IMF Executive Board 2018 Article IV Consultation with Mozambique

IMF Executive Board 2018 Article IV Consultation with Mozambique
Photo credit: Julien Lagarde

07 Mar 2018

On March 5, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Mozambique.

In recent years, Mozambique’s economy has been adversely affected by the fall in commodity prices and adverse weather conditions, as well as by the issue of undisclosed loans in the spring of 2016 and the ensuing freeze in donor support. Growth decelerated in 2016 to 3.8 percent (from 6.6 percent in 2015) and the latest data show that the economy grew by 3.7 percent in 2017, driven by a recovery in agriculture and mining activity (due to a surge in coal production).

A tight monetary stance, coupled with exchange rate appreciation, led to a steep fall in inflation to 6.3 percent (year on year) in January 2018, from a peak of 26 percent in November 2016. However, the 2017 fiscal deficit on a modified cash basis (i.e., including external and domestic arrears) is estimated to have increased to around 8.2 percent of GDP compared to 7.6 percent of GDP in 2016, mainly due to continued spending pressures, including from a higher wage bill and high debt service costs.

The external current account deficit continued to narrow in 2017. This was due to a boom in mining exports and to a contraction in megaproject imports of services. Another factor was the one-off inflow in income associated with the capital gain tax from the sale of ENI’s stake in the Coral South natural gas field to Exxon Mobil. Debt remains in distress as the stock of public sector debt-to-GDP reached 128.3 percent at end-2016, with several debt payments missed, including on the Mozam Eurobond.

The outlook remains challenging. Absent further policy action, real GDP growth is expected to further decline over time while inflation would remain at current levels. The fiscal deficit would expand, leading to further accumulation of public debt and crowding out of the private sector. Banks’ rising exposure to the government, combined with high interest rates, create potential macrofinancial vulnerabilities.

Staff Report


Mozambique’s economy faces serious macroeconomic challenges. Despite a loose monetary/fiscal policy mix through mid-2016, the economy slowed from 2015 because of a series of shocks, including lower commodity prices and adverse weather conditions. The economic situation deteriorated further following the disclosure in April 2016 of undisclosed borrowing by the Proindicus and MAM public companies and the ensuing freeze in donor budget support. Growth has continued to slow and fiscal policy has remained fairly loose in 2017. Public debt has been rising at an unsustainable pace and debt has remained in distress with several payments on external borrowing missed.

Monetary policy has carried the burden of adjustment. Tight monetary policy since October 2016 has helped rebalance the foreign exchange market, lower inflation, and strengthen net international reserves. The government eliminated fuel and wheat subsidies, reintroduced automatic adjustment of fuel prices, and raised electricity and public transportation prices. However, significant spending pressures are expected to result in an overall 2017 fiscal deficit exceeding 8 percent of GDP (on a modified cash basis). The large financing needs of the Treasury combined with a restrictive monetary stance to stabilize inflation continues to press market interest rates higher, depressing credit availability to the private sector – particularly to SMEs – and affecting economic activity, employment, and socio-economic conditions.

Mozambique’s financial sector has come a long way since the volatility observed in 2016. The instability created by the resolution of Moza Banco and Nosso Banco has abated. The system is currently characterized by an increasing gap between credit growth and monetary aggregates and high government financing needs. The rapid disinflation and returned stability in the FX market have left real interest rates in domestic currency at elevated levels. Private credit demand has contracted, which resulted in high liquidity for the balance sheet of the system being allocated to government securities. Vulnerabilities remain related to rising NPLs, increasing government expenditures arrears and debt sustainability of SOEs.

Recent Economic Developments

In response to then high inflation and depreciating exchange rate, the Bank of Mozambique (BM) considerably tightened monetary policy from October 2016. This tightening increased demand for domestic currency and helped stabilize the exchange rate and rebalance the foreign exchange market. Since June 2017, broad stability has returned to the foreign exchange market. International reserves increased because of the accumulation of external arrears and of occasional interventions by the BM. At end 2017, reserves reached a level equivalent to 5.5 months of non-megaproject imports. In April 2017, the BM changed its operational monetary target to a short-term interest rate (MIMO) and started a cautious easing cycle totaling three policy rate cuts by 225 basis points to 19.5 percent in December (see Selected Issues Paper Chapter I). In the same period, reserve requirements were reduced by 150 basis points to 14 percent.

The current policy mix has resulted in a sharp decline in credit to the economy. The rapid reduction in inflation in the last year led to high real interest rates and higher demand for deposits and lower demand for credit in domestic currency. In December 2017, the policy rate reached 12 percent in real terms while y/y domestic credit to the economy contracted by 12 percent in nominal terms whereas deposits in domestic currency grew by 13 percent till November. The resulting gap between credit to the private sector and monetary aggregates in domestic currency has helped finance the governments’ significant funding needs, albeit at a higher cost.

The current account deficit has continued to narrow in 2017. An essential factor in this narrowing was the one-off inflow in income associated with the capital gain tax. It was also due to a 12.7 percent of GDP megaproject current account surplus. This surplus resulted from a boom in coal export volumes and prices, and to the 55 percent contraction in megaproject imports of services as many of the on-going projects were completed in 2016. The non-megaproject trade balance of goods deteriorated, with exports of goods falling by almost 8 percent, and imports growing by 3.3 percent, year-on-year in 2017. At the same time, net foreign direct investment in the non-megaproject economy continued to fall to about $1.3bn in 2017, half of the $2.6bn inflows registered in 2015.

Mozambique’s public debt is in distress. The stock of public sector debt-to-GDP reached 128.3 percent at end-2016, including domestic debt (24.6 percent of GDP). Sovereign arrears have been incurred on the Mozam Eurobond coupon and on the debt service of Proindicus and MAM, as well as on two loans from Brazil to the state-owned airports company, Aeroportos de Mozambique (AdM), for which the state-guarantee has been called. The overall stock of external arrears on public and publicly guaranteed external debt service reached $709.7 million by end-2017, including arrears under bilateral discussions with five official creditors amounting to $94 million (Libya, Iraq, Angola, Bulgaria and Poland). The authorities are currently servicing all other multilateral and bilateral external debt obligations. Discussions between the government and private creditors have not progressed since the government announced in October 2016 its intention to restructure the private external debt.

Policy Discussions: Maintaining Macroeconomic Stability

The current economic situation requires an urgent rebalancing of the policy mix to ensure durable macroeconomic stability, while enhancing growth prospects and making inroads in reducing poverty and income inequality. Discussions focused on the need for: (i) fiscal adjustment to restore fiscal sustainability and bring the fiscal deficit in line with financing availability while containing public debt; (ii) normalization of monetary policy and challenges in the financial sector, and (iii) strengthening governance and transparency, including by addressing the institutional weaknesses and corruption underlying the hidden loans, while advancing other structural reforms to generate growth and employment.

Strengthening resilience and containing financial sector risks

The central bank is committed to implementing further monetary and financial sector reforms to gain structural resilience. The central bank continues to strengthen its governance, organization, analytical tools and monetary and FX operation framework with cooperation of Norges Bank and IMF technical assistance. The plan intends to enhance financial stability analysis, reporting, communication; modernize the national payment system and oversight; and improve currency cash management. The financial regulatory framework is being strengthened to mitigate vulnerabilities and enhance bank resolution capacity.

The current environment constrains credit growth. Banks are placing their extra-balances in domestic currency at the central bank in the form of excess reserves, or via reverse repos in the overnight market. The currently high real returns and low risks of those liquidity placement options constrain credit growth. Moreover, the increase in minimum capital requirements, to be phased in over three years, while welcome for the overall strengthening of the system, reduces at the margin the profitability of intermediation in the current circumstances.

The banking system continues to hold significant capital and liquidity buffers. New regulations to increase the CAR and establish minimum liquidity requirements were put in place in 2017. While reports indicate that banks remain liquid, well capitalized, and profitable on average, there is heterogeneity across institutions. In addition, nonperforming loans (NPLs) have increased substantially, from 5.5 percent of total loans at end-2016 to 11.4 percent in September 2017. Several factors underlie this deterioration. Staff encouraged the authorities to remain watchful of loan classification, collateral valuation, and provisioning.

The bank resolution framework needs strengthening to deal with systemic failures and the safety net is still incipient. Weaknesses in the legal framework complicated the resolutions of Moza and Nosso Banco. In the absence of other reputable buyer, Moza was sold to the BM’s pension fund; Moza is currently run by professional bankers and is gradually recovering. Staff encouraged the authorities to establish a policy to ensure independent governance and adequate surveillance, and prepare a divestment strategy for the medium term. It supports ongoing work to prepare a new bank resolution framework aimed at enhancing the resolution powers of the BM. Strengthening the deposit insurance scheme is also warranted. The Fund stands ready to continue providing technical assistance in these areas.

Modernizing the 1992 central bank law would strengthen the BM’s credibility and monetary policy effectiveness. In particular, the law allows lending to the government interest-free yearly-loans up to 10 percent of revenue collected in the penultimate year. Staff recommended that, as a first best, the new law ban credit to the government or strictly limit it as a second best.

Staff commended the authorities for their efforts at promoting financial inclusion within the 2016-2022 National Strategy. Mobile banking and electronic currency could play a key role in extending the network of transactions and creating opportunities for people in rural areas with low income levels. Staff encourages the authorities to continue efforts to implement the Financial Inclusion Strategy and periodically assess if further measures are needed.

Mozambique adopted IFRS in 2007 and will transition to IFRS9 in 2018. The change includes a move toward impairment modelling, among other factors, and the process should be carefully phased-in to avoid unintended consequences.

Structural Policies: Strengthening governance and promoting inclusive growth governance

While Mozambique’s anti-corruption legal framework is sound, it is lacking in implementation and enforcement. In 2012, a comprehensive legislative anticorruption package was approved and aligned the legal framework with international standards. Notwithstanding these efforts, lack of resources and poor prioritization have resulted in an ineffective implementation of the legal framework. A Central Public Ethics Commission (GCCC) was created to prevent and investigate conflict of interest. Yet it was only recently given an office; the commissioners cumulate their GCCC responsibilities with other full-time jobs. While the asset disclosure system is comprehensive, its implementation falls behind international best practices: asset disclosures are not published, sanctions for non-compliance or false declarations are not sufficiently dissuasive, and verifications are not strategic. During 2017, only 55 percent of officials complied with their obligation to declare assets with no consequences for the 45 percent who did not declare.

In the wake of disclosure of hidden debt in 2016, the authorities are working on an action plan to strengthen governance, improve transparency, and ensure accountability. Fund and World Bank staff discussed with the authorities’ joint recommendations for the action plan. The key recommendations include:

  • Governance:

    • Introduce a framework for fiscal responsibility and efficient management of natural resources wealth.

    • Strengthen the issuance and management of public debt and guarantees, and prepare recovery or restructuring plans for SOEs in financial distress; the latter includes liquidating Ematum, MAM, and Proindicus after transfer of security assets to the State.

    • Improve public investment and assets management, and put in place a framework for government autonomous entities, and address arrears.

  • Transparency:

    • Support public and parliamentary oversight through reporting, disclosure, and amendments to laws governing public finance, SOEs and the extractive industry sector. Improving fiscal reporting through: (i) enhancing reporting on commitments, arrears, debts and other obligations under guarantees, and major public investment decisions; (ii) requiring annual reporting on SOEs and government autonomous entities, including quarterly reporting on the financial operations of a subset of SOEs presenting large fiscal risks; (iii) publishing annual fiscal risks assessment and consolidated financial statements of SOEs in line with IFRS standards; and (iv) disclosing beneficial ownership in the extractives sector, including State’s participation and the rules governing its financial relations with SOEs.

  • Accountability:

    • Resolve the issue of unreported loans of EMATUM, MAM and Proindicus, and strengthen compliance, enforcement and key laws supporting the fight against corruption, including stepping-up anti-corruption efforts to prevent abuses in the administration of SOEs, and back accountability process and case resolution. Staff commends the authorities for submitting to Parliament the SOE law and for approving a decree providing a regulatory framework for the issuance of public debt and guarantees.

Information gaps in the audit of hidden loans need to be addressed. The completion of the Kroll audit report and the publication of its summary in June 2017 are important steps towards greater transparency. However, critical information gaps remain unaddressed regarding the use of the loan proceeds. Staff urged the authorities to provide full clarity on this use.

Strengthening the fiscal framework for managing natural resource wealth is essential. Staff recommended to consider fiscal rules and a sovereign wealth fund to underpin a fiscal responsibility law, while noting that reducing costly debt must take precedence in the short term. To raise awareness on these issues, staff suggested organizing a high-level workshop to discuss international experiences and best practices ensuring an efficient management of natural resources over time.

Structural reforms to support inclusive growth, reduce poverty, and promote economic diversification. Structural reforms to remove impediments to investment and employment creation are necessary for diversified and sustained inclusive growth, and to support poverty reduction. Underdeveloped infrastructure, difficulties with corruption, and ambiguous regulations are key challenges according to Doing Business (Mozambique ranks 138th out of 190 countries in 2018). The private sector also struggles with unresolved public-sector arrears and tight and expensive access to credit. Staff urged the authorities to adopt, in consultation with the World Bank, a set of reforms aimed at improving the weak business climate.

Mozambique is one of the most vulnerable countries to natural disasters and climate risks. The country’s geographic location and topography (particularly low-lying elevation) add to the risk. Additionally, weak socio-economic infrastructure, high poverty, and heavy dependence on rain-fed agriculture magnify these risks, in a context of limited access to insurance. Limited preparedness and lack of adequate resources further inhibit the country’s crisis adaptation and response capacity. Staff recommends the authorities integrate climate change mitigation within their developmental agenda and preparedness going forward.

Selected Issues paper

I. Towards a new monetary policy regime in Mozambique

Many central banks in low-income countries (LICs) in Sub-Saharan Africa are modernizing their monetary policy regimes. The role of monetary policy in LICs has been a controversial topic. Mishra et al. (2012), for example, argue that the weak institutional framework prevalent in LICs drastically reduces the role of securities’ markets rendering traditional monetary transmission mechanisms using market interest rates and market-determined asset prices weak and unreliable. However, Berg et al. (2013) based on event studies applied to four Sub-Saharan economies (Kenya, Rwanda, Tanzania and Uganda) found that the transmission mechanism is effective with large policy-induced changes in the short-term interest rates strongly transmitting to market interest rates, exchange rates, output and inflation. The transmission occurred even though, like in other LICs, the four countries have relatively small, concentrated and bank-dependent financial systems. The authors observed that monetary transmission was stronger in Kenya and Uganda. In the first case, the authorities explicitly signaled the monetary policy stance with a short-term interest rate and described their intentions in terms of an inflation objective. In the case of Uganda, the inflation targeting lite regime seemed simpler and more transparent. The initial success with modernizing monetary policy frameworks in some central banks in Sub-Saharan economies has attracted the attention of other central banks in the region, including that of Mozambique.

Up until April 2017, Mozambique’s monetary policy framework was exclusively targeting monetary aggregates. The main de jure objective of the Bank of Mozambique (BM) was to preserve the value of the national currency, with reserve and broad money serving, respectively, as the operating and the intermediate targets. Under this regime, the money multiplier and velocity were assumed to be stable and predictable, while exchange rates were freely determined, with BM intervening only to smooth excessive exchange rate volatility. Two interest rates were used to aid reserve money targeting and help communicate the monetary policy stance – the standing lending facility (FPC) and the deposit (FPD) interest rates. These defined an interest rate corridor within which interbank market rates usually fluctuated. Open market operations through T-bills and repo issuances, combined with an interest rates’ corridor, were primarily aimed at containing reserve money below a given targeted ceiling.

Box 1. Transiting to a New Monetary Policy Regime

The BM is gradually transiting to a new monetary policy regime. In April 2017, it introduced, for the first time, the Reference Monetary Policy Interest Rate (known as MIMO). The MIMO is an overnight interest rate at which the BM intervenes in the interbank market. The interventions are conducted through overnight reverse repos at the MIMO rate with full allotment, thereby aligning overnight secured money market rates closely with the MIMO. It was also expected that the MIMO would help strengthen the interest rate formation mechanism and transparency in the market. While the MIMO is expected to signal the monetary policy stance, the BM continues to monitor monetary aggregates for informational purposes. The introduction of the MIMO rate implicitly recognized the difficulties entailed in communicating the monetary policy stance through reserve money ceilings, but it also somewhat encouraged the public interpretation that the BM will seek to maintain the MIMO rate positive in real terms. In this context, understanding the bimonthly MPC decisions regarding the level of the MIMO rate and the resulting impact on future inflation appears to have gained greater public attention in Mozambique.

Important changes have also been introduced in the foreign exchange and credit markets, which should support the new monetary policy regime. A Reference Exchange Rate was introduced in May 2017 which replaced the multiple exchange rates that were in effect in the market. The new reference rate is based on transactions between commercial banks and their customers, and it is published three times a day in the BM website. In June 2017, the BM introduced, in consultation with commercial banks, the Standardized Prime Interest Rate (Indexante Unico) for banks’ lending. Although banks can add a risk spread over this prime rate, it makes banks’ final interest rates on loans directly linked to monetary policy decisions. This is because the prime rate is strictly defined as the arithmetic average between the BM’s FPC rate and the reverse repo rate plus 600 basis points which have been agreed to represent banks’ funding risk. While some argue that the 600 basis points spread may be too high, the Reference Exchange Rate and the Standardized Prime Rate, which are published in the BM website, were important measures to strengthen transparency in the process of exchange rates’ and interest rates’ formation.

The current regime is de facto a precursor of an inflation targeting regime. BM’s recent monetary policy decisions have become more forward-looking, interest-rate based and model-based. Specifically, inflation has emerged more clearly as the final objective of monetary policy and its forecasts are model-based. The medium-term inflation objective remains 5-6 percent as set by the Government. The MIMO is the operational target signaling the monetary policy stance to achieve the inflation objective. This can be confirmed by a greater emphasis given to inflation expectations in recent MPC reports. Overall, MPC decisions build strongly on the Forecasting and Policy Analysis System (FPAS) like in other modern inflation-targeting central banks. Monetary aggregates such as reserve money and broad money remain in the BM radar, but as information variables only.

The embryonic monetary regime will often face challenges that will likely test the policy resolve and credibility of the BM. Building credibility is critical to enable the central bank to effectively signal the monetary policy stance and help anchor inflation expectations. Building capacity to improve inflation forecasting, correctly identifying the monetary policy transmission mechanisms, fostering the development of the interbank market, improving communications, striving for a close coordination with the fiscal authorities, and strengthening the BM legal framework are all essential in the process of building credibility.

II. The governance challenge in Mozambique

An increasing body of literature, including case studies and survey data, shows that weak governance and corruption severely hampers economic performance. Economic performance is impacted through several channels, especially in the domains of fiscal, market regulation, financial sector oversight, and the rule of law. This undermines the society’s trust in government, puts at risk the quality of public institutions, and give rise to rent seeking behavior, eroding the general rule of law, and slowing overall economic development.

For Mozambique, governance and corruption indicators have been progressively deteriorating. Over the past ten years, the Worldwide Governance Indicators (WGI) deteriorated on all six dimensions. While Mozambique still fares better than Sub Saharan Africa’s (SSA) averages on two indicators, (voice & accountability and regulatory quality), it continues to fall behind neighboring countries in government effectiveness, control of corruption, and rule of law. The gap between its percentile ranking for control of corruption (21) and SSA average (31) stands out and marks a rapid drop since 2010 (41 percentile rank). This is in line with findings from other governance and perception of corruption indices, including the Corruption Perception index (CPI), the Ibrahim index of African Governance (IIAG), and the survey of business leaders by the World Economic Forum.

Several factors underlie this progressive deterioration in governance and corruption in Mozambique. These include: (i) a large informal economy with limited financial inclusion, which allows for a high share of cash transactions, and makes it difficult to track and control illicit transactions; (ii) a large, complex and obscure structure of beneficial ownership of state owned enterprises; (iii) a patronage political culture that often relies on the provision of benefits and public goods in exchange of political support; and (iv) weak and underfunded oversight and regulatory institutions.

The government recognizes the magnitude of the problem, but a coherent strategic plan remains to be enforced. Supporting anti-corruption efforts was at the forefront of president Nyusi 2014 presidential campaign and was emphasized in his inauguration speech, promising zero tolerance with government corruption. However, progress has been slow with momentum building up only recently. A new anti-corruption plan was adopted in November 2016 after the disclosure of hidden loans. This was also followed by other corruption cases making it to the news headlines. While Mozambique has an updated anti-corruption framework, it faces the challenge of effective implementation and enforcement.