i The World Bank’s biannual Mozambique Economic Update (MEU) series is designed to present timely, 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 focus section(s) analyzing issues of particular importance. The focus sections for this edition address debt, inflation and fiscal risk from public corporations. The MEU series seeks both to inform discussions within the 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 cut-off date for the current edition of the MEU is 20th of November 2016. ii Contents Abbreviations and Acronyms .................................................................................................................................... v Acknowledgements ........................................................................................................................................................ vi Executive Summary ........................................................................................................................................................ 1 Part One: Recent Economic Developments ........................................................................................................ 4 International Developments .................................................................................................................................. 4 Exchange Rate and Inflation ................................................................................................................................ 5 Economic Growth ..................................................................................................................................................... 6 Fiscal Policy .............................................................................................................................................................. 7 The External Sector .................................................................................................................................................. 11 Monetary Policy ............................................................................................................................................................ 13 Outlook ....................................................................................................................................................................... 15 Focus one: In the shadow of debt ................................................................................................................................ 18 The debt position: then and now ........................................................................................................................ 19 The outlook is fragile ............................................................................................................................................... 20 Where to next ............................................................................................................................................................ 22 Focus two: Inflation at record highs ....................................................................................................................... 23 A perfect storm: depreciation, drought and conflict .................................................................................... 24 The policy response has had a limited impact so far .................................................................................... 26 A disproportionate impact on the poor ............................................................................................................ 27 Focus three: Risky business - fiscal risk from state-owned enterprises ........................................................ 28 Government’s involvement in the public corporations has heightened fiscal risks .............................. 28 Reforms to strengthen oversight and manage fiscal risks from public corporations are urgent ........ 30 FIGURES Figure 1: Growth has been sluggish among some of Mozambique’s major trading partners ............. 4 Figure 2: …and global commodity prices remain low .................................................................................... 4 Figure 3: Depreciation has accelerated significantly since the start of 2016 ............................................ 5 Figure 4: … and has outpaced other African economies .............................................................................. 5 Figure 5: Manufacturing and services contributions to growth have fallen ............................................. 7 Figure 6: … whilst confidence indicators suggest a sharp decline in perspectives since debt revealed .. 7 Figure 7: Over execution of recurrent expenditures at end-September is of concern ......................... 8 Figure 8: Cuts across all SES with the exception of health ............................................................................ 8 Figure 9: The cost of borrowing for government has increased significantly ......................................... 10 Figure 10: …and average yields on Eurobonds have far exceeded peer countries .................................. 10 Figure 11: Reserve levels have fallen as the non-megaproject current account widens ......................... 12 Figure 12: The trade deficit has decreased following a contraction in imports ......................................... 12 Figure 13: …and an increase in megaproject exports ...................................................................................... 12 iii Figure 14: FDI inflows have been falling despite a pick-up in megaproject FDI ................................................. 12 Figure 15: Monetary tightening kept commercial rates positive in real terms ..................................................... 14 Figure 16: Metical deposits have been falling whilst foreign currency deposits increased .............................. 14 Figure 17: Government borrowing was driving credit growth but began slowing after debt revelations ...... 14 Figure 18: Nominal credit to the economy continued to increase in early 2016 but declined sharply in real terms .. 14 Figure 19: Debt profile is dominated by foreign currency denominated debt .................................................... 20 Figure 20: …which has increased with the addition of Proindicus/ MAM and currency depreciation ........... 20 Figure 21: Mozambique’s debt position has deteriorated when compared to other African countries ...... 21 Figure 22: Higher debt service is placing the economy under severe strain ....................................................... 21 Figure 23: …and the outlook may deteriorate depending on the trajectory of the metical ............................. 21 Figure 24: Commercial loans accounted for less than a fifth of debt stock at end of 2015 ........................... 21 Figure 25: … but will represent 40 percent of debt service in the medium term on current terms .............. 21 Figure 26: Rising food prices are driving inflation after an extended period of stable prices .......................... 24 Figure 27: Inflation in the center of the country is high but has recently been overtaken by the south .......... 24 Figure 28: The hike in food inflation is accentuated when compared to most peer countries ..................... 24 Figure 29: A myriad of factors have contributed to localized price increases ..................................................... 25 Figure 30: Disparity between food and non-food items is evidenced when accounting for tradeable effects ..... 26 Figure 31: …with increases in prices for key food items rising nearing 100 percent .......................................... 26 Figure 32: Determinants of CPI variability ...................................................................................................................... 26 Figure 33: Food products consumed by poor households experienced sharper price increases ................. 27 Figure 34: The majority of public enterprises are under-performing ...................................................................... 28 Figure 35: Borrowing has been the main method of government financing for public corporations .......... 29 Figure 36: Guarantees have been mostly awarded to companies with weak financial performance .......... 29 Figure 37: Heavy borrowing in foreign currency exposes public corporations to currency depreciation ... 29 TABLES Table 1: Government Finances 2016 .......................................................................................................................... 10 Table 2: Spending on Social and Economic Sectors ............................................................................................... 10 Table 3: The Balance of Payments ............................................................................................................................. 13 Table 4: Outlook .............................................................................................................................................................. 17 BOXES Box 1: Main Monetary Policy Committee measures taken since July 2015 .................................................. 14 Box 2: Financial vulnerabilities in Mozambique’s banking sector ..................................................................... 15 Box 3: Mozambique’s hidden debt ........................................................................................................................... 18 Box 4: Measuring inflation: the Consumer Price Index ....................................................................................... 23 iv Abbreviations and Acronyms ADM Mozambique Airports (Aeroportos de Moçambique) AIM Mozambique News Agency (Agência de Informação de Moçambique) BdM Bank of Mozambique (Banco de Moçambique) CAD Current-Account Deficit CFM Mozambique Ports and Railways Company (Caminhos de Ferro de Moçambique) CPI Consumer Price Index DSA Debt Sustainability Analysis EDM Mozambique Electricity (Electricidade de Moçambique) EMATUM Mozambican Tuna Company (Empresa Moçambicana de Atum) FDI Foreign Direct Investment FGD Deposit Guarantee Fund (Fundo de Garantia de Depósitos) FPC Standing Lending Facility (Facilidade Permanente de Cedencia) FPD Standing Deposit Facility (Facilidade Permanente de Depósito) GDP Gross Domestic Product GNI Gross National Income HIPC Heavily Indebted Poor Countries 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 LNG Liquefied Natural Gas MAM Mozambique Asset Management MASA Ministry of Agriculture and Food Security (Ministério da Agricultura e Segurança Alimentar) MCEL Mozambique Cellular MEF Ministry of Economy and Finance (Ministério da Economia e Finanças) MMBTU 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) PPP Public-Private Partnership REER Real Effective Exchange Rate SCF Standby Credit Facility SIMA Agricultural Market Information System (Sistema de Informação de Mercados Agrícolas) SSA Sub-Saharan Africa SOE State-Owned Enterprise VAR Vector Auto Regression VAT Value Added Tax VTB Vneshtorgbank WDI World Development Indicators WEO World Economic Outlook WB World Bank v Acknowledgements This edition of the Mozambique Economic Update was prepared by a team led by Shireen Mahdi (Senior Country Economist, GMF13). The team included Anna Carlotta Allen Massingue (Research Analyst, GMF13), Natasha Sharma (Senior Economist, GMF13), Carlos da Maia (Poverty Economist, GPV01), Julian Casal (Senior Financial Sector Economist, GFM01) and Rafael Saute (Senior Communications Officer, AFREC). The team is also grateful for the support provided by Carolin Geginat (Program Leader, AFCS2). Peer reviewers were Richard Record (Senior Economist, GMF07) and Rafael Chelles Barroso (Senior Economist, GMF01). The report was prepared under the overall guidance and supervision of Mark R. Lundell (Country Director, AFCS2) and Mark Roland Thomas (Practice Manager, GMFDR). vi executive summary Executive Summary Mozambique is navigating a complex crisis. The economic downturn is having a disproportionate impact on the poor This has been a testing year for Mozambique. An ongoing downturn, brought about by low CPI inflation (12-month % change), 2016 commodity prices, drought and conflict, was compounded by the fallout from the discovery of hidden debts in April 2016. The revelation of USD 1.4 billion in previously undisclosed commercial loans dented confidence in the country and derailed its track record for high growth and economic stability. The level of debt took an explosive path with the addition of the previously undisclosed loans, making Mozambique one of the countries in Africa with the highest debt to GDP ratios. The Source: INE and World Bank staff estimates onerous terms of the loans and the pace of currency depreciation created severe liquidity with food price inflation hitting 40 percent. constraints that are placing Mozambique’s Inflation has been higher for the poor as food capacity to meet debt service obligations in products account for a dominant share of their question. The outlook is uncertain and rests on consumption basket. The weaker metical has the outcome of Mozambique’s negotiations with also increased the debt burden significantly. The commercial creditors, with complex discussions previously undisclosed loans pushed public debt ahead in 2017. In the meantime, the fiscal up to 86 percent of GDP at end 2015. By end outlook is under immense pressure and budget 2016, this debt is forecast to reach 130 percent plans face significant uncertainty. of GDP, with a large share of this increase being due to the exchange rate effect. These events contributed to the sharp pace of currency depreciation. The metical depreciated It did not take long for the effects of the ongoing by 42 percent against the US dollar in the first economic turmoil to register on Mozambique’s ten months of the year, and 57 percent when growth record as GDP began to contract compared to the start of 2015. The rate at which sharply in the second and third quarters of 2016. the Mozambican currency depreciated outpaced Foreign direct investment (FDI), and exports, are that of most other African commodity exporters, projected to fall by 17 and 8 percent respectively including Nigeria and Angola, where economic in 2016. These declines, coupled with falling pressures have also been acute. The weaker consumer demand, and fiscal and monetary metical accelerated the pace of inflation, making tightening, are contributing to a sharp reduction high prices the most acutely felt symptom of the in GDP growth. Following three consecutive ongoing economic downturn by Mozambicans, quarters of slowing economic activity in 2016, with a disproportionate impact on the poor. Year- growth for the year is forecast at 3.6 percent. on-year inflation reached 25 percent in October, 1 mozambique economic update december 2016 Clearly, Mozambique’s macroeconomic stability Progress is also being made on the governance has been shaken-up. But equally as important, front. The initiation of an independent audit of the the sharp deterioration in economic conditions Empresa Moçambicana de Atum (Mozambique is having a deep impact on Mozambican Tuna Company, EMATUM), Mozambique Asset households, especially the poor, and its nascent Management (MAM) and Proindicus loans is a small and medium sized business sector which, key step in rebuilding confidence, and signifies along with agriculture, underpins the non- the focus of the authorities on restoring relations megaproject part of the economy. The financial with the International Monetary Fund (IMF) and sector is also under pressure as the failure of two other partners. banks in the second half of 2016 underscores the vulnerabilities of the sector. The potential for growth remains strong. The policy response is picking up pace. Mozambique’s gas production prospects shape expectations for a recovery in growth to 6.6 The policy response picked up pace in the percent by 2018. Recent developments indicate second half of 2016. A revised budget for 2016 progress with the Rovuma basin gas megaprojects, was a first step in adjusting the fiscal framework such as the approval of the investment plan for to the new realities. This budget revised revenue the Coral South offshore facility, which brings projections downwards and restructured the the final investment decision for this multi-billion spending program. A step in the right direction project closer in sight. albeit limited and subject to significant downside risk. The initiation of debt restructuring talks by the Government of Mozambique is also a significant move and shows efforts to tackle the Megaprojects shape growth expectations debt burden head-on. Real GDP (% change), 2010-18 The Banco de Moçambique stepped-up its monetary tightening regime with eight consecutive rate increases since October 2015, amongst other measures. There are signs that pressures on the external position are easing. Policy rate increases have kept commercial bank rates above inflation and credit levels show signs of adjustment. Goods imports are expected to decline by 33 percent in 2016, signaling an adjustment driven by a weaker metical and reduced foreign currency liquidity. The rate of currency depreciation has also slowed as the metical remained relatively stable in October Source: INE and World Bank staff estimates and November 2016. 2 executive summary In the meantime, existing megaprojects are beyond. In the short term, much rests on the showing resilience and may benefit from a boost outcome of the debt negotiations initiated by the in the near term from an improving outlook Government of Mozambique and the transparent for key commodity prices. Both megaprojects handling of the independent audit. Beyond exports and FDI are set to increase in 2016 this, key items on this agenda include setting compared to the previous year. In terms of the a medium term framework for restoring fiscal commodity outlook, prices for aluminum and sustainability, anchored in a target for reducing gas, two of Mozambique’s largest exports, are debt and a credible fiscal adjustment program. expected to begin recovering in 2017. Similarly, Enhanced financial sector surveillance and the a rally in coal prices and the recently completed strengthening of crisis management instruments railway improve the prospects for coal exports. is also a priority, particularly if further monetary This is encouraging, but the challenge remains for tightening is in the pipeline in the near term. Mozambique to ensure that future wealth from Moreover, the current economic circumstances these sectors is deployed, with transparency, to highlight the need to manage fiscal risks and spur growth in the non-megaproject economy contingent liabilities better. In this regard, reforms and lift the poor to prosperity. to develop effective oversight over state-owned enterprises and other public entities are urgent, Rebuilding confidence and along with reforms to overhaul the framework for managing guarantees. restoring stability. The agenda for restoring economic stability and confidence will stretch into 2017 and possibly 3 mozambique economic update december 2016 Part One: Recent Economic Developments challenging economic conditions in the largest International Developments economies and commodity exporters—Angola, Nigeria, and South Africa—as they continue Sluggish global growth. to face low commodity prices and suffer the effects of regional drought. Growth in South The global economy remains fragile in 2016. Africa, Mozambique’s main trading partner, has Global GDP growth has slowed down in the first decelerated considerably in the last two years half of the year, partly due to sluggish growth in the (Figure 1) and is estimated at only 0.6 percent in Chinese economy which has impacted global trade 2016, with downside risks seeming imminent amid and demand for commodities. Similarly, several faltering agricultural production, rising inflation and advanced economies have continued to struggle high unemployment. with a weak economic outlook whilst uncertainty in financial markets related to the UK’s Brexit has Pressures persist for commodity exporters as dampened growth in the Eurozone area. prices remain low. Average prices for coal and oil were 44 and 31 percent lower in the six months The effects of low commodity prices, adverse to June than a year earlier, respectively. Aluminum weather conditions and political uncertainties, and gas prices have fallen 14 percent in the same have continued to weigh on African economies. period (Figure 2). Growth in the region is slowing, reflecting the Figure 1: Growth has been sluggish among Figure 2: …and global commodity prices remain some of Mozambique’s major trading partners… low Quarterly GDP Growth Rates in Selected Countries, Selected Commodity Price Trends, 2012-16 2012-16 (2005 = 100) Source: OECD and World Bank Source: World Bank 4 part one: recent economic developments Exchange Rate and significant volumes of additional debt were revealed in April 2016. These revelations Inflation created increased uncertainty amongst donors and foreign investors regarding the real state Sharp currency depreciation has altered of public finances. As a result, donors put their the playing field for Mozambique. budget support on hold, while FDI and external credit lines to the private sector contracted. Mozambique’s currency has lost significant value Expectations are also playing their part. Holding over the last 12 months. The metical depreciated the metical in the face of persistent depreciation by 42 percent against the US dollar in the first ten and high inflation has become increasingly months of 2016, and 57 percent when compared unappealing to Mozambicans. This is evident in to the start of 2015 (Figure 3). The rate at which the informal currency exchange market, where the Mozambican currency depreciated outpaced the gap between the official and informal rate that of most other African commodity exporters, has recurrently exceeded 10 percent. including Nigeria and Angola where economic pressures have also been acute (Figure 4). The The depreciation contributed to an real effective exchange rate (REER) has shown a acceleration in inflation. Average year-on-year similar trend, with real currency depreciation at inflation reached 25 percent in October, with the end of October recorded at 42 percent since food price inflation climbing up to 40 percent. January 2015. The situation is made complex by a confluence of domestic and external shocks. Dependency Several factors have accelerated the on imports made currency deprecation a key depreciation of an already weakening metical. driver of inflation. Regional drought and internal The volume of foreign currency inflows which political conflict1 have also contributed to the was on a declining trend, given the falling spike in prices (see focus section 2 for a further commodity prices, contracted further after discussion on inflation). Figure 3: Depreciation has accelerated Figure 4: … and has outpaced other African significantly since the start of 2016… economies. Nominal exchange rates, 2014-16 Local currency unit / USD and Mozambique Real Effective Exchange Rate, (% change since Jan 2015) Source: BdM Source: BdM and INE 1 Conflict between the ruling party, Frente de Libertação de Moçambique (FRELIMO) and its main opposition, Resistencia Nacional de Moçambique (RENAMO), has erupted owing to disagreements about the results of the 2014 general elections. The intensification of armed conflict in central regions in recent months has resulted in mediation from foreign envoys including the European Union and former SADC heads of state. 5 mozambique economic update december 2016 Economic Growth Services, where momentum had been building Lower confidence in the economy after during the boom years, are struggling to the recent debt revelations derailed weather the downturn. Mozambican consumers Mozambique’s growth trajectory as are understandably holding back as they adjust investment, exports and consumer to higher prices and uncertain prospects. Growth demand decline . in tourism is checked by a low outlook for South African and European visitors. External demand It did not take long for the effects of the for professional services is also shrinking as ongoing economic turmoil to register on FDI stalls. Adding significant contraction in the Mozambique’s growth record. A continued public administration sector, services’ average gradual downturn was expected as Mozambique contribution to GDP in the first three quarters entered 2016 with slowing growth, low was 43 percent lower than in 2015. commodity prices and slackening investment.2 Instead, output recorded a sharp decline since Mozambique extractive and manufacturing previously undisclosed debts surfaced. Second sectors are also slowing down. The extractive and third quarter growth dipped to the slowest sector marked a 60 percent decrease in its quarterly rates on record in eight years at 3.4 contribution to growth in the first three quarters and 3.7 percent (Figure 5), placing the growth as it climbs down from its peak at the height of forecast for 2016 at 3.6 percent, down from 6.6 gas exploration, and as final investment decisions percent in 2015. for the Rovuma basin gas megaprojects remain pending. The manufacturing sector’s average Lower investment, falling exports and contribution to growth in the first three quarters decreasing confidence are key drivers of lower declined by 3 percentage points compared growth. Falling investment, caused, in part, by to 2015, driven by decelerating utility and an uncertain outlook for commodity prices, construction sectors. was compounded by a drop in investment as Mozambique’s debt position worsened (Figure The agricultural sector continues to be an 6). The country faced successive downgrades by important contributor to growth, but has credit ratings agencies, which have weakened suffered the effects of the regional El-Niño investor confidence.3 Foreign direct investment drought. Agriculture’s average contribution to is falling and is expected to record a 17 percent GDP contracted by 6 percent in the first three annual decline by end 2016. This decrease quarters of 2016 as producers in the southern comes as a result of a slowdown in the non- regions of Mozambique were affected by dry megaproject4 economy largely due to a pullback conditions. The impact of the drought was on investment in real estate, construction and mitigated by the low share of these regions in financial services. Lower exports, public sector the total agricultural production. consolidation and monetary tightening are also contributing to the slowdown in growth. 2 Growth in 2016 was forecast at 5.8 percent in the previous Mozambique economic update, prior to the debt revelations. 3 Mozambique’s rating has downgraded several times by Fitch, Moody’s and S&P to CC, Caa3 and CC respectively, during the course of the year. Outlook on ratings by Moody’s and S&P remain negative. 4 Mozambique’s megaproject economy includes extractive industry such as coal, heavy sands and gas. It also includes activities from a large aluminum smelter as well as electric energy from the Cahora Bassa Hydroelectric Dam. 6 part one: recent economic developments Figure 5: Manufacturing and services contributions to growth have fallen … Quarterly contribution to growth by sector, 2015–16 Source: INE Figure 6: … whilst confidence indicators suggest a sharp decline in perspectives since debt revealed Trend in economic confidence indicators, 2015–16 (2004 = 100) Source: INE Fiscal Policy GDP). The additional debt and ensuing currency depreciation also implied a sharp increase in debt The revelations of USD 1.4 billion in previously service obligations, potentially adding a further 2 undisclosed debt have changed Mozambique’s percent of GDP in debt service per year. Further fiscal landscape as higher debt service, a pressures were felt in revenue collection as the plunge in donor support and a lack of room slowing economy yielded a 7 percent shortfall in for borrowing shrink fiscal space. revenues in the first half of 2016. Taken together, budget support cuts, higher debt service and The debt revelations have placed the fiscal lower revenues are estimated to have reduced outlook under immense pressure. The revelations fiscal space by at least 5 percent of GDP in 2016. triggered an immediate suspension of the IMF Although the authorities had embarked on a program5 and donor support to the budget. fiscal consolidation program, and even though These sources financed 6 percent of the budget the restructuring of the EMATUM bond in March on average over the last three years (2 percent of 2016 brought some relief, a sharp adjustment to 5 The IMF’s program with Mozambique, which is currently suspended, consists of a Policy Support Instrument (PSI) and Standby Credit Facility (SCF) of about USD 283 million. 7 mozambique economic update december 2016 the 2016 budget plans became necessary. The total budget cut was modest and will be confronted by spending pressures. The revised The plans for fiscal adjustment so far budget presents a 0.3 percent nominal reduction are a step in the right direction, but the in total spending against the original budget for 2016 budget is subject to significant 2016. Sharp cuts in the domestic investment and downward risk. goods and services budgets (which fell by 30 and 14 percent, respectively) were offset by higher debt The macroeconomic assumptions underlying service and contingency allocations, along with the budget are optimistic. The budget estimates a rise in the metical value of external funding due GDP growth at 4.5 percent in 2016, which is an to currency depreciation. When externally funded ambitious target, given economic performance spending is excluded, the total spending cut amounts in the first three quarters of the year. A further risk to 3 percent. The budget also faces pressures in key stems from the assumed exchange rate, which spending areas, including the wage bill, pensions at an annual average of 52 meticals to the dollar, and transfers. For instance, civil servants’ salaries has already been exceeded by the evolution of the and pensions registered 91 percent and 100 percent currency since the adoption of the budget. execution rates respectively by end-September, which is a cause for concern (Figure 7). Shortcomings in revenue collection will continue to pose a risk to the revised projections. Spending on the social and economic sectors,6 Revenues and grants are now projected to be 9 which account for almost two thirds of total percent lower than in the initial budget. Although expenditure (excluding interest), was also the downward revision is appropriate, the extent affected with an overall cut of 4.7 percent. All of the economic contraction so far and continued sectors have been subjected to budget cuts, currency depreciation suggest that the revised with the exception of the health sector, which 2016 budget might still overestimate revenues. experienced a 10 percent increase driven by Tax collection has been subpar in the first three external financing (Figure 8). Education spending, quarters due to lower import levels resulting which accounts for 20 percent of the budget, from the currency depreciation. Megaproject had the smallest nominal reduction followed contributions to revenue have also fallen as a result by agriculture and rural development (3 and 4 of low commodity prices and a fall in aluminum percent, respectively). The largest contraction production. Similarly, income tax receipts may was felt in the infrastructure sectors: roads (16.5 be lower than the revised estimates due to the percent), water and public works (9.1 percent) difficult environment for local businesses. and mineral resources (12.2 percent). Figure 7: Over execution of recurrent Figure 8: Cuts across all sectors with the expenditures at September-end is of concern exception of health Budget execution for selected items as at Sep 2016 Changes to sectoral expenditure in revised 2016 budget Source: MEF Source: MEF 6 This includes education, health, infrastructure, agriculture and rural development, the judicial system and social welfare and work. 8 part one: recent economic developments The route back to debt sustainability rates on government treasury bills more than is complex, requiring a sharp fiscal doubled since January 2016 and bond yields adjustment to achieve macroeconomic have followed suit (Figure 9 and Figure 10). stability. Controlling wage bill growth, which had Much depends on the outlook for debt gathered pace in recent years, will be important restructuring already initiated by the for fiscal adjustment. The government wage government.7 The Proindicus and MAM debt bill increased by 140 percent since 2010. On raised the government’s stock of debt to 86 average, between the period 2010 to 2014, percent of GDP at end 2015. The debt service annual compensation adjustments accounted obligations of these loans impose a heavy for 73 percent of the increase in the wage bill burden that pushes the cost of debt service (a rate much higher than inflation over this well above 40 percent of revenue and grants period), followed by new recruitments at 21 until 2020. The Government of Mozambique percent, and promotion and progression of is pursuing a restructuring of these loans, and public servants at 6 percent. A large part of the estimates debt stock to reach 130 percent of wage bill is comprised of non-wage benefits, GDP in 2016. Hence, the fiscal outlook would which accounted for an average of 60 percent be influenced by the outcome of any deal. In its of all spending on compensation of employees absence, the debt service looms as a substantial from 2008 to 2012. Moreover, compared with fiscal risk. peer countries, Mozambique’s wage bill is large, as a share of both GDP and domestic revenue.8 Even after debt restructuring, the pressure to These trends, if carried forward would pose a realize a sharp fiscal adjustment will continue. challenge to fiscal adjustment. Looking ahead, Mozambique has retained steadily growing it will be important for the government to check primary and overall fiscal deficits since 2005 as the momentum that has been building in wage fiscal expansion built momentum in the boom bill growth by setting limits to manage demands years. Restoring fiscal stability will require a for salary increases and control growth in the deviation from this trend. Rather than being wage bill in non-priority sectors. a short term exercise, fiscal consolidation is a prolonged endeavor that requires a strong Improving the management of the public medium term fiscal framework. And in high sector pension scheme is equally as important debt situations, achieving a primary surplus is, to ensure the sustainability of the system. The in most instances, a vital part of the effort to civil service pension scheme, operated by the consolidate the budget and reduce the debt Instituto Nacional de Previdência Social, is a burden. This is a high bar in Mozambique’s pay-as-you-go scheme in which payments case, given the high levels of inflation, in that it paid to current pensioners are financed from implies nominal reductions in spending when contributions paid by current workers, with expenditures are all already falling in real terms. any emerging deficit being a liability of the But it may be necessary given the diminished state. An analysis of the sustainability of the capacity to finance the budget and the sharp system, including the long term potential for a increase in governments cost of borrowing. At mismatch, is important in the context of a fiscal almost 20 percent in October 2016, interest consolidation program. 7 http://www.mpd.gov.mz/images/Presentation_to_Creditors_by_the_Ministry_of_Economy_and_Finance_-_25_October_2016.pdf 8 World Bank. Mozambique Public Expenditure Review. 2014. 9 mozambique economic update december 2016 Figure 9: The cost of borrowing for government Figure 10: …and average yields on Eurobonds has increased significantly... have far exceeded peer countries T-bills auction (average interest on term > 63 days), 2013-16 Average yield (tenor 2023 +- 1 year), May – October 2016 Source: MEF Source: Bloomberg Table 1: Government Finances 2016 (percent of GDP) Initial Budget Revised Budget Total Revenue 25.9 24.1 Tax Revenues 22.3 21.0 Non Tax Revenue 3.7 3.1 Grants 3.6 2.6 Total Expenditure 32.3 32.0 Current Expenditure 20.0 20.9 Of which: Compensation to employees 10.5 10.2 Interest on public debt 1.8 2.2 Capital Expenditure 12.3 11.1 Domestically financed 6.1 4.2 Externally financed 6.2 6.9 Net Lending 1.2 1.1 Overall Balance -4.0 -6.3 Primary Balance -0.9 -3.1 GDP (nominal, MZN billions) 680 687 Source: MEF Table 2: Spending on Social and Economic Sectors 2016 (MZN billions) Initial Budget Revised Budget %O Education 45,801 44,400 -3.1 Health 21,608 23,896 10.6 Infrastructure 40,895 34,951 -14.5 Roads 28,725 23,986 -16.5 Water and Public works 9,138 8,303 -9.1 Mineral Resources 3,033 2,661 -12.2 Agriculture and Rural Development 15,340 14,726 -4.0 Judicial system 4,272 3,943 -7.7 Social action and Labor 5,648 5,337 -5.5 Source: MEF 10 part one: recent economic developments The External Sector imports, were an additional source of pressure on the current account. However, the large With imports falling faster than exports, drop in consumer imports will be sufficient the current account deficit for the 2016 is to lower the current account deficit from 41.6 expected to narrow to 39 percent of GDP. percent of GDP in 2015 to 38.9 percent in 2016. Although this trend eases pressures on the A sharp decline in imports signals an external position, it is an adjustment caused by adjustment driven by a weaker metical and a reduction in purchasing power and reduced reduced foreign currency liquidity. Goods consumption of essential goods, and is telling of imports are contracting and are expected to be the extent of the economic downturn. 33 percent lower in 2016 than in the previous year. The fall in imports is largely driven by Central bank reserves remain under pressure. declining non-megaproject imports. Consumer goods have been widely affected, including Low investor confidence has had a significant basic imports such as cereals, sugar and impact on investment in the non-megaproject cooking oil, along with items such as imported economy. FDI is expected to contract by 17 vehicles which are set to experience an over percent by the end of 2016 (Figure 14) as non- 50 percent decline by year end. This indicates megaproject investment declines, with the brunt an adjustment in the import bill as currency being felt by the construction, real estate and depreciation and foreign exchange scarcity financial sectors.9 Final investment decisions make imports increasingly unaffordable. for the Rovuma basin gas projects are yet to be reached, although hopes remain that one Total exports are set to contract by 8 percent of the Rovuma basin gas projects10 will reach in 2016. The overall drop in exports is heavily this milestone by the end of 2016. Despite this, driven by a contraction in agricultural exports other megaprojects continue to advance with during the first half of 2016. With the exception activities such as the launch of Sasol’s new of cashew nuts, exports decreased for all drilling campaign in Inhambane, bolstering agricultural products as the sector suffered the investment in the second quarter of 2016, and effects of the regional El-Niño drought. Ongoing continued investments in coal production. As a military tension may have also contributed to result, megaproject FDI is anticipated to register the decline by limiting circulation on main a 25 percent increase in 2016. highways linking production hubs to domestic and international markets. Megaproject exports, Central bank reserves continued to fall which accounted for 60 percent of total during the first nine months of the year. Net exports in the last five years, have shown some international reserves fell from USD 1.99 billion, resilience and are projected to increase by 9 or 3.2 months of non-megaproject imports, at percent by end 2016. Earnings from coal exports the end of 2015 to USD 1.72 billion, or about have risen due to a significant boost from the 2.9 months of imports, by September 2016. The completion of the Moatize - Nacala-a-Velha central bank increased foreign currency reserve railway. Electricity, heavy sands and gas exports requirement to 15 percent in June, which shored are also on the increase. Together, increased up the central bank’s international reserves by earnings from these exports are projected to USD 207 million, and a subsequent increase offset the anticipated 14 percent decline in in November 2016 may contribute further. aluminum exports (almost 40 percent of total However, downside risks are looming given megaproject exports) reflecting the sluggish shortfalls in balance of payments financing, recovery in prices. and the continued call on reserves as a source of foreign currency for some basic food and A drop in donor assistance, increased debt fuel imports as well as the government’s debt service, along with persistently high service service obligations. 9 In the 12 months to the end of September 2016, real estate, financial services and construction FDI fell by 82, 62 and 60 percent respectively. 10 The ENI led consortium’s investment in the Coral south gas field. 11 mozambique economic update december 2016 Figure 11: Reserve levels have fallen as the non- Figure 12: The trade deficit has decreased megaproject current account widens … following a contraction in imports… Mega and non-megaproject current account balance and Imports and trade balance, quarterly 2015-16 change in reserves; year-on-year 2009-16 (USD millions) (USD millions) Source: BdM Source: BdM Figure 13: …and an increase in megaproject exports Figure 14: FDI inflows have been falling despite Exports, quarterly 2015-16 (USD millions) a pick-up in megaproject FDI Net FDI, semesterly 2013-16 (USD millions) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Source: BdM Source: BdM 12 part one: recent economic developments Table 3: The Balance of Payments (USD millions, unless 2015 2016 otherwise stated) Actual Projection 15/16 Current Account (% of GDP) 41.6 38.9 … Current Account -6155 -4076 -34% Trade Balance -6785 -4285 -37% Goods, net -4164 -1925 -54% Exports 3413 3132 -8% Megaproject 2057 2244 9% Non-megaproject 1356 888 -35% Imports 7577 5057 -33% Megaproject 917 841 -8% Non-megaproject 6660 4216 -37% Services, net -2622 -2360 -10% Income and transfers, net 630 209 -67% Capital & Financial Account -5566 -3653 -34% FDI, net -3711 -3098 -17% Megaproject -1117 -1400 25% Non-megaproject -2594 -1698 -35% Other, net -1567 -399 -75% Overall Balance -589 -423 -28% Source: BdM and World Bank staff estimates Monetary Policy show signs of adjustment (Figure 15). Deposit rates have followed suit, but with what seems The central bank continued tightening its to be a diverging trend between domestic monetary stance since the last quarter of and foreign currency and deposits. A decline 2015, as foreign-exchange and inflationary in metical deposits starting at the end of 2015 pressures accelerated. was accompanied by an increase in foreign currency deposits, suggesting a preference The Banco de Moçambique stepped-up for hard currency amongst depositors as its monetary tightening regime with eight confidence in the domestic currency decreased consecutive rate increases since October (Figure 16). Financial system credit grew at a 2015.11 The monetary policy stance sought to 12-month average of 38 percent in nominal slow the metical’s depreciation and attenuate terms. Inflation and loose government credit the pass-through effect on inflation, whilst policy through to April 2016 (when debt levels limiting the draw on central bank reserves. It led spiked) contributed to this growth (Figure 17). to a shift away from the interventions in foreign It is important to note, however, that given the exchange markets seen in late 2015 to a focus high levels of inflation, credit levels have been on maintaining positive real interest rates and falling in real terms. Credit to the economy, reducing excess liquidity. This has required regular an indicator of demand, began contracting in and steep increases in policy rates to keep up real terms from April 2016 onwards, signaling with inflation and deteriorating confidence in the a shift in the capacity of the economy (Figure metical. Policy rate hikes have been accompanied 18). Monetary tightening, together with lower by series of other measures, including higher demand and liquidity constraints, may have also bank reserve requirements (Box 1). contributed to a currency depreciation as the metical remained relatively stable in October Policy rate increases have kept commercial and November 2016. bank rates above inflation and credit levels 11 The standing lending facility rate (facilidade permanente de cedência, FPC) has been raised from 7.5 percent to 23.25 percent. Similarly, the standing deposit facility rate (facilidade permanente de depósito, FPD) has followed suit, increasing from 1.5 percent to 16.25 percent. 13 mozambique economic update december 2016 Box 1: Main Monetary Policy Committee measures taken since July 2015 Increase in key Central Bank reference rates Other • Standing Lending Facility increased • MZN 700 thousand limit on spending abroad 1575 basis points to 23.25 percent • Intervention in the interbank markets to • Standing Deposit Facility increased 1475 ensure compliance with the monetary basis points to 16.25 percent base target • Limit Commercial Bank usage of Adjustments to Commercial Bank reserve standing lending facility window for requirements financing to twice a week • Reserve requirement on domestic and foreign • Compulsory daily exchange rate currency increased from 8 to 15.5 percent reporting from Commercial Banks increased to 3 times a day Figure 15: Monetary tightening kept commercial Figure 16: Metical deposits have been falling rates positive in real terms whilst foreign currency deposits increased Central Bank and Commercial Bank interest rates and CPI, Commercial Bank deposits, 2014-16 (millions) 2010-16 (12 month % change) 30% 25% 20% 15% 10% 5% 0% Source: BdM and INE Source: BdM Figure 17: Government borrowing was driving Figure 18: Nominal credit to the economy credit growth but began slowing after debt continued to increase in early 2016 but revelations declined sharply in real terms Decomposition of nominal credit growth, 2015-16 Credit to the Economy, 2012-16 (12-month % change) (MZN millions) Source: BdM Source: BdM 14 part one: recent economic developments Box 2: Financial vulnerabilities in Mozambique’s banking sector The Central Bank’s intervention in Moza financial institutions. As a result, some Banco, Mozambique’s fourth largest bank, banks may limit their government exposure, and the revocation of license of the smaller and provision against default. This could Nosso Banco, underscores how quickly exacerbate credit concentration risk in vulnerabilities in the financial sector can banks willing to accept guarantees. Limited emerge. A combination of slower growth, understanding of counterparty exposure currency depreciation, and tighter monetary could also lead to higher interbank lending policy have heightened the exposure of rates, which may accentuate liquidity risks, Mozambique’s banks to risks. Increased particularly for weaker banks. The central lending rates are raising the cost of financing, bank’s decision to limit access to its overnight leaving borrowers and adjustable rate loan window to two days a week will entice banks holders more exposed. This occurs as the to improve liquidity management. economic downturn and falling demand take their toll on Mozambican businesses. Heightened surveillance and effective Moreover, currency depreciation has crisis management tools are needed. In increased debt-servicing costs for foreign the short term, focus on diagnosis including loans. As a result, non-performing loans strengthening surveillance of banking in the banking sector (which averaged 4.3 sector, stress-testing, asset quality review, percent on aggregate and 7 percent for bank resolution and crisis management smaller banks as of September 2015) may arrangements will be crucial to managing be on the rise. Updated figures will likely vulnerabilities. More medium term measures reveal a higher degree of asset impairment such as bank supervision enhancements requiring additional provisioning, which and development of an emergency liquidity reduces bank profitability and could assistance framework could be instilled undermine capital adequacy. Balance sheet once the economic downturn subsides. mismatches are also on the rise as foreign The intervention in Nosso Banco has also currency denominated deposits have grown elevated the role of the deposit guarantee while lending has remained limited due to fund (FGD). Reimbursements to individual regulatory restrictions. depositors resident in Mozambique have begun, with an insured coverage level of Uncertainty surrounding the restructuring MZN 20 thousand. Corporate, foreign of external commercial debt poses currency, and non-resident accounts are significant risk to the investors holding excluded from deposit insurance. these loans, which could include domestic Outlook expected to begin recovering in 2017, South Africa’s prospects diverge from the regional Growth prospects amongst Mozambique’s trends. Political and economic woes in this main trading partners are weak, but slowly important trading partner for Mozambique are recovering commodity prices may bring having significant implications for its growth, some relief in the near term. expected at just 1.1 in 2017. Growth prospects for Mozambique’s main Commodity prices are expected to mount trading partners are sluggish. Growth rates for a gradual recovery by mid-2017. Prices for the European Union, South Africa and China, some of Mozambique’s main exports are which are three of Mozambique’s main trading expected to increase, with aluminum and gas partners, is projected to decline in 2016 and prices projected to rise by 3.2 percent and 6.8 2017. Although Sub-Saharan Africa’s growth is percent respectively. Meanwhile, prices for coal 15 mozambique economic update december 2016 are experiencing a sharp, recent surge12 that, if gas, two of Mozambique’s largest exports, are persisting, could yield a significant increase in expected to begin recovering in 2017. Similarly, the value of this export. In contrast, tobacco a rally in coal prices and a new railway improve prices are expected to contract slightly in 2017. the prospects for coal. Spillover effects of the A stronger US dollar and tighter US monetary megaproject economy are also anticipated with policies will maintain downward pressure on services’ contribution to growth gaining further commodity prices. prominence. Despite accounting for roughly 20 percent of output, contribution to growth from Mozambique’s growth for 2016 is the agricultural sector is expected to remain large projected at 3.6 percent and is subject to and supply side policies to boost production downward risk, but LNG prospects shape and climate resilience, such as investment in expectations for a recovery in growth to technological inputs and infrastructure can help 6.6 percent by 2018. propel the sector. Growth in 2016 is projected to decelerate to The fiscal outlook will be shaped by 3.6 percent. The slowdown in 2016 reflects the outcome of debt restructuring the extent of the debt driven downturn, along negotiations, with a sharp adjustment with the effects of the recent regional drought. needed under any scenario. This outlook is subject to significant downward risk as monetary and fiscal tightening pick Budgetary pressures will be acute in the medium up pace and as the business environment even if debt is restructured. Mozambique’s becomes increasingly restrictive, while private Ministry of Economy and Finance estimates sector expectations weaken. Adverse climatic a revenue impact from the Rovuma basin gas conditions, brought on by La Niña, may also pose production starting in 2021. In the meantime, a risk. Should this materialize, the costs of flood the country’s fiscal position is likely to remain damage and impact on food production would under stress and deep consolidation reforms pose a significant challenge for the agricultural will be required. A thorough reassessment of sector. Short term inflationary pressures are also investment spending and inefficient recurrent likely to persist, given the country’s dependence expenditures will be necessary. Measures to on food imports from South Africa, where contain spending pressures from the public inflation is on the rise. Continued political sector wage bill and the subsidy programs will tensions in central and northern regions may be needed. In addition, a thorough review of the further hamper growth. state enterprise sector, including liquidation and sale of un-strategic assets, should be considered Mozambique’s LNG prospects shape as an option to reduce fiscal risk and increase expectations for a recovery in growth to 6.6 government resources. percent by 2018. Recent developments indicate progress with the Rovuma basin gas projects, Short term pressures on the external such as the forward purchase agreement for position are likely to spill into 2017. gas from the Coral South Floating facility,13 which brings the final investment decision for The current account deficit may expand this multi-billion project closer in sight. In the to over 55 percent of GDP by 2018 as LNG meantime, existing megaprojects are showing megaprojects are expected to kick-off and some resilience and may benefit from a boost triple both FDI and import levels. Flows to in the near term from an improving outlook other megaprojects are anticipated to follow for key commodity prices. Both megaproject suit as coal production ramps up in Moatize exports and FDI increased in mid-2016. In and Sasol’s investment in Inhambane province terms of the outlook, prices for aluminum and continues to expand. However, megaprojects 12 Prices of coking coal have rallied more than twofold this year amid China's push to curb overcapacity and pollution. Premium hard coking coal prices in Australia, which dominates global exports, rose to USD 289.30 a ton at the start of November, up from about USD 85 at the beginning of June. 13 BP signed a deal with ENI, Italian multinational oil and gas company, agreeing to buy all output from the consortium’s Coral South Floating facility in Mozambique. Annual production is expected to reach 3.3 million tons. 16 part one: recent economic developments alone are unlikely to ease external pressures in posing a significant risk. Moreover, non- the short term given the outflow of their FDI to megaproject investment may remain subdued capital imports. As such, the non-megaproject in 2017 as uncertainty and macroeconomic balance will continue to face pressures from instability persists. the import bill, with rising petroleum prices Table 4: Outlook 2015 2016p 2017p 2018p External Scenario Real GDP (% ∆) European Union 1.6 1.6 1.6 1.5 China 6.9 6.7 6.5 6.3 Sub-Saharan Africa 3.0 2.5 3.9 4.4 South Africa 1.3 0.6 1.1 2.0 Nominal Commodity Price (% ∆) Aluminum $/mt -10.8 -5.4 3.2 3.3 Coal, Australia $/mt -18.0 0.9 -5.2 1.1 Natural gas, Europe $/mmbtu -27.7 -39.7 6.8 7.0 Tobacco $/mt -1.7 -2.2 -0.7 -0.7 Domestic Scenario Real GDP & Current Account Balance Real GDP (% ∆) 6.6 3.6 5.2 6.6 Current Account Balance (% of GDP) -41.6 -38.9 -37.4 -56.1 p = Projection Source: World Bank 17 mozambique economic update december 2016 Focus One: In the shadow of debt Almost two decades ago, Mozambique was percent ten years later. Soon after HIPC, the amongst the first round of countries which stock of debt began rising again, coinciding with proved itself as an economic reformer in return the government’s plans to pursue an ambitions for debt relief. Under the Heavily Indebted Poor public investment program. And, by 2016, Countries (HIPC) initiative, the external debt stock revelation of hidden debt definitively reversed reduced from 160 percent of Gross National Mozambique’s post-HIPC gains. Income in 1998 to a far more manageable 33 Box 3: Mozambique’s hidden debt The hidden loans saga surged on the heels The borrowing was intended to tap into of a restructuring deal for the already the gas industry through two large projects. highly controversial EMATUM loan, in April The first, Proindicus, intended to use a USD 2016. Mozambique contracted a previously 622 million loan from Credit Suisse to undisclosed sum of USD 1.4 billion in provide integrated security services (aerial, non-concessional debt between 2009 maritime and terrestrial) to gas companies, and 2014 by issuing guarantees to state marine vessels and other sea traffic as well controlled companies and through direct as providing search and rescue services. borrowing from bilateral lenders. This The second company, Mozambique Asset debt includes two guarantees for loans Management (MAM), was created to build contracted by commercial companies / install shipyards in the ports of Pemba formed with state equity participation, and Maputo with finance from a USD 535 amounting to USD 1.16 billion. In addition million loan facilitated by VTB. Maintenance to these guarantees, the recently disclosed and logistical services would be provided to debt includes four direct loans from Proindicus and other large LNG operators. bilateral lenders contracted between The final maturity dates on each loan are 2009 and 2014. This debt, equivalent to March 2021 and May 2019, respectively. approximately 10 percent of GDP, had not been previously disclosed to the World A final set of loans, tallying up to about Bank and IMF. The debt is additional to USD 220 million were contracted during the EMATUM company bond, which was the period 2011 to 2014. Funds were made originally issued in September 2013 backed available by bilateral lenders, however, the by a state guarantee, then restructured as originating country and terms of the loans a sovereign bond in April 2016. remain undisclosed. 18 focus one: in the shadow of debt The debt position: then and now. a liquidity crisis: the capacity to service debt. The sheer size of the loans, their commercial Mozambique set-off on a path of accelerated interest rates, and the fact that both loans are borrowing after receiving HIPC debt relief. on amortizing schedules starting in 2015 and Scaled-up borrowing to finance ambitious 2016 mean an additional USD 233 million in debt public investment plans from 2012 onwards service annually over the next five years.18 The launched Mozambique’s debt profile on an depreciation of the metical further compounds upward trajectory (Figure 19). The debt to GDP this burden, inflating the debt service obligations ratio quickly increased from 40 percent of GDP of these loans in metical terms. The outcome in 2012 to 73 percent of GDP by end 2015 before of this is overwhelming: if Proindicus and MAM’s the hidden debts were taken into account. The debt service fall due as state obligations, the increase in debt ratios are at odds with the plans overall debt service would jump from 7.3 percent since the authorities had embarked on a program of revenue in 2012 to over 40 percent in the of fiscal consolidation with support from the medium term. IMF program. Debt service obligations were also easing as the restructuring of the EMATUM bond Mozambique is now one of the most indebted to a bullet payment in 2023 lowered annual debt countries in Africa. At the start of the decade, the service by approximately USD 110 million. ratio of public sector debt to GDP in Mozambique was similar to other countries experiencing The ratio of public sector debt to GDP took increasing growth, including Angola, Ethiopia, an explosive path with the addition of large Ghana and Kenya. Mozambique’s debt to GDP previously undisclosed external loans. The debt ratio quickly surpassed many African countries revelations pushed public debt to 86 percent and has now exceeded that of Ghana,19 of GDP in 2015 and shifted the country to an Angola and other African peers who have also unsustainable position. With 90 percent of the experienced both credit growth and declining country’s debt being denominated in foreign commodity prices in recent years (Figure 21). currency, the steep depreciation of the metical in 201614 has compounded the debt burden. Although commercial loans account for 18 Public debt levels are now expected to exceed percent of external debt, they represent 40 100 percent of GDP until 2020. percent of external debt service between 2016 and 2021. Commercial external debt is With solvency indicators already under strain, dominated by the Mozambique bond, and the the additional debt, and continued depreciation MAM and Proindicus loans. Multilateral debt created severe liquidity constraints, placing represents just over 40 percent of the debt stock, Mozambique’s capacity to meet debt service but concessional terms lower its load in terms obligations in question. Soaring debt levels have of debt service. The third category, bilateral worsened the country’s liquidity and solvency debt, is more heterogeneous. It is composed ratios.15 Solvency indicators, which include of a combination of concessional and non- the debt-to-GDP ratio, were already under concessional loans, with a handful of large loans significant stress at end-201516 and bordering for infrastructure projects raising total bilateral the debt sustainability thresholds of economies debt service to 42 percent of the total20 (Figure at high risk of debt distress.17 The Proindicus 24 and Figure 25). and MAM loans transformed the situation into 14 The metical depreciated from an average 48.5 in December 2015 to an average 76.6 in September 2016. 15 Liquidity ratios measure the country’s ability to meet (short term) maturing obligations with available financing, whilst solvency ratios indicate ability to meet long term financial commitments. A government is solvent if the present value of future primary balances is greater than or equal to the public debt stock. 16 Based on the Debt Sustainability Analysis (DSA) carried out at the end of 2015. 17 For Mozambique, the threshold for present value of public and publicly guaranteed external debt as percent of GDP is 40 percent and 150 percent as a percentage of exports. In the 2015 DSA, the ratio of present value external debt-to-GDP in 2015 stood at 39.9 percent and external debt to exports at 143.4 percent. 18 Average for 2016-2021. 19 Ghana’s DSA classification changed to high risk in March 2015 due to a rapid increase in domestic debt levels and a series of Eurobond issuances, as well as a large depreciation in the local currency. 20 These include loans to finance investments in Maputo and Nacala airports, and the Katembe bridge in Maputo. 19 mozambique economic update december 2016 The outlook is fragile. metical. Figure 23 presents the debt to GDP ratio at different exchange rate scenarios. An end of Mozambique faces a medium term fiscal 2016 exchange rate of MZN/USD 75 would see predicament given the large volume of debt debt levels spike to almost 116 percent of GDP obligations due before gas production begins and a rate of GDP MZN/USD 80 would see debt to have a significant impact on state revenue. levels reach 123 percent of GDP by end 2016. The anticipation of a booming gas industry and The sources of pressure to the metical are not massive revenue from gas sales underpinned the exclusively domestic. With a much anticipated government’s plans to expand public investment, Federal Reserve meeting scheduled before the financed in part through commercial borrowing. end of 2016, the possibility of an increase in US Reality has been far from this: the commodity interest rates is distinct and continuing through price crunch and persistent delays in making 2017. It represents an exogenous pressure final investment decisions for the large gas on the metical that adds to the significant projects have pushed back production dates. domestic short term and structural pressures Whilst recent developments indicate progress, on the currency. Contingent liabilities from state- production before 2021 seems unlikely and owned enterprises and the domestic banking maybe subject to further delay. Hence, given sector are also sources of instability for the debt the aggressive repayment profile for both the outlook. Most of Mozambique’s state-owned Proindicus and MAM loans21 (Figure 22), the enterprises have a weak financial position and authorities are under significant pressure in the many have over borrowed in foreign currency medium term. (focus section three). Coupled with the banking sector’s exposure to the economic downturn Continued currency depreciation, fiscal risk (Box 2), Mozambique may be under pressure from state-owned enterprises and an exposed to shoulder significant contingent liabilities in banking sector are major risk factors. The debt the near term. outlook is highly sensitive to the trajectory of the Figure 19: Debt profile is dominated by foreign Figure 20: …which has increased with the addition currency denominated debt… of Proindicus/ MAM and currency depreciation Composition of public debt, 2016 External and domestic debt, after debt disclosure, 2008-16 (% of GDP) Source: MEF Source: MEF 21 MAM annual repayments are USD 134 million plus interest (7.8 percent) and Proindicus are USD 119 million plus interest (3.75 percent). 20 focus one: in the shadow of debt Figure 21: Mozambique’s debt position has deteriorated when compared to other African countries Public sector debt to GDP ratio, 2010–16 Source: World Bank and IMF Figure 22: Higher debt service is placing the Figure 23: …and the outlook may deteriorate economy under severe strain… depending on the trajectory of the metical External debt service to revenue ratio, 2012-20 External debt to GDP ratio with varying exchange rate scenarios, end of period rate, 2016 Source: MEF Source: MEF and World Bank staff estimates Figure 24: Commercial loans accounted for Figure 25: … but will represent 40 percent of debt less than a fifth of debt stock at end 2015… service in the medium term on current terms Composition of external debt stock, 2015 Composition of external debt service, average 2016-21 Source: MEF Source: MEF 21 mozambique economic update december 2016 Where to next. that are a source of contingent liabilities to the state. The existing oversight arrangements are Alleviating liquidity pressures. The Mozambican fragmented and patchy. For instance, there is government has commenced restructuring talks currently no entity responsible for overseeing with its creditors to help restore liquidity, and the fiscal risks in companies where the government outcome of this process will shape the fiscal is a shareholder.22 This applies to a list of over outlook. Realism and prudence in estimating the 100 companies, in which the state has direct and state’s capacity to repay its debt will be critical. indirect shareholding, including Proindicus, MAM This implies full awareness of the potholes and EMATUM. Establishing a single oversight unit, ahead when estimating the capacity to service which would assess and advise on fiscal risks debt, including the considerable level of fiscal from the entire public corporation sector, would risk from state-owned enterprises, the banking help to address this shortcoming. Similarly, fiscal sector, fuel subsidies, and pressures from civil risks from the banking sector are increasingly service remuneration (and pensions) in an significant as the effects of the economic inflationary context. It also implies a conservative downturn become more visible, as well as in the approach to estimating when gas revenues will absence of financial system safety nets such as a flow in. Successfully restructuring may bring fully capitalized deposit insurance scheme. much needed relief now, but could produce an accumulation of deferred payments in the early Overhaul the framework for managing 2020s amidst uncertainty around production guarantees. The current legal framework for timelines and the outlook for gas prices. awarding guarantees is highly discretionary, with little in terms of a guiding framework for Restoring fiscal sustainability. Setting a path risk based evaluation. Budget laws set a nominal back to debt sustainability will require further annual guarantee limit that is not backed by firm fiscal adjustment. Restoring fiscal sustainability criteria for the acceptable risk profile, the terms rests on firm targets for reducing debt and a of the guaranteed loan, the strategic relevance of falling primary deficit, backed by a program of the project, or clear links to a medium term debt fiscal adjustment. Public debt consolidations strategy. To improve this, the legal framework tend to be more successful when based on should be revised to include criteria for assessing recurrent budget cuts and when accompanied the feasibility of a guarantee and the conditions by accommodating monetary policy to stimulate of strategic relevance under which a guarantee growth. The composition of the adjustment also would be considered. Guidelines should be matters, with those concentrated in transfers and established for risk assessment based on the the government wage bill being more consistent feasibility of the proposed project, the financial with growth than ones driven by tax increases viability of a company, and compatibility with a and cuts in the investment budget. A sound sustainable debt strategy. Particular attention, in adjustment strategy will help restore credibility line with these principles, is merited if the kick-off and anchor market expectations about fiscal of Mozambique’s gas megaprojects generates sustainability. In Mozambique’s case, this means demand for sovereign guarantees. Furthermore, an overhaul of the country’s fiscal planning to provisions should be established for the potential a framework that bridges the period to when realization of these contingent liabilities through gas revenues can be prudently expected and mechanisms such as guarantee fees charged by establishing a credible Medium Term Fiscal to the borrowing entity and a Contingency Framework underpinned by a sustainable public Fund specifically for guarantees. The checks sector debt strategy. and balances must also be put in place. This includes collective responsibility in the authority Managing contingent liabilities. The current to approve guarantees and institutionalized circumstances have highlighted the importance disclosure of the terms, outstanding amounts, of developing effective oversight over state- as well as the underlying risk assessment. owned enterprises and other public entities 22 The oversight unit based in the National Treasury is responsible for only a small number of enterprises, and its operations are at a nascent stage. The remaining companies fall under IGEPE, an institution with a prime role to manage the state’s shares – i.e. IGEPE has an investor function rather than a supervisory role. 22 focus two: inflation at record highs Focus Two: Inflation at record highs Inflation has been the most acutely felt costlier, but at a more modest pace (14 percent). symptom of the ongoing economic downturn The price hikes are country- wide. Food inflation by Mozambicans. Inflation has accelerated in Beira has hovered near 40 percent over the considerably over the past year, after a three year last four months. More recently, a combination period of stable and low prices. Average year- of low production and costlier imports has on-year inflation reached 25 percent in October, aggravated price hikes in the south, with food with food price inflation reaching 40 percent inflation in October registering at a record high (Figure 26). Non-food inflation has also picked of 43 percent in Maputo (Figure 27). up as the weakening currency has made imports Box 4: Measuring inflation: the Consumer Price Index The Consumer Price Index (CPI) measures and northern Mozambique: Maputo, the evolution of prices for a basket of goods Beira, and Nampula, with Maputo prices and services deemed to be representative being weighted at 50 percent. Recently, of the average consumer. Goods and the CPI has also been calculated for Tete, services are divided into 12 main groups, Quelimane and Chimoio. Mozambique’s ranging from food and transport to health CPI largely tracks urban prices. Data and education. Foods and non-alcoholic collection is carried out at urban or semi- beverages account for over 45 percent urban markets every week, whilst shops of the basket. The national average rate and other service providers are visited on of inflation is calculated based on retail a monthly basis. prices in three cities in southern, central Whilst many neighboring and peer countries rich peers fared somewhat better: Nigeria has have experienced rising prices in 2016, the experienced a notable increase in food prices increase has been most accentuated in but these have remained below Mozambique’s Mozambique and Angola (Figure 28). Southern levels. Angola’s price levels, like Mozambique, African countries exposed to the El-Niño gained an alarming momentum in the third drought (such as South Africa, Zimbabwe and quarter of the year, with year-on-year food Botswana) registered milder price inflation. Food inflation registering above Mozambique’s level inflation in South Africa was 13 percent in August in September. 2016. Similarly, Mozambique’s African resource- 23 mozambique economic update december 2016 Figure 26: Rising food prices are driving inflation Figure 27: Inflation in the center of the country is after an extended period of stable prices high but has recently been overtaken by the south CPI inflation rate, 2012-16 CPI Food inflation rate by location; 2014-16 (12-month % change) (12-month % change) Source: INE Source: INE Figure 28: The hike in food inflation is accentuated when compared to most peer countries Regional CPI inflation rate; August 2016 (12-month % change) Source: Country Statstistics Agencies A perfect storm: depreciation, drought and tobacco, furniture and electronic items. Trends and conflict. show a clear divergence, with spiking prices for tradables juxtaposed against milder inflation for The heightened depreciation of the metical has non-tradable (Figure 30). played a major role in driving inflation. Imports account for a large share of Mozambique’s The regional drought has also contributed as consumption basket, and have become more the El-Niño phenomenon causes shortfalls in expensive as the metical weakens. This tendency food supply in Mozambique and neighboring is evident when the price trend for tradables countries. Mozambique sources the bulk of its is distinguished from non-tradable goods and food imports from South Africa, which has suffered services.23 Tradable items, which make up roughly from a drought and seen its own agricultural output 40 percent of the CPI basket, include imported contract by 6.5 percent in the first quarter of the food products and medication, alcoholic beverages year. South African food price inflation accelerated 23 Tradable refers to goods and services that are primarily sourced abroad. 24 focus two: inflation at record highs as a result, spilling over to Mozambican prices. Escalating military tensions in central regions are Zimbabwe and Mozambique’s southern producing placing further pressures on prices. Provinces regions also experienced low rainfall and lower north of Inhambane are suffering limited food production. The resulting price increases are circulation of goods along major trade routes and staggering: the average retail price for a kilogram have restricted access to goods imported from of maize grain increased 92 percent, in the twelve Malawi and South Africa. Convoys under armed months to September 2016, whilst rice increased escort have been reported on highways linking 85 percent. Cooking oil, one of the items included to neighboring countries.25 With this, frequency in the government’s list of basic goods, increased of travel has reduced giving rise to increased by over 76 percent during the same period and uncertainty in supply and further stoking inflation fresh cassava by 87 percent (Figure 31). Together, in central regions. the items represent over 25 percent of total food household expenditures.24 Figure 29: A myriad of factors have contributed to localized price increases Prices of select food products, 12 month % change, September 2016 NORTH 51.62 % MAI ZE G R AI N 13.04% F R ESH C ASSAVA 64.71% RICE 118.21% C OOK I NG OI L CENTRAL 102.61% M AIZ E GRAIN 119.19% FRE S H CAS S AVA 80.87% RICE 90.01% COOKIN G OIL SOUTH 111.76 % M AIZ E GRAIN 76.79% FRE S H CAS S AVA 77.55% RICE 69.08% COOKIN G OIL El Niño Drought El Niño Floods Conflict Zone 24 The proxy for national expenditure is based on an aggregated food bundle, weighted by maize flour, which accounts for 17.2 percent, whilst cassava flour represents 8.5 percent. 25 Following a series of attacks, Mozambican authorities introduced convoys under armed escort on a 200km section of the National Highway Seven (EN7) that carries traffic from neighboring countries such as Zambia and Malawi through Tete and Manica and onto the port of Beira (AIM). 25 mozambique economic update december 2016 Figure 30: Disparity between food and non- Figure 31: …with increases in prices for key food items is evidenced when accounting for food items rising rapidly tradable effects… Tradable and Non-tradable CPI inflation rate; 2016 Price variation for selected products; September 2016 (12-month % change) (12-month % change) Source: INE, World Bank staff estimates Source: SIMA, MASA The policy response has had a limited of a vector auto regression (VAR) model that impact so far. measures the extent to which monetary policy can influence the CPI in Mozambique. This VAR The authorities’ attempt to subsidize and model captures the linear interdependencies administer prices of certain food products among monetary policy and external drivers of has brought little respite. In April 2016, the inflation such as foreign exchange trends and Mozambican government introduced a list prices in trading partner countries to show the of reference prices for main imported food lagged impact of a given shock on inflation. products in order to mitigate the high prices.26 The list covers over 60 goods: roughly 20 fresh food products and over 40 grocery goods such Figure 32: Determinants of CPI variability as tooth paste and butter. It is an approach In percentage of total variance explained, months after a that has yielded partial results at best, and that shock is difficult to enforce in the face of market pressures. For instance, although the reference price for potatoes and onions was lowered by 42 and 24 percent respectively, retail prices have not followed suit. In the meantime, subsidies for wheat have been reinstated amid threats of bread price increases. However, with global wheat prices projected to increase slightly and a weakened currency, it is likely that pressures will remain into the near term. Monetary policy tightening has also had little impact on inflation so far. Weak monetary policy transmission channels and external drivers of inflation are potential explanations. Source: World Bank staff estimates based on BoM data To explore this, Figure 32 presents the results 26 The list was prepared by Customs and Ministry of Industry and Commerce, in collaboration with different trade associations including Associação Mukhero, AMIM and Frescata. Reference prices are given in South African Rand (ZAR) on a FOB basis. 26 focus two: inflation at record highs The estimation results show that the US dollar average inflation for the poor and actual inflation exchange rate explains the largest share of the levels in the last 6 months (Figure 33). variability of the consumer price level nominal exchange rate variations - affecting about 4 Mozambique’s inflation problem is complex and percent of price variability in the near term, and multi-faceted. The overwhelming influence of over 30 percent in the medium term. South both domestic and external factors means that African CPI also has a significant effect on price there is no quick fix. Still, two lessons can be variability due to the effect on food prices. drawn from the current circumstances. Firstly, Monetary policy instruments do have an impact policies to boost domestic food supply will on price level variations, but with a more muted reduce dependency on imports and exposure effect and with a lag of 2 to 6 months. The total to exchange rate fluctuations. Investment in share of the variance explained by commercial technological inputs and infrastructure can bank’s interest rate is small in the near term, but help propel Mozambique’s sluggish agricultural it becomes more substantial and increasingly sector. Similarly, investments in agricultural important after two months. Broad money research and extension, and irrigation gains further importance after four months infrastructure will continue to be an important whilst banks’ credit to the private sector gains source of crop yield improvements and climate importance after 7 months. resilience. In parallel, more should be done to protect Mozambicans from episodes of high A disproportionate impact on the poor. inflation through investment in social safety nets. Examples of safety nets include school feeding Inflation is taking a heavy toll on the poor. programs, support in-kind and cash transfers On average, food expenditure represents over through public works programs. 70 percent of the consumption basket for the bottom 40 percent27 making them extremely susceptible to food price shocks. In Nampula Figure 33: Food products consumed by poor and Zambezia, two of Mozambique’s poorest households experienced sharper price increases provinces, food represents 78 and 72 percent Poverty weighted CPI inflation rate; 2016 of the poor’s consumption - well above the 48 (12-month % change) percent share apportioned to food in the CPI. In effect, since the CPI represents the average consumer, it underreports the impact of higher prices on the poor when food inflation is the driving element. A simple restructuring of the index is indicative in this regard. Adjusting the weight of food products that have a significant share of expenditure for the bottom 40 percent provides a broad estimate of food inflation for the poor.28 Increasing the overall weight of food in the CPI to approximately 70 percent,29 the average for the bottom 40 percent, shows significant and sustained deviation between Source: INE, World Bank staff estimates 27 Based on the 2008/2009 poverty assessment. Data from the latest poverty assessment had not been published at the time the analysis was carried out. 28 Weights for select food items in the CPI’s food group (with an expenditure share above 5 percent) were adjusted using expenditure weights for a computed national food bundle, based on 13 poverty food bundles. 29 The increase in weight on the food poverty index mirrors the significance of food expenditure for the bottom 40 percent. Weights for remaining CPI categories have been adjusted but proportions to overall non-food weight are kept constant. 27 mozambique economic update december 2016 Focus Three: Risky business - fiscal risk from state-owned enterprises Mozambique’s public corporation sector has characterized by a weak financial position been underperforming and, given current (Figure 34). The portfolio consists of 13 public economic conditions, is posing an increasing enterprises and 109 companies in which the state level of fiscal risk to the economy. In scaling-up has shareholding. Available data indicates that the its investment program, Mozambique increasingly state holds a further stake in at least 112 private used public corporations to contract non- companies through indirect shareholding or concessional debt, state guarantees, and other subsidiary arrangements. The state’s investments finance through public-private partnerships (PPPs). are spread across numerous sectors without a These investments are largely being undertaken specific strategy guiding investment decisions. In by public corporations with a weak financial track some cases public enterprises are also exercising record, and in the absence of a unified framework a regulatory function, presenting a conflict of for monitoring performance and overseeing risk. interest. Lack of a clear dividend policy makes it These developments, and the fragile economic challenging for the state to plan for this revenue outlook, underscore the importance for stream. Often, dividends payments are waived Mozambique to prioritize efforts to strengthen to support internal investment activities. At fiscal risk management, with a particular focus on present, a large share of the sector suffers from the activities of the public corporation sector. a weak financial position and under-reporting. Moreover, the portfolio is dispersed and a clear Government’s involvement in the public mapping of the entities and their relationships corporations has heightened fiscal risks. is not available, making it difficult to assess the state’s exposure to fiscal risk. Mozambique’s public corporation sector has been growing in size and complexity, and is Figure 34: The majority of public enterprises are underperforming Company annual profit / loss, 2012-14 (MZN millions) Source: MEF 28 focus three: risky business - fiscal risk from state-owned enterprises Borrowing is the main source of financing for guarantee limit, published in the Budget Law. public corporations and a leading contributor Fiscal risks have been heightened further by the to fiscal risk. Subsidies are provided to some current sharp depreciation of the metical given enterprises but the volume has been relatively that a large share of the public corporations’ loan limited. Subsidies have represented 0.2 percent portfolio is denominated in foreign currency of GDP on average since 2012.30 On-lending (Figure 37). In this context, it is of concern that and guarantees are the largest source of state information on the stock of public enterprise debt financing and have been typically issued to is not systematically monitored, consolidated or entities that are poorly performing (Figure 35 made publically available. It is also a concern that and Figure 36), indicating a lack of assessment the controls applicable to public corporation and due diligence procedures. In recent years, borrowing are thin, and that the framework for guarantees have far surpassed the annual governing guarantees is lacking. Figure 35: Borrowing has been the main method Figure 36: Guarantees have been mostly awarded of government financing for public corporations to companies with weak financial performance Total flows, 2012-15 (MZN billions) Company net earnings, 2011-14 (MZN millions) Source: MEF Source: MEF and company financial statements Figure 37: Heavy borrowing in foreign currency exposes public corporations to currency depreciation Outstanding loan amounts for key public corporations based on latest financial statement, 2011-15 (USD millions) Source: Latest available company financial statement 30 A large share of total subsidies has gone to public enterprises in the communication and transport sectors. 29 mozambique economic update december 2016 In this context, fragmented oversight over comprehensive mapping exercise of the sector public corporations is of particular concern. has been undertaken. The exercise should Current oversight arrangements are fragmented include details of public enterprises and private and need to be strengthened in order to manage companies with shareholding companies, as the complexities of an under-performing public well as their subsidiary companies and any inter- corporation sector. A unit based in the National company shareholdings. Treasury Directorate in MEF is responsible for overseeing the 13 public enterprises, but only to The establishment of a single oversight a limited extent. What is more concerning is that unit, covering both public enterprises and currently no entity has oversight responsibilities shareholding companies, is a critical reform for managing fiscal risks in the 109 shareholding measure. Establishing the unit would bring companies or the 112 companies in which the Mozambique in line with good practices followed state holds indirect shareholding. The role of in the region. The degree of oversight and IGEPE (the agency for managing the state’s control exercised by the unit should be guided shareholdings) is focused on representing by the financial viability of an entity and potential the interests of the state in its capacity as exposure to fiscal risk. Enhanced oversight Shareholder, rather than holding the mandate arrangements would be applied to entities to manage fiscal risks. This fragmentation and that are experiencing financial vulnerabilities, the gaps in oversight disable the state’s capacity while greater autonomy could be awarded to to govern the sector. entities that are well-performing. Reporting and disclosure of public corporations’ financial Weak reporting practices from public information needs to be strengthened to provide corporations make oversight and decision- an informed basis for decision-making, fiscal risk making on fiscal risks challenging. Despite evaluation and accountability of government existing legal requirements explicitly stating that assets and liabilities. A key step in this regard is financial reports should be publicly disclosed, this the preparation of a memorandum statement practice is not adhered to by a large number of that presents consolidated information on the public enterprises and shareholding companies. government’s investment in public corporations When available, it is not common practice and their financial position, to be included in the amongst the corporations to include a financial annual state accounts. risk assessment in their reports. This, coupled with the fragmented oversight arrangements, The ongoing revision of the legal framework impedes the authorities’ capacity to prepare and governing public corporations presents an disclose the consolidated financial position of important opportunity to strengthen fiscal risk the sector, including the position in terms of management and to implement some of the public corporation debt. above mentioned reforms. It is recommended that the coverage of the public enterprise law Reforms to strengthen oversight and be clearly defined to encompass all entities that manage fiscal risks from public corporations are owned or controlled by the state, including are urgent. subsidiaries and indirect shareholdings. It would be important that mechanisms for fiscal risk A clearly defined strategy for government management are incorporated into the law, participation in the sector is of paramount specifically: (i) establishing the state’s role in importance. The strategy would set out the overseeing all public corporations through rationale for state ownership and define public a dedicated unit reporting to the Minister of policy objectives that companies are required Economy and Finance; (ii) setting adequate to achieve. The strategy would also provide controls to govern borrowing and guarantees; a basis for a revision of the government’s (iii) establishing provisions for improved current portfolio, with the aim of focusing on transparency and reporting; and (iv) requiring companies with clearly defined economic the development of financial and operational and social objectives. Rationalization of the performance targets. current portfolio can only be achieved once a 30 References Aeroportos de Moçambique, various years, ‘Relatório e Contas’, Maputo, Mozambique. Allen, R. and Vani, S. 2013 ‘Financial Management and Oversight of State-Owned Enterprises,’ in The International Handbook of Public Financial Management, eds. 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