An International Monetary Fund (IMF) staff team led by Mr. Alvaro Piris conducted discussions virtually in the context of the 2021 Article IV Consultation with Mozambique ending on December 16, 2021.

At the end of the mission, Mr. Piris issued the following statement:

“The Mozambican economy is recovering from a sharp contraction, following several years of economic shocks. While the authorities have managed prudently and successfully addressed COVID and security-related challenges, including with international support, concessional financing has now declined, and high public debt and tight financing constraints should be addressed through fiscal measures. A tight monetary stance has helped keep inflation in check and preserve macroeconomic stability, but limits credit growth and scope for the exchange rate to facilitate economic adjustment. Reducing fiscal financing needs through a moderate adjustment that does not impair recovery will help put debt on firm downward trajectory, and allow for a better policy balance.

“A modest but broad-based recovery is taking hold in 2021. After real GDP contracted in 2020—the first contraction in 30 years—growth resumed in early 2021 and is expected to reach 2.2 percent for the year. Robust growth in agriculture and mining was complemented by modest recovery in services as COVID-related restrictions were eased. Seasonal factors, supply-chain constraints, and international food and fuel price increases led inflation to rise to 6.8 percent (y-o-y) in November, remaining within the Bank of Mozambique’s target of less than ten percent.

“The COVID pandemic, and the conflict and humanitarian emergency in the north of the country are intensifying fragility. Two large waves of COVID infections in the first and third quarters of 2021 prompted strict confinement measures, lowered incomes, and resulted in loss of schooling for an already vulnerable population. Terrorist attacks have caused thousands of deaths and displaced more than 800,000 people in the northern province of Cabo Delgado, with many in the northern region suffering food insecurity.

“The longer-term outlook is shaped by LNG production, with downside risks. Growth is expected to rise further in 2022, reflecting a broader recovery of the non-LNG economy. In the longer term, non-LNG growth is projected at 4 percent (conservative relative to historical rates, potential linkages with the LNG sector and scope for diversification). Overall growth will rise sharply as LNG projects begin production, currently expected in 2023 and 2026. While agricultural performance may be stronger than envisaged in 2022 considering expected favorable meteorological conditions, new waves of COVID infection could prompt confinement measures, while firms’ (including state-owned enterprises’) balance sheets have been weakened by the crisis, reducing scope for investment, and potentially weakening banking sector asset quality over time. Vulnerability to natural disasters and the effects of climate change are a recurrent vulnerability, as is renewed deterioration of the security situation that could further delay or stop the LNG projects.

“Fiscal pressures are acute. While the authorities have managed the crisis prudently so far, high debt and limited financing constrain fiscal policy. Government revenues have held up well since the start of the pandemic, but expenditure pressures have intensified due to the security and humanitarian situation in the north of the country, COVID-related spending (including the vaccine rollout) and a reform of public sector remuneration. The economic difficulties of SOEs and contingent liabilities (of about 10 percent of GDP) from the disputed debts associated with Proindicus and MAM represent risks, while exchange rate depreciation could increase public and publicly guaranteed debt.

“With little concessional financing after COVID support packages in 2020, reliance on domestic financing from banks has been heavy. With demand for further government bonds declining, domestic expenditure arrears are emerging. The 2022 budget includes spending cuts, particularly in domestically financed investment, and the authorities expect to use the SDR allocation to finance fiscal activities, but additional financing would still be required.

“Decisive policy action is needed for debt to remain on a sustainable path, reduce vulnerabilities, and free up resources for priority expenditures. On current policies, primary fiscal balance (after grants) would be reached only in 2026, after LNG revenues become more significant. Additional budgetary resources could be raised through reforms in tax policy—notably VAT exemptions, with care to minimize the impact on the most vulnerable households—and revenue administration. To rebalance expenditures towards priority areas—the security and humanitarian challenges, health, education, social and resilient infrastructure needs—savings on the public wage bill and continuing reforms in public financial management are needed.

“The Bank of Mozambique maintained a tight policy stance through 2021 to preserve macroeconomic stability. Prompted by rising inflation expectations in late 2020, the BM raised the policy rate by 300 bps to 13.25 percent in January, more than reversing cuts in 2020. With high real rates, inflation expectations have remained well-anchored despite global price pressures, the exchange rate has been very stable, and credit subdued. Cuts in reserve requirements in September 2021, enabled by the SDR allocation, led to some capital outflows as banks increased net foreign assets, and did not lead to an appreciable improvement in credit conditions.

“Gradual progress towards adopting inflation targeting continues. Reforms to the monetary policy operational framework continued and a new regulation enabled reopening the foreign exchange derivatives market in April, following a year-long suspension. Amendments to the BM Organic law will strengthen independence and institutional arrangements, but progress has been slow in the context of the pandemic. A new foreign exchange market law is in preparation, and a new intervention policy is being finalized. As fiscal policy is tightened and financing pressures abate, creating conditions for more flexibility would support better market determination of exchange rates and permit more rapid progress towards inflation targeting. Over time, a more flexible exchange rate would play a role as a macroeconomic shock absorber—important in the context of large, prospective LNG income. This could be achieved through reducing the foreign exchange sold by the BM for fuel purchases and lifting regulatory impediments to exporters in selling foreign exchange.

“Pandemic related regulatory waivers have been lifted. Banks report strong capital and liquidity positions, while nonperforming loans remain relatively stable at close to 10 percent. Waivers on provisioning requirements for restructured loans expired in June 2021, and a rise in NPLs is expected in the near- to medium-term, possibly including from financially stressed SOE’s. Regulations governing recovery and resolution planning are in preparation, and the mission encouraged the authorities to consider reforms to the creditor hierarchy in insolvency, legal safeguards in resolution, and resolution funding to further strengthen the crisis management framework.

“The authorities are completing steps to strengthen the AML/CFT framework. A recent assessment by the Eastern and Southern Africa Anti-Money Laundering Group found significant technical compliance and implementation deficiencies. Prompt action is needed to avoid inclusion on the FATF gray list after the current observation period ends in June 2022. A comprehensive action plan, elaborated with World Bank support, and a draft National Risk Assessment are close to completion. Reforms to the AML law are being developed, including to enable collection and maintenance of up-to-date beneficial ownership information. The BM is developing a risk-based supervision framework for AML/CFT with technical assistance.

“If well managed, natural resource wealth can significantly support development. Higher growth and fiscal revenue from LNG would provide scope for investing in health, education and social protection, climate change adaptation, and paying down public debt. A broad consensus across society is needed to decide on priorities, and institutions that balance investment against saving resources to reduce debt, mitigate macroeconomic distortions from high foreign exchange flows and fiscal revenue volatility, and for future generations. Noting the first revenues will begin to flow in 2023, the mission encouraged the authorities to develop a final proposal outlining priorities and arrangements for a sovereign wealth fund, and broaden the public debate around the proposal.

“Momentum on governance reforms should be maintained. The government’s Diagnostic Report on Transparency, Governance and Corruption lays out key policy areas and concrete measures. Significant progress has been made recently in strengthening public expenditure control, and modernizing budget programming, improving budget execution and treasury management. Areas for further reform include a revision of the public probity law, publication of beneficial ownership in mining license applications, publication of the Fiscal Transparency Evaluation, and implementation of Safeguards Assessment recommendations.

“Economic diversification is a key challenge to raise productivity and avoid excessive dependence on natural resources. The authorities recently launched the update of the National Strategy for Development (ENDE), inviting comments and contributions from a broad set of domestic and international stakeholders, including the IMF. This could be an important step towards developing the institutional framework to promote economic complexity and diversification.

“Discussions on supporting the government’s program with an Extended Credit Facility are scheduled to begin soon. A Fund-supported program could help ease financing pressures as the economic recovery takes hold, support the authorities’ agenda in poverty reduction and restoring sustainable and equitable growth, while also helping catalyze additional development financing. Staff stand ready to commence negotiations in late January 2022, in accordance with the authorities’ preferred timeline.

“The mission team thanks the authorities for their hospitality and productive discussions and expresses solidarity with the people and government of Mozambique as they respond to the COVID pandemic, and the humanitarian and conflict situation in the North of the country, among many challenges.”