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 and constraints to growth, followed by a focus section analyzing an issue of particular importance. The focus section for this edition evaluates Mozambique’s evolving fiscal risks in a context of rising public investment. 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 this edition of the MEU was 28 March 2016. ii Contents Abbreviations and Acronyms ...................................................................................................................................... v Acknowledgements ...................................................................................................................................................... vi Executive Summary ..................................................................................................................................................... 1 Part One: Recent Economic Developments ......................................................................................................... 3 International Developments .................................................................................................................................. 3 Economic Growth and Inflation ........................................................................................................................... 4 Fiscal Policy ............................................................................................................................................................... 7 The External Sector ................................................................................................................................................. 9 Monetary Policy ....................................................................................................................................................... 12 Outlook ...................................................................................................................................................................... 14 Part Two: Risks vs. Returns: the Implications of Scaling-Up Investments in an Emerging Resource-Rich Economy ............................................................... 15 Introduction............................................................................................................................................................... 15 What Are Fiscal Risks? ............................................................................................................................................. 15 The Public Investment Program .......................................................................................................................... 16 Major Sources of Fiscal Risk ................................................................................................................................. 18 How Can Fiscal Risks Be Managed? ................................................................................................................... 23 Conclusion ............................................................................................................................................................... 24 References ..................................................................................................................................................................... 25 FIGURES Figure 1: Growth is slowing among many of Mozambique’s major trading partners ........................... 3 Figure 2: …and global commodity prices have fallen substantially ............................................................. 3 Figure 3: Slower growth in the resource sector is contributing to a broader deceleration ................. 4 Figure 4: …while agriculture and manufacturing’s contributions to growth increase ............................ 4 Figure 5: The metical has depreciated against the dollar and the euro while remaining broadly stable against the rand ........................................................................................................................................ 5 Figure 6: Both the nominal and real effective exchange rates have depreciated since 2010 .............. 6 Figure 7: Inflation began rising rapidly in late-2015, driven by food prices ............................................... 6 Figure 8: Fiscal deficit narrowed in 2015 and is expected to continue on this trend in 2016 ............. 8 Figure 9: Capital and petroleum goods contribute to lower import growth ............................................ 10 Figure 10: …given that FDI inflows have weakened substantially ................................................................... 10 Figure 11: A dramatic rise in the CAD between 2010 and 2012 was accompanied by a similar spike in total investment .................................................................................................................................. 11 Figure 12: The start of Sudanese oil production in the early 1990s rapidly narrowed the CAD .............. 11 iii Figure 13: Interventionist monetary policies have lowered international reserves. .................................. 12 Figure 14: In 2014 the BdM drew on its international reserves to inject liquidity ....................................... 13 Figure 15: …and both total domestic credit and credit to the government increased rapidly ............... 13 Figure 16: In late 2015 the BdM began raising interest rates .......................................................................... 13 Figure 17: …as the monetary base contracted, while M3 continued to expand ........................................ 13 Figure 18: Public investment increased through 2014 ..................................................................................... 17 Figure 19: Public investment spending is relatively high compared to peer countries ........................... 17 Figure 20: Total external debt levels are rising .................................................................................................... 18 Figure 21: ...as the overall fiscal balance has been deteriorating ................................................................... 18 Figure 22: Loans are rising rapidly in relation to grants .................................................................................... 19 Figure 23: ...and are increasingly being undertaken on non-concessional terms ..................................... 19 Figure 24: Public debt is largely denominated in foreign currency ............................................................... 19 Figure 25: The depreciation of the Metical has raised the present value of debt-to-GDP ratio ............ 20 TABLES Table 1: Government Finances ................................................................................................................................. 8 Table 2: The Balance of Payments ............................................................................................................................ 9 Table 3: Outlook ........................................................................................................................................................... 14 BOXES Box 1: Recent Exchange-Rate Trends .................................................................................................................. 5 Box 2: The Current-Account Deficit .................................................................................................................... 10 Box 3: Flawed PPP Arrangements in Colombia and Portugal ....................................................................... 22 iv Abbreviations and Acronyms 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 EMATUM Mozambican Tuna Company (Empresa Moçambicana de Atum) FPC Standing Lending Facility (Facilidade Permanente de Cedência) FPD Standing Deposit Facility (Facilidade Permanente de Depósito) GEP Global Economic Prospects GDP Gross Domestic Product GNI Gross National Income INE National Statistics Institute (Instituto Nacional de Estatística) IMF International Monetary Fund MEF Ministry of Economy and Finance (Ministério da Economia e Finanças) MMBTU Million British Thermal Units Mt Metric tons MZN New Mozambican Metical PII Integrated Investment Plan (Programa Integrado de Investimento) PPP Public-Private Partnership SSA Sub-Saharan Africa VAT Value Added Tax 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 Julio Revilla (Lead Economist, GMFDR). The team included Natasha Sharma (Senior Economist, GMFDR and lead author of part two), Shireen Mahdi (Senior Economist, GMFDR), Anna Carlotta Allen Massingue (Research Analyst, GMFDR), Mario Gutierrez (Consultant, GMFDR), Maria Gracia Ramos (Consultant, GMFDR), and Poorva Karkare (Consultant, GMFDR). Peer reviewers were Raju Singh (Program Leader, LCC8C), Praveen Kumar (Lead Economist, GMFDR), and Catriona Mary Purfield (IMF). Comments were also received from Carolina Renteria (Lead Economist, GMFDR). 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 against the US dollar in 2015, accentuating Recent Economic inflation at a time when rising food costs as Developments a result of drought already amplified prices. Inflation spiked to 11.1 percent in December. After several consecutive years of strong growth, Mozambique’s economic performance In an effort to contain the metical’s depreciation has decelerated to its slowest pace since 2009. and manage inflation, the central bank A continued decline in global commodity intervened by selling off foreign reserves and prices, weak growth amongst trading partners tightening the monetary policy stance in the and the effects of a regional drought have last quarter of 2015. International reserves contributed to a reduction in GDP growth fell by about US$780 million in 2015, with the from 7.4 to 6.3 percent in 2015. Export prices bulk of the decline (72 percent) occurring in for aluminum and coal decreased by 18 percent the last four months of 2015. The exchange and 12 percent respectively in 2015, reducing rate has since fluctuated between 45-52 MZN/ the value of production of these key industries. US$ as a result of the central bank’s role in the Lower levels of foreign direct investment (FDI) market, but the underlying pressures remain. have further accentuated the declining trend On top of these difficulties, Mozambique’s in the extractive, manufacturing and services debt levels have been rising and the country sectors. Agricultural production, which employs was downgraded by credit rating agencies most of the country’s labor force, remained in March 2016 in reaction to a government robust in 2015, but the onset of El Niño related initiative to restructure the EMATUM “tuna climatic conditions caused a regional drought bond”. The restructuring deal represents in late 2015 and is increasing food insecurity considerable easing to the government’s amongst the most vulnerable households. finances. Nevertheless, exposure to fiscal risk from public debt, guarantees, and the state Fiscal consolidation has also contributed to the owned enterprise sector remains heightened. slowdown in growth, with cuts in investments and current expenditures through the course of the year. The low commodity prices and Outlook slowing investment placed pressures on the GDP growth in 2016 is projected to decelerate external position. The current account deficit further to 5.8 percent, before recovering to widened from 38 to 41 percent of GDP in 2015. over 7 percent in 2017. The slowdown in 2016 External account pressures also contributed to reflects the continued decline in commodity the depreciation of the metical by 30 percent 1 mozambique economic update march 2016 prices for key Mozambican exports, effects of the ongoing drought on agricultural production Fiscal Risks and further fiscal tightening. This outlook Part two of the Mozambique Economic Update is subject to additional downward risk if gas explores Mozambique’s heightened exposure megaproject investments are deferred to 2017, to fiscal risks from public debt, guarantees, and if higher debt levels result in sharp macro state owned enterprises and public private policy adjustments. Given the weak external partnerships. Substantial public investment position, further currency depreciation is likely is necessary to address the country’s limited and will add to inflationary pressures in 2016 human capital stock and considerable through its effect on the cost of imports. The infrastructure deficit, and discoveries of large central bank continues to respond to these natural resource reserves will significantly alter developments by increasing rates, most recently the country’s fiscal situation. Anticipating these in early 2016. However, additional monetary changes, the government has been substantially tightening could strain economic growth even scaling-up public investment over the last few further as higher interest rates have negative years. Financing has taken various forms and knock-on effects on the private sector and the has contributed to increased debt financing, the banking sector’s portfolio. provision of guarantees for public corporations, and increasing public-private partnership Taken together, economic conditions in 2016, arrangements. However, these choices are not including a potential investment shortfall, risk free. Liabilities have accumulated at a rapid point to the importance of securing the final pace while the due diligence mechanisms to investment decisions for the development govern them remained lagging. The EMATUM of the Rovuma basin gas fields. Notably, the situation in particular has generated substantial prospects for Mozambique’s gas sector remain fiscal risks for the government, as would be sound even under current market conditions, the case with other large guarantees. These and large associated foreign direct investment developments highlight the need to improve flows are expected between 2017 and 2020. monitoring, disclosure and management of These flows will support the widening of the debt and fiscal risks. These efforts should current account deficit from 41 percent of be complemented by measures to improve GDP in 2015 to over 70 percent of GDP by the government’s capacity to manage public 2018. Gas exports are expected to ramp up investments, including enhanced processes for by 2022 and the current account deficit to evaluating projects that are likely to expose the shrink thereafter. country to fiscal risks. 2 part one: recent economic developments Part One: Recent Economic Developments International Developments in SSA. In previous years high commodity prices played a central role in boosting growth among Global economic growth slowed in 2015. resource-rich countries such as Mozambique, South Africa, Zambia and Zimbabwe. However, The global GDP growth rate is estimated to falling commodity prices have put pressure have declined from 3.4 percent in 2014 to 3.1 on Mozambique's extractive industries sector, percent in 2015. China’s slowing growth rate has particularly the continued decline of global coal curbed its global imports, including commodity prices, which is undermining the development imports from Africa (China currently accounts of the country's nascent coking-coal industry. for about 5 percent of Mozambique’s exports). Meanwhile, Europe’s recovery remains anemic, Aggregate economic growth in SSA slowed and global financial markets have begun to from 5 percent in 2014 to 3.4 percent in 2015, adjust in anticipation of tighter monetary policies adversely affecting regional trade. Growth in in the United States. South Africa, Mozambique’s main trading partner, remains sluggish at about 1.3 percent in 2015. Lower commodity prices and uncertain global Growth has also decelerated in neighboring economic and financial conditions have Malawi and Zimbabwe. weakened growth among commodity exporters Figure 1: Growth is slowing among many of Figure 2: …and global commodity prices have Mozambique’s major trading partners… fallen substantially. GDP Growth Rates in Selected Comparator Countries (%), Selected Commodity Price Trends, 2010-15 2013-15 (2005 = 100) Source: IMF and World Bank Source: IMF and World Bank 3 mozambique economic update march 2016 Economic Growth investment decisions for the development of the Rovuma basin remain pending. A decline in and Inflation growth rates amongst Mozambique’s key trading partners also limited demand in export sectors at Mozambique’s economic performance a time when low commodity prices are already slowed after several consecutive years causing a strain. In addition, fiscal consolidation of strong growth as it navigates lower in 2015 contributed to lower growth levels, with commodity prices and reduced FDI. cuts in recurrent and investment expenditures through the course of the year. Slowing extractive and service sectors contributed to a reduction in GDP growth In contrast, agriculture and manufacturing from 7.4 percent in 2014 to 6.3 percent in 2015. increased their contribution to growth. Growth in services, which accounts for over 50 Manufacturing grew by 9 percent in 2015, percent of output, declined as financial services, reflecting high growth in the power generation real estate and tourism failed to attain growth and water sectors, along with core manufacturing levels similar to 2014. A substantial deceleration activities. Agriculture, which employs most of in the extractive industry’s growth, from 44 the country’s labor force and represents almost percent in 2014 to 9 percent in 2015, also a quarter of total output, grew at 6 percent and contributed further to the drop in GDP growth. increased its contribution to overall output. Yet, although agriculture remained robust, the onset The continued decline in global commodity of El Niño caused a regional drought in late 2015 prices and worsening external and domestic and is increasing food insecurity amongst the demand conditions contributed to a slowdown most vulnerable households. in growth. Lower levels of FDI accentuated the declining trend in extractives and services as final Figure 3: Slower growth in the resource sector Figure 4: …while agriculture and manufacturing’s is contributing to a broader deceleration… contributions to growth increase. GDP at 2009 Prices (quarterly % change, year-on-year) Contribution to GDP growth by Sector Source: INE Source: INE Inflation accelerated in the second half The 12-month CPI inflation rate reached 11.11 of 2015. percent in December 2015, up from 1.1 percent a year earlier. Most of the increase occurred in Consumer price inflation continued to the last quarter of the year, as the 12-month accelerate in 2015, driven by rising food inflation rate in September was only 1.3 percent. prices and the depreciation of the metical. 1 Inflation refers to Maputo area. 4 part one: recent economic developments By end 2015, food prices were 20 percent above especially against the South African rand, in the their level in December 2014.2 In December last part of the year increased the cost of food 2014 12-month food-price inflation was just 1.6 imports. Inflation has continued on an upward percent. However, local flooding and a regional trend in 2016, with consumer prices reaching drought put upward pressure on food prices 11.6 percent year-on-year in February 2016. in late 2015, while the metical’s depreciation, Box 1: Recent Exchange-Rate Trends Since October 2014 the increasingly robust Greater exchange-rate flexibility accelerated recovery of the US economy has caused the metical’s depreciation in 2015, after central most global currencies to depreciate bank interventions reduced international against the US dollar. The expected reserves. The recent deceleration in capital tightening of US monetary policy and inflows further increased pressure on the the decline of international commodity exchange rate. Depreciation is expected to prices have contributed to this trend. As a spur inflation via higher import prices, with a result, by the end of 2015 the metical had notable effect on food. Mozambique is not depreciated by 32 percent against the dollar heavily dependent on the US market given since mid-2014, falling by 14 percent in the that its main trading partners are South Africa last 6 months alone. and the euro zone, which has mitigated the impact of the depreciation. Figure 5: The metical has depreciated against the dollar and the euro while remaining broadly stable against the rand. Source: BdM The metical has depreciated less sharply main trading partners, indicates that the against other major currencies. Although metical depreciated by 8 percent overall in the third quarter of 2015 it depreciated during 2015, compared to a year earlier, but faster against the South African rand and the monetary policy interventions caused it to euro, it has now recovered slightly and the stabilize in the final months of the year. The nominal depreciation against the rand has recent depreciation should have a modest been reversed. An analysis of Mozambique’s impact on the trade balance due to the relative multilateral nominal exchange rate, a importance of large-scale investments in the weighted-average of the currencies of its natural resource sector. 2 Food prices carry a 40 percent weight in the CPI. 5 mozambique economic update march 2016 Figure 6: Both the nominal and real effective exchange rates have depreciated since 2010. Source: BdM A variable auto-regression model based rates and the mandatory reserve ratio due to on quarterly data indicates that an annual concerns about rising inflation in a context increase of 1 percent in the nominal exchange of slowing growth. However, the recent rise rate boosts inflation by just 0.2 percent.3 A in inflation primarily reflects adjustments in modest pass-through effect contributed to administratively determined prices for certain inflation remaining above the government’s staple foods and utilities in addition to the target, prompting the central bank to tighten depreciation of the metical. its monetary policy by raising both interest Figure 7: Inflation began rising rapidly in late-2015, driven by food prices. The CPI Inflation Rate (Maputo, 12-month % change) Source: INE 3 The model considers external inflation as an external supply shock approximated by aluminum prices. GDP represents domestic economic activity and exchange-rate shocks are identified by nominal depreciation dynamics, which are computed as the variation in the metical’s exchange rate against the dollar after controlling for supply and demand shocks. Finally, domestic inflation is calculated using the Maputo CPI. 6 part one: recent economic developments Fiscal Policy the capital budget being sharper than those for recurrent spending. The budget also maintains Fiscal policy is pursuing consolidation to a steady upwards trend in the nominal public reverse previous slippages and respond to sector wage bill and debt service. Overall, the imbalances in the external sector, but the fiscal deficit is set to narrow further from an burden of adjustment is heaviest on the estimated 6.5 percent of GDP in 2015 to 4.0 capital budget. percent of GDP in 2016. Lower capital spending and reduced lending to Public debt ratios have been increasing state entities helped reduce the overall fiscal but success in restructuring EMATUM will deficit to 6.5 percent of GDP in 2015. Recurrent bring some relief. spending remained largely steady. Although recurrent spending estimates for 2015 show a The depreciation of the metical contributed reduction compared to the previous year, the to the increase in the public debt ratio from decline was driven by a one-off adjustment 56 percent of GDP in 2014 to 73 percent in made in 2014 to account for previously un- 2015. Similarly, the debt service to revenue ratio budgeted maritime security outlays. In contrast, increased from 3.6 percent in 2014 to 9.1 percent the domestically financed capital budget in 2015 and is projected to increase further in narrowed. Net lending, dominated by externally 2016. These trends reveal the vulnerability of the financed loans to public enterprises, also shrank debt position, particularly to the depreciation of from 3 percent of GDP in 2014 to 0.4 percent in the Metical given that most of Mozambique’s 2015. Revenues remained robust in 2015 with a debt is held in foreign currency. nominal increase of around 3 percent compared to the previous year, when capital gains receipts The authorities are seeking to reduce the debt had been a boon.4 service burden by restructuring the EMATUM bond. The proposal, which is intended as a The budget for 2016 foresees further friendly restructuring, will bring much needed consolidation as part of a policy package to relief to the government’s position in the short rebalance the budget and mitigate pressures term as it would convert the bond from an on the external position. The budget amortizing to a bullet bond with an extension anticipates increased revenue collections with in maturity from 2020 to 2023. Nevertheless, the improvements in tax administration. A further restructuring proposal quickly prompted credit revenue boost would arise if capital gains taxes rating downgrades by Moody’s and Standard & are realized in 2016 from the sale of assets in Poor's when it was announced (Fitch maintained extractives sector megaprojects. Expenditures its rating) which may affect investor sentiment. are projected to decline, with adjustments to 4 Italy’s Eni Group paid the government about US$400 million in capital gains taxes following the sale of its stakes in Mozambican oil and gas fields to the China National Petroleum Corporation in the first half of 2014. Excluding capital gains taxes, tax receipts grew by about 15 percent in 2015 as tax enforcement was strengthened for both personal and corporate taxes through the course of the year. Despite this, total revenues decreased as a share of GDP, from 27.3 in 2014 to 25.6 in 2015). 7 mozambique economic update march 2016 Table 1: Government Finances (percent of GDP) 2014 2015 2016 Acutal Estimate5 Budget Total Revenue 27.3 25.4 26.1 Tax Revenues 23.4 20.9 22.4 Non Tax Revenue 4.0 4.5 3.7 Grants 4.2 4.3 3.7 Total Expenditure 39.1 36.3 32.5 Recurrent Expenditure 24.1 21.5 20.1 Of which: Compensation to employees 11.2 11.0 10.5 Interest on public debt 1.0 1.5 1.8 Maritime security 2.8 -- -- Capital Expenditure 15.0 14.6 12.5 Domestically financed 8.2 7.3 6.2 Externally financed 6.8 7.2 6.3 Net Lending 3.0 0.4 1.2 Overall Balance -10.6 -6.5 -4.0 GDP (nominal, MZN million) 536 587 676 Source: MEF, IMF and WB Figure 8: Fiscal deficit narrowed in 2015 and is expected to continue on this trend in 2016. Government Finances (in MZN millions) Source: MEF, IMF and WB 5 Preliminary estimates. The official 2015 budget execution figures were not available by March 2016. 8 part one: recent economic developments The External Sector and declining transfers. Falling prices for Mozambique’s major commodity exports and The deterioration of the current account slowing growth rates among its main trading and lower FDI have worsened the balance partners curbed export growth. Official grants of payments. also registered a decrease. These movements were partly counteracted by an improvement in The current account deficit widened from the service balance, which registered a notable 38 to 41 percent of GDP in 2015, driven by reduction in construction and professional a worsening trade balance for merchandise services, a side effect of lower investment in 2015. Table 2: The Balance of Payments (millions US$) 2014 2015 %Δ Actual Estimate 14/15 Current Account -5797 -6185 7% Trade Balance -6968 -6815 -2% Exports g&s 4641 4095 -12% Exports g&s 11609 10910 -6% Income and transfers, net 1170 630 -46% Capital & Financial Account 5691 5601 -2% FDI, net 4902 3711 -24% Other, net6 789 1890 139% Overall Balance -106 -584 451% Source: BdM The decline of commodity prices since mid- Merchandise imports dropped by 5 percent 2013 in the context of a sluggish global in 2015 as a result of cheaper oil and lower economic recovery contributed to a 14 FDI. Petroleum product and megaproject percent reduction in merchandise exports. imports shrunk by almost 50 and 40 percent Mozambique’s exports are dominated by respectively, and were the main drivers of the aluminum, coal, and natural gas which have decline in imports. However, slowing growth suffered significant declines in prices. As such, and the depreciation of the metical also affected the fall in commodity exports was largely driven consumption related imports such as motor by lower prices rather than output volumes.7 vehicles, which recorded a 22 percent reduction. Agricultural commodities tended to depart from this trend and have shown robust export Foreign direct investment inflows contracted performance. Sugar, tobacco and cashew, which by 25 percent in 2015. With a larger current together represented 12 percent of merchandise account deficit and reduced FDI, the BdM exports, grew by 16 percent in 2015 due to reported a cumulative deficit of nearly US$584 higher outputs and a slight recovery in tobacco million in the overall balance of payments in prices in the second half of 2015. 2015, up from 106 the previous year. 6 Other includes errors and omissions. 7 Export earnings from aluminum fell by 14 percent, coal by 24 percent, and gas by 20 percent. 9 mozambique economic update march 2016 Figure 9: Capital and petroleum goods Figure 10: …given that FDI inflows have contribute to lower import growth… weakened substantially. Imports, 2013-15 (in US$ millions) Net FDI, 2013-15 (in US$ millions) Source: BdM Source: BdM Box 2: The Current-Account Deficit been joined by major investments by Mozambique’s traditionally small current- Kenmare in heavy sands extraction and by account deficits (CADs) have widened in Rio Tinto and Vale in coal mining. recent years as the value of imports has significantly exceeded the value of exports. Large megaproject-related FDI inflows have Large-scale megaproject-related imports caused the CAD to widen from an average have driven this trend, beginning with of around 11 percent of GDP from 2004 to investments in aluminum production, and 2010 to around 40 percent of GDP from followed by the expansion of the mining and 2012 to 2015. This reflected a huge increase gas sectors financed by FDI. Unlike other in total investment, which shot to over 50 developing countries, Mozambique’s CAD is percent of GDP in 2012. In recent years not primarily financed by grants and loans, slowing growth among Mozambique’s main and FDI covers the CAD without adding to trading partners, especially China, and low the external debt burden. international commodity prices have caused exports to stagnate. Meanwhile, imports The country’s first major FDI-financed have continued growing, even as capital megaproject was the US$2 billion Mozal inflows have declined. The CAD is currently aluminum smelter, which opened in 2000. estimated at 41 percent of GDP in 2015 and The Sasol gas plant came online in 2004, is projected to exceed 70 percent of GDP by and a gas pipeline expansion is currently 2018 as the gas fields in the Rovuma basin planned. These megaprojects have since are developed. 10 part one: recent economic developments Figure 11: A dramatic rise in the CAD between 2010 and 2012 was accompanied by a similar spike in total investment. Source: IMF, International Financial Statistics A large and persistent CAD could potentially The lag between FDI inflows and rising threaten external stability, but the current export volumes differs by country, and widening of the CAD is expected to be longer lead times tend to imply larger temporary as it is primarily financed by increases in production. For example, Sudan megaproject-related FDI. Assuming that FDI began exporting oil nearly 20 years after the inflows successfully contribute to long-term start of oil exploration and after almost a increases in economic output, rising exports decade of investment and infrastructure should help narrow the CAD over time. development. Following years of large Technological spillovers can accelerate this deficits, the start of oil production narrowed process, and the international experience the CAD dramatically. suggests that large CADs are associated with faster rates of economic growth. Figure 12: The start of Sudanese oil production in the early 1990s rapidly narrowed the CAD. Source: IMF, International Financial Statistics 11 mozambique economic update march 2016 In Mozambique, a further decline in global deficit over the medium term, as several commodity prices and/or a deteriorating megaprojects are still in their early stages. economic outlook among its main trading At present, Mozambique’s CAD is not cause partners could delay resource exports. for serious concern, as current large-scale Domestic political or economic instability investments in extractive industries are could also undermine investor confidence. likely to yield future surpluses. However, the authorities must continue to closely monitor Large CADs are common among resource- the CAD, as it could become unsustainable rich developing countries, and Mozambique's in a context of diminishing FDI. current account is expected to remain in Monetary Policy International reserves have fallen due to the worsening balance of payments (BoP) and the BdM’s interventions in the foreign- Figure 13: Interventionist monetary policies exchange market. have lowered international reserves. Liquid International Reserves (in US$ millions) The BoP deficit coincided with the central bank’s interventions in the foreign-exchange market to control the depreciation of the metical and limit its pass-through effect on inflation. Reserves fell from US$2.8 billion, or nearly 3 months of imports, at the beginning of 2015 to roughly US$1.9 billion, or about 2 months of imports, by end-December with the largest share of the decline (US$561 million) occurring in the last four months of the year. International reserves fell a further US$167 million in the first two months of 2016. Source: BdM The BdM intervened in foreign exchange government was growing at an average markets in an effort to stabilize the exchange 12-month rate of 15 percent by end-year, up rate while also injecting liquidity to mitigate from an average of about 3 percent in April. the associated contraction of both the The metical’s depreciation has prompted a shift monetary base and the supply of credit to the from external to domestic borrowing. economy. The growth of BdM’s net domestic assets and domestic financial credit mirrors the The central bank began tightening its decline in its international reserves, reflecting its monetary stance in the last quarter of reliance on sterilization to minimize the negative 2015, as foreign-exchange and inflationary impact on the monetary base, ease exchange- pressures intensified. rate pressures and attenuate the pass-through effect on inflation. The central bank has continued tightening monetary policy since the last quarter of 2015. The government’s increased borrowing from After having maintained its standing lending the financial system may have a crowding out facility (facilidade permanente de cedência, effect on private sector investment. Despite FPC) rate fixed at 7.5 percent for a year, the the authorities’ approval of a conservative BdM implemented four rate increases between 2015 budget, financial sector credit to the October 2015 and February 2016, bringing the 12 part one: recent economic developments rate to 10.75 percent by end-February 2016. Continued pressure on the foreign-exchange The central bank also raised the standing market and the metical’s depreciation prompted deposit facility rate (facilidade permanente de the BdM to tighten its monetary stance later in depósito, FPD) in similar stages from 1.5 percent the year. Liquidity constraints are expected to in September to 4.25 percent by February 2016. slow the growth of credit to the economy and In parallel, the reserve ratio was increased relieve pressure on both the exchange rate and from 8 to 10.5 percent. Additional measures international reserves. Credit policy remained were also adopted in late 2015 to help contain loose through September 2015, as financial foreign-exchange outflows, including a limit on system credit grew at a 12-month average of international payments with credit cards. over 25 percent. Figure 14: In 2014 the BdM drew on its Figure 15: …and both total domestic credit and international reserves to inject liquidity… credit to the government increased rapidly. Credit and International Reserves (in MZN billions) Total Credit and Credit to the Government (in MZN billions) Source: BdM Source: BdM Figure 16: In late 2015 the BdM began raising Figure 17: …as the monetary base contracted, interest rates… while M3 continued to expand. FPC Interest Rate Monetary Base and M3 (12-month % change) Source: BdM Source: BdM 13 mozambique economic update march 2016 Outlook European Union growth is expected to decelerate to 1.5 percent in 2016, followed by The adverse external environment is a marginal rise to 1.6 percent in 2017. Growth expected through 2016 with sluggish in China is projected to further decelerate from global growth and low commodity prices. 6.9 percent in 2015 to 6.5 percent in 2016 and 6.2 percent in 2017. Sub-Saharan Africa growth Weak external demand conditions are expected is expected to fall to 3.0 percent in 2016, before to continue through 2016 and into 2017. rebounding to 4.0 percent in 2017. A sharp The aggregate growth rate among advanced decrease is forecasted for South Africa, from economies is projected to remain unchanged 1.3 percent in 2015 to 0.6 percent in 2016, and in 2016 and rise slightly to 2.0 percent 2017. a recovery to about 1.2 percent in 2017. Table 3: Outlook 2015e 2016p 2017p External Scenario Real GDP (% change) Advanced 1.9 1.9 2.0 European Union 1.6 1.5 1.6 China 6.9 6.5 6.2 Sub-Saharan Africa 3.4 3.0 4.0 South Africa 1.3 0.6 1.2 Commodity Nominal Price (% change) Aluminum $/mt -10.8 -6.9 4.0 Coal, Australia $/mt -18.0 -13.0 3.8 Natural gas, Europe $/mmbtu -27.8 -17.4 3.2 Tobacco $/mt -1.0 1.2 -1.2 Domestic Scenario Real GDP and Inflation (% change) Real GDP % change 6.3 5.8 7.7 Inflation CPI average 3.6 6.5 5.6 e: Estimate; p: Projection Source: IMF (WEO) and World Bank Commodity prices are expected to continue over 7 percent by 2017. The slowdown in 2016 their decline in 2016, with a gradual recovery reflects the continued decline in commodity anticipated by mid-2017. A stronger US dollar prices for key exports and the effects of the and tighter US monetary policies will maintain ongoing regional drought on agricultural and downward pressure on commodity prices. Prices food prices, which may remain elevated. This for Mozambique’s main exports are expected outlook is subject to additional downward risk to drop further in 2016, with aluminum prices if gas megaproject investments are deferred projected to fall by 7 percent, coal prices by 13 to 2017, and if higher debt levels result in percent and gas prices by 17 percent. Meanwhile, sharp macro policy adjustments. The weaker tobacco prices are expected to increase slightly metical adds further inflationary pressures in in 2016 before contracting in 2017. 2016 through its effect on the cost of imports. The central bank continues to respond to these GDP growth is expected to continue developments through additional monetary decelerating in 2016 before recovering tightening. However, these interventions could in 2017. strain economic growth even further as higher interest rates have negative knock-on effects GDP growth in 2016 is projected to decelerate on the private sector and the banking sector’s further to 5.8 percent, before recovering to 14 part two: risks vs. returns: the implications of scaling-up investments in an emerging resource-rich economy portfolio. medium term prospects remain sound. The continued depreciation of the exchange Taken together, short-term pressures in 2016 rate could gradually help stimulate exports, as point to the importance of securing the final long as inflation remains contained. However, investment decisions for the development of the development of non-commodity exports will the Rovuma basin gas fields. In this regard, require adequate investment in complementary the prospects for Mozambique’s gas sector infrastructure. The continued depreciation of remain sound and large associated FDI flows the metical should also contain the growth of are expected between 2017 and 2020.8 These intermediate and capital imports. flows will support the widening of the current account deficit and boost growth. Gas exports Short-term pressures on the external are expected to ramp up by 2022 and the current position are pronounced in 2016, but account deficit to shrink thereafter. Part Two: Risks vs. Returns: The Implications of Scaling-Up Investments in an Emerging Resource-rich Economy Introduction have led the three major international credit rating agencies to downgrade the country’s This section explores Mozambique’s sovereign credit rating. The objective of this heightened exposure to fiscal risks arising section is to describe the evolution of fiscal risks from its efforts to increase public investment. in the context of the government’s recent drive Substantial public investment is necessary to to increase public investment and to provide address the country’s limited human capital recommendations for addressing those risks. stock and considerable infrastructure deficit, and discoveries of large natural resource reserves will What Are Fiscal Risks? significantly alter the country’s fiscal situation. Anticipating these changes, the government has Fiscal risks can be broadly defined as the risk been substantially scaling-up public investment that fiscal outcomes will deviate from what was over the last few years. In today’s resource expected when a budget or other forecast was constrained environment, the government is prepared. Fiscal risks can arise from unforeseen financing these ambitions through different changes in the economy that cause key variables means, such as an upward trend of resources such as the growth rate, the exchange rate, or allocated through the budget,9 raising debt, public revenues to differ from projections. As providing guarantees for public corporations, substantial resource revenues are expected to and increasing public-private partnership (PPP) come on stream over the medium term, the arrangements. However, these choices are not volatility of commodity prices particularly for risk free, as Mozambique’s fiscal vulnerabilities coal and liquefied natural gas will become an 8 Progress towards final investment decisions has been steady and was boosted by the approval of ENI’s area 4 development plan in February 2016. 9 With the exception of 2015 resource allocation to public investment has been rising each year. 15 mozambique economic update march 2016 increasingly important source of fiscal risk, which the Heavily Indebted Poor Countries Initiative the government will have to carefully manage. in 1999, which greatly improved its debt profile. However, as far back as 2001 a review of public Fiscal risks can also arise from specific events or spending identified fiscal risks stemming from policy arrangements. Natural disasters, pension the financial sector, the pension scheme and liabilities and unsustainable borrowing by potential natural disasters. Fifteen years later the subnational governments are examples of specific country’s exposure to fiscal risks is increasing, fiscal risks that can increase the government’s and a growing debt burden, substantial investor expenditure obligations. Contingent liabilities are uncertainty and rising macroeconomic instability an especially critical concern. For example, if have had adverse implications for growth. the state explicitly guarantees a loan undertaken by a public corporation and it cannot be repaid The Public Investment according to the agreed-upon terms, the state will be obligated to service the loan. In the case Program of an implicit contingent liability, there may The government has been rapidly scaling up be an expectation that the state will intervene public investment. Mozambique’s Council of even without an explicit guarantee. Contingent Ministers approved an Integrated Investment Plan liabilities are often unquantifiable and uncertain, (Programa Integrado de Investimento, PII) in 2013. making fiscal risks challenging to manage. The PII outlines a number of priority areas for investment, including agriculture and irrigation, Changing economic conditions may exacerbate ports and railways, airports, roads and bridges, certain fiscal risks related to public investment. energy, fishing, human capital development, An unanticipated slowdown in growth could water supply, and youth housing. Well-targeted cause investment projects to fail to realize their investments could increase human and physical anticipated revenue potential. For example, a capital and generate higher growth rates. project that generates revenue through user fees might suffer from weakening demand. A Nominal public investment levels increased deteriorating exchange rate could raise debt- each year between 2009 and 2014 to reach service costs, diminishing fiscal revenues and/ 19.1 percent of GDP. However, spending levels or increasing real expenditure obligations. This were projected to decline to 15.5 percent could heighten the fiscal risks of the public of GDP in 2015 as the government scaled investment program at a time when the public back expenditures in response to short-term finances are most vulnerable. financial challenges (Figure 18). Externally financed investments through concessional The issue of fiscal risks is not new in loans and grants fluctuated at 7 to 8 percent Mozambique. The collapse of two state-owned of GDP between 2009 and 2014. Domestically banks in the 1990s increased government financed investment through fiscal revenues liabilities related to nonperforming loans. or commercial loans has steadily increased Financial sector reforms were subsequently each year, from MZN 13.43 billion in 2009 to introduced, including the privatization of the an estimated 41.03 billion in 2015.10 Excluding two banks. Rising debt levels have also been a projections for 2015, loans to public corporations serious issue, with external debt peaking at 366 via the budget have also been increasing. percent of gross national income (GNI) in 1994. The government qualified for debt relief under 10 Values are expressed in real terms with 2009 as the base year. 16 part two: risks vs. returns: the implications of scaling-up investments in an emerging resource-rich economy Figure 18: Public investment increased through 2014. (Public investment, % of GDP) Source: MEF Mozambique’s public investment budget is can use this revenue stream to expand public relatively large compared to peer countries investment. Public investment in Mozambique (Figure 19). A number of countries across SSA is high compared to both emerging resource- have made efforts to scale up public investment. rich countries such as Uganda and Tanzania, Resource-rich countries, as well as those and countries with established resource revenue anticipating significant resource revenues, streams such as Angola and Botswana. Figure 19: Public investment spending is relatively high compared to peer countries. Gross fixed capital formation, public sector (% of GDP) Source: WDI, IMF, 2012 to 2014 (latest available year) In addition to increasing the investment budget fiscal risks. First, public investment is increasingly the government is using other mechanisms financed through borrowing, adding to the to expand public investment, which are government’s direct liabilities. Second, public heightening the country’s vulnerability to corporations are becoming increasingly 17 mozambique economic update march 2016 engaged in public investment,11 which could investments are undertaken. The authorities are generate contingent liabilities if the government implementing a number of large infrastructure has provided financial guarantees to these projects through public corporations using bilateral companies. Third, PPP arrangements involving loans contracted on non-concessional terms. public corporations are also becoming more For example, the South Maputo Development prevalent. If a project does not realize its Company ( Empresa de Desenvolvimento anticipated returns the government may be Maputo Sul), a public corporation, is managing expected to intervene, even if this is not explicitly the implementation of the Maputo ring road, provided for in the contract. These alternative Katembe bridge and Ponta d’Ouro road projects financing mechanisms are particularly attractive using a US$725.8 million loan provided by the when budgetary resources are constrained. The China Export-Import Bank. The expansion of following subsections describe each of these Nacala and Maputo airports were also financed sources of fiscal risks in greater detail, with through non-concessional borrowing. reference to relevant examples given the lack of published data. Public and publicly guaranteed debt levels are rapidly increasing. Total external debt levels rose Major Sources of Fiscal Risk from 38 percent of GDP in 2010 to an estimated 63 percent of GDP in 2015 (Figure 20), as the Fiscal risks associated with rising debt overall fiscal balance declined (Figure 21). Notably, levels. in 2014 the overall fiscal balance fell due to increased spending on the wage bill and public The government is increasingly borrowing to investment.12 The increase in loans compared to finance large-scale infrastructure projects. grants is notable (Figure 22), especially as these Borrowing for current investments can lead loans are increasingly non-concessional in nature, to higher growth and promote positive which is raising overall public liabilities (Figure 23). socioeconomic returns, but only if the right Figure 20: Total external debt levels are rising… Figure 21: ...as the overall fiscal balance has been deteriorating. Total external debt (% of GDP) Source: Debt Sustainability Analysis, 2015 Source: MEF and IMF 11 The term “public corporation” encompasses (i) non-financial public corporations, including 14 public corporations that are fully owned by the government, (ii) financial public corporations such as the Bank of Mozambique and the National Investment Bank, and (iii) private companies in which the government has shareholdings. The state has both direct and indirect shareholdings in private companies, which are not fully disclosed. 12 This trend was accentuated by the expenditure demands of the election cycle, and windfall revenues from one-off capital gains taxes related to the consolidation of gas ownership structures in the Rovuma Basin in the previous year. 18 part two: risks vs. returns: the implications of scaling-up investments in an emerging resource-rich economy Figure 22: Loans are rising rapidly in relation Figure 23: ...and are increasingly being to grants... undertaken on non-concessional terms. Annual borrowing and grants (in MZN billion) Annual borrowing by type of loan Source: MEF Source: GoM Fiscal Risk Statement, 2015 Mozambique’s risk of external debt distress is levels (Figure 25). Under baseline assumptions still moderate, although risks have heightened. of the exchange rate the present value of debt- A Debt Sustainability Analysis (DSA) conducted to-GDP ratio is within the threshold.13 However, in November 2015 found that while the risk if the metical depreciates against the dollar by 15 of external debt distress remains moderate, percent, which would be closer to the market the depreciation of the metical against the exchange rate in March 2016 the present value US dollar has increased debt ratios and debt- of debt-to-GDP threshold would be breached. service requirements. Given that the public If the metical was to depreciate by a further debt is largely denominated in foreign currency 30 percent the ratio would be even higher at a (Figure 24), exchange-rate dynamics have projected 56.5 percent of GDP in 2016. important implications for debt sustainability Figure 24: Public debt is largely denominated in foreign currency. Public debt (% of GDP) Source: Debt Sustainability Analysis, World Bank staff estimates 13 Under the baseline scenario the exchange rate was projected as follows US$ 1 = MZN: 2015 (45.0), 2016 (45.9), 2017 (46.9), 2018 (47.8), 2019 (48.8) and 2020 (49.8): The threshold value of debt sustainability for the present value of debt to GDP ratio is 40 percent of GDP. 19 mozambique economic update march 2016 Figure 25: The depreciation of the Metical has raised the present value of debt-to-GDP ratio. Source: Debt Sustainability Analysis, World Bank staff estimates If the government is unable to meet its international creditors, backed by a government obligations, the shrinking fiscal envelope and guarantee.15 US$350 million was dedicated to rising risk of debt distress could have negative tuna fishing activities and US$500 million to implications for the economy. The threat of a maritime security. The value of the guarantee debt default can erode private sector confidence vastly exceeded the ceiling specified in the and discourage investment. Moreover, an 2013 budget law. In 2014 government-issued unsustainable debt trajectory can increase the cost guarantees amounted to US$392.6 million,16 of commercial borrowing. Elevated risks of debt significantly higher than in previous years, with distress in Ghana and Zambia, two other resource- the bulk of the guarantees assigned to EMATUM. rich SSA countries, have led to downgrades in their sovereign credit ratings. EMATUM’s government-issued guarantee represents a substantial fiscal risk. EMATUM Fiscal risks arising from explicit contingent was established through a large state-backed liabilities: the case of EMATUM. loan guarantee, even though the project was not included in the PII and the procurement Certain public corporations have benefited from was completed without tender. EMATUM is government guarantees as part of the recent experiencing financial distress, with expectations drive to increase public investment. Each year that the government will assume the entire debt, the government issues a ceiling for guarantees, exceeding the value of the guarantee approved in which is approved by parliament in the budget the Budget Law. In 2014 EMATUM recorded losses law. The total stock of government guarantees of US$25.3 million. Following an intervention is not published. In 2013 the Mozambican Tuna by the government and the central bank, a first Company (Empresa Moçambicana de Atum, tranche of repayments was made in September EMATUM) was founded as a private entity with the 2015 in the amount of US$105 million, of which government serving as the majority shareholder.14 US$77 million went toward debt repayment and EMATUM received a loan of US$850 million from US$27 million toward interest payments. 14 The Mozambican government's Institute for the Management of State Holdings (Instituto de Gestão das Participações do Estado) owns 34 percent of the shares, the Mozambican Fishing Company (Empresa Moçambicana de Pesca) owns 33 percent and the final 33 percent is owned by the Management of Investments, Holdings and Services company (Gestão de Investimentos, Participações e Serviços), which is majority owned by the government’s social services agency. 15 Credit Suisse raised US$500 million, while a Russian bank, VTB, raised a further US$350 million. 16 US$392,640,127.39 is equivalent to MZN 12,328,900,000 based on the 2014 exchange rate: US$1 = MZN 31.4. 20 part two: risks vs. returns: the implications of scaling-up investments in an emerging resource-rich economy The EMATUM situation has generated a number issuance of new guarantees. The maritime of adverse economic consequences. The security element of EMATUM’s operations was financial infeasibility of EMATUM’s operations was regularized by incorporating that element of the one of the key factors behind the downgrading loan into national budget documents. In addition, of Mozambique’s sovereign credit rating in 2015, public guarantees were published for the first time as it became increasingly apparent that EMATUM in the country’s 2014 audited state accounts. In would continue to add to the government’s debt November 2015 the country also published its obligations. In order to attract foreign investors first fiscal risk statement. While the document the EMATUM bond is primarily denominated in does not fully disclose information about the foreign currency,17 placing further stress on the government’s liabilities, it represents a positive debt burden as the metical depreciates. The step in improving transparency. government has successfully negotiated the restructuring of the EMATUM bond, with 81.7 Fiscal risks arising from implicit contingent percent of investors approving the “early swap” liabilities: public corporations and PPPs. offer. The move prompted Moody’s and Standard and Poor’s credit ratings agencies to further The State Equity Holdings Management downgrade Mozambique’s sovereign credit rating, Institute19 has determined that a number which may affect broader investor sentiment.18 of Mozambique’s public corporations are commercially non-viable and represent a The EMATUM situation also raises concerns potential fiscal risk to the government. The regarding the quality of Mozambique’s public government recently signaled its intention to financial management institutions. International privatize more than half of the country’s public bond markets can be an attractive option, as they corporations, which are either not contributing allow governments to access large amounts of to key policy objectives or are operating at a financing quickly and without increasing the tax loss. Demonstrating the poor financial health burden. However, for a loan to be undertaken on of Mozambican public corporations, the non-concessional terms the project incurring the government did not expect to receive any debt must be financially viable and have the capacity dividends from its shareholdings from 2012 to to generate the expected returns. This can be 2014.20 Contrary to these projections, however, assessed through project appraisals and feasibility nine public corporations generated dividends in studies, neither of which was used to assess 2014, with nearly half derived from the BdM and a EMATUM. The international experience highlights quarter from the Mozambique Ports and Railways the importance of strong public institutions in Company (Caminhos de Ferro de Moçambique, enabling resource-rich countries to reap the benefits CFM). This indicates that the government must of their natural resource endowments. improve its capacity to forecast revenue inflows from public corporations, and that the majority There are signs that the government is of public corporations do not generate dividends making efforts to improve fiscal transparency. for the state. Mozambique is the first country in Africa to make its public finances available for the IMF’s Certain public corporations implementing major fiscal transparency evaluation, which is publicly public investment projects are not generating a accessible. The authorities are also taking steps profit, but are still receiving non-concessional to improve reporting on fiscal operations, such loans. For example, the government has invested as reporting on public corporations and the heavily in financing airport expansion through 17 The loan is comprised of different currency denominations: US$516 million, €291 million and MZN 1.1 billion. 18 Under the original terms of the EMATUM deal a yield of 8.5 percent was agreed to for a seven-year bond with a two-year grace period. The bond has an amortizing structure giving it a weighted average life of 4.5 years. The government’s revised offer to investors swaps the debt for new US dollar denominated 2023 bonds maturing in January 2023, priced at 80 percent holding a coupon of 10.5 percent. The “early swap” offers holders a 105 percent ratio, bringing the coupon above 11 percent. The debt swap will enable the government to smooth its debt maturity profile. 19 The State Equity Holdings Management Institute is a public entity under the oversight of MEF. 20 From 2013 dividends from companies have been reported in audited state accounts. 21 mozambique economic update march 2016 borrowing,21 but the state-controlled public is involved in a number of PPPs, including a corporation Mozambique Airports does not large-scale initiative to construct the railway link yield any dividends to the state. A related public between Moatize and Nacala and expand the corporation, LAM Mozambique Airlines (Linhas Nacala port. This project has an estimated cost Aéreas de Moçambique), which has a monopoly of more than US$5 billion, with financial support over the country’s airspace, has been running provided by the Brazilian mining company Vale, deficits for the past two years. Mozambique and will be implemented from 2013 to 2017. The Telecommunications (Telecomunicações de National Oil Company (Empresa Nacional de Moçambique) is another public corporation Hidrocarbonetos) may also become involved facing a financial deficit. Mozambique Cellular in PPPs going forward. (MCel) is a publicly owned mobile phones operator, which is similarly facing considerable While PPPs can be used to scale-up public financial challenges, leading to speculation that infrastructure, there are substantial fiscal the government may sell its shares. Since the risks involved. PPPs are essentially risk-sharing government owns these companies either in full arrangements. Risks are assigned according or in part, their poor financial health could add to to the comparative advantage of the parties the state’s fiscal obligations. involved, with the private sector typically addressing construction-related risks and the A number of PPP agreements22 are being government managing political risks. Moreover, implemented to develop Mozambique’s PPPs are sometimes used to defer the costs of natural resource-related infrastructure. There a major investment until additional budgetary has been a significant increase in the use of resources are available. However, in some PPP arrangements since 2011, with many countries poorly planned and managed PPPs supporting the development of infrastructure have resulted in large and unexpected fiscal for coal mining. Projects are also underway to costs due to poor contract design, excessively develop ports in key areas such as Pemba and optimistic assumptions about revenue potential Palma to facilitate the transportation of natural from user fees and government-provided resources, and projects designed to increase minimum income guarantees (Box 3). energy generation and export are ongoing. CFM Box 3: Flawed PPP Arrangements in Colombia and Portugal Colombia’s 1991 Constitution and a series contingent liabilities were not systematically of economic reforms promoted private assessed or included in the budget. sector involvement in areas traditionally managed by the state. As a result, PPP In Portugal the government pursued schemes emerged in areas such as electricity PPPs largely to overcome budgetary generation and distribution, transportation and constraints in a broad range of sectors telecommunications, largely backed by state including ports, energy, transportation, guarantees. When demand dropped below health and water services. Between 1995 the contractual targets established in the PPPs, and 2010 the government entered into the government was forced to make large 22 PPP arrangements in the road sector, payouts to its private partners. At the time, accumulating nearly €13.7 billion in debt, 21 A new terminal was built at Maputo International Airport through a US$70 million contract to a Chinese construction firm. Further modernization work is underway on the runways with an estimated cost of US$65 million. Similarly, the Brazilian national development bank provided a non-concessional loan to finance the refurbishment of Nacala airport. 22 PPPs are typically long-term contracts. Investment and service provision are usually carried out by the private sector, with support from the public sector, and user fees which contribute to cost recovery. 22 part two: risks vs. returns: the implications of scaling-up investments in an emerging resource-rich economy more than two-thirds of which was owed was also affected, as domestic banks were to commercial banks. In most cases PPPs no longer financially leveraged. As a result, were privately financed with a concession private investors called on state guarantees, awarded to the private sector. Costs were contributing to a rapid deterioration in to be recuperated through tolls, user Portugal’s fiscal position and forcing the fees or shadow tolls. Following the 2008 government to seek financial assistance and financial crisis, demand projections failed to renegotiate the terms of the contracts. materialize as growth slowed. Access to credit Source: Salazar (2013), Sarmento and Renneboog (2014) and WDI Mozambique’s experience with PPPs has been growth rates and commodity-price volatility.23 mixed, and they could become a source of significant fiscal risk in the future. In the case of The second step is to disclose fiscal risks. the Nacala railroad, investment by the operator Improving disclosure processes can help and rail traffic have failed to meet expectations. ensure that fiscal risks are subject to appropriate Moreover, it is unclear whether comprehensive scrutiny, which can promote more effective feasibility studies were conducted to determine policy responses. In some countries the the railroad’s commercial viability in addition to government is legally obligated to disclose its prospects for service provision. While the fiscal risks. For example, Uganda’s 2015 Public government does not provide explicit guarantees Finance Management Act requires that the for PPPs, since public corporations are often government publish a fiscal risk statement, party to the agreement there may be an implicit which must include the distinct sources of fiscal assumption that the state will intervene if the risk along with a cost estimate and an alternative project does not realize its expected returns. fiscal framework based on more realistic Should economic conditions weaken, the macroeconomic assumptions. In Colombia, growing use of PPPs could entail significant publishing the estimated cost of guarantees fiscal risks by creating unexpected financial has reduced incentives to hide potential state obligations on the part of the government. obligations by making them more closely comparable to conventional expenditures. How Can Fiscal Risks While Mozambique has made progress by Be Managed? publishing its first fiscal risk statement, there is significant scope for further improvement. The first step in better managing fiscal risks is Moving forward, risks related to contingent to more thoroughly assess and quantify them. liabilities from guarantees to public corporations Fiscal risks by nature are difficult to quantify and PPPs should also be assessed. Establishing because they are predicated on an uncertain a fiscal risk unit will help coordinate information event in the future. However, steps can be taken from different departments. Such a unit will also to improve risk assessment, such as establishing be able to address the capacity and information upper and lower limits on the potential costs of gaps involved in estimating contingent liabilities identified risks. In other countries contingent and other sources of fiscal risks. Ensuring that liabilities related to guarantees for public the unit has a properly qualified and experienced corporations or PPPs are calculated annually by staff, including experts with strong quantitative examining contractual conditions and changes in and legal backgrounds, will be important, but key economic variables. Methods have also been may take time to develop. devised for estimating other types of fiscal risk that may affect the economy such as economic 23 For example, in Chile two panels of experts forecast potential GDP and long-run copper prices over a five-year period. The two extreme calculations on either end are discarded, an average of the estimates is taken and the results are published. 23 mozambique economic update march 2016 Conclusion The government’s ambitions to scale-up public prominence of public corporations and PPPs investment in Mozambique have resulted all suggest that fiscal risks are becoming more in the country’s heightened exposure to pronounced. The EMATUM situation in particular fiscal risks, which will need to be carefully has generated substantial fiscal risks for the managed. Financing for public investment government. These developments highlight has expanded rapidly through an increase in the need to improve monitoring, disclosure and budgetary resources and in other ways that management of fiscal risks. These efforts should defer government obligations. Short-term be complemented by measures to improve budget constraints increase the attractiveness the government’s capacity to manage public of alternative financing mechanisms, particularly investments, including enhanced processes for as future earnings are expected to significantly evaluating projects that are likely to expose the expand once resource revenues come on country to fiscal risks. stream. Rising debt levels and the growing 24 References IMF (2015) ‘Fiscal Transparency Evaluation,’ IMF: Washington DC IMF (2015) ‘Republic of Mozambique: Fifth Review under the Policy Support Instrument and Request for Standby Credit Facility – Debt Sustainability Analysis,’ IMF: Washington DC IMF and IDA (1999) ‘Republic of Mozambique: Initiative for Heavily Indebted Poor Countries Completion Point Document,’ Washington DC Republic of Mozambique, Ministry of Economy and Finance (various years) ‘Audited State Accounts,’ Maputo, Mozambique Republic of Mozambique, Ministry of Economy and Finance (various years) ‘State Budget,’ Maputo, Mozambique Republic of Mozambique, Ministry of Economy and Finance (2015) ‘Declaration of Fiscal Risks,’ Maputo, Mozambique Salazar, N. (2013) ‘Fiscal Risk Management for Development: The Case of Colombia,’ Background Paper for the World Development Report, 2014 Sarmento, J., M. and Renneboog, L. (2014) ‘The Portuguese Experience with Public-Private Partnerships,’ Tilburg University, Netherlands World Bank, (2001) ‘Mozambique Public Expenditure Management Review’ World Bank: Washington DC World Bank, (2014), ‘Elements to consider when establishing the envisaged Development Bank of Mozambique,’ World Bank: Washington DC World Bank (2014) ‘Mozambique - Public Expenditure Review: Addressing the challenges of today, seizing the opportunities of tomorrow,’ World Bank: Washington DC World Bank (various years) ‘World Development Indicators,’ World Bank: Washington DC 25