Mozambique: Letter of Intent
Maputo, March 17, 2000
Dear Mr. Fischer:
1. This letter supplements the government's letter with annexed memorandum dated June 10, 1999. It informs you of the progress in implementing the first-year program under the Poverty Reduction and Growth Facility (PRGF) arrangement until early this year, when the worst natural disaster in our history dramatically changed Mozambique's needs and prospects. As the impact of the recent floods has not yet been fully assessed, the short-term economic outlook and the government's financial policy targets described in this letter remain tentative.
2. The macroeconomic objectives for 1999 were largely achieved. Strong economic activity in the construction, tourism, and energy sectors led to a 9 percent increase in real GDP in 1999, and the 12-month rate of inflation was 4.8 percent in December, below the program's projection of 5.5 percent. The metical depreciated by 7.6 percent vis-à-vis the U.S. dollar during 1999, offering a margin of real depreciation that is welcome against the background of a weaker-than-expected balance of payments position.
3. Faced with a shortfall in foreign program assistance since mid-1999, the central bank has intervened in the foreign exchange market in support of the metical. In the process, the end-September 1999 performance criterion with respect to net international reserves (adjusted for smaller-than-expected aid flows) was missed by a small margin; by end-December 1999, the level of net international reserves was back on target. Meanwhile, neither the end-September nor the end-December program ceilings on the central bank's net domestic assets were observed, mainly because of strong demand for bank credit by the private sector and a surge in demand for cash around the turn of the year. As much of the demand for credit appears to have been driven by investment in new construction and economic activity in the primary sectors, the central bank took an accommodating stance through most of 1999; however, it recognizes that an excessive monetary expansion poses the risk of reigniting inflation.
4. The ceiling on the domestic primary fiscal deficit for end-September 1999 was observed. A small shortfall in customs revenue and excise taxes was compensated by smaller transfer payments and higher repayment of credit to enterprises, compared with the programmed amounts. The postponement of the national elections from October to December also played a role in the observance of the budgetary target for end-September, as the bulk of the election costs only arose in the last quarter of the year. The end-December benchmark for the deficit was exceeded by 0.6 percent of GDP, primarily on account of higher-than-expected current noninterest expenditures in goods and services.
5. As noted, economic and financial prospects for 2000 were recently compromised by severe flooding, which disrupted water supply, agricultural production, and transportation in large parts of the country. With the support of the international community, the government has been taking actions to alleviate damage in the most affected areas and prevent an outbreak of disease. The government anticipates slower GDP growth, lower revenue and exports, and higher expenditure needs as a result of the disaster. However, the fact that it is still too early to fully quantify the effect of the floods on production, prices, and the balance of payments creates a margin of error around some of the program assumptions and targets.
6. The quantitative targets for 2000 shown in Table 1 have been revised in an effort to take into account these and other recent developments and to reflect the changes brought about by the debt relief Mozambique is receiving, or expecting to receive, under the Initiative for Heavily Indebted Poor Countries (HIPC Initiative). These changes would lead to a domestic primary deficit of Mt 2,150 billion, compared with the original program target of Mt1,000 billion. The higher deficit reflects the additional poverty-reducing expenditures associated with debt relief under the HIPC Initiative, the full-year effect of the salary decisions of 1999, the ongoing civil service reform, and the expenditure related to disaster relief. The government intends to proceed with the final stages of implementation of the value-added tax and with the strengthening of customs administration, and has adopted a revenue target for 2000 of Mt 7,430 billion. This target takes into account an expected loss of tax revenue caused by the effect of the recent floods on economic activity.
7. In light of the recent rapid expansion in monetary aggregates, and to preempt an acceleration of inflation and an exchange rate depreciation, the Bank of Mozambique has moved toward a tighter monetary stance by raising the legal reserve requirement from 6.8 percent to 7.95 percent and by intensifying placements of treasury bills in the money market. As a result, the interbank market interest rate has risen from just over 10 percent during October-November 1999 to 13 percent in March 2000. In the remainder of this year, domestic open market operations will continue to gain significance as a tool for monetary management, while foreign exchange market intervention will focus on observance of the targets for net international reserves. To improve the monitoring of monetary developments, the Bank of Mozambique has taken steps to reduce statistical discrepancies in interbank flows. Furthermore, in order to preserve the stability and soundness of the financial system, the Bank of Mozambique will take all necessary actions to ensure that specific prudential standards are observed and that all enforcement measures specified in the new law of financial institutions are strictly applied. The government will be vigilant in overseeing the rapid transformation of Mozambique's financial sector, and will seek to ensure that the restructuring of the two banks partly owned by the state is completed this year with the full support of all their shareholders.
8. All the structural performance criteria set for end-September and end-December 1999 were observed, except the one related to the submission of customs legislation (basic customs act, customs code, and law on customs tribunals) to the National Assembly. The delay reflected a slowdown in government procedures in the run-up to the national elections before December 1999. In the process of preparing the legislation, the government also changed the content of the package. The customs personnel statute and career stream, as well as the basic customs act, designed to revise the mandate and institutions of the customs system, were recently approved by a ministerial and a presidential decree, respectively, and the law on customs tribunals was submitted to the National Assembly. A comprehensive and consolidated set of customs regulations will be prepared for government approval in early 2001.
9. Four of the ten structural benchmarks set out in the program for completion by March 2000 could not be observed on time. The delay in implementing these structural measures is primarily related to the slowdown in the governmental and legislative agenda caused by the elections and the changes in the cabinet, and in no way reflects a weakening of the government's commitment to economic reforms. The status of the unobserved measures and their updated schedule is summarized below:
- Procedures governing customs warehousing and transit trade (end-September 1999). There was a delay in implementing this measure because of the need to include additional regulations, but the new procedures were recently approved.
- Redeployment of 500 redundant customs personnel (end-December 1999). The redeployment of redundant customs personnel toward a target level of about 1,100 staff suffered a temporary slowdown. It is now expected that the target level of customs personnel will be attained by April 2000.
- Review and adoption of a position to rationalize the system of exemptions (end-March 2000). The government has recently adopted the terms of reference for a review of the system of tax and customs exemptions. The review, to be completed by August 2000, will focus on an assessment of current policies and on the formulation of a simple, transparent, and cost-effective system of investment incentives. The government will work closely with a bilateral donor and the staffs of the Fund and the World Bank in the preparation of this review.
- Policy statement on the future of public companies (end-March 2000). A policy statement and timetable of actions will be prepared by June 2000, with the goal of strengthening the performance of the 11 wholly owned public enterprises and the 22 companies with majority government share.
11. Progress has been made in improving social conditions, particularly in the health and education areas. The government has developed a five-year Poverty Action Plan based on its recent poverty assessment. In the budget for 2000, the higher level of government expenditure made possible by debt relief received, or expected, under the HIPC Initiative has been allocated among several priority areas. The government intends to strengthen the administrative and technical capacity for compiling and monitoring social and development indicators, and will publish a set of such indicators by end-May 2000. This will complement planned work on poverty monitoring in the Ministry of Planning and Finance. Furthermore, the government will begin by end-May 2000 the regular publication of a quarterly disaggregated budget execution statement, including expenditure tables according to the economic and functional classification of expenditure. The second publication, covering the results for the first two quarters of 2000, will take place by end-August of this year.
12. The government will undertake, before the end of this year, a study of policy instruments and implementation mechanisms to stimulate the production, distribution, and processing of raw cashew nuts. The study will evaluate the impact of the new cashew law, its associated costs, and its poverty implications. It will identify the key distortions in the sector and evaluate the effects of alternative policies on poverty, efficiency, and the balance of payments. The study will also propose the most appropriate policies to address these distortions in a direct and transparent manner. In this context, the government will facilitate the public discussion of its cashew sector policies. Meanwhile, the government will not raise the tax on exports of raw cashews above 18 percent and will refrain from introducing any measure that hampers the free market mechanism.
13. The government has recently increased the import surcharge on sugar in an attempt to provide temporary protection for the rehabilitation of the sugar industry. Aware of the need to assess the merits and costs of this policy in light of its effects on economic efficiency, real wages, and opportunities for smuggling and rent-seeking behavior, the government will undertake a review of sugar sector policy to evaluate the competitiveness of the sector in the local, regional, and world markets and consider the effect of any domestic distortions in the sector on firms' investment decisions. If the review establishes that government support for the sector is justified on economic grounds, it will then compare the merits of continuing the present policy of variable import surcharges with replacing it by firm-specific subsidies to producers from the budget. In this case, the review will also propose the amount, duration, and form of delivery of such support.
14. The government of Mozambique believes that the policies and measures set forth in its letter and memorandum on economic and financial policies dated June 10, 1999, as well as in this letter, are adequate to achieve the objectives of the program, but it will take any further measures that may become appropriate for this purpose. In view of the measures taken or to be taken to bring the program back on track, and to permit conclusion of the first review under the PRGF arrangement, the government requests that the Fund grant waivers for the nonobservance of the end-September 1999 net domestic assets and net international reserves targets and the structural measure on submission of customs legislation to the National Assembly, which constituted performance criteria under the program. The government further requests that, in view of the immediate balance of payments need arising from the recent flood disaster, the amount of the current three-year PRGF arrangement be increased from the equivalent of SDR 58.8 million to the equivalent of SDR 87.2 million and that the additional amount be disbursed in full, together with the second originally scheduled disbursement to the equivalent of SDR 8.4 million, following the completion of the first review under the arrangement. The government of Mozambique is determined to fully implement its program and to comply with the targets set out in this letter.
15. Mozambique is looking forward to receiving additional debt relief under the enhanced framework of the HIPC Initiative. In preparation, the government has produced an interim poverty reduction strategy paper (PRSP), which sets out the main components of the Poverty Action Plan, accompanied by a program of further work (including consultations) and a timetable to complete a full PRSP by March 2001. The government is committed to achieving further progress on its program of social and structural measures and accelerating the process of public sector reform, particularly in the areas of fiscal transparency, governance, and accountability. In this context, the government will complete a review of transparency of fiscal management in relation to the Code of Good Practices on Fiscal Transparency by May 2000. The government is also in the process of determining the medium-term budgetary costs associated with the poverty reduction strategy and the outlook for external financing of the budget. This work, to be completed by September 2000, will be folded into a revised and extended three-year macroeconomic framework and a matrix of structural measures focusing on flood-related reconstruction, poverty reduction, growth-oriented policies, and the maintenance of a stable macroeconomic environment.
Luisa Dias Diogo
Minister of Planning and Finance
Ministry of Planning and Finance
Adriano A. Maleiane
Bank of Mozambique
Mr. Stanley Fischer
Acting Managing Director
International Monetary Fund
Washington, D.C. 20431