The World Bank’s biannual Mozambique Economic Update (MEU) series is designed to present timely and concise assessments of current economic trends in Mozambique in light of the country’s broader development challenges. Each edition includes a section on recent economic developments and a discussion of Mozambique’s economic outlook, followed by a focus section analyzing issues of particular importance. The focus section for this edition addresses the impact of the economic downturn on Mozambique’s private sector. The MEU series seeks both to inform discussions within the World Bank and to contribute to a robust debate among government officials, the country’s international development partners, and civil society regarding Mozambique’s economic performance and key macroeconomic policy challenges. The cutoff date for the current edition of the MEU was June 30, 2017. Contents Abbreviations and Acronyms ....................................................................................................................................... iii Acknowledgements .................................................................................................................................................... iv Executive Summary .................................................................................................................................................... 1 Part One: Recent Economic Developments .............................................................................................................. 3 Economic Growth .................................................................................................................................................... 3 Exchange Rate and Inflation .................................................................................................................................. 6 The External Sector ................................................................................................................................................. 7 Monetary Policy ........................................................................................................................................................... 10 Fiscal Policy ................................................................................................................................................................... 12 Outlook ........................................................................................................................................................................... 17 Part Two: Mozambique’s Private Sector – a tale of two speeds ..................................................................... 19 Mozambique’s Firm Landscape prior to the crisis ........................................................................................... 19 Impact of the Economic Downturn .................................................................................................................... 23 Supporting small and medium enterprises through the crisis and beyond ............................................. 27 References ..................................................................................................................................................................... 30 FIGURES Figure 1: First quarter growth in 2017 shows signs of improvement driven by the extractive sector .. 4 Figure 2: … which continues to play a key role in shaping the Mozambican economy ....................... 4 Figure 3: The discovery impact of FDI on job creation in Mozambique .................................................... 5 Figure 4: The metical began recovering in October 2016… .......................................................................... 6 Figure 5: …but inflation remains sticky as pressures from electricity and fuel prices are pronounced .. 6 Figure 6: The trade balance has been narrowing…............................................................................................ 8 Figure 7: …as imports of non-essential consumer and capital goods fell.................................................. 8 Figure 8: A surge in coal prices improved overall exports ............................................................................ 9 Figure 9: … and helped augment central bank reserves ................................................................................ 9 Figure 10: Contraction in non-megaproject FDI has dampened overall FDI levels................................... 9 Figure 11: …as investment falls in key sectors .................................................................................................... 9 Figure 12: Growth in credit to the economy continues to decline …........................................................... 11 Figure 13: … as commercial bank interest rates continue to rise .................................................................. 11 Figure 14: Government borrowing has fallen in 2017 ...................................................................................... 11 Figure 15: Deposit levels have remained stable ....................................................................................................... 11 Figure 16: Replenishment by commercial banks has softened the drawdown on reserves for debt service and fuel payments...................................................................................................................... 11 Figure 17: Consolidation efforts have been limited….............................................................................................. 14 Figure 18 …with domestic financing playing a significant role in covering expenditures ..................... 14 Figure 19: Subsidies on petrol have been marginal as fixed prices have been near actual prices…..... 16 i Figure 20: …whilst diesel subsidies have been sizable as the authorities look to dampen public transport costs .. 16 Figure 21: Oil price recovery and increased fuel demand will place pressures on domestic prices…............ 16 Figure 22: Utilities and extractive industries punch above their weight in terms of value added …............... 21 Figure 23: …and Maputo has captured a large share of firm growth ..................................................................... 21 Figure 24: Maputo has also accounted for the largest share of employment created ...................................... 22 Figure 25: …and employment growth has been diversified .................................................................................... 22 Figure 26: The share of small and medium firms has been growing…................................................................... 22 Figure 27: …as well as in productivity ............................................................................................................................... 22 Figure 28: Productivity dispersion within sectors has declined suggesting increased competition .............. 22 Figure 29: GDP forecasts based on business demand indicators ............................................................................ 24 Figure 30: Declining private sector confidence is reflected in slower growth….................................................... 24 Figure 31: … turnover indices show sharp downturns in commerce and services ............................................. 24 Figure 32: Exports show a divergence between extractives and the rest of the of exporting private sector................................................................................................................................................ 24 Figure 33: … and industrial production indicators confirm this trend .................................................................... 24 Figure 34: Economic crisis transmission channels to the private sector ............................................................... 25 Figure 35: The economic crisis has further aggravated the declining trend in tourism earnings…................. 26 Figure 36: ...in part due to lower overnight stays and international arrivals .......................................................... 26 Mozambique scores poorly in several Doing Business indicators when compared to the Figure 37: region’s average.................................................................................................................................................. 27 TABLES Table 1: The Balance of Payments .......................................................................................................................... 8 Table 2: Central Government Finances ................................................................................................................. 15 Table 3: Spending on Social and Economic Sectors ........................................................................................... 15 Table 4: Outlook ............................................................................................................................................................. 18 BOXES Box 1: Extractives FDI and job spillovers ............................................................................................................ 5 Box 2: The fuel subsidy reforms .......................................................................................................................... 16 Box 3: Listening to the private sector - what business confidence tells us about growth .......................... 23 Box 4: Tourism – slowing even before the economic crisis ............................................................................ 26 ii Abbreviations and Acronyms AIAS Administration for Water and Sanitation Infrastructure ( Administração de Infraestruturas de Agua e Saneamento) BoP Balance of Payments BdM Bank of Mozambique (Banco de Moçambique) CAD Current-Account Deficit CEMPRE Business Survey (Censo de Empresas) CPI Consumer Price Index EMATUM Mozambican Tuna Company (Empresa Moçambicana de Atum) FDI Foreign Direct Investment FIPAG Water Supply Investment and Heritage Holding (Fundo de Investimento e Património do Abastecimento de Água) FPC Standing Lending Facility (Facilidade Permanente de Cedência) FPD Standing Deposit Facility (Facilidade Permanente de Depósito) GDP Gross Domestic Product GFSM Government Finance Statistics Manual IGEPE State-owned Equity Holdings Management Institute (Instituto de Gestão das Participações do Estado) INE National Statistics Institute (Instituto Nacional de Estatística) IMF International Monetary Fund IPI Industrial Production Index LNG Liquefied Natural Gas MAM Mozambique Asset Management MCT Ministry of Culture and Tourism (Ministério da Cultura e Turismo) MEF Ministry of Economy and Finance (Ministério da Economia e Finanças) MBTU Million British Thermal Units Mt Metric tons MZN New Mozambican Metical OECD Organization for Economic Co-operation and Development PETROMOC Mozambique Petroleum (Petróleos de Moçambique) PPI Producer Price Index PPP Public-Private Partnership REER Real Effective Exchange Rate SSA Sub-Saharan Africa SOE State Owned Enterprise VAT Value Added Tax WDI World Development Indicators WEO World Economic Outlook WB World Bank iii Acknowledgements This edition of the Mozambique Economic Update was prepared by a team led by Shireen Mahdi (Senior Country Economist, GMF13). The team included Carolin Geginat (Program Leader, AFCS2 and lead author for part two), Anna Carlotta Allen Massingue (Research Analyst, GMF13), Joao Leonel Antunes Morgado (Consultant, GMF13), Gemechu Ayana Aga (Economist, DECEA), and Adelina Mucavele (Program Assistant, AFCS2). Peer reviewers were Ari Aisen (IMF Resident Representative for Mozambique), Ian Walker (Lead Economist, GPSJB), and Silvia Muzi (Program Coordinator, DECEA). The report was prepared under the overall guidance and supervision of Mark R. Lundell (Country Director, AFCS2) and Ivailo Izvorski (Acting Practice Manager for GMF13, GMFDR). iv executive summary Executive Summary The Mozambican economy is showing some signs of A positive outlook for growth recovery. Real GDP (% change), 2010-19 After a difficult 2016 which saw a sharp slowdown in growth and shocks to both the currency and inflation, early trends in 2017 show signs of improvement. First quarter GDP growth in 2017 picked up to 2.9 percent, more than double the growth rate of the preceding quarter. The metical, which had been steadily depreciating against the dollar in the first ten months of 2016 is now more stable after having strengthened by 28 percent against the US dollar over the last 9 months. A strong monetary policy response was key to this Source: INE, World Bank staff estimates; f=forecast. shift, which also helped inflation to slowly begin easing by mid-2017. In addition, international to pose large risks to the economy. Inflation reserves are recovering as exports accelerated remains very high at 18 percent, with direct whilst imports remained subdued. Improving implications for Mozambican households and commodity prices and a recovering coal industry for monetary policy, which seeks to ensure are central to these trends and also contribute to a stable price environment. Monetary policy the outlook for growth. Strengthening prices for remained tight and has supported a significant coal, aluminum and gas, a post el Niño recovery adjustment in the external sector. But in agriculture, and progress in the peace talks, Mozambique’s reference lending rate is now could steer growth to 4.6 percent in 2017, and amongst the highest in sub-Saharan Africa, towards 7 percent by the end of the decade. and average commercial bank lending rates in the region of 30 percent are prohibitively high But economic conditions for much of the private sector. More needs remain challenging. to be done to help Mozambique’s economy recover, but the monetary tightening cycle Despite these improvements, the Mozambican may have peaked. A stronger exchange economy remains weakened and exposed to rate, easing inflation, and lower credit levels significant risks. Although up on the previous suggest that the monetary policy cycle could quarter, first quarter growth in 2017 remains begin to loosen as the economy continues below the levels seen in recent years. And to adjust. However, making this transition with much of the growth outlook hinging smoothly will require a coordinated and on developments in the extractives sector, robust fiscal policy response. commodity price fluctuations will continue 1 mozambique economic update july 2017 A sharper fiscal policy response in needed. A growing government wage bill Wage bill and public investment spending Although progress had been made, (% of total expenditures), 2010-16 Mozambique’s fiscal position continues to be unsustainable and the overall fiscal adjustment has been limited. Without progress in the debt restructuring process to date, the country’s debt position remains untenable. Subsidy reforms, a difficult area to tackle, have advanced and will contribute to easing fiscal pressures. But accumulating arrears and domestic financing are impeding the fiscal adjustment. The wage bill continues to be a significant source of pressure whilst recent cuts to the investment budget are affecting the economic and social sectors, and potentially worsening the Source: MEF, World Bank staff estimates composition of the budget. In addition, fiscal risks, particularly from some of Mozambique’s and the impact of the ongoing economic large state-owned enterprises, are materializing downturn on its performance. It notes growth and may compromise fiscal recovery efforts if and increased dynamism amongst firms as not managed proactively. Mozambique underwent a resource driven growth acceleration. The number of firms in Clearly, a large agenda lies ahead in restoring the the formal sector has doubled since 2002. health of Mozambique’s public finances. Progress These businesses now employ twice as many with the debt restructuring negotiations is critical workers as in 2002, and much of this expansion for reestablishing fiscal stability and halting the happened in the non-extractive private sector. accumulation of arrears to creditors. Consolidation In addition, the share of small and medium reforms to control the wage bill and strengthen enterprises is growing, a phenomenon that revenue administration would also help to ease bodes well for overall productivity growth. pressures on the budget and limit the build-up These are positive signs. However, the of arrears to suppliers. Equally as important for ongoing economic downturn is likely to have restoring sustainability would be a commitment a disproportionately negative impact on these from the authorities to pursue policies that help emerging micro, small and medium enterprises. Mozambique build fiscal buffers and ingrain A review of the emerging evidence indicates prudence in the management of public finances that while extractives, other megaprojects, and in the long-term. Such a policy agenda would large industries are showing some resilience, involve pursuing targets towards a primary surplus the rest of the private sector, the green shoots and a sustainable debt profile in the long-term. of the economy, are facing reduced growth in It would also involve reforms to strengthen the demand, higher costs, and more difficult access legal frameworks for managing debt and fiscal risks to credit. Hence, reestablishing macroeconomic from SOEs and other public sector entities. stability through a balanced mix of fiscal and monetary policy is a priority for private sector Supporting the private growth. Lastly, given its openness and continued sector through the crisis. exposure to external shocks, reforms to increase the long-term resilience of the private sector are Part two of the Mozambique Economic Update important if Mozambique is to meet its potential explores the profile of the formal private sector for a diversification and job growth. 2 part one: recent economic developments Part One: Recent Economic Developments The ongoing economic downturn reveals Economic Growth the vulnerability of the service sector, which is dominated by low-productivity activities, After a sharp slowdown in growth in to demand shocks. Over the past 15 years, an 2016, the first quarter of 2017 shows expansion took place in the service sector as signs of improvement driven by the commerce and low-skill services grew with extractive sector. consumption. It generated a large share of employment growth in the economy. Two thirds GDP growth picked up to 2.9 percent in the of jobs created in the formal economy since first three months of 2017 (year-on-year) after 2002 were created in services.2 Including the slowing to 1.1 percent in the last quarter of 2016, informal service economy would further raise but remains below recent levels. A large share this figure. Output from services contracted the of this improvement comes as Mozambique’s most in 2016, with a notable slowdown in all recovering coal industry overcomes several services subsectors except financial services3 structural problems. The Nacala logistics extending into the first quarter of 2017. Being a corridor became fully operational by early 2017, low-skill/ low-productivity sector that is exposed and along with the increase in coal prices, has to domestic demand shocks, services took the boosted exported volumes of coal. The ceasefire brunt of the economic fallout with large potential has been equally important for the agricultural implications for jobs and small enterprises. sector as improvements in security and the ability to circulate since early 2017 is helping The downturn also highlights a fragile farmers in central Mozambique to market manufacturing sector that is exposed to their goods. Despite these improvements, first declining domestic demand. Manufacturing’s quarter growth remains below its level during contribution to growth contracted by over two the previous year and is well below growth thirds when compared to 2015, and continued rates seen in Mozambique in recent years due to decline in the first quarter of 2017. This trend to lower investment, weakened demand, and is confirmed by the Industrial Production Index policy tightening. Spending restrictions in public (IPI), which shows falling production levels for investment also contributed to a contraction non-durable consumables, intermediary goods in the public administration’s contribution to and equipment. Employment levels in industry growth1 (Figure 1). have also faltered. According to the Economic 1 The public sector’s contribution to growth fell from 1.6 percent of GDP in 2015 to 0.6 percent in 2016. Real government consumption grew by 5 percent, down from a 12 percent growth in the previous year. 2 According to firm census data, 207,906 jobs were created in the formal economy between 2002 and 2015, 133,705 of which were in the services sector. 3 Financial sector output grew by 15 percent, largely a result of the effect the exchange rate depreciation had on the sector’s deflator. 3 mozambique economic update july 2017 Activities Index4 prepared by the National such as low access to inputs and high transport Institute of Statistics (INE), the largest contraction costs may have delayed or prevented a supply in employment was experienced in the industrial response in the short-term. sector, especially food manufacturing where the average employment index fell by almost 7 The extractive sector has been a pocket percent between 2015 and 2016. of resilience and a driver of the recent improvement in growth. Extractives maintained Agriculture’s performance has been driven by double-digit output growth in 2016.5 This climatic conditions. Agriculture, which accounts trend continued in early 2017 with a 41 percent for 21 percent of GDP and employs around expansion in output, making extractives the 75 percent of the labor force, faced adverse driver of the pick-up in first quarter GDP growth. climatic conditions in 2016 with the onset of the Sizable foreign direct investment (FDI) inflows regional el-Nino drought. The sector’s growth and recovering commodity price were behind slowed from 3.1 percent in 2015 to 2.5 percent this. It is a welcome trend, given the importance in 2016, and it registered a negative contribution of this sector for crowding in investment and to growth in the first quarter of 2017. Agricultural creating jobs (see Box 1). However, it is indicative export earnings fell and productivity levels of the extent of concentration in the economy, for domestically consumed foods remained especially in exports (Figure 2). It also calls for low. A weaker metical may have presented renewing the focus on diversifying exports an opportunity to the sector through more through a more dynamic private sector (see competitive prices, but climatic conditions were part two for a discussion of the impact of the a countervailing force and structural constraints economic downturn on the private sector). Figure 1: First quarter growth in 2017 shows signs Figure 2: … which continues to play a key role of improvement driven by the extractive sector … in shaping the Mozambican economy. Sectoral contribution growth, 2014-17 Extractives and aluminum contribution to the economy, 2011-16 10% 8% 6% 4% 2% 0% -2% -4% Source: INE Source: INE, BdM 4 A short-term index looking at the behavior of three major monthly indicators: turnover, employment and wages. 5 Extractives grew by 16 percent in real terms in 2016. 4 part one: recent economic developments Box 1: Extractives FDI and job spillovers What happens to foreign direct investment when a developing country makes an unpredictable giant oil or natural gas discovery? A recent analysis of developing and emerging economies from 2003 to 2014 found that FDI booms related to natural resources lead to a bonanza of other diversified FDI projects in manufacturing, services, construction and other sectors. Mozambique’s FDI inflows have boomed since 2010 and in 2012 Mozambique received 15 percent of all sub-Saharan African FDI (while it accounts for a little less than 1 percent of SSA GDP). In 2013-2015 FDI amounted to 70 percent of Mozambique’s GDP, the highest share of all African countries. A recent study by Toews and Vézina notes that over 100 greenfield non-extraction project announcements were recorded from 2009 to 2014, 45 of which in Maputo. These projects are expected to have a cumulative worth of around USD 21 billion and to create 25,500 jobs, mostly in construction, manufacturing and services. The study suggests that these inflows were stimulated by Mozambique’s natural resource discoveries. Using the weighted average of jobs created through FDI in countries with no natural resource discoveries as a control, the authors find that this represents a 50-fold increase in jobs created due to FDI (Figure 3). The authors also matched information on individual jobs to FDI projects across cities, sectors and years, and estimated the impact of these FDI projects on jobs by city and sector. The results indicate that one additional FDI project in a particular city and sector, e.g. a new British bank in Beira or a new South African supermarket in Tete, created at least 434 jobs on average. Additionally, the authors found that the average wage in a particular city in a particular sector increased by 0.8 percent with each extra FDI project. Figure 3: The discovery impact of FDI on job creation in Mozambique Non-extractives FDI jobs created (annual), 2003-14 Source: Resource discoveries, FDI bonanzas, and jobs: evidence from Mozambique. Gerhard Toews (University of Oxford); Pierre-Louis Vézina (King’s College London). 2016. 5 mozambique economic update july 2017 Exchange Rate and Inflation The exchange rate appreciates as the given Mozambique’s reliance on imported economy adjusts, but inflation remains high. goods, including foods.7 As a result, food inflation began cooling in November 2016 driven The metical has made considerable gains by a reduction in the cost of imports (including since the last quarter of 2016 supported by rice and wheat) and improved climatic condition increased export earnings and monetary policy post the el-Nino drought, which has helped to tightening. Mozambique’s currency appreciated drive overall inflation down.8 28 percent against the US dollar between October 2016 and June 2017 and by almost 29 Price increases for energy and fuel items pushed percent against the main trading currencies over non-food inflation up since February. A package the same period6 (Figure 4). Increased export of fiscal reforms aimed at rolling back subsidies earnings due to recovering commodity prices and administered pricing have put non-food are key to this trend. Reduced liquidity resulting inflation on an upward trend since the start of the from an increase in the reserve requirement has year. Electricity tariffs increased in October 2016, also lessened supply of the metical. and fuel prices at the pump, which had been fixed since 2011 were since raised twice9 in efforts to Headline inflation declined to 18.1 percent eliminate subsidies. This, combined with a spike in the 12 months to June 2017, down from a in charcoal prices, led to a 66 percent increase peak of 26.3 percent in November 2016, as in the price index for electricity, gas and other the stronger metical helped reduce the cost fuels by April 2017 (Figure 5). Transport prices of imported goods. The metical’s appreciation also increased over this period, with a significant against the US dollar and the South African rand part of the increase coinciding with the upward is a major contributor to the easing in inflation revisions in fuel prices. Figure 4: The metical began recovering in Figure 5: …but inflation remains sticky as pressures October 2016… from electricity and fuel prices are pronounced … Exchange rate against key trading currencies CPI inflation rate – national, food, non-food and electricity, (% change since Jan 2016) gas and fuel, 2015-17 (12-month % change) Source: BdM Source: INE 6 Mozambique’s multilateral nominal exchange rate, a weighted-average of the currencies of major trade currencies. 7 The base effect in the CPI has also contributed to the deceleration in the 12-month inflation rate: the sharp increase in the CPI in December 2015 means the basis for comparison in December 2016 was much higher than that for November 2016. In addition, the CPI has recently been rebased and the downward revision of the weight applied to food items may have contributed further. 8 Food accounts for 33 percent of the basket of goods in the consumer price index. 9 In October 2016, then in March 2017. 6 part one: recent economic developments The External Sector The current account deficit narrowed Trends in early 2017 suggest a further narrowing to 38 percent in 2016 as the economy of the current account deficit as imports remain underwent an adjustment through lower subdued despite the stronger metical. An imports and falling investment flows. increase in global oil prices was the main driver of a 9 percent increase in goods imports in the Mozambique registered a positive goods first quarter (year on year), whilst the underlying balance in the last quarter of 2016 for the demand for fuel and other imports remained first time in over two decades, which helped subdued. Rallying coal and aluminum prices to lower the current account deficit by 30 are supporting a continued growth in exports,11 percent. The current account deficit narrowed which is likely to offset shortfalls in agricultural to 38 percent of GDP, down from 40 percent export performance (Figure 8). of GDP in 2015. A 36 percent drop in goods imports was the most important factor behind The sharp adjustment in imports eased this shift. This adjustment in imports was pressure on external reserves. sufficiently strong to counter a drop in current income from donor financing and an increase Gross international reserves recovered to USD in service imports.10 A 17 percent increase in 2.3 billion by May 2017, enough to cover almost exports, driven by megaprojects, also helped 4.3 months of imports or 6.1 months excluding to narrow the current account. megaprojects (Figure 9). Mozambique’s balance of payments (BoP) deficit is largely As in previous years, the current account driven by imbalances in the non-megaproject deficit was largely financed by foreign direct economy and is often a source of pressure on investment. Net FDI financed approximately the country’s external reserves.12 The decline in three quarters of the current account deficit in non-megaproject imports helped ease pressure 2016. Mega-project FDI increased by 4 percent on external reserves. The BoP deficit narrowed in 2016 (Figure 10). This contrasts with the by 22 percent in 2016 corresponding to the shift rest of the economy, which saw a 32 percent in the current account balance, which helped drop in investment driven by a slowdown in reduce demand for reserves. This, coupled with real estate, financial services and construction monetary policy measures (discussed below), (Figure 11). supported a steady recovery in reserves from March 2017. 10 Current income inflows to the central government are estimated to have contracted by 70 percent, whilst other income inflows fell by 45 percent in 2016. 11 Coal prices increased by 54 percent and aluminum prices by 24 percent in the twelve months to March 2017. 12 This includes support to ensure consistent supply of food and fuel imports, and payment of public sector debt service. 7 mozambique economic update july 2017 Table 1: The Balance of Payments (USD millions, 2015 2016 unless otherwise stated) Actual 15/16 Current Account (% of GDP) 39.9 38.1 … Current Account -5,968 -4,195 -30% Trade Balance -6,469 -4,250 -34% Goods, net -4,163 -1,459 -65% Exports 3,413 3,355 -2% megaproject 2,057 2,413 17% non-megaproject 1,356 942 -31% Imports 7,577 4,814 -36% megaproject 917 771 -16% non-megaproject 6,660 4,043 -39% Services, net -2,306 -2,791 21% Income and transfers, net 502 55 -89% Capital & Financial Account -5,342 -3,704 -31% of which FDI, net -3,867 -3,093 -20% megaproject -1,273 -1,322 4% non-megaproject -2,594 -1,771 -32% Other, net -1,188 -472 -60% Overall Balance -625 -491 -22% megaproject (e) 1.9 18.4 … non-megaproject (e) -627.2 -509.4 … Source: BdM; e=estimates Figure 6: The trade balance has been narrowing… Figure 7: …as imports of non-essential consumer and capital goods fell. Quarterly trade balance (USD millions) and metical/dollar Goods imports, 2013-17 nominal exchange rate, 2014-17 (USD millions) Source: BdM Source: BdM 8 part one: recent economic developments Figure 8: A surge in coal prices improved Figure 9: … and helped augment central overall exports... bank reserves Quarterly goods exports, 2015-17 International reserves and monthly cover, 2014-17 (USD millions) (USD millions) Source: BdM Source: BdM Figure 10: Contraction in non-megaproject Figure 11: …as investment falls in key sectors FDI has dampened overall FDI levels… Net FDI, 2013-17 (USD millions) FDI growth in key sectors, 2016 (12 month % change) 2013 2014 2015 2016 2017 Q1 Source: BdM Source: BdM 9 mozambique economic update july 2017 Monetary Policy The monetary policy tightening cycle may the accumulation of reserves. It also reduced have peaked as the economy continues metical liquidity, which allowed the central to adjust. bank to accumulate forex in response to liquidity needs. Nevertheless, pressures on the Interest rates remain high, but signs of easing reserve position also persisted; provisions for inflation and a stronger exchange rate may fuel imports and government debt servicing support monetary policy loosening in the represent roughly ninety percent of total medium-term. Mozambique’s reference lending outflows (Figure 16). rate – the facilidade permanente de cedência - is amongst the highest in sub-Saharan Africa at The authorities are enhancing banking 22.75 percent. Commercial bank lending rates sector stability as key indicators deteriorate. stood at 28.6 percent13 in May 2017, 870 basis points higher than the previous year (Figure 13). Financial indicators show a banking sector under Lending rates were raised to these levels by end increasing strain. The financial system’s solvency 2016 to keep interest rates positive in real terms, ratio (capital as a proportion of liabilities) contracted stabilize a depreciating currency, and reduce by 5.8 percentage points between October 2016 inflation. As monetary policy took effect, the and January 201715 following the central bank’s metical gained value and inflation eased slightly. intervention in Moza Banco and failure of Nosso As a result, recent policy fine-tuning measures Banco. The average non-performing loan ratio for slightly loosened the position, suggesting that Mozambique’s banking sector increased by 1.2 the policy tightening cycle may have peaked by percentage points in the 12 months to January early 2017. The Banco de Moçambique removed 2017, with almost half of the increase in the the MZN 700 thousand (approximately USD last three months.16 Rising interest rates and a 10,000) credit card spending limit whilst abroad weakened economy contributed to this increase. in early 2017 and eased the reference lending rate in April 2017 by 50 basis points based on Recent reforms to strengthen banking expectations of a downward trend in inflation. sector resilience are important but come at Simultaneously, the central bank introduced a a difficult time. The Banco de Moçambique benchmark policy rate for the interbank market raised commercial banks’ minimum capital to promote transparency and improve monetary requirement from MZN 70 million to MZN 1.7 policy transmission. billion (USD 1 million to USD 25 million, based on the exchange rate at the time). The solvency With an appreciating currency, shrinking credit ratio requirement was also revised upwards from and growing reserves, monetary policy has 8 percent to 12 percent. Banks have been given supported a significant adjustment. Credit to three years to comply with this change, although the economy contracted by 15 percent in real some of the larger banks already conform to the terms in the 12 months to May 2017, and began new solvency ratio. These measures come at a decelerating in nominal terms since October time when the banking sector faces significant 2016 (Figure 12). Gross international reserves risks from declining private sector demand and recovered to approximately USD 2.3 billion by weak repayment capacity in the public sector, end of May 2017, representing an estimated especially amongst state-owned enterprises. 4.3 months of goods and non-factor services These measures may lead to some consolidation import cover (6.1 months when excluding and may strengthen foundations if the sector mega-projects). Increases in commercial can navigate through these turbulent times. bank reserve requirements14 contributed to 13 Average for one-year maturity loans. 14 The reserve requirement sets the minimum amount of reserves that must be held by a commercial bank. The requirement increased from 10.5 percent at the start of 2016 to 15.5 percent by the end of the year. 15 The average solvency ratio for the banking system decreased from 14.8 percent in October 2016 to 9 percent in January 2017. 16 The ratio increased from 4.5 percent in January 2016 to 5.2 percent in January 2017. 10 part one: recent economic developments Figure 12: Growth in credit to the economy Figure 13: … as commercial bank interest rates continues to decline… continue to rise Credit to the economy, 2014-17 Central and Commercial Bank interest rates and CPI, 2014-17 (12 month % change) (percentage, unless otherwise stated) 35% 30% 25% 20% 15% 35% 10% 30% 5% 25% 0% 20% -5% 15% -10% 10% -15% -20% 5% 0% -5% -10% -15% Source: BdM Source: INE, BdM -20% Figure 14: Government borrowing has fallen in 2017 Figure 15: Deposit levels have remained stable Decomposition of nominal credit growth, 2015-17 Commercial Bank deposits (MZN million) and (MZN million) metical/dollar nominal exchange rate, 2015-17 Source: BdM Source: BdM Figure 16: Replenishment by commercial banks has softened the drawdown on reserves for debt service and fuel payments… Quarterly reserve usage and replenishment, 2015-16 (USD millions) Source: BdM 11 mozambique economic update july 2017 Fiscal Policy of total expenditure and roughly 2.1 percent of GDP, continues to be suspended following Accumulating arrears and growing the revelation of previously undisclosed domestic financing are slowing the fiscal borrowing. This, coupled with reduced access adjustment. to external borrowing, has resulted in higher levels of domestic financing, with the central While the fiscal deficit narrowed substantially bank gaining more prominence as a source of in 2016 on a cash basis,17 the accumulation financing through short-term loans.24 Central of payment arrears suggests that fiscal bank credit to government increased by almost consolidation efforts are under pressure. The 600 percent in 2016. Most of this increase was fiscal deficit is estimated to have narrowed to realized in the last quarter. This trend continued 4.5 percent of GDP from 6.4 in 2015, on a cash in early 2017 as central bank credit increased basis, due to an 11 percent increase in revenues18 further by 43 percent in the first quarter of the and a sharp contraction in capital spending in year. The share of financing through treasury favor of the recurrent budget (Figure 17). Total bonds fell as demand declined with the investment spending was 39 percent lower government’s deepening financial difficulties. than foreseen in the budget whilst recurrent Treasury bond rates averaged 28.3 percent at the spending overshot by 4 percent due to higher most recent auction,25 which was nevertheless wage, pension and subsidies costs.19 At the same undersubscribed by 45 percent. time, the government’s limited payment capacity ramped up the pace of accumulation of arrears. A changing budgetary composition: less Amounts accrued to private creditors and fuel investment, fewer subsidies, and a growing suppliers alone in 2016 and 2017 so far are wage bill. estimated at around USD 660 million,20 almost 6 percent of GDP.21 These pending payments to The wage bill continues to be a significant suppliers, including fuel distribution companies, source of pressure on the budget. Difficulties in and to private creditors reduce overall spending containing new admissions led to overspending on a cash basis but represent sizable government on civil service salaries. Despite cuts to the obligations that lead to a wider deficit if estimated décimo terceiro26 salary, higher than planned on a commitment basis.22 recruitment in education, health, agriculture and policing27 caused the wage bill to reach 111 Domestic financing played a more prominent percent of the budgeted amount for 2016. If not role in financing the 2016 budget (Figure 18). countered, continued acceleration in the public- Development partners’ support to the budget, sector wage bill risks worsening the composition which has historically23 represented 6.5 percent of the budget by reducing growth enhancing 17 Cash-based accounting only recognizes income when it is received and spending when it is paid, and does not report commitments (or liabilities) to pay for goods and services already received. 18 Currency depreciation also supported revenues as tax on imported goods was higher. 19 Spending on subsidies was 214 percent of the revised budget following the authorities’ decision to reengage in subsidies to wheat and transporters to mitigate effects of deteriorating economic conditions on the lives of Mozambicans. 20 Amount includes arears on EMATAUM, MAM and Proindicus loans, as well as fuel supply arrears from June 2016 onwards. Arrears to private creditors include principal and interest payments. Interest payments arrears (roughly 2 percent of GDP) contribute to widening the fiscal deficit. 21 Supplier arrears are not routinely reported in official fiscal reports. 22 Mozambique’s fiscal accounts are presented on a cash basis. Traditionally, several governments recorded their government accounts on a cash basis only, however, the IMF’s Government Finance Statistic Manual (GFSM) proposes that governments should also record accrual accounts to get an indication of the full spectrum of governments fiscal position. In the latter, commitments such as government debt servicing or employee pension obligations would be included in the fiscal accounts. 23 Historical data refer to period 2010 – 2015. 24 The current legal framework allows the government to draw an amount up to 10 percent of the penultimate year’s revenues on a short-term basis. 25 http://www.bvm.co.mz/index.php/pt/mercado/comunicados/362-apuramento-dos-resultados-sessao-especial-de-bolsa- obrigacoes-do-tesouro-2017-3-serie-2. 26 The annual Christmas bonus paid to public servants, also known as the thirteenth salary, was cut but half in 2016. The bonus was not paid to people in managerial positions including Ministers, Deputy Ministers and Heads of SOEs. 27 As per the January to December 2016 Budget Execution Report, page 29. 12 part one: recent economic developments and social expenditures whilst propping up the allowing prices at the pump to fluctuate with high costs of the public sector. global prices (see Box 2). Similarly, electricity and water prices were revised upwards to increase Cuts in the investment budget and low the cost recovery and improve the financial disbursement rates constrained spending on position of utility providers. The challenge for the social and economic sectors in 2016.28 the government, however, will be to reform Having averaged roughly 19 percent of GDP subsidies whilst encouraging entities to operate between 2010 and 2015, spending on the under efficient conditions in order to avoid the social and economic sectors declined to 14 pass-through of inefficiencies to consumers. percent of GDP by 2016.29 A significant drop Mitigating the impact on poor households will occurred in 2016 (almost 3 percent of GDP) require a transition to targeted subsidy programs with sizable cuts in the investment budgets of and strengthening of social safety nets, making these key sectors being a major factor. Spending these policy priorities. Moreover, as previously was particularly constrained for infrastructure mentioned, progress in wage bill control will investments in roads and public works, and in help to balance the fiscal reforms and prevent the agriculture budget. Water was the exception the over-dependence on subsidy removal as the amongst the infrastructure sectors as it benefited main lever for adjustment. from an increase in external financing30 which helped to boost its expenditure during the year Fiscal risks are materializing and may (Table 3). The education and health budgets compromise fiscal recovery efforts if not fared somewhat better than other social and managed proactively. economic sectors. These two sectors, which accounted for over half of total spending Fiscal consolidation efforts must address since 2010 on average, saw 12 and 10 percent materializing fiscal risks from SOEs. The increases in spending respectively during 2016. operational weaknesses of Mozambique’s Much of this increase is linked to growth in these state owned enterprises have been aggravated sectors’ wage bills. Nevertheless, these sectors by the economic downturn. Growing foreign also faced difficulties in executing non-salary currency loan portfolios, some large inefficient spending, including the funding of transfers to investments, and reliance on central government provincial education directorates and the costs support placed these companies on a weak of medical supplies. footing when the currency depreciated sharply in 2016 and demand slowed. Consequently, the Subsidy reforms have progressed and will ease SOE portfolio’s performance is deteriorating and fiscal pressures, but they transfer the burden a number of key SOEs are struggling to meet to the population, which makes safety net debt service obligations. Business interlinkages mechanisms a priority. Historically, the public between non-performing public entities are sector subsidized basic goods and services common and are a source of concern as such as bread, electricity, transport and fuel. delays in payments between SOEs may further The ongoing economic downturn intensified accelerate financial distress to often already the strain these outlays place on the government poorly performing entities. A proactive plan to budget. The authorities have started tackling resolve the difficulties of strategic companies these costs head-on to reduce their fiscal under distress and structural reforms to limit burden. Subsidies to bread and salt producers the fiscal risks from other companies are more were removed in March and April, respectively, urgent than ever. and fuel price subsidies were eliminated by May, 28 This includes education, health, infrastructure, agriculture and rural development, the judicial system and social welfare and work. 29 Spending on the social and economic sectors reached 60 percent of total expenditure in 2013 but declined progressively thereafter to 48 percent by 2016. 30 Overall spending in the sector increased 142 percent to MZN 6.2 billion, or 0.9 percent of GDP. Much of this is attributed to a five-fold increase in externally financed investment spending by FIPAG. 13 mozambique economic update july 2017 Mozambique’s debt position remains Although progress had been made, the pace untenable. of reforms to bring public finances back to a sustainable positon needs to be accelerated. Debt levels had been on a rising trajectory prior to the undisclosed borrowing, and were magnified Despite the recent measures to contain the further by currency depreciation in 2016. The debt cost of subsidies and investment spending, revelations pushed external debt up from 66 to 76 Mozambique’s fiscal position continues to be percent of GDP in 2015. The sharp depreciation of unsustainable. Progress with the debt restructuring the currency in 2016 (32 percent) accounted for negotiations is critical for reestablishing fiscal the majority of the increase in the stock of external stability and halting the accumulation of arrears debt to 111 percent of GDP by end 2016. Domestic to creditors. Reforms to control the wage bill and borrowing pressures also increased in 2016 as the strengthen revenue administration would also help fiscal situation deteriorated at a time when external to ease pressures on the budget and limit the build- financing was reduced. Total debt stock at the end up of arrears to suppliers. Equally important for of 2016 is estimated at 120 percent of GDP, placing restoring sustainability would be a commitment the country in an unsustainable position. from the authorities to pursue policies that help Mozambique build fiscal buffers and ingrain Debt restructuring remains key to restoring prudence in the management of public finances in fiscal buffers and macroeconomic stability. the long-term. Such a policy stance would involve Mozambique is currently unable to service all its pursuing targets for shifting to a primary surplus debt obligations. It’s default on the sovereign bond and a sustainable debt profile in the medium-term. was the first for African countries since Ivory Coast It would also involve reforms to strengthen the defaulted on its government bonds in 2011. Arrears legal frameworks for managing debt and fiscal risks to private creditors have continued to accumulate from SOEs and other public sector entities. Lastly, in 2016 and 2017 and stand at approximately USD without clear measurement and reporting of the 590 million31 by July 2017. Hence, the country is fiscal deficit and government arrears, assessing the likely to remain in debt distress in the medium-term fiscal situation and taking the appropriate actions unless the authorities can agree with creditors on is difficult. Hence, updating the presentation of a restructuring of a portion of its debt. Measures to Mozambique’s fiscal reporting framework to strengthen domestic debt management throughout be more consistent with Government Finance the public sector, not only central government, are Statistics standards would be a key to the success also a key ingredient for restoring stability. of such a reform program. Figure 17: Consolidation efforts have been limited… Figure 18: …with domestic financing playing a significant role in covering expenditures Annual change in revenue and expenditure, 2013-16 T-bills auction (average interest on term > 63 days), (% of GDP) Central Bank credit to government, 2015-17 Source: MEF and World Bank staff estimates Source: BdM 31 This figure represents interest and principal arrears. 14 part one: recent economic developments Table 2: Central Government Finances (percent of GDP) 2014 2015 2016 Actual Actual Estimates Total Revenue 27.5 25.2 24.0 Tax Revenues 23.5 20.8 20.1 Non-Tax Revenue 4.0 4.4 3.9 Grants 4.3 3.2 2.4 Total Expenditure 39.1 34.3 30.0 Current Expenditure 24.0 21.1 21.5 Of which: Compensation to employees 11.3 10.9 11.3 Interest on public debt 1.1 1.3 2.4 Capital Expenditure 15.1 13.0 8.5 Domestically financed 8.3 7.2 3.4 Externally financed 6.8 5.8 5.1 Net Lending 3.0 0.4 0.9 Overall Balance (cash basis) -10.3 -6.4 -4.5 Primary Balance (cash basis) -6.2 -5.1 -2.1 GDP (nominal, MZN billions) 532 592 689 Source: MEF and World Bank staff estimates Table 3: Spending on Social and Economic Sectors (MZN billions) 2015 2016 %o Actual Estimates Education 41,815 46,732 11.8 Health 18,399 20,265 10.1 Infrastructure 21,592 16,903 -21.7 Roads 15,044 8,103 -46.1 Water 2,560 6,202 142.3 Public works 2,022 1,149 -43.2 Mineral Resources 1,967 1,449 -26.3 Agriculture and Rural Development 11,366 8,831 -22.3 Judicial system 4,238 4,050 -4.4 Social action and Labor 5,901 4,692 -20.5 Total 103,311 101,473 -1.8 percentage of GDP 17.5 14.7 … Source: MEF 15 mozambique economic update july 2017 Box 2: The fuel subsidy reforms Ongoing reforms to Mozambique’s fuel same period. Diesel, which represents 70 subsidy system are estimated to bring percent of total fuel consumption, was the annual savings of up to 2 percent of GDP most heavily subsidized product. As part of over the next five years. Mozambique kept its reforms to consolidate the budget and fuel prices unchanged between July 2011 reduce exposure to external shocks, the and October 2016. The difference between government of Mozambique implemented the government set prices and actual costs a series of retail price increases starting resulted in a subsidy averaging almost 1 September 2016. By May 2017, diesel and percent of GDP between 2010 and 2014, petrol prices at the pump were unsubsidized. and over 3 percent of revenue during the Figure 19: Subsidies on petrol have been Figure 20: …whilst diesel subsidies have marginal as fixed prices have been near been sizable as the authorities look to actual prices… dampen public transport costs Fixed and real petrol price, 2011-17 Fixed and real diesel price, 2011-17 (MZN per liter) (MZN per liter) Source: MIREME and World Bank staff estimates Source: MIREME and World Bank staff estimates This reform comes in time to mitigate the fiscal impact of rising fuel prices and Figure 21: Oil price recovery and increased growing domestic consumption. Fuel fuel demand will place pressures on imports, excluding LPG, registered at USD domestic prices… 192 million in the first quarter of 2017, up 57 Evolution of domestic consumption and average crude percent on the same quarter last year and oil prices, 2014-20 highlighting the effects of oil price recovery. Average crude oil price in 2017 is estimated at an average of USD 55 per barrel, up from USD 43 per barrel in 2016. This trajectory is expected to continue in the near-term although growth may be contained by the rebounding U.S. shale oil industry. Rising domestic demand for fuel products linked to population and economic growth pose further pressures. Total fuel consumption increased an average of 17 percent annually between 2012 and 2016, with a notable 70 Source: BdM and World Bank staff estimates 16 part one: recent economic developments percent increase in 2013 following a surge regimes make a clear case for reform. in FDI and megaproject activity. Careful attention should be paid, as part of this policy package, to mitigate impacts on Looking ahead, steadfast implementation the poor. The authorities will need to invest and investments in expanding robust in robust safety nets, such as cash transfer safety nets are key to the sustainability of programs and selected targeting to shelter the reform. Mozambique’s fiscal constraints vulnerable populations. and the inefficiency of general subsidy Outlook A more favorable external environment Growth in agriculture and extractives, is expected in 2017 as commodity prices along with progress in the peace talks, gradually recover and growth picks up in could steer growth towards 7 percent by advanced and emerging economies. the end of the decade. The pickup in trade and favorable financing Growth is projected to follow an upward conditions are contributing to projections of trajectory over the coming years, with some stronger global growth. Growth is predicted risks to the outlook. Recoveries in commodity to recover modestly in emerging market and prices and in the agricultural sector, post el- developing economies, including sub-Saharan Niño, are the main pillars of the World Bank’s Africa, as obstacles to growth in commodity 4.6 percent growth outlook for 2017. Moreover, exporters diminish, while activity in commodity after a sharp slump in confidence in 2016, the importers continues to be robust. Growth in one approval of the final investment decision by of Mozambique’s major trading partners, South the ENI led consortium to begin developing Africa, is forecast to recover slowly albeit within the Rovuma Basin Area 4 gas fields is expected a context of policy uncertainty.32 to contribute to improving investor sentiment in 2017. In the medium-term, further progress A recovery of commodity prices could bolster in developing Mozambique’s Rovuma basin Mozambique’s growth outlook, at least in gas projects, developments in the coal sector, the short-term. The recovery in commodity and stabilizing macroeconomic conditions prices, evident in the first quarter of 2017, is set are expected to ease inflationary pressures as to continue at least in the short-run and could well as improve both investor and consumer support further gains from Mozambique’s key sentiment. Peace in central Mozambique exports: coal, aluminum and gas. Coal prices are would add a further boost to the outlook if the projected to rise by 6.2 percent in 2017. There is, ongoing peace talks result in lasting stability. The however, a risk that they could contract again in outlook is positive but it is subject to downside the following years as global supply increases. risks. The likelihood of this positive outlook is Coking coal prices, which peaked at a record contingent on an economic recovery program USD 309 in November last year, are forecast that balances fiscal and monetary policy and to follow a downward trend in the coming that provides breathing space to Mozambique’s years albeit remaining above USD 100 until the nascent small and medium enterprise sector. end of the decade. If price increases can be Moreover, with much of the outlook hinging on sustained and additional production capacity developments in the extractives sector, trends from the recently opened Nacala coal terminal in commodity prices and global demand for is capitalized, coal’s contribution to growth in the resources will continue to pose large risks to Mozambican economy could remain significant. growth. Furthermore, whilst spillover effects 32 World Bank Global Economic Prospects, June 2017. 17 mozambique economic update july 2017 from FDI and large extractives investments into outlook. A comprehensive plan to reform the the economy can be expected, more is needed state’s enterprise sector, including restructuring to strengthen growth and job creation in the and exit strategies where necessary, are key to non-megaproject economy. mitigating these risks and their potential impact on Mozambique’s economic recovery. The fiscal outlook is strained with consolidation remaining a key priority, and External pressures may ease further as significant fiscal risks ahead. growth and investment pick up. Mozambique’s fiscal outlook continues to be The current account deficit is expected challenging, and will depend on the pace of to contract to roughly 30 percent of GDP fiscal recovery reforms. Consolidation reforms in 2017 before expanding to almost 60 remain a priority. Having made progress in percent of GDP by 2019 to accommodate reforming subsidies, additional measures to LNG infrastructure development. Preliminary check growth in the wage bill and limit inefficient data for 2017 point to a further contraction in investments will help to place the economy in the current account balance, largely driven a more stable position. The resolution of the by growing coal exports and reduced import ongoing debt restructuring process would levels. This trend should help to stabilize the represent a boost to the fiscal outlook and metical and bolster reserves. A sharp increase an important shift towards reestablishing in gas investments is expected to widen the macroeconomic sustainability. deficit in the medium-term, largely supported by an accompanying increase in FDI. Fiscal risks from state-owned enterprises are heightened and pose a significant risk to the Table 4: Outlook 2016 2017p 2018p 2019p External Scenario Real GDP (% ∆) Euro Area 1.8 1.7 1.5 1.5 China 6.7 6.5 6.3 6.3 Sub-Saharan Africa 1.3 2.6 3.2 3.5 South Africa 0.3 0.6 1.1 2.0 Nominal Commodity Price Aluminum USD/mt 1,604 1,800 1,828 1,856 Coal, Australia USD/mt 66 70 60 55 Coking coal, Australia USD/t 146 194 132 115 Natural gas, Europe USD/mbtu 4.6 5.0 5.2 5.4 Tobacco USD/mt 4,806 5,000 4,960 4,920 Domestic Scenario Real GDP and Current Account Deficit Real GDP, % ∆ 3.8 4.6 5.3 6.4 Current Account Deficit, % of GDP -38.1 -29.5 -36.0 -57.1 Source: World Bank, Bloomberg; p = Projection 18 part two: mozambique's private sector - a tale of two speeds Part Two: Mozambique’s Private Sector – A tale of two speeds This section explores the profile of evidence indicates that while megaprojects and Mozambique’s formal private sector and the large industries are showing some resilience, the impact of the ongoing economic downturn rest of the private sector, the green shoots, are on its performance. The recently released firm facing reduced demand, higher costs and more census, Censo de Empresas (CEMPRE), which difficult access to credit. Given Mozambique’s covers Mozambique’s formal private sector, openness and its exposure to the commodity suggests that Mozambique’s resource- driven cycle, reforms to improve the business growth acceleration has been accompanied by environment, strengthen competition, as well an expansion in the non-extractive private sector. as improve education and skills are essential. The overall number of firms doubled since 2002 and these businesses now employ twice as many Mozambique’s Firm workers as in 2002. In spite of this, dynamics in the firms’ landscape have been lopsided. The Landscape prior to the private sector remains highly concentrated with crisis a small number of large firms dominating output on one end of the spectrum, and a large number Between 2002 and 2015, formal of less productive micro firms on the other end. employment and the total number of There is also a persistent pull wielded by Maputo, firms in Mozambique doubled;33 Maputo which continues to attract the largest share of amplified its position as the country’s new economic activity. center of economic activity. There have been some positive signs. The share Mozambique experienced robust growth of small and medium enterprises in the formal in the number of firms over the past 15 private sector is growing, a phenomenon that years and significant growth in the services bodes well for overall productivity growth. sectors.34 According to the latest firm census, However, the ongoing economic downturn the number of firms that are formally registered is likely to have a disproportionately negative in Mozambique grew by 4 percent per annum impact on these emerging micro, small and between 2002 and 2015.35 Data shows that medium enterprises. A review of the emerging growth was particularly robust in construction 33 Based on data from the recently completed business census: 2014/2015 Censo de Empresas (CEMPRE). The census covers formally registered businesses only. 34 Data shows a decline in the number of firms for manufacturing and agriculture between the two census periods (2002 and 2015). 35 According to the latest business census CEMPRE, the number of registered formal firms increased from 28,314 in 2002 to 43,010 in 2015. 19 mozambique economic update july 2017 and services such as real estate, financial The formal private sector continued to be services, transport and logistics. The number dominated by a handful of firms, with 70 of firms in the manufacturing sector remained percent of employment, revenues, and value unchanged, while that of agriculture and fishery, added in Mozambique being generated by and tourism declined. just seven percent of all registered firms. This concentration constituted only a slight Almost two thirds of firm growth in the improvement in comparison with 2002, when past decade happened in Maputo City and 70 percent of revenues and employment were the Greater Maputo area. The Maputo area, generated by only five percent of all firms. The which contains approximately 10 percent of role played by Mozambique’s highly capital Mozambique’s population captured 62 percent intensive megaprojects was a key driver of the of the expansion in the number of firms. Maputo concentration in value added amongst the City and greater Maputo also registered the large firms. It presents a stark contrast with highest rates of employment growth, followed Mozambique’s micro firms. In 2015, three fourths by the provinces of Sofala and Nampula. of firms in Mozambique’s formal sector were micro businesses that employed fewer than New jobs were created particularly by firms in five employees. These were typically involved poorer regions. In 2002, 28,000 firms reported in low productivity endeavors, and all together employing 255,000 people. By 2015, both the accounted for just 16 percent of revenue and 13 number of firms and employment had doubled. percent of employment. Employment growth between 2002 and 2015 was widespread, with significant job growth in Since 2002, the productivity of the average central and northern provinces including Tete, firm in the extractives sector by far outpaced Sofala, Nampula and Zambezia, where poverty that of firms in other sectors. With an annual levels are accentuated. Outside of the extractives increase of 22 percent, labor productivity of the sector, the highest employment growth was average firm in the extractives sector grew more registered in the real estate sector. than seven times as fast as in the agricultural sector, the only other sector which registered The bad news: Informality remained high significant positive productivity growth between and value added in the formal sector 2002 and 2015. Also, while still small in terms continued to be concentrated in a few of its overall contribution to GDP, firms in the large firms. extractives sector were also already punching above their weight in terms of each firm’s Much of the private sector in Mozambique contribution to value added. Similarly, exports remains informal. Approximately 40 percent of from the extractives sector have been increasing Mozambique’s GDP is currently produced in the steadily, accounting for on average 25 percent informal private sector, one of the highest shares of all exports between 2011 and 2016. And more in Sub-Saharan Africa.36 According to the latest than half of total FDI flows have gone to the household survey, between 70 to 80 percent sector since 2009. of the Mozambican labor force works in the informal sector. Those working in the informal The good news: A greater share of small sector lack access to legal protection, social and medium enterprises and signs of security and pension benefits. Because of the increasing competition within sectors informal nature of their business they also have signal some budding dynamism in no access to formal finance and might find it Mozambique’s private sector outside of difficult to recruit skilled labor; two factors that the extractives sector. will limit their ability to grow their activity and contribute to economic growth. There have been some signs of a growing “middle” in Mozambique’s firm landscape, a 36 IMF Regional Economic Outlook 2017. 20 part two: mozambique's private sector - a tale of two speeds development that bodes well for productivity symptom of efficient allocation of resources growth.37 While Mozambique’s firm landscape across sectors is that productive firms drive the continued to be dominated by very small (so less productive ones out of business. As a result, called micro) firms,38 there were some signs of productivity dispersions tend to be smaller in a slowly growing “middle “, i.e. the share of small more competitive sectors. In 2015, productivity and medium sized firms was increasing. Since dispersions of firms in Mozambique still tended 2002, the share of small and medium sized firms, to be high within sectors with the exception of defined as firms with 5 to 19 (small) and 20 to the financial sector. However, when compared 100 (medium) employees, grew from 19 to 25 to 2002 these within sector productivity percent. Moreover, the share of these “middle” dispersions have been on the decline across firms among the group of high performing firms the board, suggesting a tendency towards more increased from 21 to 36 percent (Figure 26). efficient resource allocation (Figure 28). Within sector productivity dispersion has declined the There were also signs that some sectors are most amongst agricultural firms, as well as in the slowly becoming more competitive. One education sector and financial services. Figure 22: Utilities and extractive industries punch Figure 23: … and Maputo has captured a large above their weight in terms of value added… share of firm growth Concentration of value added per sector,39 2015 Share of firm growth by province, 2002-15 Source: INE, Censo de Empresas (CEMPRE) Source: INE, Censo de Empresas (CEMPRE) 37 The firm landscape in many developing countries tends to be marked by a “missing middle”, a dearth of small and medium size firms, as firms choose to stay informal or very small to avoid excessive government regulation. This phenomenon is problematic for economic growth as it has been shown to be associated with weak overall productivity growth as informal and very small firms tend to lack access to resources like capital and skilled labor (La Porta and Shleifer, 2008). 38 Three quarters of firms in Mozambique employ fewer than five employees. 39 Concentration is measured by dividing the sector’s share of total value added by its share of total firms. For example, electricity and gas contribute 2.3 percent to total value added but since this is generate by only 0.4 percent of total firms, it is a sector with a high concentration of value added . 21 mozambique economic update july 2017 Figure 24: Maputo has also accounted for the Figure 25: … and employment growth has been largest share of employment created … diversified Share of new jobs created by province, 2002-1540 Formal private sector employment by sector, 2002-15 0-5 5 - 10 10 - 15 15 - 20 >20% Source: INE, Censo de Empresas (CEMPRE) Source: INE, Censo de Empresas (CEMPRE) Figure 26: The share of small and medium firms Figure 27: …as well as in productivity has been growing… % of total number of firms by firm size % of firms in the top productivity quartile by size Source: INE, Censo de Empresas (CEMPRE) Source: INE, Censo de Empresas (CEMPRE) Figure 28: Productivity dispersion within sectors has declined suggesting increased competition Percentage difference between labor productivity for 90th percentile productive firms and 10th percentile productive firms, 2002 / 2015 Source: INE, Censo de Empresas (CEMPRE) 40 The map presents the share accounted by each province in total job creation between 2002 and 2015, by taking the level change in jobs per province over total additional jobs in the country. 22 part two: mozambique's private sector - a tale of two speeds Impact of the Economic Downturn Private sector confidence, a key indicator positive FDI flows helped support growth in for growth, had already been on the extractives exports.43 The rest of the exporting decline before the debt crisis. private sector however suffered a decline. Constraints in access to credit and slowing The private sector’s outlook started investment are likely to have played a key role deteriorating in mid-2015 and plunged further in this trend, along with the impact of the El Niño after the debt crisis. The pprivate sector’s drought on agricultural exports. demand and employment prospects and their overall confidence in the economy started Industrial production indicators further weakening in 2015 when low commodity prices confirm a lower level of resilience in the non- and tapering gas exploration became headwinds extractives economy. Whilst extractive industries to growth. The debt revelations in April 2016 experienced modest growth in production triggered a deeper crisis in confidence that was levels since the onset of the downturn, all eventually reflected in a decline of business other industrial sectors experienced a significant confidence indicators and translated into a sharp contraction in 2016. Extractives and minerals reduction in growth. recorded 14 percent growth in production. Meanwhile, industries such as food processing A divergence appears between megaproject and other small industries registered 5 and 33 firms and the rest of the private sector when percent declines in production respectively assessing the impact of the economic crisis. (Figure 33). Recent trends indicate that the non-extractives Commerce and services, core pillars of the private sector is hit hard by the current domestic economy, have been particularly downturn. Export trends in 2016 demonstrate affected by the economic downturn. this divergence; extractives exports increased41 Commerce and services, which have been by 43 percent whereas non-extractive exports indirect beneficiaries of the extractives boom, declined by 19 percent in 2016 (Figure 32). A saw their turnover decline by 14 and 13 percent commencing recovery in commodity prices by respectively in 2016 (Figure 31).44 the end of the year, especially for coal,42 and Box 3: Listening to the private sector - what business confidence tells us about growth “Soft data” such as business confidence a retrospective forecast of GDP in 2015 and indicators can be informative of short-term 2016, using business demand and a seasonal economic prospects and the likely direction component as explanatory variables, shows of “hard data” such as GDP growth. In the case the convergence between the soft and the of Mozambique, the relationship between hard data. The forecast is close to the actual these two indicators is informative. When in most quarters but seasonal peaks seem statistically tested, the business demand to be underestimated suggesting a certain indicator is found to have a causal correlation measure of conservatism in private sector with GDP at a one quarter lag. Based on this, expectations. 41 Extractives refer to precious stones, heavy sands, coal and natural gas. 42 Coal exports increased by 91 percent. 43 Despite the recovery observed in 2016, megaproject exports are still 1 percent below their 2014 level in USD terms. 44 Commerce includes wholesalers, retailers and car sales. Services include transport, tourism, real estate, social sectors and other services. 23 mozambique economic update july 2017 Figure 29: GDP forecasts based on business demand indicators Quarterly real GDP, (MZN billions) Source: World Bank staff estimates based on INE data Figure 30: Declining private sector confidence Figure 31: …turnover indices show sharp is reflected in slower growth… downturns in commerce and services Trend in economic confidence indicators, currency Average Year-on-Year Variation depreciation/appreciation against USD since Jan 2015, (Constant Prices) 2015-17 (2004 =100 for indicators) Source: INE, BdM Source: INE, Censo de Empresas Figure 32: Exports show a divergence between Figure 33: …and industrial production indicators extractives and the rest of the of exporting confirm this trend. private sector… Annual Exports, 2013-16 (USD Millions) Industrial Production Index Year-on-Year Variation Source: BdM Source: INE 24 part two: mozambique's private sector - a tale of two speeds Demand, investment, credit and costs are 2016. The private sector is likely to face key transmission channels. further upward pressures on the cost of labor as employees may seek to maintain The ongoing economic downturn and their purchasing power in real terms under macroeconomic environment is affecting a high inflation context. Mozambique’s small and medium enterprises through falling demand and investment, and • High cost of accessing credit domestically. higher costs, including in credit markets. We Access to finance has become very difficult review these issues in turn: for exporters and non-exporters. Lending by domestic banks has slowed from already • Falling investment in the non-extractives low levels. Real credit to the private sector economy. Total investment in the economy decreased by roughly 14 percent45 in the 12 declined by 30 percent in real terms in months to December 2016, as real interest 2016. At the same time, FDI inflows fell rates remained largely positive throughout by 20 percent, driven by lower external the year. Exporting firms have also found it investment in the non-extractives economy difficult to access credit in foreign currency, (down 27 percent). Among non-exporting an important prerequisite for their trading sectors, real estate and construction were activities, as foreign currency liquidity particularly affected, with FDI down from tightened in the second half of 2016. As 40 to 75 percent. such, the stock of domestic credit in foreign currency declined by 30 percent between • Capital, input, and labor cost pressures. January 2015 and December 2016. Higher costs driven by a weakened metical and high inflation are raising the cost of • A drop in demand growth. Growth in intermediate and capital goods imports, and consumption fell to 5 percent in 2016, having placing pressure on the cost of labor. As averaged 7 percent since 2010 as a spike shown in Figure 34, intermediate and capital in inflation eroded purchasing power and goods imports decreased by 17 percent in as the government’s budget came under 2016. The trend is more pronounced for pressure. The fall in demand had a direct the non-extractive sectors, where the value impact on sectors serving domestic markets of these imports declined by 41 percent in such as services and local food processing. Figure 34: Economic crisis transmission channels to the private sector % change, 2015-16 Source: INE, BdM 45 Variation of credit to private sector in domestic currency. 25 mozambique economic update july 2017 Box 4: Tourism – slowing even before the economic crisis Despite the huge potential of the tourism conflict in the center of the country are sector, it has been struggling since at least affecting the performance of the sector. 2012. Hotel revenues were 34 percent lower A study by USAID-SPEED – Economic in 2016 than in 2012. In the same period Cost of Conflict in Mozambique (2014) – of time, tourist and business international found that the conflict between late 2013 arrivals decreased by 24 percent. The and the first quarter of 2014 resulted in an volume of overnight stays and the average estimated decrease in spending on tourism duration of stay has also fallen mildly. of 26 percent (equivalent to approximately USD 3.25 million). Additionally, obtaining a The decline of this sector throughout business or tourism visa for Mozambique the last five years suggests that tourism remains burdensome in comparison with its could be suffering from structural neighboring countries despite some recent constraints which go beyond the current facilitation in granting access to visas at the crisis. International arrivals may have been border. These trends indicate that tourism compromised by the high cost of domestic is a sector that needs to be bolstered for it and international flights to Mozambique, an to meet its potential., especially now that underperforming national carrier, and the progress is being made in securing peace image of instability caused by the armed in central Mozambique. Figure 35: The economic crisis has further Figure 36: ...in part due to lower overnight aggravated the declining trend in tourism stays and international arrivals earnings… Hotel revenues, 2012-16 Overnight stays and international arrivals, (USD millions) 2012-16 (Thousands) Source: INE Source: INE 26 part two: mozambique's private sector - a tale of two speeds Supporting small and the depreciating metical. The fiscal adjustment program is also commencing, but it comes at a medium enterprises relatively modest pace. In the meantime, the private through the crisis and sector has been operating under tight monetary beyond policy conditions and a high interest environment. Looking ahead, a rebalancing towards a credible In the short-term, reestablishing macroeconomic fiscal adjustment program would help the monetary stability through a balanced mix of fiscal and policy tightening cycle to be unwound as the monetary policy is critical. An uncertain and currency stabilizes and inflation decelerates in the weakened macroeconomic context is one of the second of half of 2017, which help ease the pressure major causes of disruption to private sector activity. on Mozambique’s small and medium enterprises. The onset of Mozambique’s current economic In addition, placing debt on sustainable path and downturn has been met with a policy response to introducing structural reforms to public finances support the recovery of the economy. The response will improve the risk profile of the Mozambican has been more heavily anchored in monetary economy and attract more foreign capital to policy, which has been important for stabilizing support private sector investment. Figure 37: Mozambique scores poorly in several Doing Business indicators when compared to the region’s average… Doing Business indicators – Mozambique vs Sub-Saharan Africa, 2017 (Distance to Frontier) Source: World Bank In the medium-term, overcoming the structural • Infrastructure and skills: According to the factors that constrain the competitiveness of 2016 World Economic Forum’s Global the private sector and its resilience to shocks Competitiveness Index, Mozambique is a priority. As extractive industries play an scores low on the provision of infrastructure, increasingly important role Mozambique’s higher education and training, innovation economy will continue to be exposed to the and business sophistication. Compared to commodity cycle and external shocks. There other low-income countries in the region, are also risks that the non-extractives sector gets Mozambique falls particularly behind on stifled by the heavy economic weight of the human capital relevant factors such as the extractives sector. Reforms to make the private quality of the health and education system. sector more resilient and competitive will help These factors limit the ability of Mozambican Mozambican firms to weather future crises and to firms to compete in the world. In addition, realize the potential for a dynamic and diversified Mozambique’s labor law imposes high costs economy. Some of the key policy areas include: on taking a chance on those who might still 27 mozambique economic update july 2017 require training on the job: The Mozambican takes that long to get justice many contracts labor law forbids firms the use of short-term and economic activities never take place. -contracts for permanent tasks and imposes Weak contract enforcement has been found on them one of the highest costs of dismissal to keep firms from formalizing50 and credit in Sub-Saharan Africa.46 to be rationed as banks fear that they cannot enforce collateral.51 Similarly, weak court • Access to credit: Mozambican firms have systems discourage firm’s from developing limited ability to access finance in exchange and exporting products that are contract- for collateral with scarce credit information intensive (usually, the higher value added and a weak collateral framework for non- products)52 and foreign investors’ from moveable assets being key constraints. In setting up shop in a foreign country.53 addition, the absence of a legal framework that would allow for the collateralization of • Insolvency and firm resolution: Economic movable assets such as farm inventories and crises can result in firms having to go out of jewelry limits those who could pledge other business. In such cases, it is important that possessions.47 Further, building “reputational an insolvency regime is in place that supports collateral” instead of “physical collateral” is firm resolution in a way that guarantees a difficult in Mozambique. The absence of high recovery of assets so that they can be a comprehensive credit reporting system quickly re-deployed into the economy. In compromises banks’ ability to distinguish Mozambique, investors can currently hope good from poor performers and makes to recover 34 cents to the dollar of the assets them reluctant to lend in the absence invested in company. This is a higher rate of collateral.48 Similarly, equity finance is than in other Sub-Saharan African countries, constrained by a corporate governance but only half of what can be recovered regime that provides few incentives for firms through insolvency proceedings in high- to make financial information and audited income countries. reports of their activities available. As a result, investors are hesitant to invest because they • Leveling the playing field: As the economy cannot assess the viability of firms seeking rebounds from the crisis, it will also be finance.49 important that new firms find it easy to enter the market and get a fair chance to • Contract enforcement: It takes 950 days to compete. This requires business registration enforce a simple contract in Mozambique, procedures that are simple and competition 50 percent longer than in other Sub-Saharan policies that ensure a level playing field for all African countries, and the costs associated firms. Firm entry regulations in Mozambique with going to court are nearly three times as have been eased over the years,54 but there high as in the rest of the continent. When it remains room for streamlining the procedural 46 World Bank (2016b). 47 A draft Secured Transactions law has been prepared and is in the final stages of approval. The implementation of this law will be an important achievement for Mozambique and will help expand the range of collateral available to borrowers. 48 As of the latest Doing Business Report, the public credit registry at the Central Bank contains information for only 5 percent of the country’s population and there are limitations to what type of data is collected for this 5 percent. A private credit bureau does not exist. In addition, the legal framework for the collateralization of movable assets is very limited. Both factors resulted in a score of only 25 out of 100 points on the distance to frontier measure of the “Getting Credit Indicator” in the latest publication. 49 As of the latest Doing Business report, Mozambique scores only 43 out of 100 points on the distance to the frontier measure for “Protecting Minority Investors”, the indicator capturing the quality of a country’s corporate governance regime. 50 Dabla-Norris and Inchauste (2007). 51 Economies with a more efficient judiciary, in which courts can effectively enforce contractual obligations, have been found to have more developed credit markets and a higher level of development overall. See, for example, Mehnaz Safavian and Siddharth Sharma (2007). 52 Nunn (2007) found that countries with weak contract enforcement are less likely to export goods that require relationship- specific investments. According to his estimates, contract enforcement explains more of the patterns of trade than physical capital and skilled labor combined. 53 See, for example, Esposito et al. (2014). 54 According to Doing Business, the time to start a business was reduced from 174 to 19 days and the number of procedures reduced from 15 to 10 between 2006 and 2016. However, other countries reformed more aggressively at the same time, which explains why Mozambique still ranks relatively low on this indicator. 28 part two: mozambique's private sector - a tale of two speeds complexity imposed on the private sector. Governments that resort to excessive Worldwide, Mozambique still ranks 137 out of regulation or make it cumbersome for 190 economies in this regard. Competition firms to comply with regulatory obligations, policy in Mozambique is still taking its first such as complicated procedures for tax steps.55 While the legal framework has been payments,58 represent an unnecessary cost in place since 201356 and a competition to firm activity and create incentives for firms authority was constituted in 2014, it has yet to stay informal. Unfortunately governance to take up operations.57 indicators for Mozambique reflect a gradual decline of government effectiveness, control • Supportive government institutions: For of corruption, the rule of law, voice and firms to focus on their productive activities, accountability over the past several years. they require the support of their governments. 55 Competition policy is generally seen as the fourth pillar for government’s economic policy, along with monetary, fiscal and trade policies. Competition policy is defined as the policy specifically directed to prevent anticompetitive business practices by firms and unnecessary government intervention in the marketplace and is usually carried out by a competition agency as defined by a competition law. (UNTAD (2011)). 56 The Competition law is Law 10/2013 of 11 April 2013. Further steps towards the implementation of the competition law in Mozambique were taken with the publication of the Statute of the Authority and of the Competition Law Regulation on 1 August and 31 December 2014, respectively. 57 World Bank (2016a). 58 According to Doing Business, the total statutory tax rate for Mozambican firms is low compared to other countries in the region and even compared to rich countries, but Mozambican firms deal with more than twice as many payments as their peers in richer countries, tax audits are frequent and a VAT refunds take a long time. 29 mozambique economic update july 2017 References Dabla-Norris, Era and Gabriela Inchauste, 2007, ‘Informality and Regulations: What Drives Firm Growth?’ IMF Working Paper No. 7/112, International Monetary Fund, Washington, DC. Esposito, Gianluca, Sergi Lanau and Sebastiaan Pompe. 2014. “Judicial System Reform in Italy: A Key to Growth.” IMF Working Paper 14/32, International Monetary Fund, Washington, DC. 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