Fiscal Policy Challenges in light of Emerging Financing Needs

1. Fiscal Policy Challenges in light of Emerging Financing Needs Government of Mozambique In collaboration with the IMF and the World Bank March 22-25, 2010

2. Objective of the Presentation Objective 1: Assess past experience on how fiscal policy formulation and implementation and the fiscal structural reforms contributed to macroeconomic stability Objective 2: Understand how new challenges (particularly the need to sustain high growth) may require adapting the fiscal stance and what reforms are needed to continue preserving macroeconomic stability

3. Part 1:Where do we come from?Assessing past experienceS. Rosa

4. Mozambique: A remarkable success story • The authorities largely achieved their macroeconomic objectives underlying Mozambique’s last PRGF and the current PSI • Real GDP growth • Reduced poverty rate • Low inflation • Reduced current account deficit (after grants) • Sustained capital inflows • Comfortable international reserves level • Low public debt burden and a low risk of external debt distress

5. The road to success Successful post-conflict transition, leading to a stable social and institutional environment Continued support from development partners Sound structural adjustment process, backed by ownership, setting up the foundation of a market based economy Strong reform focus on the fiscal and monetary institutions and operations Formulation and implementation of credible economic policies

6. Pillar 1: A strong reform effort building up a modern tax administration • 1997: Institution of the value added tax, replacing the sales tax system • 2001: Creation of the unit in charge of tax reforms • New Tax Law • Creation of the revenues on income (enterprises and personal) • Creation of a tax identification number • 2003: Creation of the counsel for the coordination of customs policies • 2004: Set up of the customs administration • 2005: Creation of an integrated tax administration, covering internal as well as trade-related taxation • 2009: A new fiscal regime for concessions in the natural resource sector

7. Pillar 1: Reshaping the tax sources, raising tax collection

8. Pillar 1: Tax collection rates are high compared to regional peers

9. Pillar 2: Reforming the Public Financial Management System • 2002: Approving a comprehensive, modern, public financial management Law (SISTAFE) • Providing the institutional and legal pillars for a modern budget preparation and execution framework • 2003-present: public sector budget and financial management integrated IT system (e-SISTAFE) • Supporting the implementation of integrated, real time, comprehensive budget preparation and execution IT framework • Accounting sub-module → Link with budget classification • Financial management sub-module (single treasury account) → Link with real time financial resource management • Budget preparation sub-module → Anchoring spending expectation (amounts and destination) • Budget execution sub-module → Facilitating high frequency budget execution reports

10. Pillar 2 Outcomes: The Budget as a credible instrument of fiscal policy • Over time budget execution was more in line with the approved budget • Main spending categories became more predictable

11. Pillar 2: Higher budgetary expenditure targeting priority sectors Sustained revenue effort and large aid flows helped increase total expenditure and raise priority spending

12. Fiscal policy avoided domestic financing to make room for private sector credit Credit to the private sector increased steadily This fiscal stance was very effective, simple to communicate, and easy to monitor It contributed to a predictable and a stable business environment It helped achieve macroeconomic stability Inflation declined, despite occasional spikes Mozambique: Evolution of the Main Fiscal Balances (percent of GDP) 10.0 5.0 0.0 - 5.0 - 10.0 - 15.0 1997 - 2003 2,004 2,005 2,006 2,007 2,008 2,009 Overall balance (before grants) Overall balance (after grants) Net external borrowing Net credit to the government Pillar 3: A simple and effective fiscal anchorlimiting domestic financing - protecting the private sector

13. The fiscal deficit was therefore largely financed by borrowing from external sources on concessional terms, thus avoiding nonconcessional external borrowing. Such limits were considered appropriate in the post-civil war era because of the availability of concessional donor support and the country’s weak administrative capacity. Concessional loans with long maturities were also considered more appropriate for public investment with long lags to maturation. Pillar 3: A simple and effective fiscal anchorThe key role of budget support and project aid

14. Responding to the exogenous shocks:The role of fiscal policy • The two exogenous shocks prompted the authorities to temporarily widen the fiscal deficit. • The primary fiscal deficit has more than doubled during the last four years, particularly in 2009, reflecting: • Measures to shield the population from the impact of higher fuel and food prices ; • Counter-cyclical policy shift to cope with the impact of the global crisis. • During these episodes, Mozambique benefited from a scaling up of budget aid. This may not now be sustainable.

15. Overall assessment : A successful transition Increased revenues Higher priority spending High project spending Overall deficit financed on highly concessional terms

16. Part 2: What Next?Laying the Foundation of a Frontier EconomyAdapting the Fiscal AnchorS. Rosa

17. Sustaining high growth in Mozambique:The case for adapting the fiscal stance • Circumstances cast doubt whether the current fiscal anchor—avoiding recourse to domestic financing and near-zero access to nonconcessional external borrowing—is still appropriate • This anchor makes it difficult to credibly loosen policies when facing temporary shocks • Aid flows may have peaked and could well flatten or decline over the medium to long term, calling for alternative financing sources • The decline in trend growth underscores the importance of spending on infrastructure to raise growth and export potential • Several studies point to the lack of network infrastructures in Mozambique; these could be growth enhancing but may require lumpy, front-loaded public investment

18. Raising investmentChallenge # 1: Identifying financing options • In principle higher investment could be financed by creating fiscal space • Increasing revenue collection→ some margin exists • Reducing nonpriority spending → Small size, relatively inflexible (e.g., wages); margin for cuts appears slim • Obtaining higher concessional aid → donor support is likely to flatten (at best) • Increasing domestic financing → a limited increase could be consistent with deepening financial markets but would need to preserve a healthy growth of credit to the private sector • Seeking external financing on commercial terms → could be feasible if limited and targeting growth-enhancing projects so as to preserve debt sustainability and macroeconomic stability • Sovereign Bonds • Credit Lines • Other

19. Raising investmentChallenge #2: Identifying and implementing growth-enhancing projects Key Message: The basic debt dynamic equations show that the growth response to increased public investment is one of the most critical aspects affecting debt sustainability • Central to securing the growth dividend is building capacity to identify, select, implement, and operate high-yield projects • For projects financed by the public sector, it is key that the procurement framework maximizes the return on public resources • The management of state-owned assets by SOEs and PPPs should ensure sound, market-based regulation and supervision, avoiding political interference • Even if all of the above is met, assessing the growth impact requires solid cost/benefit analysis, an assessment of the impact on the private sector, and focus on the macroeconomic impact; because of these complexities, assumptions should be realistic and debt sustainable under moderate growth projections

20. Raising InvestmentChallenge # 3: Stepping-up budget and debt monitoring • PFM: Expanding the coverage of e-SISTAFE, strengthen risk-based ex-ante and ex-post audits, monitor SOEs. • Scope of the budget coverage: cover revenue and spending operation at the sub-national level and the operations of selected state-owned enterprises (SOEs) and other public entities. (More consistency with GFS) • Tax policy: Reforms could contribute to increase tax revenue and improve the business climate, by reducing the number of taxes, simplifying the remaining taxes, broadening their bases, and eliminating the bias against the formal sector. • Tax administration: Better coordination between customs and internal tax activities within the Revenue Agency, integrating tax administration into Sistafe , tightening risk-based audits, implementing a multi-functional large tax payers unit. • Debt management: Continue strengthen the debt unit to enable it to formulate a coherent borrowing strategy, analyze the macroeconomic and fiscal impact of new borrowing, and enhance the monitoring of risks (e.g., related to the SOEs).

21. The bottom line:A new fiscal stance Under certain assumptions, the fiscal anchor would be adapted to allow for higher domestic and external nonconcessional borrowing, over a limited time horizon, to implement high-priority investment projects Capital spending could be increased by an amount consistent with macroeconomic stability and debt sustainability The resulting temporarily higher fiscal deficit would be publicly announced as part of an effective communication strategy. The challenge will be to determine who much domestic and nonconcessional external borrowing is possible, taking into account the negative growth feedback of excessive domestic debt and reduced credit to the private sector

22. Would this hold together?Understanding the importance of assumptions • Mozambique’s low debt level provides some fiscal space for stepping up public investment • But: • The growth response will be key. Wasteful investment that does not promote growth will quickly deteriorate Mozambique’s good starting position. • The investment-led growth will have to generate a proportionate level of receipts to ensure cost recovery (either users’ fees or revenues) but… • ….if tax or fee charges are too high, the net impact would undermine growth and lead to unsustainable debt. • Low cost recovery rates, everything else being equal, result in loss-financing needs which would, in turn, harm private sector growth. • Key to secure high productivity in investment projects is to allow the fast absorption of inputs (goods, services, managerial capacity)

23. Conclusions: A Promising outlookThe importance of having all the ingredients in place • Investments need to be well identified to ease growth bottleneck • There needs to be capacity in place to plan and monitor project execution, limit fiscal risks, and ensure cost recovery • Fiscal policy makers need to communicate a clear strategy, allowing for a temporary easing of the fiscal stance, consistent with debt sustainability under prudent growth, tax collection, and cost recovery assumptions • The IMF and the WB can help assess policies consistent with macroeconomic stability and debt sustainability • But we need to take a closer look on the risks and qualify our assumptions NEXT PRESENTATION ON THE DSA

24. Questions? Thank You!