Mozambique - Country Assistance Strategy

Document of The World Bank Report No. 20521 MOZ MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF MOZAMBIQUE June 14, 2000 Africa Region  The last Country Assistance Strategy was dated November 21, 1997 Currency Equivalents Currency Unit = Metical (Mt) US $1 = 15,717Mt (as of April 2000) Abbreviations and Acronyms AAA Analytic and Advisory Activities AMSCO Africa Management Services Company APDF Africa Project Development Facility APL Adjustable Project Loan CAR Country Assistance Review CAS Country Assistance Strategy CDF Comprehensive Development Framework DPT Diphtheria, Pertussis, Tetanus EMPSO Economic Management and Private Sector Operation ESAF Enhanced Structural Adjustment Facility ESSP Education Sector Strategic Program ESW Economic and Sector Work FDI Foreign Direct Investment FIAS Foreign Investment Advisory Service FRELIMO Frente de Libertac,o de Mocambique GDP Gross Domestic Product GEF Global Environment Facility IIPC Highly Indebted Poor Countries IDA International Development Association IlC International Finance Corporation IMF International Monetary Fund JSA Joint Staff Assessment M&E Monitoring and Evaluation MIGA Multilateral Investment Guarantee Agency NGO Non-Governmental Organization NPV Net Present Value PARPA Action Plan for the Reduction of Absolute Poverty OED Operations Evaluation Department PER Public Expenditure Review PODE Enterprise Development Programn PRGF Poverty Reduction and Growth Facility PROAGRI Programa Nacional Para o Desenvolvimento Agricola PRSP Poverty Reduction Strategy Paper RENAMO Resistencia Nacional de Mo,ambique SADC Southern African Development Community SME Small- and Medium-sized Enterprise SWAP Sector Wide Approach TA Technical Assistance UN United Nations UNAIDS United Nations AIDS Program UNDP United Nations Development Programme WBI World Bank Institute IDA IFC Vice Presidents: Callisto Madavo Assaad Jabre Director: Michael Sarris Cesare Calari Task Manager: Jehan Arulpragasam James Emery  FOR OmF L USE ONLY MOZAMBIQUE COUNTRY ASSISTANCE STRATEGY TABLE OF CONTENTS Executive Summary i Introduction 1 I. Social, Political, and Economic Context 1 A. Historical and Political Context _ 1 B. Poverty, Social Context and Issues 2 C. Economic Context and Issues 4 D. Governance 6 E. Medium-Term Economic Outlook and External Environment 7 II. Developing the Bank Group's Country Assistance Strategy 8 A. The Context for Developing this CAS 8 B. Performancc Under the Previous CAS 9 C. Portfolio Management 10 D. Lessons Learned 12 E. Strategic Orientation 13 III. Mozambique's Development Agenda and the Bank Group's CAS 15 A. Increasing Economic Opportunities through Private Sector Led Growth 16 1. Strengthening the Private Sector Environment and the Financial Sector 16 2. Developing Infrastructure 17 3. Promoting Rural Development and Agriculture 18 4. Ensuring Sound Environmental Management 19 5. Promoting Innovation, Competitiveness and Employment 20 B. Improving Governance and Empowerment_ 21 1. Reforming the Public Sector 21 2. Improving the Rule of Law __________________ 22 C. Increasing Human Capabilities 22 1. Preventing and Reducing the Impact of HIV/AIDS 23 2. Improving Health 23 3. Improving Education 24 4. Social Protection 24 IV. The Bank Group's Country Assistance Strategy: Implementation 25 A. Alternative Scenarios for the Lending Program and Non-Lending Services_ 25 B. Development Partnerships _ 27 C. Program Monitoring and Evaluation 28 D. Risks and Risk Management 28 Conclusion 29 This document has a restricted distnbution and may be used by recipients only in the perfonnmice of their official duties. Its contents may not otherwise be disclosed without World Bank authorizaion.   MOZAMBIQUE COUNTRY ASSISTANCE STRATEGY Table of Contents TEXT TABLES Table 1 Mozambique: Social Indicators Table 2 Outcomes Under the Last CAS TEXT BOXES Box 1 HIV/AIDS in Mozambique Box 2 Sources of Mozambique's Recent Growth Box 3 Mozambique's Program of Liberalization and Economic Reform Box 4 Sector Wide Approaches (SWAPs) and Development Partnerships in Mozambique Box 5 Mozambique: Country Assistance Review (CAR) 1998 Box 6 CAS Non-lending Activities ANNEXES Annex A2: Mozambique at a Glance Annex B 1: Mozambique: Summary of Proposed IDA Program, FY2001-2003, by Case Annex B2: Mozambique: Selected Indicators of Bank Portfolio Performance and Management Annex B3: Mozambique: Bank Group Program Summary Mozambique: IFC and MIGA Program, FY97-00 Annex B4: Mozambique: Summary of Non-lending Services Annex B5: Mozambique: Poverty and Social Development Indicators Annex B6: Mozambique: Key Economic Indicators Annex B7: Mozambique: Key Exposure Indicators Annex B8: Mozambique: Status of Bank Group Operations (Operations Portfolio) Mozambique: Statement of IFC Held and Disbursed Portfolio Annex B9: Mozambique: Country Assistance Strategy Matrix FYO1-03 Annex B 10: Mozambique: CAS Summary of Development Priorities Annex C: Mozambique: The Government's Program, its Poverty Reduction Strategy and the CAS Annex D: Mozambique: CAS Consultations Annex E: Mozambique: A Framework for Development Partnership Map: Mozambique   MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF MOZAMBIQUE EXECUTrWE SUMMARY The last World Bank Country Assistance Strategy (CAS) for Mozambique, covering fiscal years 1998 through 2000, was discussed by the World Bank Board in December 1997. The World Bank Group CAS presented herewith covers the fiscal years 2001 to 2003. It supports the Government of Mozambique's Five-Year Program and its interim Poverty Reduction Strategy Paper (PRSP). In April 2000, the interim PRSP, which included the Government's Action Plan for the Reduction ofAbsolute Poverty ( PARPA), was considered by the World Bank Board to be an adequate framework for the enhanced FHPC Initiative decision point and a sound basis for the future development of a full PRSP, scheduled for completion in March 2001. Mozambique reached the completion point under the original HIPC framework in June 1999. Mozambique has made enormous strides since the end of the war in 1992, when it was still heavily reliant on food aid and its economy was centrally planned. Today the country is at peace, a market economy is in place, and substantial progress has been made on a challenging reform agenda, all leading to a growth rate among the highest in the world. Even so, thc lives of most Mozambicans continue to be characterized by poverty, illiteracy, and disease, in a country which continues to be one of the poorest in the world. The challenge for Mozambique today - and the focus of the Government's program and emerging poverty reduction strategy - is to sustain broad-based, private sector led growth and ensure that its benefits are broadly distributed and reach the poor. For the implementation of an effective anti-poverty strategy, institutions, norms and attitudes need to change so that govemance is improved and people are empowered to initiate and control the actions that affect their lives. Public sector capacity to deliver basic services and enforce a consistent legal and regulatory framework supportive of private sector development remains limited; physical infrastructure is inadequate; and the financial sector is still developing. The domestic private sector also faces significant challenges in acquiring the skills, experience, and innovation needed to exploit new sources of growth and to compete successfully in the world economy. Despite progress on many fronts, more needs to be done to increase private sector skills, productivity, and competitiveness; to strengthen and diversify foreign direct investment; to integrate under-served areas with high growth potential into the national economy; to continue to improve economic management; and to create economic opportunities for all, including the poor. Action is also needed to control HIV/AIDS, which now constitutes the greatest single threat to development. Preparations of this CAS involved extensive consultations with a wide variety of groups, including government officials, donors, NGOs, trade unions, religious leaders, academics, joumalists, the private sector, and the rural poor. These groups largely agreed that the highest priorities on Mozambique's development agenda over the next few years should be to improve the quality of human resources (especially linked to labor needs), expand capacity in public administration, increase support to rural development, better assist the private sector, expand infrastructure (including roads, electricity and telecommunications), and improve health care.  - ii - These are long-term goals with short-term implications for Mozambique's policies and public spending choices and for this CAS. Poverty reduction is the overall goal of the Govemment and of the Bank Group in Mozambique. In supporting the Government's program, the CAS is designed to help (i) increase economic opportunities, (ii) improve governance and empowerment, and (iii) improve human capabilities. These are the pillars of the Government's new Five Year Program (2000-2004) and of this CAS. A key objective of this CAS is to improve the focus, effectiveness, and monitoring of poverty reduction efforts, especially by helping the Government to operationalize its poverty reduction strategy. Most new IDA lending, as well as IFC investments and advisory services, will focus on increasing economic opportunities which, through growth promotion and participation, is likely to have the greatest impact on reducing poverty, even in the short-term. IDA lending will contribute to developing infrastructure (particularly in the rural areas), improving the environment for private sector activities, and promoting investment, innovation, competitiveness and employment. In support of this agenda IFC will provide advisory assistance, capacity building, and financing to develop private infrastructure, build the financial sector, and support small and medium-scale enterprises (SMEs), as well as foreign investors, in developing key sectors where Mozambique is competitive. New IDA lending under this CAS will also be directed to improving governance and empowerment, as limited administrative capacity and effectiveness is currently a primary constraint to reform, growth, and development. Operations in this area will focus on improving public sector management and capacity as well as strengthening the Government's decentralization efforts; this will promote empowerment as well as the effectiveness of programs addressing poverty reduction. Support will also be given to improving the legal and judicial system, with a view to facilitating private sector led growth. New IDA lending in support of improving human capabilities will be limited, because there already is substantial IDA support from ongoing programs (particularly in delivering basic health and education) as well as from planned Bank analytical services. IFC will support private providers of health and education services. The Bank will also provide support to the Government's new program to fight HIV/AIDS. Lending under the base case over FYO 1-03 will range up to the indicative IDA allocation of US$540 million but is likely to be below this allocation as a consequence of IDA's strategic decision to match lending with the country's absorptive capacity and the availability of grant funds from other donors. Lending under the high case will range up to US$655 million and is contingent primarily on increased absorptive capacity, implementation of related public sector reforms, and progress in implementing the poverty reduction strategy. The low case, which would result from significant deterioration in governance, economic management, or implementation of the poverty reduction strategy, would involve lending at about one-third of the indicative IDA allocation. The Bank Group's business strategy presented in this CAS is complemented by an extensive complement of advisory and analytical activities to Mozambique. Triggers include performance with respect to the portfolio, the poverty reduction strategy, the public sector reform program, the FIV/AIDS program, and various economic reforms (including demonopolization of the energy, transport, and telecommunication sectors for the high case, and policy reversals in the areas of privatization, the financial sector, and trade policy for the low case). IFC's investments, with a current portfolio of about US$150 million, are expected to increase substantially over the CAS period, so that Mozambique will remain one of the Corporation's largest portfolios in Africa. Mozambique is a high-reward country, but the strategy also carries several medium-term risks. There is a political risk that the opposition's dissatisfaction with the 1999 election results, drawing on a feeling among some groups of civil society that popular participation in decision-  - iii - making is unduly limited, could lead to political paralysis and possibly civil strife. The perception that growth is not sufficiently benefiting most people, or not sufficiently benefiting Mozambican businesses and workers, could result in protectionist and distortive regulations and a more general backsliding on reform. The growth of HIV/AIDS could substantially increase poverty. Efforts to improve public sector capacity may not yield results quickly enough to improve absorptive capacity and program implementation. Adverse developments in neighboring countries, which are increasingly linked to Mozambique, can dampen growth prospects. In addition, climatic variations and natural disasters can adversely affect agricultural productivity and growth and limit poverty reduction. The Bank recognizes these risks and is working to mitigate them. To this end, it is supporting decentralization and good governance, supporting the participatory development of a poverty reduction strategy, improving awareness of Government work on poverty reduction and its achievements, and better disseminating analytical work on the Bank's own poverty-reduction activities, the impact of policy choices, and the benefits of strategic thinking on competitiveness. The Bank is also supporting implementation of the Government's HIV/AIDS Plan to help limit the spread of the disease. Trade diversification and active participation in regional organizations will help mitigate the risk that regional crises will impede Mozambique's growth; and efforts to identify, reduce and transfer risks associated with hydro-meteorological hazards should provide better protection against natural disasters. The following issues are suggested for Board discussion: - Is the World Bank Group's proposed support to the Government's evolving poverty reduction strategy appropriate and adequate? * Is the evolving division of labor appropriate among the Government, the Bank and Mozambique's other external partners?   MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE REPUBLIC OF MOZAMBIQUE INTRODUCTION 1 Mozambique has made tremendous strides in the past few years. A sound economic reform program has been implemented, with substantial support from external partners. The transition from war to peace and from a central planning system to a market economy is reaping results. Mozambique's growth rate has accelerated and last year was among the highest in the world. Heavily reliant on food aid just a decade ago, the country now produces almost enough food to feed itself. Mozambique ranks first arnong 20 countries on the "optimism index" in a survey of business people active in Africa. 2. But alongside this good news are daunting challenges which face the nation, its people, and its partners. Mozambique is still one of the poorest countries in the world. Poverty, isolation, illiteracy, and disease characterize the everyday life of most Mozambicans, who often feel that the benefits of growth are not reaching them. The country is also vulnerable to floods and droughts. Most recently, in February and March 2000, devastating floods killed 700 people, displaced 250,000 and put about two million people into severe economic difficulties. Mozambique's growth and poverty reduction strategy is based on environmentally sustainable and inclusive private sector growth. But the public administration remains weak, despite significant reform and improvement, and it continues to face challenges of capacity and resources to deliver basic infrastructure and services and to properly enforce a consistent legal and regulatory framework essential for private sector development. The emerging domestic private sector needs access to infrastructure and financing, and must also acquire the skills, experience, and innovation required to exploit new sources of growth and to compete successfully in the new world economy. Finally, Mozambique's young democracy remains fragile, and underlying political tensions continue to task nation building and threaten national stability. 3. The challenge facing Mozambique today is how to sustain growth and reduce poverty. Many important economic reforms have been completed, but others are needed to increase private sector skills, productivity, and competitiveness and create economic opportunities for all, including the poor. Infrastructure has been built to support service delivery and the growth of markets, but more needs to be done to integrate under-served areas with high growth potential. Institutions as well as norms and attitudes need to change so that governance is improved and people are empowered to initiate and control the actions that affect their lives. These are long- term goals with short-term implications for Mozambique and for this CAS. Increasing economic opportunities, enhancing governance and improving human capabilities are key actions for reducing poverty in Mozambique, and this CAS outlines the Bank Group's contribution to this enormous endeavor. I. SOCIAL, POLITICAL, AND ECONOMIC CONTEXT A. Historical and Political Context 4. Since the end of the civil war, Mozambicans have made tremendous progress in reforming their country. The transition from a socialist command economy to a democratic market economy is largely complete. The Frente de Liberta9qo de Mo9ambique (Frelimo),  - 2 - which governed Mozambique during the war, retained control of govermnent through national elections in 1994 and 1999, transforming itself in the process from a socialist to a market-oriented democratic party. The main opposition party, Resistencia Nacional de Mofambique (Renamo), which came close to winning the December 1999 elections, has generally supported Mozambique's political and economic transition, though there continues to be political tension. Government policies are under intense scrutiny and often the subject of contentious public debate. B. Poverty, Social Context and Issues 5. Per capita income in Mozambique, at $230 in 1999, is below the average for sub-Saharan Africa ($480) and the low income group ($520). The Human Development Index, an index of income, education and life expectancy, ranks Mozambique 169th out of 174 countries. Key social indicators for Mozambique continue to be below the averages of Sub-Saharan Africa and those of low-income countries as a whole (see Table 1). Table 1.: Mozambique: Social Indicators Mozambique Sub Saharan Africa Low Income GNP per capita (atlas method, US$) 230 480 520 Poverty: national headcount index 69 Life expectancy (at birth, years) 47 51 63 Infant mortality (per 1,000 live births) 134 91 69 Child malnutrition (% of children under 5) 41 Access to safe water (% of population) 24 47 74 Illiteracy (% of population age 15+) 60 42 32 Gross primary enrollment 71 77 108 Male 79 84 113 Female 60 69 103 HIV/AIDS prevalence rate 14.5 7 6. A 1996-97 Household Survey on Living Conditions, the first integrated survey undertaken nationally, shows that poverty is pervasive. About seven in ten Mozambicans reported consumption below the national poverty line (US$0.40 per day). One-third of the population is considered to be 'ultra poor', with consumption expenditure 60 percent or less of the poverty line. 7. About 80 percent of Mozambique's poor live in rural areas; about 70 percent of the rural population is poor; and over 90 percent of rural adults work in agriculture. There is significant regional variation in poverty. Sofala, Tete, and Inhambane have the highest poverty incidences, but 40 percent of the poor live in densely populated Nampula and Zambezia. Rural households, poor or non-poor, typically have low access to services. In 1996-97, the mean distance of rural households to a market was 16 km and to a health center 29 km. Poor households are also larger and have higher dependency ratios than the non-poor. Nearly all rural households have land, but land per capita is higher for the non-poor, chiefly because household size is lower. In urban areas, the non-poor tend to be wage-laborers employed in commerce, services, and the public sector, whereas the poor declare themselves to be self-employed or unemployed. 8. Widespread poverty is reflected in Mozambique's social indicators (see Table 1). The poor and ultra-poor tend to miss more days of work from illness than the non-poor, and are less likely to seek treatment. Lack of health care, hygiene, and access to safe water and sanitation allows preventable disease to flourish. Malaria, measles, diarrhea, and acute respiratory infections remain leading killers of children. HlV/AIDS, having already infected about 14.5 percent of the adult population, has serious implications for Mozambique's development  - 3 - prospects (see Box 1). Though poverty explains some of the differences in health and education outcomes, these differences correlate more closely with gender and rural-urban divisions. Box 1.: HIIV/AIDS in Mozambique The civil war ended in 1992, but the war againstAIDS continues, and now constitutes the greatest single threat to Mozambique 's development. In Africa most carriers of the AIDS virus will die of AIDS-related illness within ten years. In Mozambique, as elsewhere, the HIV prevalence rate is rising exponentially, and has already reached about 14.5 percent in the adult population. The virus is no longer localized in high-risk groups but affects the whole population. The overall picture is bleak Health services are beginning to be overloaded with AlDS-related cases, diverting resources away from other serious illnesses. As a result, hard-won gains in life expectancy and infant and child mortality are being reversed AIDS-related deaths are now projected to make as many as 800,000 Mozambican children orphans by 2002. Moreover, adults die ofAIDS-related illnesses such as tuberculosis during what should be their most productive years. Multi-country evidence suggests that at HIV prevalence rates of 15 percent, GDP growth per capita is reduced by about 0. 8 percent per annum, and at 25 percent, as in Zimbabwe, growth per capita is reduced by 1.5 percent. In Botswana, for example, despite rapid growth, HIV/AIDS has brought poverty back to levels last seen ten years ago. Mozambique is vulnerable to similar reversals. Action is needed now, at all levels of society, to prevent and control the spread of IIV 9. Food insecurity, prevalent during the war, continues to contribute to malnutrition. Though Mozambique has nearly achieved food self-sufficiency, the average rural household still suffers through a pre-harvest hungry period of several months per year, and malnutrition remains widespread. In 1996-97, with 64 percent of Mozambicans living in food-insecure households, 43 percent of children were stunted and 6 percent wasted. Even though the degree of market participation has increased since 1993, in 1996 only half of all agricultural households sold any part of their output. 10. Mozambican girls and women continue to do less well than boys and men. The maternal mortality rate, at 1,100, is high. There is poor access to health services in general and poor quality of services directed specifically to women. Literacy rates among women (particularly in rural areas) are much lower than among men, with negative implications for agricultural productivity and child health and nutrition. While access to education is increasing, the gross primary enrollment rate among females (60 percent) is still much lower than among males (79 percent). One in five households is headed by a female; these households have less adult labor and consequently cultivate less land, and they participate less frequently in paid employment. Although remittances from absent family members make these households on average no worse- off than male headed households, households without remittances are typically worse-off. Households with male adults working elsewhere are also more at risk of HIV/AIDS. Family law in Mozambique also discriminates against women. A married woman has limited rights to make independent economic decisions or enjoy full ownership of assets, and a widow's rights to inheritance are secondary to males in the family. Finally, domestic violence against women is a hidden issue, which requires a legal response. To address these issues, the Government, in coordination with civil society, is implementing the National Post-Beijing Plan of Action (NBPA), and key sector ministries have included gender in their sector plans. 11. The national poverty assessment, recent analytical work, and the interim Poverty Reduction Strategy Paper (PRSP) highlight important policy implications for a poverty reduction strategy based on an analysis of the determinants of poverty:  - 4 - * Accelerate economic growth, particularly in agnrculture and rural areas. * Improve educational levels, particularly among girls and women. Improve the productivity of small-holder agriculture, through simple technology and input improvements. * Generate off-farm employment opportunities. * Increase the market integration of small-holder households, mainly through increasing infrastructure, C. Economic Context and Issues 12. Economic Performance and Policies. Mozambique's recent economic performance, buoyed by good agricultural seasons, has been impressive, though it represents a recovery from very low base levels. GDP growth averaged 5.5 percent annually between 1987 and 1996 and 11 percent annually between 1997 and 1999. Inflation dropped sharply from almost 50 percent in 1996 to low single digits today. At the same time, investor confidence has grown. Between 1996 and 1998, consumption grew by an average of 9 percent annually, and investment by 13 percent annually. Merchandise exports increased by 42 percent from 1996 to 1998 as a result of increased export volumes and higher commodity prices for prawns, cashews and cotton. Foreign direct investment (FDI) has also increased, and, as a result of large investment associated with the Mozal aluminum smelter, it reached US$213 million in 1998. At about 3.3 percent of GDP over 1996-98, FDI is high relative both to the size of the economy and to other African countries. TIhese are indications that foreign investor confidence is growing rapidly and FDI sources are becoming more diverse. Box 2.: Sources of Mozambique's Recent Growth Mozambique 's economic growth has been led by smallholder agriculture. Value added in the agriculture and livestock sector grew at more than 9 percent peryear after 1996, fueled by expansion in land under cultivation. Agricultural growth has been particularly strong in the north and center. The services sector has also grown well, at 6 percent per annum on average, buoyed by revival in transport, tourism, and the financial sector. Slower to recover have been large-scale commercial agriculture and industry. Many companies have gone through protracted privatization and restructuring processes and have suffered market losses. However, afirm survey undertaken in 1997 showed that manufacturing, concentrated in a few sectors (food, drinks, and tobacco; chemicals; and minerals), experienced robust growth of almost 40 percent annually between 1995 and 1997. In terms of sales growth, firms outside Maputo appear to be growing as rapidly as firms in the capital, despite lower quality infrastructure. This growth is mostly due to increased capacity utilization, which averaged about 50 percent (compared to 10 to 30 percent in 1989), rather than expansion. Employment levels in aggregate have remained stable. A ll three types offirms surveyed (private firms founded before 1991, new entrants, and privatizedfirms) had strong average growth rates in sales, but employment growth in privatizedfirms had stagnated or declined It is the new entrants that have been creating most of the new jobs in manufacturing; new firms recorded a 6 percent average rate of employmentgrowth from 1992 through 1997. 13. Mozambique's strong performance has been, and continues to be, supported by substantial foreign assistance. Since 1986, the Government has received US$8 billion in external aid, or almost US$600 million per annum (currently about 17 percent of GDP). In recent years, 50 percent of government spending and 75 percent of public investments were financed by external aid. These aid flows allowed Mozambique to maintain consumption levels while increasing public investments needed to expand the economy in a post-war period where financial demands for reconstruction exceeded potential revenues from a debilitated economy. High levels of aid have allowed Mozambique to focus its fiscal policy on stimulating growth while reducing domestic financial imbalances only gradually. From 1987 to 1998, expenditures increased by four percent annually, with revenues growing slightly more.  - 5 - 14. A sound program of economic reform and management - based on privatization, financial sector reform, investment promotion, trade and price liberalization, sound macroeconomic management and substantial public investment - has underpinned Mozambique's ongoing economic transformation and growth record (see Box 3). While Mozambique's recent accomplishments have been impressive, this success is fragile: the local private sector has limited market experience and has yet to find avenues for sustained growth; the financial sector remains inefficient with limited ability to finance investment; employment creation needs to be accelerated; public sector institutions are weak, including in their capacity to enforce and regulate the new market economy; the country remains dependent on aid and vulnerable to external and weather-related shocks; and the reform program is subject to protectionist sentiment within segments of civil society, particularly in urban areas. Box 3.: Mozambique's Program of Liberalization and Economic Refortn Privatization: Government has restructured or privatized over 1, 200 companies. Financial sector reform: The Government created a central bank; adopted regulations on licensing, capital adequacy, and exposure limits; and sold the two state-owned banks. The private financial sector now includes eleven banks, a leasing company, and seven otherfinancial institutions. Investment promotion. The Government established a progressive investment regime, promotedfree trade zones to encourage manufactured exports, transformed the Investment Promotion Center from a regulatory to a promotion agency, and reduced administrative red tapefor investors. Sound macroeconomic management: Monetary control, and the sale of the two state banks, brought macroeconomic stability. In 1996, the Government transferred customs management to a private company; in 1999 it introduced a value added tax (VAT); and it is now implementing a new budget framework law and a rolling medium-term expenditure framework (MATEF). Exchange, trade, and price reforms: Mozambique today has one of the most open trade regimes in southern Africa. The exchange rate regime has been liberalized and import licenses abolished Prices have been liberalized except for afew consumer goods. Public expenditure: Gradual fiscal adjustment in a context of improved revenues and sustained aid has enabled Mozambique to increase spending on roads, health and education. Today 55 percent of the 27,000 km road network is in good or fair condition, and only 10 percent sometimes impassable, compared to 10 and 30 percent respectively in 1992. From 1994 to 1998, the Government nearly doubled its share of current expenditure on health (from 10 to 18 percent) and education (from 5 to I 0 percent). Health care has improved as over 300 first-levelfacilities have been rehabilitated or constructed, often in remote rural areas, and about nine in ten reliably carry essential drugs and medical supplies. In addition, over 3,000 lower primary schools have been rehabilitated or constructed over the 1990s, doubling the number that existed at the end of the war. 15. Economic Prospects: Mozambique benefits from a variety of agroecological and other natural resources which, if sustainably managed, provide a good basis for growth. Agricultural growth is key to ensuring that growth translates directly into poverty reduction. Short and medium term prospects for agricultural growth are good: only 15 percent of arable land is currently cultivated. Other sources can also be exploited. The 2,700 km coastal zone has many unique habitats, offering opportunities for wildlife and tourism developments. Large perennial rivers offer significant prospects for irrigating agriculture and developing hydroelectric power. Substantial gas and coal reserves have been found, and prospecting continues for petroleum and mining. Tourism, mining, agroprocessing, and light manufacturing can generate significant employment. Attracting foreign investment will be important to this effort. Large investments exploiting the transportation corridors or exporting energy (gas, coal or electricity) or energy- intensive manufactured products (iron, steel and aluminum) are under active consideration by large international companies. Here the challenge will be to develop linkages, especially to the growing service sector, to maximize the benefits for the poor; this is likely to occur primarily through spin-off effects, such as employee training, connected infrastructure developments, and improved Government tax revenues that can subsequently be channeled into poverty-reducing  - 6 - activities. Substantial and permanent poverty reduction will also require sustained growth in value added and in jobs created within the Mozambican economy. To grow, over the medium- to long-term Mozambican firms will need to become increasingly competitive in evolving world markets, capitalizing on knowledge and innovation. D. Governance 16. Mozambique has consolidated some gains in governance in recent years. An active multiparty parliament debates national policy; freedom of the press is respected; and core labor standards, which include the rights to free association and collective bargaining and prohibit discrimination, are protected in the labor law. National elections were held in December 1999 as planned, and though the opposition initially denounced the results as fraudulent, the elections were declared free and fair by international observers. 17. Red tape and associated corruption continue to impede business. A 1996 study by IFC and the Foreign Investment Advisory Service of the Bank Group (FIAS) detailed the administrative red tape facing investors. An inter-ministerial working group established to address those problems has since achieved significant improvements; however, obstacles remain. A recent firm-level survey found that governance problems - primarily related to onerous regulations, weak enforcement, and bureaucratic burden - were the most important problems faced by businesses. Excessive bureaucracy and poor enforcement related to a weak judiciary branch create incentive and opportunity for corruption. This is exacerbated by low levels of pay amnong public sector staff, who may therefore seek additional sources of income, as well as low levels of training, which hinder their ability to efficiently administer government systems. Firns acknowledge that, at least in customs, progress has been made in this regard through introducing private management. With regard to public sector accountability, the Administrative Tribunal (the supreme audit body) is constitutionally independent but, like the Inspector General (the Government's internal auditor), lacks the resources to be an effective monitor. Reform and capacity building efforts in the areas of budget management, accounting, and auditing are aiming to address the areas of economic governance, and implementation of a recent budget law has resulted in some improvements in the transparency and management of the budgetary process. 18. Taking a broader view of the governance area, the Government is refocusing its activities on the core areas of public sector responsibility and moving from being a direct provider of services to a facilitator in areas where private initiative is likely to improve efficiency. The Govermment has started to decentralize public functions, most notably in 1998 by establishing 33 municipal governments, to improve public services by bringing political accountability down to the local level. It is also deconcentrating decision-making responsibility to make government bodies more responsive to local needs. It has undertaken civil service reform, decompressing salaries in 1998, implementing a revised career stream and remuneration system in 1999, and initiating various capacity-building programs. The emphasis now is on broadening and deepening the reforms required to manage a market economy. This is necessarily a medium and long term agenda. 19. Much remains to be done. Changes in institutions continue to lag legislative changes, and changes in the norms and attitudes of civil servants lag further. Although the civil service is learning that its role in a market economy is to assist the private sector in every way that it can without impeding competition, its capacity to fulfil this role is constrained by low education, limited private sector experience, and low morale resulting from poor wages and the uncertainty that reforn inevitably engenders. The size of Mozambique's civil service relative to population is low by African standards; hence the state is thinly spread and has difficulty in delivering services and enforcing legislation in every district. Ancillary functions remain weak (e.g. there  - 7 - are only 500 legal practitioners and no internationally certified accountants in the country). Continued weakness in the public sector and an expansion in corruption could compromise economic growth and constrain service delivery by creating bureaucratic bottlenecks, deterring private investment, and undermining public confidence in the reform process. Thus, improving governance is an important part of Mozambique's poverty reduction strategy. E. Medium-Term Economic Outlook and External Environment 20. Medium-Term Economic Outlook: Sustaining the current level of broad-based economic growth while, simultaneously, keeping inflation low and improving the delivery of social services, are central elements of the Government's strategy to reduce poverty in the medium term. Although the growth target for 2000 has been revised down as a result of the recent floods, prospects remain sound that Govermment can achieve its objectives of annual GDP growth rates in excess of 7 percent and inflation rates below 5 to 7 percent over the medium-term (2001- 2003), assuming no further adverse exogenous shocks and continued satisfactory implementation of the reform program (Annex B6). Achieving these growth objectives is expected to reduce the national poverty headcount index from 69 percent in 1997 to about 60 percent in 2004, as targeted in the Government's interim PRSP. Success will require Government to continue to maintain a prudent monetary and fiscal stance, improve the environment for the expansion of private sector activities and investment, and foster the development of a strong export base through liberal investment and trade policies. Domestic fiscal balances will gradually be reduced, but improvements in revenues in the context of a growing economy, together with sustained external aid, will permit continued expenditures in support of poverty reduction efforts. While external aid will remain necessary, Mozambique should be able to reduce its aid depenidency in the coming years. Under this base case economic scenario, it is expected that small-holder agriculture will expand, large-scale commercial agriculture will begin to revive, and manufacturing will grow across all sectors and in non-traditional areas, increasing employment. At the same time, deeper regulatory reform should encourage further investment in energy, transportation, and telecommunications; and megaprojects such as Mozal should remain on track to begin productive activities, further increasing and diversifying the export base. Mozambique's medium-term prospects, while favorable, are subject to risks; these are discussed in paragraph 79. 21. External Debt, Debt Sustainability, and the HIPC Initiative: In December 1998 Mozambique's external public debt totaled about US$6 billion (US$2.7 billion in net present value (NPV) terms). Of this, 49 percent was owed to Paris Club bilateral creditors, 37 percent to multilateral creditors (of which 55 percent was owed to IDA), and 14 percent to non-Paris Club and commercial creditors. Debt service payments amounted to about 20 percent of export earnings on average. The NPV of debt-to-export ratio was 538 at end-1998. In June 1999, Mozambique reached the HIPC completion point and received debt relief amounting to about US$3.7 billion (US$1,716 billion in NPV terms), with IDA granting relief amounting to US$975 million (US$381 million in NPV terms). Enhanced HIPC debt relief, which Mozambique is expected to obtain at the completion point in 2001 (the decision point was reached in April 2000), will amount to about US$254 million more in NPV terms, bringing the cumulative assistance under the HIPC Initiative to US$ 1.97 billion in NPV terms and lowering the NPV of debt-to- export ratio to 150 and the debt service-to-export ratio to below 5 percent from 2002 onward. In NPV terms, the debt remaining after relief is about one-fourth of the US$2.7 billion that would have been owed without HIPC Initiative assistance. This will substantially improve Mozambique's external viability and sustainability and, as debt service savings are directed to poverty reduction, it will also bring benefits to the poor. 22. External Financing: Continued and stable support in the form of bilateral and multilateral grants and credits, with debt relief, will be important in enabling Mozambique to  - 8 - meet its medium-term development objectives. At an international donors' conference in Rome in May 2000, Mozambique's extemal partners pledged US$453 million to finance the costs of emergency reconstruction following the severe floods in February and March. Financing needs for the Government's new five-year program will be discussed at a Consultative Group meeting planned for June 2000. Reliance on aid flows is projected to decline gradually over the next decade, as strong economic growth and increased levels of private sector financing diminish aid's share of GDP and of the budget. 23. Regional Context: Though its economy is more inwardly oriented than its neighbors', Mozambique's dependence on regional trade and investment flows is high, and developments in the region can significantly influence the pace and sustainability of its development. Trade flows with South Africa are the most important, representing 15 percent of total exports and 53 percent of imports in 1997. Mozarnbique in December 1999 ratified the SADC trade protocol, which aims to gradually establish a regional free trade area. Mozambique is also likely to join a regional trade guarantee facility covering Eastern and Southern Africa. With political stability and greater investor confidence, Mozambique has also become an attractive destination for South African and more recently other regional investors, such as Mauritius. 24. Regional cooperation is slowly emerging in energy, transportation, and water resource management. FDI concentrated around the Maputo corridor, and rail and port rehabilitation in the Beira and Nampula corridors, will increase economic interdependence between Mozambique and its westerly neighbors. Energy reserves near Cahora Bassa and planned megaprojects based on coal and hydroelectricity can result in further integration as the energy is sold directly to foreign markets (particularly South Africa and Zimbabwe). Mozambique is a central member of the South African Power Pool, as a key supplier of electricity and owner of the main trunk transmission line, and interconnection with Malawi and Tanzania is currently under consideration. Regional approaches to water resource management are also needed. Since the 1 970s, upstream riparians have diverted much of the yield of several cross-border rivers for irrigation and other uses, creating a need for Mozambique to negotiate a more equitable water distribution to satisfy its own requirements. Regional cooperation on watershed management and hydrologic and climatic monitoring is also essential for natural disaster mitigation I. DEVELOPING THE BANK GROUP'S COUNTRY ASSISTANCE STRATEGY A. The Context for Developing this CAS 25. Mozambique stands at an important juncture in its development. Its first elected post-war Government has completed its term and much of the economic reform agenda, set out in its five- year plan, has been completed. Over the period in which this CAS was developed, the new Government formulated and presented to the National Assembly a new five-year Government Program (2000-2004), focused on the reduction of poverty, and published its accompanying Action Plan for the Reduction ofAbsolute Poverty (PARPA) as part of its interim PRSP. The PARPA is expected to evolve, through extensive consultation, into a full PRSP. (See Annex C). 26. This CAS is designed to support the Government program and the emerging national dialogue on Mozambiquc's priorities for poverty reduction. It was developed through an extensive consultative process, fully described in Annex D. The CAS process was designed to initiate a wider Government-led dialogue to forge a common long-term vision and development framework for Mozambique. There is an emerging consensus regarding the importance of defining the country's development agenda, increasing government ownership, and fostering strong partnerships among government, donors, civil society, and the private sector. These are some of the principles of the Comprehensive Development Framework (CDF), and they are  - 9 - critical to achieving Mozambique's poverty reduction goals. They have been discussed with Mozambique's key development partners with a view to jointly articulating Government priorities and mapping out the current development activities of the Govemment, donors, NGOs and the private sector (see Annex E) so as to improve coordination and coverage of the country's development agenda in the future. Further steps in this process will build on Mozambique's accumulated experience with four ongoing sector wide approaches (SWAPs) to strengthen existing partnerships (Box 4). Box 4.: Sector Wide Approaches (SWAPs) and Development Partnerships in Mozambique A SWAP is an agreement between the Governmnent and its development partners concerning sector policies and strategies, resource projections to support strategy implementation, and common management arrangements using national administrative systems to the fullest extent possible. Implementation of IDA-supported projects in health, education, agriculture and roads has been, or soon will be, integrated into SWAPs. With fourteen or more donors represented in each SWAP, most large donors have moved away from supporting discrete free-standing projects in these sectors. This has resulted in greater organization and complementarity in each sector, lesser demands on Government capacity, and improvedfiscal management (as the approach enables the Government to incorporate allfunding for each sector into the national budget). Moreover, by consolidating accounting, auditing and monitoring procedures, SWAPs allow donors to distance themselves from day-to-day operational issues and enhance Government leadership, transparency and accountability. IDA has been heavily involved in developing SWAPs, including in identifying sector strategies and appropriate procurement, disbursement, management and monitoring systems. Joining forces behind a common strategy has been relatively easy. The main difficulties have resultedfrom the SWAP 's heavy reliance on relatively weak national administrative systems andfrom the centralizing effect of a single nationalfunding system. To improve performance, current efforts are focused on strengthening financial management capabilities for sectoral ministries in Maputo and the provinces. Decentralized planning mechanisms, combined with greater, predictable and consistent funding for sectoral programs, are being used to drive the provincial agenda and increase regional responsiveness. Although Mozambique is not a CDF pilot country, SWAPs give effective operational implementation, at the sectoral level, to the CDF principles of shared vision, Government ownership, and partnership. This approach has worked particularly well in expanding infrastructure. With about US$475 million or 55 percent of the IDA portfolio programmed in SWAPs sectors, the Bank has made a large investment in this approach, which is already providing returns. B. Performance Under the Previous CAS 27. The previous CAS defined three strategic priorities: promoting rapid broad-based private-sector-led growth; building capacity and developing human resources; and strengthening development partnerships. Throughout the CAS period the Bank operated broadly in the base case, with new lending concentrated on infrastructure and on sector programs in water, agriculture and education. Lending, at US$521 million, was slightly above the projected base case total of US$480 million. Although two projects were postponed due to implementation delays in predecessor projects, the resulting decline in lending was more than offset by increased lending in other operations including an adjustment operation, which was delivered as an IDA grant in the form of FHPC interim assistance, and an unprogrammed flood emergency recovery project. IFC's portfolio increased substantially to about US$150 million; it is now among the largest IFC portfolios in Africa. IFC invested US$120 million in the Mozal aluminum smelter, the Corporation's largest single committed investment anywhere in the world, and played a key role in mobilizing other commercial finance for this US$1.3 billion project. MIGA also supported Mozal with a US$40 million guarantee, and is working on a possible US$75 million guarantee to support investments on power transmission lines to Mozal. IFC supported the establishment of a  - 10- foreign bank that has established a wide branch network, created an investment banking affiliate, and brought new levels of service and competition to the sector. Other IFC investments, including SMEs, were concentrated in agribusiness, which helped re-establish commercial agriculture in rural areas, and in tourism. Overall, under the previous CAS, progress was made against stated development objectives and most country performance indicators and benchmarks were met, though sometimes with delay (see Table 2), generally resulting from capacity problems. 28. The Government's program, coupled with continued stability, good weather for several years, and support from external partners, is contributing to welfare gains in Mozambique. There is no definitive data on income/expenditure trends at the household level and many service delivery indicators are monitored with a lag. Yet all available data point to continued improvements. Since 1994, per capita consumption has grown by about 6.4 percent per annum, and per capita agricultural GDP by about 8.4 percent per annum, while cereals production by smallholders has doubled. Survey data suggest that poverty in the provincial capitals fell from 73 percent in 1992/93 to 65 percent in 1996/97. Access and coverage of education and health services has improved. Between 1996 and 1998, an index measuring health service delivery per person increased by 38 percent; DPT immunization rose from 63 percent to 77 percent; geographical disparities in service delivery fell; and quality indicators (such as the proportion of health units with basic drugs and trained personnel) improved. Over this period, the gross primary enrolment rate increased from 62 percent to 71 percent, and the number of students in primary schools from 1.6 million to 2.1 million. C. Portfolio Management 29. As of May 1, 2000, there were 15 projects in the portfolio totaling US$813 million, compared to 18 projects totaling about US$840 million at the start of the last CAS (November 1997). About 38 percent of this portfolio has been disbursed, and the disbursement ratio is now about 20 percent, at about the same level as at the beginning of the last CAS. Disbursement lags have fallen, with earlier delays partly resulting from increased Bank involvement in relatively slow disbursing SWAPs. Portfolio performance has improved dramatically and is still improving. At present, there are no problem projects and no projects at risk, compared to one problem project and six projects at risk in early 1998. Improvement in risk indicators has resulted in large part through proactive portfolio management and the removal, through continued progress on economic policies, of the economic management risk, which applied to all IDA-assisted projects in Mozambique at the beginning of the last CAS. 30. Efforts continue to be made to improve portfolio management. There is closer coordination with the principal donors through the SWAPs. IDA lending is being limited to fit the Government's absorptive capacity. Portfolio management has been devolved to the Country Office to ensure that emerging issues are promptly and satisfactorily resolved. Monitoring now includes both a formnal annual review to check portfolio status and review progress (next scheduled for June 2000) and weekly meetings between the Resident Representative and the Governor of the Central Bank. The Country Office has recruited a tinancial management specialist and local project officers now cover most sectors, permitting more realistic project preparation that is sensitive to local conditions as well as closer monitoring of project implementation and quicker resolution of emerging problems. Local staff are also being trained in procurement and disbursement procedures with a view to accelerating implementation. Within Government, progress in public sector reform is addressing capacity constraints. In addition, technical assistance in accounting and budget execution, to be strengthened under the new CAS, is improving financial management, and public procurement issues are to be addressed through diagnostic work on the public sector. A financial assessment and procurement review will also be an integral part of the work to be done under a public expenditure review in FY01.  - 11 - Table-2.: Outcomes Under the Last CAS Perforrmance.Indicators -| Outcome AX P,Mtte broad-base4d:p,iv&-sedotp IXj:-r- - * Maintain real growth of non-energy GDP at an annual * Non-energy GDP grew 11.3% in 1997, 92% in rate of at least 5%. 1998 and 9.3% in 1999. * Maintain single digit inflation. * Achieved: inflation 1.5% in 1999. * Value added tax in place by mid-I 998. * Value added tax was introduced in June 1999. * HIPC completion point reached by mid-1999. * HIPC completion point reached in June 1999. * Agricultural SWAP (PROAGRI) implemented by 1999. * PROAGRI implemented in August 1999. * Satisfactory progress on ROCS program, including * ROCS progress satisfactory, 3,800 km roads maintenance of 15,000 km of road by 2000. rehabilitated and 15,000 km being maintained. * Comprehensive restructuring plan for CFM, the national * In progress: CFM will concession main ports and railway, including private concessioning of all three railway systems; five main port terninal ports and railway lines by end-1998. concessions already operational and several small concessions/leases have been awarded. * Liberalization of telecommunications sector * Cellphone market to be liberalized in north and commencing in 1998. center; TDM seeking 30% strategic equity partner. * Private management contracts in place for five major * Water companies serving the five major cities were urban water compamies by 1999. leased to the private sector in September 1999. * Sale by 1999 of all companies currently on the * 90 large enterprises and over 1,100 small and privatization rolls under the privatization program. medium enterprises privatized or restructured; majority public share retained in 33 companies. * Role of the Center for Investment Promotion (CPI) * Achieved. modified to enhance its investment promotion functions. * In progress. * Commercial Code revised by mid-2000. * Regulations for the Land Law of 1997 were * New land law passed in 1997. Regulatory framework to approved in December 1998. be implemented. a, BAidIdCOWa* an ddevelop hummm resdarces ______________ * Budgetary Framework Law implemented; budgetary * Law adopted in September 1998. Medium-term scenarios for the medium-term developed; rules and expenditure framework elaborated for 1998-99 procedures for budgetary execution sinplified. budget. * Local elections held in 1998 in 23 cities and 10 towns. * Elections held in June 1998. * Increase health coverage under the Health Sector * In progress: health coverage rose from 40