Document of The World Bank

Report No:31036

IMPLEMENTATION COMPLETION REPORT(IDA-37090)

ON A

CREDIT

IN THE AMOUNT OF SDR 96.2 MILLION (US$120 MILLION EQUIVALENT)

TO THE REPUBLIC OF

MOZAMBIQUE

FOR THE ECONOMIC MANAGEMENT AND PRIVATE SECTOR OPERATION

(EMPSO)

December 29, 2004

PREM1Africa Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective December 10, 2004)

Currency Unit = Mozambican Metical Mt 19,376.63 = US$ 1

US$ = SDR 1MEASURESMetric System

FISCAL YEARJanuary 1 to December 31

ABBREVIATIONS AND ACRONYMSBAu Banco Austral BCM Banco Comercial de Moçambique BCP Banco Comercial de PortugalBIM Banco Internacional de Moçambique BM Banco de Moçambique, The Central BankCAS Country Assistance StrategyCFM Caminhos de Ferro de Moçambique (Mozambican Railways)CFAA Country Financial Accountability AssessmentCPAR Country Procurement Assessment ReviewCG Consultative Groupc.i.f. cost, insurance, freightDfID Department for International Development (U.K.)EDM Electricidade de Moçambique EMOSE Empresa Moçambicana de Seguros (insurance firm)EMPSO Economic Management and Private Sector OperationFAD Fiscal Affairs Department of the IMFFIAS Foreign Investment Advisory Service (FIAS) of the IFCFMIS Financial Management Information Systemf.o.b. free on boardGDP Gross Domestic ProductGNP Gross National ProductHIPC Highly Indebted Poor Countries Initiative ICR Implementation Completion ReportIDA International Development AssociationIFC International Finance CorporationIMF International Monetary FundINSS Instituto Nacional de Segurança SocialIT Information TechnologyLAM Linhas Aéreas de MoçambiqueMIGA Multilateral Investment Guarantee AgencyMPF Ministry of Planning and FinanceMt MeticaisPAF Peformance Assessment FrameworkPARPA Programa de Acção para a Redução da Pobreza Absoluta (see PRSP)

PEMR Public Expenditure Management ReviewPER Public Expenditure ReviewPETROMOC Empresa Nacional de Petróleos de MoçambiquePRGF Poverty Reduction and Growth FacilityPRO-AGRI Agricultural Sector-Wide ProgramPRSC Poverty Reduction Support CreditPRSP Poverty Reduction Strategy Paper (see PARPA)PSR Project Status ReportQBER Quarterly Budget Execution ReportSADC Southern Africa Development CommunitySISTAFE Public Finance Management Information SystemSME Small and medium enterprisesSTD Sexually Transmitted DiseasesTA technical assistanceTDM Telecomunicações de MoçambiqueTTL Task Team LeaderWB World Bank

Vice President: Gobind T. NankaniCountry Director: Michael BaxterSector Manager: Emmanuel Akpa

Team Leader: A. Franco and J. L. Macamo

MOZAMBIQUEMZ-EMPSO

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 65. Major Factors Affecting Implementation and Outcome 96. Sustainability 107. Bank and Borrower Performance 118. Lessons Learned 139. Partner Comments 1510. Additional InformationAnnex 1. Key Performance Indicators/Log Frame Matrix 16Annex 2. Project Costs and Financing 19Annex 3. Economic Costs and Benefits 20Annex 4. Bank Inputs 21Annex 5. Ratings for Achievement of Objectives/Outputs of Components 23Annex 6. Ratings of Bank and Borrower Performance 24Annex 7. List of Supporting Documents 25

Project ID: P049878 Project Name: MZ-EMPSOTeam Leader: Antonio S. Franco TL Unit: AFTP1ICR Type: Core ICR Report Date: December 30, 2004

1. Project DataName: MZ-EMPSO L/C/TF Number: IDA-37090

Country/Department: MOZAMBIQUE Region: Africa Regional Office

Sector/subsector: General public administration sector (35%); General transportation sector (25%); Banking (20%); Telecommunications (15%); Oil and gas (5%)

Theme: Macroeconomic management (P); Public expenditure, financial management and procurement (P); Regulation and competition policy (P); State enterprise/bank restructuring and privatization (P); Infrastructure services for private sector development (S)

KEY DATES Original Revised/ActualPCD: 12/05/2000 Effective: 10/09/2002

Appraisal: 09/28/2001 MTR:Approval: 08/29/2002 Closing: 07/01/2004

Borrower/Implementing Agency: GovernmentOther Partners: None

STAFF Current At AppraisalVice President: Gobind T. Nankani Callisto E. MadavoCountry Director: Michael Baxter Darius MansSector Manager: Emmanuel Akpa Philippe H. Le HouerouTeam Leader at ICR: José Luís Macamo Peter Moll and Antonio FrancoICR Primary Author: José Luís Macamo

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: SSustainability: L

Institutional Development Impact: MBank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:The primary objective of EMPSO was to support the Government's program to consolidate macroeconomic stability and to lay the foundations for sustained private sector-led growth over the medium term. To that end EMPSO aimed to contribute to: (i) supporting the implementation of actions identified by the PARPA in the areas of public financial management and financial sector supervision (including both banking and non-banking financial institutions) to reduce the risk of financial crisis; (ii) improving macroeconomic stability as a prerequisite for sustaining growth over the medium-term; (iii) improving the investment climate for the private sector; and to (iv) laying the foundation for legal and judicial reform, both to sustain economic growth and also to enable the sector to address key legal challenges of modern societies.

These objectives are relevant with respect to the Bank’s current Country Assistance Strategy (CAS) for 2004-07 whose pillars are: (i) Improving the investment climate; (ii) Expanding service delivery and (ii) Building public-sector capacity and accountability. During the consultative discussions of the current CAS in August 2003, members of the Mozambican Cabinet reaffirmed the strong alignment the CAS and Government priorities set by the PARPA and annual plans (PES) and budget (OE).

The setting of these objectives took into consideration the macroeconomic performance of Mozambique between 1996-2001. Mozambique’s economic performance during these six years (before the Economic Management and Private Sector EMPSO came into effectiveness in October 2002), was quite impressive. GDP growth averaged 9 percent per year. Accumulated end of the year inflation had decreased from 56.9 percentage in 1996 for three consecutive years to one digit inflation rate (5.9, -1.3 and 4.8 percent) interrupted by the negative effects of the devastating floods that took place in 2000 and 2001 corroborated by the impact of the banking crises that began to emerge. Exports grew at an annual average rate of 20 percent and GNP per capita increased by around seven percent annually in the period under consideration.

In order to consolidate these achievements mentioned above and guide its efforts to reduce poverty, the Government of Mozambique approved a Five Year Program for 2000-2004 which incorporated an interim Action Plan for the Reduction of Absolute Poverty (PARPA). This plan was endorsed by the Bank and the Fund Boards in March 2000 as the country’s interim PRSP. It formed the basis for the preparation of the Bank’s Country Assistance Strategy (CAS), (approved in June 2000) as well as it set the ground for the preparation of the Government’s poverty reduction strategy articulated in the PARPA 2001-2005. The PARPA was completed in April 2001 and was endorsed by the Bank and the Fund Boards in August 2001 as the country’s first full PRSP allowing the country to achieve the Enhanced HIPC completion point.

The June 2000 CAS and the Government’s Five Year Program adopted identical pillars: (i) increasing economic opportunities through private sector led growth (ii) improving governance and empowerment and (iii) increasing human capabilities. Equally harmonized were the CAS performance indicators and targets to reflect the monitoring plan incorporated in the Program and the PARPA. It was within this context of harmonization and creation of conditions for the achievement of the objectives set in all these documents that the Economic Management and

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Private Sector Operation (EMPSO) was approved in August 2002 and came into effectiveness, as mentioned, in October 2002.

3.2 Revised Objective:The EMPSO primary objective was not revised during implementation.

3.3 Original Components:For EMPSO to achieve its objectives it was agreed with the Borrower to coordinate the implementation of a set of actions and reforms that had to be undertaken during the period 2002-2003. Since all of these actions were designed to lead directly to the second tranche conditions, and took the form of plans to get to that point, it is not necessary to discuss them separately in detail here. Suffice it so say that these preliminary actions were taken in time for project effectiveness in August 2002. The key actions that triggered the release of the Second Tranche can be summarized in the matrix below.

The relationship between the EMPSO Development objectives and the actions that were implemented as required for the release of the Second Tranche can be summarized in the following matrix:

Development objective Second Tranche ConditionsA. Macroeconomic Stability No conditions but the Borrower was expected to

maintain overall PRGF targetsB. Public Sector Management Budget Execution reports reflecting spending of Donor

funds starting with 2002 Q1Incorporate projections of ministerial own receipts (receitas próprias) in 2003 Budget Plans

C. Legal and Judicial Reform Strategic Integrated Plan for the Legal and Judicial Sector 2002-2006 approved

D. Private Sector Developmnet Assessment of BIM completedBank compliance with prudential rules enforcedAudit of 2001 accounts of EMOSE completed and actuarial analysis of INSS initiatedTelecommunications law submitted to ParliamentAdvisers for the privatization of LAM appointed

A short description of actions and reforms aiming to improve public sector management by the Borrower as referred to in paragraph 9 of the Letter of Development Policy, can be presented as follows:

(a) Obtaining data on monthly off–budget revenues, the so called Receitas Próprias (licenses, fees, taxes and other items) by public institutions, computing estimates for the year, and incorporating all such known estimates into fiscal year 2003 budget plans;

(b) Reporting donor-funded expenditures, using the new functional classification, as statistical

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annexes in the budget execution reports, starting with the report for the first quarter of the 2002 fiscal year;

A short description of actions and reforms directed at contributing to legal and judicial reform and promoting private sector development by the Borrower were planned to include:

(a) Approval of the final Strategic Integrated Plan for the Legal and Judicial Sector 2002-2006 by the Borrower’s legal and judicial coordinating board (Conselho de Coordenação de Legalidade e Justiça), in which all the Borrower’s four legal and judicial sub-sectors are represented (Ministry of Justice, Supreme Court, Administrative Court, and Attorney-General); and adoption of respective strategic plans by these sub-sectors;

(b) Receiving the report by the specialist or advisory group that has assessed Grupo BIM, including deficiencies in its system of corporate governance and financial as well as operational risk management which led to extensive risk management failures, and transmittal of such report by the Borrower to the Association;

(c) Transmittal to the Association of a list of the Banks that have received letters from the BM specifying their respective compliance or non-compliance with prudential regulations, in reference to end-June 2002 accounts, duly prepared within international accounting and auditing standards (IAS). This was to be done by the Borrower. The referred list was required to indicate where the banks have not achieved full compliance with prudential regulations, together with the confirmation that the Banco de Moçambique (BM, the Central Bank) has taken appropriate corrective measures;

(d) Completion of: (a) an independent audit of the 2001 Empresa Moçambicana de Seguros's (EMOSE, an insurance state-owned company) accounts, including an opinion on mathematical reserves, valuation of real estate holdings and other fixed assets, information systems and accounting standards; and (b) initial steps of an independent actuarial analysis of the INSS by appointment of consultants;

(e) Submission to the National Assembly of a telecommunications law reflecting the sector policy, satisfactory to the Association; and

(f) Appointing of investment advisers for the privatization of Linhas Aéreas de Moçambique (LAM, the Mozambique state-owned airlines).

3.4 Revised Components:The design of EMPSO was not revised during implementation.

3.5 Quality at Entry:The Quality at Entry is rated as satisfactory. The reasons for this rating include (i) consistency of objectives with the Country Assistance Strategy (CAS) and government priorities and other donor supported programs; (ii) quality of the design of EMPSO; and (iii) reasonableness of assumptions about relevant external factors (such as political risk arising from narrowing of electoral margins of the ruling party, macroeconomic risk related to low confidence in the financial sector resulting

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from financial crisis that hit two main commercial banks and fiduciary risk that was known to be high).

One of the CAS pillars supports private sector led growth. The EMPSO letter of development policy recognizes the importance of the private sector in promoting economic growth. It reaffirms the commitment of the Government to the formulation and implementation of policies and reforms conducive to a business environment that is favorable to the development of private sector activities. Such policies and reforms include the strengthening of bank supervision and liberalization of telecommunication and air transport sectors, both included in the conceptualization of EMPSO.

The quality of the design of EMPSO is seen as adequate and representing and a step forward in the direction of a programmatic multi-year approach to be embodied in subsequent Poverty Reduction Support Credits. Harmonization with PARPA/PRSP allowed for strong ownership of most of the actions supported by the operation. The adoption of a two-tranche approach permitting an earlier disbursement for partial completion of actions and a final disbursement for completion was considered appropriate for taking stock of the implementation of important policies as they were delivered and facilitating financial resources to move ahead.

The operation contributed to the mitigation of some of the risks identified during its conceptualization in particular the macroeconomic risk related to low confidence in the financial sector resulting from financial crisis that hit two main commercial banks and fiduciary risk. Contributing to the strengthening of banking supervision and supporting efforts directed to greater transparency and improved reporting of public expenditures are the main mitigation elements foreseen.

In parallel to the components of EMPSO, Mozambique had successfully implemented four programs with the IMF. In June 2003, the IMF completed its fifth and final review of the fourth program, a Poverty Reduction and Growth Facility (PRGF) arrangement. At the end of 2003 the IMF began discussions on a new program with the authorities. This program was approved by the IMF Board on July 9, 2004. Being Mozambique a prolonged user of IMF resources, the IMF staff under new rules was required to complete an impact study of past assistance as well as prepare a strategy on future assistance to the country before a new program could be arranged. While this study was undergoing, the IMF discussed and agreed with the Government on quarterly targets for inflation, monetary and fiscal performance, and actions to implement the diagnostic reviews of the four largest commercial banks for IAS compliance, and monitore developments in each of these areas.

Evaluation of Objectives

The reforms and actions above were conceptualized to contribute to the attainment of the primary objective of EMPSO as stated in this report.

The integration of donor-funded expenditures and ministerial own receipts in the state annual budget was viewed as linked to the need for improving budget comprehensiveness for the sake of

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spending effectiveness and transparency and improving the relation between the PARPA objectives and the budget resource allocation. It was generally accepted that there was a need to address the omission of these important sources of budget resources. The absence of this sort of intervention would allow for the continuation of one of the main weaknesses in the system and for the encouragement of illicit behavior.

The approval of the Strategic Integrated Plan for the Legal and Judicial Sector 2002-2006 was seen as one important step to address the slow redress by courts and encourage contract enforcement in the medium term. A well functioning legal and judicial sector is still regarded as one of the pillars on a sound business environment.

The interventions in the financial sector were designed as part of a set of actions to prevent serious crisis in the sector, following recent alarming events that contributed to low confidence over the future of the banking system1 as the financial sector is key for the development of the private sector and sustaining a stable and sound economy that would trigger long-term growth. It was generally admitted that there was a need to send a strong signal of commitment to address a number of issues requiring proper management freedom and tools applicable to the sector. This included government withdrawal from two major banks, clarification of the role of supervisors, introduction of flows of information based on acceptable accounting and audit routines and clarification of financial viability of EMOSE and INSS, as two important players in the financial sector.

The reforms in the telecommunications and the air transport sectors were designed to increase competition, lower costs to the user of these services and business operators and diversify the type of services. Presently it is understood that liberalization before privatization is the right policy sequence and not the contrary as a strong regulator needs to be in place.

Interviews with senior officials from the World Bank and from the Borrower and the Implementing Agency that were involved in the preparation, supervision and coordination of all the actions and reforms listed above confirmed that all parties regarded almost all of them as clearly linked to the objective of the EMPSO and important for the country. However, some of the reforms are seen today as having been unrealistic and complex in terms of required time span for their completion, coordination capacity of the Borrower and the legal framework for enforcing their implementation.

The issues of unrealistic time span and or complexity were particularly mentioned with respect to the reforms in the fiscal area where some Borrower senior officials admit that it was only possible to make a start of the recording of off-budget revenues. Officials from the World Bank do not concur completely with this opinion and consider that much more could have been achieved if more efforts had been put in this area. Presently both the World Bank and the Borrower consider it unrealistic to expect an independent actuarial analysis of the INSS completed within two years, as initially intended, but this could not have been foreseen at the time of the preparation of the operation.

1Such events included financial difficulties in two large commercial banks that later required a re-capitalization at

the order of about 4percentage of GDP. This caused serious interest rate and inflation pressures.

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In a few other cases the mandate of the coordinating bodies to enforce the implementation of agreed actions could have been better understood.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:Objectives and outputs by component

The degree to which EMPSO achieved its relevant objective is satisfactory. This conclusion is based on the economic situation prevailing at the time of preparation of the present Implementation Completion Report. It is also based on the fact that all the actions and reforms that were agreed to be undertaken as conditions for the operation to come into effectiveness and seven out of eight conditions that were set for the release of the second tranche were achieved. The overall performance of actions and reforms that were undertaken in order meet the credit conditions for the release of the second tranche can be summarized as follows:

Components Achievement (as required for the release of 2nd Tranche)

Comment

Ministerial own receipts Achieved Recording was initiated but not all off-budget revenues are yet being recorded. There is still more work to be done and the 2005 budget has gone another step forward by including some 0.4 percentage of GDP of these revenues

Donor funded expenditures Achieved Recording was initiated, a study to improve coverage and discuss implications is under preparation for the health sector. SISTAFE implementation will improve recording and tracking of these expenditures

Legal and judicial reform Achieved The plan was approved as required but there is still a long way to go before it brings the desired results

Assessment of BIM Achieved However, there are reservations as good earnings in the past year resulted from revaluation of foreign currency earnings. Provisions for pensions are still inadequate

Bank’s compliance with International Accounting Standards

Partially achieved A waiver was granted but central bank has been following prudential ratios on a quarterly basis as required. So far, most banks still using Mozambican accounting. Many banks will adopt IAS shortly as required in their countries of origin.

Independent audit of EMOSE& Actuarial analysis of INSS

Achieved

Achieved

The audit was undertaken

INSS’ records are being computerized for the first time

Telecommunications law Achieved No TDM monopoly anymore, new companies entered the market

Air transportation Achieved No LAM monopoly anymore, new company entered the market

Combining this summary and the opinions of people interviewed the achievement of objectives and outputs can be presented in more detail and are discussed as follows:

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Ministerial own receipts. The objectives and outputs of this component were achieved. The Government has continued the practice of including “off-budgets” revenues (that is, both ministerial own receipts or “receitas próprias”, and off-budget donor-provided funding) into budget plans. The inclusion of ministerial own receipts was initiated in the ministries of Health and Public Works (2000-2003). For 2004, this form of revenues were planned to amount to Meticais (Mt) 274 billion or equivalent to US$12 million. Actual collections during the first semester of 2004 were of the order of - Meticais (Mt) 104 billion or equivalent to US$4.8 million. The objective of budget comprehensiveness was not achieved. The Government is aware that not all off-budget revenues are yet being recorded but is grateful to EMPSO for having stimulated the process to get started. In implementation of the new Financial Management Information System (SISTAFE) and the 2005 draft budget include 647 billion Mt or US$28 million of these revenues. This is in line with the need for improving budget coverage, which requires a better knowledge of information flows and of the legal nature of various ministerial own receipts. A more comprehensive budget will allow for improved allocation decisions with priority given to poverty reduction, the main focus of government’s fiscal policy. The current draft of the 2005 budget that will soon be sent to parliament is incorporating some 0.4 percentage of GDP of these revenues. SISTAFE implementation with its single Treasury account is bringing higher levels of public finances discipline.

Donor funded expenditures. The objectives and outputs of this component were achieved as required for the release of the second tranche of the operation. It should be noted, however, that work needs to be done to capture donor funding through cross-checking. One of the issues is that although most funding is recorded in the budget the expenditure related to that funding is not completely recorded in the Quarterly Budget Execution Report (QBER), thus the objective of fully reporting these types of expenditures was not achieved. The MPF has managed to track a proportion, calculated at about 38 percentage of total donor off-budget flows as shown in the QBER. This poor recording and reporting of donor funds disempowers the MPF vis-à-vis spending agencies that receive substantial funds directly from the donors. The government is also aware of the need to deal with this issue in a cost effective way and taking into account its complexity. To that end, the government has initiated preparations for an in-depth study of off–budget revenues in the health sector without neglecting possible negative implications of higher coverage on the overall Government wage bill2

and the possible trade off between the extent of the collections and bureaucratic burden that ensuring higher coverage entails. There are high expectations that this study will bring more knowledge about the magnitude of donor funded

2 During the Joint Annual Review in April 2004, the possibility was raised that further inclusion of “off-budgets”

might cause the overall Government wage bill and other important ratios (such as the budget deficit ratio) to exceed the limits that had been agreed upon with the IMF. It was decided to select one particular sector – in the event, health – to examine the implications.

expenditures not captured in the budget cycle and the main reasons for that. It is also expected that this study will shed more light on the way forward until objectives of budget comprehensiveness for the sake of spending effectiveness and transparency are fully achieved.

Legal and judicial reform. The objectives and outputs of this component as required for the

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release of the second tranche of the credit were achieved. However, Donors and other partners that supported the Strategic Integrated Plan for the Legal and Judicial Sector 2002-2006 are of the opinion that this plan is not realistic in terms of costs. There is near unanimity that the price tag is very high. This had led to a request to DANIDA to finance the preparation of a vision study expected to be completed by next year.

Judging from the assessments made by the Government and the Programme Aid Partners or G15 during the Joint Review and the Mid Year Review of the Government’s implementation of the PAF - Performance Assessment Framework (in April and September of 2004, respectively), there is still a long way to go before the results of the implementation of the approved Strategic Integrated Plan for the Legal and Judicial Sector 2002-2006 are achieved. So far only initial steps for the achievement of the results of this plan have taken place. Such steps include the training of new judges and prosecutors. It can be stated that the overall progress in this area has been slow. One of the few exceptions has been the establishment of a common long-term vision in this sector and the conducting of legislative reforms.

Major sources of concern include delays in the elaboration and presentation of a long-term reform program including a system of planning, budgeting, and monitoring that provides priority to the sector services. Further actions are required in order to reduce the prevailing high levels of pending cases and weak performance against all process targets for the sector as a whole. Of particular concern is the lack of progress in matters related to collateral and enforcement of contracts, which discourages investment. Without a clear focus on ways of addressing these issues, the development of the private sector in Mozambique will continue to be slow.

Assessment of BIM. The objectives and outputs of this component were achieved. Seen from the point of view of senior officials from the Ministry of Planning and Finance and the Central Bank, the assessment of Grupo BIM was one important step in the direction of active and preventive bank supervision and improved monitoring of the financial system by the Central Bank. The assessment was also useful for the Grupo BIM itself; it helped clarifying that there was no need for a further capital injection in BIM. It revealed that areas in urgent need of improvement included internal controls, IT system and operational risks. Initial expectations from Bank officials, that proved to be unrealistic, were centered on the need for a forensic audit. Seen from their point of view, it remains unclear to what extent there was willingness in influential segments of the Borrower to move in that direction. The report did not identify mismanagement or wrong-doing and failed to explain precisely what actions led to the financial problems. Its report of findings was sent to the Attorney General's Office but has not yet yielded anything substantive.

Bank’s compliance with prudential rules according to IAS. The objectives and outputs of this component were partially achieved and a waiver had to be requested. In 2001, BM issued a circular requiring banks to adopt IAS as of 2002, but without further definition of how IAS would be implemented. This well-intentioned decision, whose outcome remains elusive, was taken within the framework of the monitoring of key prudential ratios of the commercial banks, an ongoing practice that has been based on Mozambican accounting standards. As the complexity of the preparatory work for the transition to IAS was not properly assessed at the beginning, a waiver of this condition was awarded. Subsequently, it became necessary to provide further technical assistance to help the authorities and the banks to undertake a number of activities. These

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included the diagnostic reviews of four major banks. The diagnostic of BIM was completed in February 2004 and concluded that this bank was in a weak but positive financial situation. The other three diagnostic reviews will be completed shortly. It also included the subsequent preparation of a plan and a strategy for the transition to IAS that is expected to be ready by February 2005. A study on the requirements for the implementation on the IAS by the Central Bank, namely the training needs in its Supervision Department and the diagnostic audits of the impact of IAS conversion on the banking sector is under preparation. It is expected that the implementation of the recommendations of this study will result in a faster transition to IAS, an improved bank supervision and a minimization of risks of crisis in the financial sector, one of the pre-requisites for maintaining macro-economic stability.

Independent audit of EMOSE and actuarial analysis of INSS. The objectives and outputs of these subcomponents were achieved as required for the release of the second tranche but to different degrees. The independent audit of the 2001 EMOSE accounts was completed and the report was presented to the Bank. This action, combined with the publication of a new chart of accounts for the insurance industry in the first semester of 2004, it is an important step for subsequent transition of the insurance industry to IAS in the following phase of the reforms in this sector, with its modernization as the ultimate objective. The development and implementation of a plan for restructuring is one of the challenges foreseen for next year. An actuarial audit of INSS, the state pension fund, was initiated as a necessary step for the stability of this part of the financial sector but had to be suspended. As a result of that, the final objective of the actuarial analysis has not attained while the disbursement condition of recruiting a consulting was fully reached. All INSS records are not computerized. The Ministry of Planning and Finance and the INSS had to hire a company to enter all these records into a computer database. As soon as the database is built it will be possible to conduct the actuarial audit. It is estimated that such an audit would take up to 18 months to complete. As this study is very important for understanding what is going on with INSS long-term financial sustainability it is being taken up again in the context of the PAF.

Telecommunications law. The objectives and outputs of this component were achieved. A new law on telecommunications was prepared with the support of the Bank and approved by the Parliament after an extensive consultative process that turned it satisfactory to all stakeholders including the Bank. The new law ended the monopoly of TDM in the telecommunications sector. It allowed for the separation of TDM and MCel (the mobile phone company) as independent firms and the entrance of a competitor to MCel in the mobile phone industry3.

3 Cell phones in Mozambique evolved rapidly from what was perceived as a luxury product at the beginning to

common product used by all segments of the population from the areas covered by this type of service. It is estimated that there are 760 600 cell phones in the country.

Next steps are expected to include the preparation of by-laws and the introduction of a training program to enhance the capacity of the regulatory body of the telecommunications sector. It is beyond question that the impact of liberalization of the telecommunication services has been positive. More services are available at affordable prices. More business opportunities are being created and transaction costs are being reduced. This makes an important contribution to private

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sector led growth.

Air transportation. The objectives and outputs of this component were achieved. Important steps were given for the privatization of LAM which included the appointment of investment advisers and the development of a short-term restructuring plan covering a number of options for the participation of the private sector in this company. This might involve the sale of LAM's assets to a new company, which will then sell a majority of its share to private institutions and air transport companies. One important policy decision ended the monopoly of LAM in the Mozambican air space.

This allowed the entrance of two competitors to LAM in 2004, one of them operating the same type of equipment to the same domestic destinations. It is noticeable that the main air line operators are using all means to diversify services, offer different prices and center their attention on the clients. The private sector has more options in terms of frequency of flights as well as passenger and cargo fares.

4.2 Outputs by components:

4.3 Net Present Value/Economic rate of return:Not applicable

4.4 Financial rate of return:Not applicable

4.5 Institutional development impact:The institutional development impact may be modest but is positive. This operation was not expected to have a substantial institutional development impact. Even so, some of its components have important indirect institutional impacts. The improved reporting of ministerial receipts and donor funds has brought increased transparency. The discussions around public finance management, private sector development and good governance in particular the reform of the legal and judicial sector, all as key core cross-sector issues of the PARPA, brought the Government to include these in the PAF and PES discussions increasing dramatically the country’s ownership of its reform agenda. With the implementation of EMPSO, the willingness and the capacity to undertake bank supervision have increased. In addition to improved bank supervision, the authorities understood better the need for improved oversight of the insurance and the pensions industry. Also important was the recognition of the role of the Financial Management Information System (SISTAFE) in particular and the public sector reform in general. It should be noted that the developments that led to the creation of UTREL (Technical Unit for the Reform of the Legal Sector) are to a certain extent linked to the implementation of EMPSO. This may contribute to mitigate the high fragmentation that can be noted in the judicial and legal sector with each sub-sector (Supreme Court, Ministry of Justice, Administrative Tribunal and Bar Association) trying to advance their own agendas without a coherent overall vision for the sector. The consolidation of these impacts is expected to take place with important contribution of the next operations, including the PRSCs.

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5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:There was passive resistance to the implementation of some of the actions in the financial sector. This derived from the climate created by the already mentioned events and from the knowledge of the political power of some of the stakeholders who could lose if actions such as complete forensic audit of larger commercial banks had been undertaken in the beginning of the program. It is important to mention that EMPSO was approved in a climate of quick social and political transformation with formation of new elites moving from the public to the private sector. While the preparatory work for the identification of most of the interventions was of considerable scope, the assessment of capacities, interests and commitment of participating implementing agencies could have been better. This was particularly true in the banking sector where privatization attracted former ministers to top positions in the resulting new banks who, by virtue of circumstances, had to be supervised by the people they used to supervise for a long period during the old order. Dialogue was difficult at the beginning and resistance was obvious.

5.2 Factors generally subject to government control:Seen from the point of view of the Borrower, the main factor that affected the achievement of the outcome of EMPSO was the complexity of the actions that were agreed, the lack of harmonization between the technical capacity of implementing agency and the nature of interventions that were conceptualized and, inadequate sequencing between revision of legal framework and implementation of at least the component of EMPSO related to IAS. Before the implementation of EMPSO the dialogue (not to speak of coordination) between key implementing agencies was weak. This resulted in considerable delays in implementation of some of the actions requiring the participation of many actors. It took some time until BIM and Banco Austral understood that the coordinating role of the central bank was not interference but supporting to solve problems and implementing supervision functions set by law. It was also after some time that it was understood that there was a need to revise the law on the chart of accounts first and require the observation of IAS afterwards. Independently of all the aspects mentioned above the dedication of high officials from the Government and the Central Bank and the very positive experiences of donor coordination and harmonization that exist in Mozambique allowed for the achievement of generally satisfactory outcome in the implementation of EMPSO as its was demonstrated earlier.

5.3 Factors generally subject to implementing agency control:Same as above.

5.4 Costs and financing:

6. Sustainability

6.1 Rationale for sustainability rating:It is highly likely that the achievements generated under the auspices of EMPSO will be maintained as a number of them are of durable impact. There is commitment to maintain and expand the reforms. The political situation has been stable. No major internal disputes over the direction of the reform have been heard even in the present political climate of general democratic elections. The ownership of the primary objective of EMPSO (the consolidation of

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macroeconomic stability and laying the foundations for sustained private sector-led growth over the medium term) is a reality that surfaced in the interview with high Government and Central Bank officials. One important contribution of EMPSO was the introduction of new legislation and regulations in sectors of crucial importance for the development of the private sector. New routines were also introduced and there are no signs of possible reversals even in cases of initial resistance.

The assessment of the condition of each component from the point of view of sustainability can be summarized as follows:

Components Sustainability CommentMinisterial own receipts Not yet

sustainable Recording was initiated but not all off-budget revenues are yet being recorded. The 2005 draft budget is recording an additional 0.4 percentage of GDP of these revenues

Donor funded expenditures Not yet sustainable A study based on the health sector is under preparationLegal and judicial reform Highly unlikely Not yet achieved, there is still a long way to go before the

objectives are achievedAssessment of BIM Likely With reservations as good earnings in the past year resulted

from revaluation of foreign currency earnings. Provisions for pensions are still inadequate

Bank’s compliance with IAS Likely But not yet achieved. Many banks will adopt IAS shortly as required in their countries of origin

Independent audit of EMOSEActuarial analysis of INSS

Likely

Unlikely

The audit was undertakenNot yet achieved, INSS’ records are being computerized for the first time

Telecommunications law Highly likely No TDM monopoly anymore, new companies entered the market

Air transportation Highly likely No LAM monopoly anymore, new company entered the market

In its dialogue with the Bank and Donors during the annual and the mid year reviews (April and September 2004), the Government expressed the view that improving public sector management is at the core of its priorities for 2005. This will include working for timely budget execution and reporting, particularly in key priority areas for poverty reduction and at the provincial level. It also includes the roll out of SISTAFE and the preparation of periodic budget reports through this new system.

Private sector development, legal and judicial reform and improved supervision of the financial sector to prevent losses are further priorities agreed for 2005 in the forum mentioned above and materialized in the PAF.

6.2 Transition arrangement to regular operations:

7. Bank and Borrower Performance

Bank7.1 Lending:Bank's performance in identification, preparation assistance, and appraisal of EMPSO was satisfactory although there are some areas in which it could have been improved.

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The Economic Management and Private Sector Operation (EMPSO) was consistent with the government's development priorities since it was an important source of support to the implementation of the actions contained in the PARPA. For the same reason EMPSO was consistent with the Bank’s CAS. Bank teams that were engaged in the preparation of EMPSO provided valuable assistance to the Borrower. The skill mix and continuity of the teams assigned to the preparatory phase were adequate and resulted in a good design of the content of EMPSO, founded in sound preparatory work in most sectors, that took a considerable amount of time.

The Bank team that was engaged in the appraisal of EMPSO took into consideration the commitment of the Government and the implementing agency to coordinate the reforms. As mentioned earlier the appraisal of the legal capacity of the borrower to coordinate the implementation of the reforms according to realistic deadlines could have been more comprehensive. This could have led to a less complex set of reforms in recognition of risks of resistance to the pace of reforms agreed with the Borrower. The Bank could have done better not to expect a thorough accounting of the BIM crisis, as this was not provided anyway. Bank staff would also have done better in terms of assisting the Borrower in defining the transition strategy to IAS.

Independently of the shortcomings mentioned above the financial package of EMPSO was considered appropriate and the amount lent was regarded as adequate. The suitability of the lending instrument is beyond question. Seen from the point of view of the Borrower, EMPSO represented an advance compared to previous operations since in this case there was an immediate conversion of the amounts of each of the two tranches into local funds for budget support as soon as each tranche was released.

7.2 Supervision:The Bank performance in supervision of EMPSO was equally satisfactory. Implementation progress was adequately reported. Four PSRs were completed and the ratings given were considered realistic. In addition to regular supervision missions with sufficient time spent in the field, one of the two co-TTLs met relevant officials from the Government and the Central Bank in many cases on a weekly basis and maintained frequent telephone contact. This allowed for addressing proactively many problems before they became complicated and establishing an action plan with deadlines that enabled the achievement of the second tranche disbursement conditions.

7.3 Overall Bank performance:The Bank’s overall performance was satisfactory taking into account the assessment presented above. The long period of preparation, the combination of supervision and implementation support allowed for mutual understanding between the Bank and the Borrower. It would have been more comfortable for the Borrower to have a better understanding of the distinction between actions that represented the starting of a long process and actions that were to be completed within the life of the operation. It was only during the course of the operation that it became clear to the Borrower that in a number of cases, such as the capturing of off-budgets and the transition to IAS, EMPSO allowed for setting the ground for the continuation of initiated actions in subsequent operations.

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Borrower7.4 Preparation:The Borrower’s involvement in preparation of EMPSO is assessed as satisfactory, although there were some aspects that could have been improved. All types of governmental documents that were regarded as useful for the conceptualization of EMPSO were made available to the Bank, with a few exceptions (that included the purchase contract for Banco Austral). The Letter of Development Policy provided a good overview and rationale for EMPSO and a clear description of the program and its components. The operation was designed to fully reflect the needs of Mozambique. Generally, there was commitment and spirit of collaboration between the Bank teams and the Mozambican counterparts engaged in the preparation of EMPSO. However, as mentioned earlier, preparation of EMPSO took a very long time for a number of reasons, including apparently a resistance of the financial sector to subject itself to a full forensic audit.

7.5 Government implementation performance:The performance of the Government and the Central Bank in the implementation of EMPSO was satisfactory. Both assigned capable (although a small quantity of) personnel to manage the implementation of EMPSO. There was stability and continuity of personnel in the Government and the Central Bank. The same pattern was seen in the sectors covered by the reforms. In most cases this prevented unnecessary delays in the understanding of what needed to be done and in actual implementation of reforms.

7.6 Implementing Agency:Taking into account the evaluation presented in the paragraphs above, the overall performance of the Government and the Central Bank is assessed as satisfactory. The multiplicity of actions and their extension to the private sector required considerable coordination efforts that had to be built gradually. The results on the ground allowed for a clarification of areas where progress was visible, areas that were a source of concern and areas that represented challenges to be addressed by subsequent operations. Equally important was the clarification of staffing and training needs to ensure a smoother transition from operations covering areas of strict government domain to operations covering wider sectors of the economy, including the private sector.

There is no doubt that there is professionalism and willingness to continue the reform process even taking into account that the country had third general and presidential election on December 1-2, 2004. Apparently there are no signs of possible reversals in the commitment to the continuation of the reforms.

7.7 Overall Borrower performance:Taking the above into consideration the overall borrower's performance is assessed as satisfactory.

8. Lessons Learned

The Economic Management and Private Sector Operation (EMPSO) was on the whole a successful initiative that was conceptualized in the right moment for the continuation of a number of reforms contributing to the consolidation of macroeconomic stability and laying the foundations for sustained private sector-led growth.

Based on the assessments presented above and taking into account the opinions of the officials

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involved in the preparation and implementation of EMPSO, the most significant lessons learned from this operation include the following:

• When policy changes are introduced with the right sequencing (liberalization first and privatization afterwards) as it was the case in the telecommunications and air transportation sub-sectors, the response in the supply and the demand for goods and services can be impressive. It was the right sequencing that allowed for the tremendous response to cell phones and the entrance into operation of new air companies;

• Coordination and supervision capacity are crucial for successful implementation of policy changes. There should be an assessment of the capacity of the coordinating bodies focused on identification of possible training and or technical assistance needs and the need for reviewing existing legislation. Privatization of banks could have led to better results if there had been far more supervision, better timing and planning capacity;

• Setting plans is important but more important is the capacity to implement them and to have good monitoring and evaluation systems in place. The Strategic Integrated Plan for the Legal and Judicial Sector 2002-2006 was adopted but so far little has occurred in terms of actual implementation and impact of the prevailing conditions in the sector. Ownership to carry out the reform and avoid fragmentation is very important. The need for a coordination and robust actions is an evidence to be addressed with the creation of the the Technical Unit for the Legal Reform.

• The combination of technical work (e.g. on BER reporting) with the EMPSO conditionality as well as strong interest on the part of IMF and Donors, led to a self re-enforcing process whereby the government attributed increased importance to transparency (in reporting), competition (in air transport and telecommunications) and banking supervision. The result was stronger ownership of the EMPSO objectives by the end of the operation.

• Requiring people who perceive themselves as potential losers to provide political support to undertake painful actions can be unrealistic as illustrated by the resistance to conduct a forensic audit of a state-owned bank;

• Part of the reason for the success of the two liberalization exercises (telecommunications and airlines) is that a technical assistance project was initiated at the same time. This ensured that the Borrower had all the technical information needed. The EMPSO “backstopped” the technical assistance project on the key and difficult policy actions.

• It was very important that there was stability in the composition of missions and counterpart teams from preparation to implementation of EMPSO. This allowed mutual knowledge, better definition of priorities, reaching consensus on progress, having a common understanding of areas of concern and challenges ahead. It was mentioned several times in the interviews that working with the same people from the beginning to the end of the operation and having a co-TTL in the field narrowed cultural differences and expanded the understanding of the envisaged achievements;

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• The setting of clear and realistic objectives, based on good knowledge of the conditions on the ground represent an important element for the type of outcome that is to be achieved. However, when the objectives are clear but not realistic, as it has been seen in a few cases, there might be slow progress of implementation and marginal success during the life of the operation. Such cases included the actuarial analysis of the INSS where it was subsequently found that there are only manual records of data and the time needed for its digitalization should have been properly assessed if the diagnosis of the problem had been more accurate. Another example of unrealistic expectation include the transition to IAS that will have to be continued in the next operations as technical assistance is needed in this area.

The Economic Management and Private Sector Operation (EMPSO) was a good starting point for a smooth transition to operations like PRSCs. The Borrower is more comfortable with programmatic operations founded on phased policies and interventions to be implemented in a more realistic time horizon and involving all direct budget support donors within a common policy reform framework, the PAF.

9. Partner Comments

(a) Borrower/implementing agency:The comments provided by the Banco de Moçambique in the name of the Government:

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(b) Cofinanciers:Not applicable

(c) Other partners (NGOs/private sector):

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Not applicable

10. Additional Information

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Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome / Impact Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

12-month inflation rate 12/30/2002 Target 8%12/30/2003 Target 7%

8.7%13.5%

Ratio of revenue to GDP 12/30/2002 Target 12.8%12/30/2003 Target 13.5%

13.5%14.3%

Ratio of domestic primary deficit to GDP exluding banking restructuring costs

12/30/2002 4.4%12/30/2003 3.4%

3.2%

Overall telephone density 12/30/2002 No target 2%

Output Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

Satisfaction of prudential regulations by banks.

12/30/2002All banks satisfy all prudential regulations by 2nd tranche (anticipated calendar 2003 Q2)

12/30/2003All banks satisfy all prudential regulations

1 bank satisfying all prudential regulations, data on others unavailable

Al but two banks are satisfying all prudential regulations according to Mozambican accounting standards. Large commercial banks are in transition to IAS

Percentage Government ownership in the 2 largest banks (BAu, BIM).

12/30/2002No numerical target for end-2002 but an understanding that the share in BAu will be sold to workers shortly` and the 49% stake in BCM (now 23% in BIM) will be reduced by sale to BCP or to workers.

12/30/2003Government ownership 0% (workers' trust for BAu, sale of BIM shares)

Privatization of Government share in preparation

Number of licences for telephone operators 12/30/20021 private cellular operator awarded a licence after a fair and transparent bidding process.

12/30/2003Mobile licenses issued, 1 to MCel and 1 to a new operator.

1 private cellular operator awarded a licence (Vodacom). Though Vodacom is now threatening withdrawal, alleging undercutting by MCel which enjoys cross-subsidization from its owner TDM

Accomplished

Issuance of a pro-liberalization telecommunications law

12/30/2002New pro-competition telecoms law submitted to Parliament

12/30/2003New telecoms law passed and under implementation

Not submitted. In discussion phase still. Draft law embodies liberalization of cellular access, new operators permitted to invest in fixed lines or use other gateways. Expected April 2003.

A draft was submitted to Parliament in 2003 and approved in 2004

Privatization of TDM. 12/30/2002Investment advisers for TDM privatization appointed by Dec. 2002. The Information Memorandum is expected to be launched by 2003 Q2.

Investment advisers were appointed. Information Memorandum not yet launched as of Dec 2002

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12/30/2003Irreversible steps have been taken to privatize TDM (e.g. actual sale, or offer, or issuance of the information memorandum)

Information memorandum not yet launched

Privatization of LAM 12/30/2002LAM investment advisers appointed. Issuance of the information memorandum for the sale expected during 2003.

12/30/2003Irreversible steps taken to privatize LAM (e.g. actual sale, or offer, or issuance of information memorandum)

Investment advisers were appointed. Information memorandum not yet issued.

Information memorandum launched, proposals received and under consideration

Privatization of PETROMOC 12/30/2002Investment adviser appointed; privatization options paper written; cabinet adopts a privatization strategy

12/30/2003Irreversible steps taken to privatize PETROMOC (actual sale, or offer, or issuance of the information memorandum)

Investment adviser appointed mid-2002; privatization options paper written. Privatization strategy not yet selected.

Action not taken

1 End of project

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Annex 2. Project Costs and Financing

Not Applicable

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Annex 3. Economic Costs and Benefits

Not applicable

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Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/Preparation

JULY 23-AUGUST 13, 2000

OCTOBER 3-20, 2000

FEBRUARY 22-MARCH 22, 2001

5

8

7

COUNTRY ECONOMIST (1);COUNTRY DIRECTOR (1); RESIDENT REPRESENTATIVE (1); ECONOMISTS (2);

COUNTRY ECONOMIST (2); COUNTRY DIRECTOR (1); RESIDENT REPRESENTATIVE (1); SECTOR MANAGER (1); FINANCIAL SECTOR SPECIALIST (1); OPERATIONS OFFICER (2);

COUNTRY ECONOMIST (2); ECONOMIST (1); FINANCIAL SECTOR SPECIALIST (1); PUBLIC SECTOR SPECIALIST (1); PRIVATE SECTOR DEVELOPMENT SPECIALIST (1); FINANCIAL OFFICER (1);

Appraisal/Negotiation

DECEMBER 18, 2001

12 COUNTRY ECONOMIST (2); ECONOMIST (1); OPERATIONS OFFICER (1); CONSULTANT (1); FINANCIAL SECTOR SPECIALIST (1); PRIVATE SECTOR DEVELOPMENT SPECIALIST (1); FINANCIAL OFFICER (1); FINANCIAL ANALYST (1); FINANCIAL MANAGEMENT SPECIALIST (1); FINANCIAL ECONOMIST (1); COUNTRY DIRECTOR (1);

SupervisionOCTOBER 28, 2002

7 COUNTRY ECONOMIST (1); CONSULTANT (1);

S S

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ECONOMIST (1); SECTOR MANAGER (1); FINANCIAL OFFICER (1); PRIVATE SECTOR DEVELOPMENT SPECIALIST (1);

DECEMBER 9-13, 2002

3 COUNTRY ECONOMIST (2); ADVISOR/BANKING, CAPITAL MARKETS & FIN. ENG (1);

S S

DECEMBER 16-24, 2002

3 COUNTRY ECONOMIST (2); ADVISOR/BANKING, CAPITAL MARKETS & FIN. ENG (1);

S S

ICR

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation 41.2 204,4Appraisal/Negotiation 56.4 269,6Supervision 60.6 248,7ICR 21.4 90,1Total 179.6 812,7

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Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

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Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

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Annex 7. List of Supporting Documents

1.Memorandum of the President No. 20521 MOZ , “Country Assistance Strategy (CAS) for Mozambique”, June 14, 2000

2. Memorandum of the President No. 26747-MOZ , “Country Assistance Strategy (CAS) for Mozambique”, October 20, 2000

3. President report No. MOZ-P&553 “The Economic Management and Private Sector Operation (EMPSO)” August 2, 2002

4. Development Credit Agreement No. 3709 MOZ “The Economic Management and Private Sector Operation (EMPSO)” September 11, 2002

5. Note to the Board justifying disbursement of the Second Tranche

6. Aide-Memoire of the Identification MissionOctober 3-20, 2000

7. Back to Office Report following the Identification MissionOctober 27, 2000

8. The finalized Concept Brief December 13, 2000

9. The draft Project Information Document (PID) December 13, 2000

10. Statement of Mission Objectives for the Preparation Mission February 20, 2001

11. Aide-Memoire of the Preparation Mission: general section, excluding financial sector March 22, 2001

12. Aide-Memoire of the Preparation Mission: financial sector componentMarch 22, 2001

13. Package for Negotiations April 16, 2002. The package as cleared by LEGAF.

14. Project Status Reports Seqs 1, 2, 3, 4,

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