 11. Budgetary Management: the main objectives were (i) to improve the transparency and scope of the budget, and (ii) in the context of necessary fiscal consolidation, ensure adequate budgetary recurrent funds to finance health and education programs, maintain infrastructure and decompress civil servants salaries. Actions to be supported included: * the identification of off-budget flows (expenditures and revenues in fiscal year 1998) and classification according to defined criteria, including function, size, origin, and statutory/legal basis. Condition for second tranche release. * the identification of recurrent expenditures in the investment budget (based on the fiscal year 1999 budget) and formulation of a methodology for their correct reclassification as recurrent expenditures in future budgets. Condition for second tranche release. 12. Sustainability of Expenditures: the operation would support the Government's efforts (i) to improve the effectiveness of the budget as a tool to ensure that fiscal aggregates are sustainable in the medium term; and (ii) to improve the prioritization of public expenditures to attain stated policy objectives and outputs. Actions under this heading included: * formulation of a rolling five-year medium term fiscal framework ("Cenario Econ6mico de Medio Prazo") that links resource availability from the macro- framework to a sector-based expenditure framework, presented annually to the Conselho Econ6mico (Cabinet Economic Sub-Committee), commencing in September 1998. Action completed by negotiations.  -4 - * submission to the National Assembly of a budget proposal for fiscal year 1999 consistent with the medium-term fiscal framework, including increased shares of locally financed recurrent expenditures for health and education, relative to fiscal year 1998 budget. Action completed by negotiations. Evaluation of objectives 13 The EMRO was prepared at a time when the Government's economic policy had been successful in drastically reducing inflation and generating rapid economic growth, and was embarking on a new set of reforms aimed at sustaining growth and ensuring a wider spread of its benefits, while at the same time gradually reducing the country's dependence on external aid. This new generation of reforms involved: (i) consolidation of macroeconomic stability through improved sustainability and efficiency of public sector operations, (ii) improving the business environment and (iii) human development and poverty reduction. 14. In support of this agenda, and in addition to supporting the implementation of a stable macroeconomic framework, the EMRO focused on (i) and (ii) above through: first, revenue mobilization and the incentive regime, encompassing indirect tax reforms, trade liberalization and rationalization and simplification of import procedures; second, improved budgetary management and more effective expenditure programming (see Table 6 "Matrix of Reforms" in Statistical Annex). Support to human development and poverty reduction would result from the emphasis on ensuring the sustained financing of social sector expenditures, such as health and education. 15. Revenue mobilization and the incentive regime. During the previous phase of reforms, revenue growth had outweighed considerations of an optimal tax structure as a way of achieving fiscal adjustment without excessive expenditure cuts that would have undermined priority social and economic programs. Given the need to continue mobilizing domestic revenues and reduce dependence on external aid, it was therefore appropriate to consider that the increase of the quality and the quantity of public services necessary for poverty reduction and economic development required the development of a more efficient and less distortionary revenue mobilization system. 16. The basic structure of the domestic tax system suffered from a number of problems, namely inhibiting high rates, coupled with exemptions and special incentives regime, and weak administration, all of which interfered with an efficient allocation of resources. The turnover tax, a cascading sales tax payable at all production stages and generating around a third of total fiscal revenue, was distorting economic incentives. The consumption tax had the features more of a general sales tax than of a selective excise duty. At the same time, corporate tax rates were high by international standards, but yielded only 10 percent of tax revenue in 1997. Furthermore, non-uniform rates (35 percent for agriculture, 40 percent for manufacturing and 45 percent for all other activities) discriminated against services industries, which are labor intensive and are important in terms of employment generation.  - 5 - 17. The trade tax regime suffered from inefficiencies, despite a major trade reform, implemented in 1996, that simplified the import tariff structure, lowered the average nominal duty rate and limited exemptions. With a top duty rate of 35 percent on final goods and 2.5 percent to 7.5 percent on intermediates (5 percent on capital goods), effective protection of final products remained high. 18. Import procedures were complex due to the existence of costly and untransparent requirements for registration of importers and imports that increased transaction costs and favored corruption. In particular the Boletim de Registo de Importagdo was effectively an import license, the approval of which was subject to discretionary evaluations of Ministry of Industry and Commerce officials. 19. BudgetaryManagement and Expenditure Planning. Following the peace agreement in 1992, significant public resources were reallocated from defense toward health, education and infrastructure, at the same time as fiscal consolidation was pursued. However, the sustainability of these expenditures was threatened by insufficient recurrent funding, high dependence on external aid (two-thirds of the budget was financed by external assistance), the existence of extra-budgetary flows, inadequate classification of expenditures and the absence of a mechanism to evaluate the needs in both recurrent and capital expenditures to achieve sectoral policy objectives within a medium-term resource envelope compatible with the macroeconomic framework. The choice of this objective for the EMRO was therefore appropriate. 20. In an effort to address these problems, the Government embarked on a multi-year, phased Fiscal Management Review (FMR) process with the support of the World Bank and other donors in late 1995. As part of this process, a new Budgetary Framework Law (Lei de Enquadramento Orcamental), establishing the fundamental principles for preparing, managing, executing, controlling and accounting for the budget, was enacted in 1997 and used for the 1998 budget. For the following years, the Government intended (i) to identify off-budget flows (both expenditures and revenues), (ii) to ascertain recurrent expenditures wrongly classified as capital and formulate a methodology for their correct classification in future budgets, (iii) to develop a medium-term rolling five- year fiscal framework to be used in the annual budgeting process, (iv) to move toward linking budgeting decisions to specific outcomes, (v) to put into place a computerized system to manage and control the budget and (vi) to examining alternative modern accounting systems for public accounts. The EMRO covered items (i) to (iii). C. ACHIEVEMENT OF OBJECTIVES 21. It is difficult to assess the specific impact of the EMRO as it was part of a wider reform agenda that was satisfactorily implemented by the Government. Nevertheless, the nature of the reforms supported by the EMRO, as well as the timing for their implementation, reinforced the combined effects of sound fiscal and monetary discipline, the increased Government focus on poverty reduction and the continuation of the privatization process, and when combined with the generally favorable external environment and generous external assistance, have contributed to consolidate  -6 - macroeconomic stability, to sustain a strong supply response, and to improve social indicators. 22. Macroeconomic Performance. Mozambique's performance during 1999, the period of implementation of EMRO, remained strong, marked by rapid growth, low inflation and high private investment. A first review under the IMF's Poverty Reduction and Growth Facility (PRGF) Arrangement took place in February 2000. Despite some concerns about a weakening of performance on monetary policy and on structural reforms, the second installment under the program was approved by the IiMF Board on March 27, 2000. 23. Real GDP expanded by 9 percent in 1999, fuelled by buoyant activity in the agriculture, construction, tourism and energy sectors. Inflation remained subdued, reaching 2 percent on average (the end-of-period inflation rate was 4.8 percent against a projection of 5.5 percent), but accelerated from less than 1 percent in 1998 (Table 1). The overall fiscal deficit before grants remained below the objective of 13 percent. However, the primary deficit reached 3 percent of GDP, exceeding the program target of 2.6 percent, due to higher than projected non-interest current expenditures. Monetary policy was eased in 1999 and the rate of monetary expansion was significantly above program projections. As anticipated, the external current account deficit worsened significantly in 1999 compared to 1998 as a result of imports of capital goods for the construction of the Mozal aluminum smelter, but is expected to improve in 2000 and 2001 compared to 1999 despite the impact of the floods. Table 1: Selected Economic Indicators 1998-2001 (percent o GDP unless otherwise specified) Actual Projection Pre-Floods Post-Floods (1) 1998 1999 2000 2001 2000 2001 Real GDP ( annual growth rate) 12.0 9.0 7.0 7.2 5.4 7.9 IMflation (annual average %) 0.6 2.0 6.6 5.0 9.5 5.0 External current account: Before grants -20.5 -31.7 -23.0 -15.7 -31.5 -18.4 After grants -12.4 -21.5 -16.3 -9.1 -19.7 -11.0 Fiscal balance: Before grants -10.7 -12.1 -12.1 -10.7 -16.0 -11.5 After grants -2.4 -1.2 -5.2 -4.4 -7.0 -5.1 Memorandum item: GDP (Mt billions) 46,134 52,913 60,177 67,790 61,471 69,673 (1) Based on a World Bank assessment undertaken in March/April 2000 Source: World Bank, IMF and Government of Mozambique estimates. 24. For 2000 and 2001, macroeconomic projections have been revised due to the impact of the floods that affected the country in late February and March. In 2000, GDP growth is expected to be lower than initially projected, but will be higher in 2001 boosted by the reconstruction activities and the re-building of productive assets. Inflation is expected to accelerate to 9.5 percent in 2000, but is likely to return to its projected pre-  - 7 - disaster path in 2001, assuming the authorities will maintain a tight monetary stance. The current account deficit worsened significantly compared to initial projections as a direct result of the floods. However, the balance of payments and the fiscal gaps generated by this exogenous shock are expected to be covered by additional foreign assistance, including IDA's, as well as the acceleration of debt relief under the enhanced HIPC initiative and the deferral of debt service granted by the Paris Club. 25. Poverty. As a result of broad-based and inclusive strong economic growth, GNP per capita increased by 6.4 percent in 1999 and is projected to continue rising at around 5 percent per annum during the period 2000-2004. At this pace, the Government expects the poverty headcount to fall from around 70 percent in 1996-97 (latest data available) to 60 percent in 2004. Based on its Plan of Action for the Reduction of Absolute Poverty (PARPA), the Government prepared an interim PRSP that was used as a basis for the decision point of the enhanced HIPC in April 2000. A full PRSP, to be developed after a process of consultation is concluded, is expected to be finalized by March 2001. 26. Performance Indicators. Rather than following the traditional practice of using policy measures as monitoring indicators, the EMRO identified a set of outcome indicators to monitor the results of the policy measures, but didn't include indicative targets. The selected indicators are the following: inflation, the effective rate of import duty collection, the anti-export bias, the elapsed time for processing import applications and export growth. 27. Although average inflation (measured by the consumer price index) accelerated from 0.6 percent in 1998 to 2 percent in 1999, it remained below program projections and can be considered negligible. For 2000, it is projected to accelerate to 9.5 percent as a consequence of the floods, but is expected to slow down to 5 percent for the period 2000- 2003. 28. The effective rate of import duty collection improved from around 9 percent in 1998 to 11 percent in 1999, according to information provided by the authorities. 29. The top import duty rate was reduced from 35 to 30 percent and the real effective exchange rate of the Metical depreciated on average by 4 percent in 1999. As a result, it can be inferred that the anti-export bias was reduced compared to 1998. 30. The maximum elapsed time for the processing of import documentation is currently 48 hours, compared to three to four weeks before the simplification of import procedures. 31. Exports increased by around 5 percent in 1999 compared to the previous year and are projected to expand by around 10 percent in 2000. From 2001 onwards, total exports are projected to undergo a dramatic increase coinciding with the beginning of aluminum exports from the Mozal smelter, but exports other then those from large projects are also expected to grow faster than GDP.  - 8 - Revenue mobilization and the incendve regime 32. Tax and Trade Policy. The cascading turnover tax and the consumption tax were replaced on June 1, 1999 with a VAT and excise taxes, respectively. The value added tax is broad based, with a single rate of 17 percent, few exemptions, and a zero rate on exports. Total VAT revenue for the 6 months of 1999 was lower than expected (1,400 billion Meticais against an initial projection of 1,514 billion Meticais). The difference is due to lower revenue on imports. However, revenue on domestic activities was higher than projected: 572 billion Meticais against 417 billion Meticais initially projected. This was accompanied by a substantial increase in the number of taxpayers, which increased from 11,000 in June 1999 to more than 20,000 in January 2000, with the objective of reaching 30,000 by end-2000. VAT refunds for exporters, an important measure to stimulate export growth, are being paid within an average period of two months, according to the authorities. With a view to reduce further the anti-export bias, the VAT refund period should be made shorter. The administration of the overall tax system has been rationalized through the introduction of a unique taxpayer identification number (Nzumero Unico de Contribuinte) to be used in the processing of all taxes. 33. Simultaneously, a review of the tax system, including an assessment of the costs and benefits of special taxes and customs regimes, is expected to be completed in August 2000 (against an initial target of March 2000). Initially, the objective was the execution of a more comprehensive study, encompassing the whole tax system, and covering issues related to the distributional impact of taxation, structure, incidence and equity. 34. The top import duty rate was reduced from 35 to 30 percent in April 1999, lowering the trade-weighted import duty average to 10 percent. This reduction continues the process of trade liberalization initiated with the trade reform of late 1996, in which the trade-weighted import duty average had been reduced from 18 to 11 percent, and it was another step toward a less distorted and more open trade regime. A new reduction of the top duty rate to 25 percent is planned in early 2002. As a result, Mozambique now has one of the most liberal and simplest import tariff regimes of the region with only five rates: 0 percent for a very limited number of essential goods, 2.5 percent for raw materials, 5 percent for capital goods, 7.5 percent for intermediate goods and 30 percent for final goods. 35. Toward the end of 1999, trade liberalization suffered a setback following the increase in protection in the cashew and sugar sectors. Regarding cashew, the National Assembly passed a bill increasing the export tax on raw nuts from 14 percent to a range between 18 and 22 percent, and offering domestic processors priority in the purchase of raw nuts. The Government set the rate at 18 percent, the lowest level within the legal range. Given the potential negative impact of these measures on the many small rural households whose cash income depends on the sale of raw cashew, the Government agreed to conduct a study aimed at evaluating and rationalizing policies for the sector and to facilitate a public discussion with all stakeholders of its cashew sector policies. Regarding the sugar industry, in September 1999 the Government enlarged the scope of a variable surcharge on imports that applied only to raw sugar to include refined or (mainly) white sugar, and set its level at 45 percent in an attempt to develop local  -9 - production. In November 1999, the level of the surcharge was increased to 51 percent. In this case again, the authorities agreed to undertake a review of the sugar sector policy to be concluded by August 2000, with a view to determining whether support for the sector is warranted, and the amount, duration and form of any such support. 36. Customs reform and import administration. As part of the EMRO reform agenda, the Government continued implementing the program of reforms initiated in 1996. Import procedures were simplified before the program was presented for Board discussion. A new simplified importers registration system was adopted, and the previous cumbersome and discretionary import documentation (Boletim de Registo de Importa,do, Clean Report of Findings and customs clearing document) was replaced with a Single Administrative Document (Documento Unico). With the suppression of the BRI, import licensing by the Ministry of Industry and Commerce was effectively eliminated. As a result, the elapsed time for processing of the documentation necessary for initiating the import process was reduced from the previous three to four weeks to a maximum of 48 hours', lowering transaction costs and increasing the transparency of the import process. Despite of this progress, however, corruption remains a concern, and will continue to require special Government attention, entailing actions beyond customs, such as the police, the legal and the judicial systems. 37. The combination of improved pre-shipment inspection, customs management by a specialized private company and reduction and monitoring of import tax exemptions, yielded an increase in import tax collection rates even in the context of declining statutory import duties. Import duty rates of collection increased from less than 7 percent in 1996 to around 9 percent in 1998, and reached 11 percent in 1999 according to information provided by the authorities. 38. In 1999, the implementation of some important measures in the area of customs reform was delayed. The submission to the National Assembly of a revised package of customs legislation (comprising the basic customs act, the customs code and a new law on customs tribunals), which was a structural performance criterion under the PRGF and was planned to take place in December 1999, took place in March 2000. Likewise, the adoption of new procedures governing customs warehousing and transit trade, initially planned for September 1999, was also delayed until March 2000. The redeployment of approximately 300 redundant customs personnel is only expected to take place in the coming months, although it was planned for December 1999. This delay seems to be explained by the fact that the authorities preferred to wait until the legislation on the career profile of customs personnel was defined before lauching the retrenchment program. The current total number of staff is 1577, consisting of 790 old and 787 new staff, and is considered too high for the needs of the new customs. As a result, the technical unit in charge of customs restructuring (Unidade Tecnica de Reestructura,cao 63 percent of the cases are processed in 24 hours; 20 percent in 24-48 hours and 17 percent in 48 hours, according to the Technical Unit for the Restructuring of the Customs (UTRA). However, 20 percent of the requests are still rejected due to errors in the documentation provided (Documento Unico).  - 10- das Alfandegas, UTRA) expects the retrenchments to continue in the near future, as all officials, newly recruited as well as old ones, are subject to periodic training and evaluation exercises. 39. Rather than a weakening of Government commitment to reform, these delays seem to be the result of a careful approach in the implementation of politically sensitive measures in the run up to the Presidential and Parliamentary elections that took place in December 1999. A sign of this commitment is the fact that the contract of the specialized company managing customs, which expired in December 1999, was initially extended until June 2000 and will soon be renewed for another three years in order to ensure consolidation of the results achieved so far. During this period, the company will progressively hand over management to Mozambican managers, reinforce training activities and concentrate in developing and strengthening customs intelligence, inspection and design of risk profiles. 40. The coordination in the EMRO between domestic tax reform, trade liberalization and customs overhaul are considered particularly appropriate in the Mozambique context because of their implications in terms of stabilization. It was important to ensure that import tariff reductions proceed in parallel with fiscal adjustment and the expansion of the domestic revenue base, and not before, in order to avoid the risk of a drastic reduction of fiscal revenue that could jeopardize the stabilization objectives. The simultaneous implementation of customs reform, which translated into an increase in tax collection, also contributed to shield the budget from the potential negative revenue effects of tariff reductions. As a result, budget tax revenue increased slightly from 10.7 percent of GDP in 1998 to 10.8 percent in 1999. 41. However, trade liberalization was accompanied by an appreciation of the real effective exchange rate until 1999, which favored the production of nontradables and may have hindered export growth. As alternative domestic revenue sources develop over time and exports increase, the relative importance of the fiscal and the balance of payments objectives will diminish, allowing an acceleration in the pace of external trade liberalization that should be accompanied by a competitive exchange rate policy. Expenditure management and budgetary reform 42. Budgetary Management. A report on off-budget flows based on the fiscal year 1998 was prepared. The report covered (i) at the central level, the Ministries of Public Works and Housing, Health, and Social Action, and (ii) at the provincial level, Sofala and Zambezia, as well as (iii) external assistance from Sweden, Switzerland, Finland, Norway, Denmark and The Netherlands. The two main types of extra-budgetary flows include: (i) revenues collected by specific institutions (ministries, institutes, provinces, municipalities) that are spent without being recorded centrally, as well as other revenues such as profits of public enterprises, and (ii) donor-financed expenditure. The magnitude of off-budget revenues varies by sector, ranging from 107 percent of the recurrent budget of the Ministry of Public Works and Housing to 34 percent of the recurrent budget of the Ministry of Health. In some cases, there exists no legal basis for the collection of such revenues, which are not recorded in state accounts, and therefore  - 11 - are neither accounted for in the budget nor audited. The budget for 2000 makes modest progress in the coverage of the off-budget revenues by including privatization revenue and profits of public enterprises. The authorities agree that there is a need to accelerate the process of inclusion and intend to treat this issue as a matter of priority. Each sector will be requested to define a strategy to achieve full budget coverage in the short run. 43. The amount of donor financed expenditures not being executed through the budget is more difficult to estimate because of the variety of channels used. It is the Govemment's intention to ensure that a growing share of external assistance be channeled through the budget and executed according to the nornal budgetary mechanisms. The gradual development of sector-wide approaches, which at present include three sectors, is the appropriate vehicle to move from discrete donor-funded projects executed outside the normal budget channels toward coherent multi-donor sector programs, implemented within national policy frameworks associated with medium-term sector expenditure plans to be executed through the budget. However, this transition needs to be accompanied by continued Government efforts to improve transparency and accountability in budget management. 44. An exercise consisting on the identification of recurrent expenditures misclassified as capital and included in the investment budget was undertaken. A report based on the 1999 budget identified these expenditures, and proposed a methodology for their reclassification in future budgets. The 2000 budget identifies these expenditures, but fails to include their reclassification. Two main reasons are given by the authorities for this delay: (i) the implications in terms of primary fiscal deficit will require a thorough revision of the fiscal program and agreement with the IMF; (ii) the fact that these expenditures are entirely financed by external donors and therefore follow donor- defined execution procedures that are different from those current expenditures financed internally, which follow the normal budget channels and mechanisms. In any case, progress in this area is necessary in the short run, and the authorities should redouble efforts to accelerate the process of reclassification of expenditures. 45. In application of the Budget Framework Law, the 1998 fiscal accounts have been sent to the Administrative Court and the National Assembly for examination. 46. Sustainability of Expenditures. As part of the efforts to improve the link between specific multi-annual sector policy objectives, the necessary resources to achieve them and the overall medium-term resource envelope compatible with the macroeconomic framework, a Medium Term Expenditure Framework (MTEF) was prepared in September 1998 and used in the preparation of the 1999 budget, both to set the sectoral expenditure limits and to serve as a framework for inter-sectoral resource allocations with a medium-term perspective. A new MTEF was developed in June 1999 and used in the preparation of the 2000 budget after being discussed and approved by a ministerial committee. However, there is a need to institutionalize the MTEF process by making it a formal step in the annual budgetary process in order to ensure its contribution to fiscal sustainability. Also, it will be important to ensure continuity of the link between the development of the MTEF and the PARPA, which should help increasing the focus of sectoral multi-annual expenditure projections on activities that will better target poverty  - 12- reduction, at the same time as it will contribute to the necessary coherence between the fiscal objectives and the poverty targets in the Poverty Action Plan and the PRSP. 47. A new MTEF is currently being developed to be used as a framework for the preparation of the 2001 budget. 48. The fiscal reform measures carried out in the context of the EMRO -- re- classification of recurrent expenditures and the development of an MTEF -- were identified in the Fiscal Management Review process launched since late 1995. This process favored a very gradual approach to reformn, stretching the period for the conduction of the analytical work and the implementation of its recommendations over a considerable period of time. Given the capacity constraints facing the Mozambican administration, this gradualism contributed to ensure the continued leadership of the process by the authorities, and the close working relationship developed between the Bank and the Ministry of Plan and Finance' staffs during this process, improved the relations with Government, which facilitated the dialogue in other areas of reform. 49. Nevertheless, there is now a need to accelerate the pace of fiscal reform in this area. In particular, concrete measures need to be taken urgently to improve the transparency and monitoring of budget execution. As part of the PRGF, the Government has published a quarterly budget execution report in June 2000, comparing budget allocations and actual expenditures at central and provincial levels during the first quarter of the year, following both the economic and functional classifications. Although the publication of this first report is a commendable effort in favor of transparency, the authorities agree that the next edition should be more "user-friendly" and made easier to understand by non-specialists and the general public. Publication of the next report is planned for August 2000. By improving donors' confidence in fiscal management, rapid progress in this area would facilitate the Government's strategy of moving progressively toward a system of direct budget support in which a growing share of external assistance is executed following the normal budget procedures. D. WORLD BANK PERFORMANCE 50. The design of the EMRO was greatly influenced by the latest thinking on adjustment lending, particularly on issues related to conditionality and tranching. The focused nature of the reform agenda supported by this operation and the emphasis put on up-front measures (five out of ten measures were either completed by negotiations or before Board presentation, while the remaining five were conditions for second tranche release), is in line with recommendations from recent reviews of adjustment credits, and in particular the Higher Impact Adjustment Lending initiative. Also, the constant concern with building and protecting recipient ownership during both phases of program design and implementation is expected to contribute to the long term sustainability of the reforms. The use of outcome indicators is also in line with recent initiatives taken in the context of the SPA (Special Program of Assistance). 51. The Bank's performance in identifying and preparing the EMRO is considered satisfactory. The need to adapt to the HIPC timetable and ensure the operation would be  - 13 - implemented within a six-months period, i.e. before the HIPC completion point planned for June 1999, resulted in an operation prepared in haste. Notwithstanding this constraint, the nature and the timing of the specific reforms supported by the EMRO were appropriate. The design of the operation built on lessons and progress made in previous programs, particularly the TERC, and it paid special attention to capacity constraints. It was based on a reform agenda clearly defined, previously agreed with and fully owned by the authorities. The simultaneous emphasis on trade liberalization and the enlargement of the domestic revenue base, combined with customs reform, shielded the budget from the potential adverse revenue effects of tariff reductions that could have jeopardized the necessary fiscal adjustment, at the same time as they contributed to sustain a strong supply response. Also, the development of a MTEF and its use for the preparation of the budget in 1999 and 2000 is an important reform, but which needs to become embedded in the normal annual budget process if it is to contribute to fiscal sustainability. In order to help increasing the poverty focus of public expenditures over time, the MTEF should also be systematically combined with the findings of the poverty assessment and the actions included in the PARPA. The identification of off-budget flows and recurrent expenditures included in the capital budget are important steps that need to be followed by concrete actions in the short run in order to improve budget transparency, as the Government, in partnership with external donors, intends to move toward direct budget support in the context of SWAP's. The co-ordination with the IMF was highly satisfactory and the measures supported by EMRO were part of the PFP for 1998-2000 and the reform agenda outlined in the Final HIPC Document of March 31, 1998. 52. Supervision of the EMRO was also satisfactory. Given the short time for implementation, only one supervision mission took place, which was combined with an IMF review mission in the context of the third ESAF and with the mission to negotiate the Policy Framework Paper 1999-2001 and to prepare the Debt Sustainability Analysis for debt relief under the HIPC initiative. The fact that the operation took the form of a grant rather than a traditional IDA credit led to delays in the effectiveness and disbursement of the first tranche due to difficulties within the Bank's departments in dealing with this kind of instrument. E. BORROWER PERFORMANCE 53. The Borrower's performance during the preparation of the operation was highly satisfactory. The commitment to and the ownership of the EMRO reform program by the authorities, both at the technical and political levels, are considered to be key factors of success. The retention of dedicated and capable staff was also a determinant factor in this outcome. 54. Implementation of EMRO supported measures is considered satisfactory. All required actions were taken according to the initial plan, which resulted in full compliance. Introduction of VAT, a reform demanding high technical capacity and strong political will, can be considered a success. Politically difficult measures, like the continuation of the customs reform, or the reduction of import tariffs, were implemented effectively. However, by the end of 1999, there was a slippage on monetary policy and a setback on trade policy with the increase of the export tax on raw cashews and the  - 14 - surcharge on sugar imports. The increase of external trade protection may adversely affect economic efficiency and may have a negative impact on the income of poor households. F. PROGRAM SUSTAINABILIITY 55. The authorities'good track record in terms of economic stabilization and structural reforms, and their demonstrated commitment to the reform agenda combined with strong ownership of the reform process, bodes well for the sustainability of reforms implemented under the EMRO. 56. However, as the reform process deepens and moves into new areas that increasingly affect income distribution and resource allocation, governance and institutional issues, there are risks of a slowdown in the pace of change. This is particularly true in the case of trade liberalization and market deregulation, as illustrated by the ongoing debate in Mozambique regarding the role of trade protection in the development of local production. Therefore, the sustainability of the reforms implemented and the continuation of the good results achieved so far in terms of high growth, low inflation and improving social indicators, will depend to a large extent on the Government's capacity to steer the process to avoid these risks, at the same time as it engages decisively on a new generation of reforms. These should include the strengthening of the macroeconomic environment, improving access to and tenure of land and facilitating higher agricultural productivity, removing impediments to private sector growth, investing in human capital and improving governance. The successful implementation of this reform agenda will require, inter alia, greater attention to distributional issues to ensure that growth is inclusive and fairly distributed through appropriate tax and expenditure policies, and the need to mobilize more actively the winners from reform in order to support continued change. G. FUTURE OPERATIONS 57. According to the new Country Assistance Strategy for the period 2001-2003, IDA's next adjustment operation is planned for FY02 (base case scenario) and will focus on improving fiscal management and on private sector development. In the field of fiscal management, the next operation should build on progress achieved so far through support to the improvement of public accounting, increased transparency in budget classification and monitoring of actual expenditures, the development of consolidated fiscal and quasi- fiscal accounts, and the mainstreaming of the anti-poverty focus in expenditure programming and budgeting. Issues related to trade liberalization and tax reform will remain an important aspect of Bank/Mozambique dialogue. 58. In preparation for the future adjustment operation, a Public Expenditure Review is planned to take place in FY01, as well as ESW on the impediments to private sector development, possibly with the participation from IFC's Foreign Investment Advisory Services (FIAS). Studies on the pension system and on tax exemptions, currently under implementation, will also be used as inputs.  - 15 - H. KEY LESSONS LEARNED 59. The following are among the most important lessons learned: * Borrower ownership and commitment to the reform program is a key factor of success. The fact that the EMRO supported reforms that were clearly defined, previously agreed with and fully owned by the authorities facilitated implementation and contribute to program sustainability. * Appropriate sequencing and complementarity between macroeconomic policies and structural reforms reinforce program outcomes. The simultaneous implementation of indirect tax reform, gradual trade liberalization and rationalization and simplification of import procedures, shielded the budget from a potential decline in revenue that could have endangered fiscal adjustment, at the same time as it reduced distortions in the allocation of resources and supported a strong supply response. When combined with prudent fiscal and monetary policies, a favorable external environment and the high level of foreign assistance, this resulted in strong GDP growth, low inflation, and high private investment. * Faced with capacity constraints, a small number of selective reforms results in greater impact. The focused nature of the operation, which concentrated on a limited number of areas, enabled the Government to concentrate on actions considered critical for the success of the overall reform process, and helped implementation in face of acute capacity constraints.  - 16- PART II. STATISTICAL ANNEXES Table 1: Summary of Assessments Macroeconomic Policies X _ Sector Policies X_ Financial Objectives X Institutional Development X Physical Objectives X Poverty Reduction X Gender Concerns X Other Social Objectives X Environmental Objectives X Public Sector Management X Private Sector Development X x Identification X Preparation Assistance X Appraisal X Supervision X 99E9 9 9 S-m2glgEg 9 9Xj9vg 9 9~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~1,9- O Preparation X Implementation X Covenant Compliance X x  - 17 - Table 2: Related Bank Operations Third Economic Supported measures to improve FY97 Completed Recovery Credit macroeconomic management, through financial and fiscal reform, and to remove impediments to a sustained supply response. Second Economic Promoted macro-stability, FY95 Completed Recovery Credit financial sector reform, privatization, and improved management of public expenditures Capacity Building in Capacity building in budget FY93 Completed Legal and Public management Sector Management P~~~~aUe1O#er~~~~~~~~~~~~zdon, ~~ . ... . .- -- Flood Emergency Critical to maintaining FY00 Under Recovery Project macroeconomic stability. The implementation counter part funds generated will provide the Government with non-inflationary funds to finance the fiscal deficit created by the floods. Economic Will focus on improving fiscal FY02 Planned under the Management and management and private sector CAS base case Private Sector development scenario Operation  - 18 - Table 3: Project Timetable Identification Apri 13-24, 1998. April 14-24, 1998 Preparation n.a. May-June, 1998 Appraisal June 29-July 15, 1998 July 2-20, 1998 Negotiations November 15, 1998 October 8, 1998 Letter of Development Policy December 10, 1998 November 13, 1998 Board Presentation January, 1999 December 10, 1998 Signing n.a. December 21, 1998 Effectiveness n.a. February 17, 1999 First Tranche Release January 31, 1999 March 23, 1999 Second Tranche Release June 30, 1999 June 15, 1999 Closing Date December 31, 1999 December 31, 1999 Table 4: Credit Disbursements: Cumulative Estimated and Actual (in US$ million equivalent) FY,99; D. D ' ' D Appraisal estimate 150 Actual 150 Actual Cumulative 100% Date of final disbursement June 15, 1999  - 19- Table 5: Key Indicators, Actual And Projected, 1998-2001 (% unless otherwise indicated) Real GDP Growth 12.0 9.0 5.4 7.9 Total Investment/GDP 20.4 35.5 34.9 21.8 Gross National Savings/GDP 1/ 0.8 12.8 11.1 7.2 Export Growth (merchandise in US$) 7.9 4.8 9.8 78.9 Import Growth (merchandise in US$) 14.2 55.0 -2.2 -17.1 Current Account Balance after grants (% of GDP) -12.4 -21.5 -19.7 -11.0 Total Revenues/GDP 11.5 11.7 12.9 13.2 Total expenditure and net lending/GDP 22.2 23.9 29.1 24.6 Fiscal deficit before grants/GDP -10.7 -12.1 -16.0 -11.5 Consumer Price Index (annual avg.) 0.6 2.0 9.5 5.0 External Debt Service/exports 2/ 29.0 28.0 30.1 21.5 1/ Includes all transfers 2/ Includes assistance under HIPC from 1998 onwards Sources: MPF, INE, and World Bank staff estimates  - 20 - Page 1 of 2 Table 6: Updated Matrix of Actions Supported by the EMRO The Reform Agenda Supported by the EMRO Policy Area Condition Status A. Revenue Mobilization and the Incentive Regime 1. Domestic Taxation a. Define VAT coverage (including exemptions), Completed by adopt VAT rate; Council of Ministers will issue Negotiations decree creating the VAT Code b. Introduce VAT in replacement of the Condition of Second turnover tax Tranche release c. Introduce new consumption tax (Imposto Condition of Second sobre Consumos Espectficos) on a narrow range Tranche release of products 2. Trade Regime a. Reduce top import duty rate from 35 to 30 Condition of Second percent Tranche release b. Replace current import documentation Condition for Board (Boletim de Registo de Importaqio, Clean presentation Report of Findings and Despacho Aduaneiro) with a Single Administrative Document c. Streamline importer registration procedures Condition for Board and eliminate importer categories (as listed in presentation Diploma Ministerial 17/91 of the Ministry of Commerce and Diploma Ministerial 21/91 of the Ministries of Commerce and Finance).  - 21 - Page 2 of 2 Policy Area Condition Status B. Expenditure Management and Budgetary Reform 1. Budgetary Management a. Identify off-budget flows (expenditures and Condition of Second revenues in FY98) and classify according to Tranche release defined criteria (e.g. function, size, origin, and statutory/legal basis) so as to permit decision as to their future status including incorporation into the budget. b. Identify recurrent expenditures now in the Condition of Second investment budget (based on the FY99 budget) Tranche release and formulate a methodology for their correct reclassification as recurrent expenditures in future budgets. 2. Sustainability and Prioritization of Expenditures a. Complete formulation of a rolling five-year Completed by medium term expenditure framework (Cendrio Negotiations Economico de Medio Prazo) and present to the Conselho Econ6mico. b. Submit to National Assembly a budget Completed by proposal for FY99 consistent with the medium Negotiations term expenditure framework, including increased shares of locally-financed recurrent expenditures for health and education, relative to FY98 budget.  - 22 - Table 7: Status of Legal Covenants xa ~~~~~~~~~~~~.......... W,<2X... zzsz azz.,z s>,Z$;SfzX,z=g gXaz>,xx Schedule 2 Borrower to issue notice to implement the Condition met (1) VAT Code. (2) Borrower to issue notice to implement the Condition met consumption tax. (3) Borrower to issue decree to reduce the Condition met maximum import duty rate for finished consumer goods from 35 to 30 percent. (4) Borrower to furnish the Association a Condition met report, in form and substance satisfactory to the Association, identifying off-budget flows (expenditures and revenues in FY 98) and classifying them in accordance with criteria specified in paragraph 30 of the LDP. (5) Borrower to furnish the Association, a Condition met report based on the 1999 FY budget which identifies recurrent expenditures currently in the investment budget, in which sets forth the methodology for their appropriate reclassification as recurrent expenditures in future budgets.  - 23 - Table 8: Bank Resources - Actual Staff Inputs Prep aration toAppraisal 0.6 149.4 Appraisal 18.1 52.6 Negotiations through Board Approval 26.5 128.1 Supervision 12.3 67.8 Completion 7.7 28.4 TOTAL 65.2 426.3 Table 9: Bank Resources - Missions .(3~~~~~~~~~~~Q~~~~~~4~~~~~