October/2013. Growth. Public Disclosure Authorized. Public Disclosure Authorized. Public Disclosure Authorized. Public Disclosure Authorized

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized HIGHLIGHTS: MOZAMBIQUE ECONOMIC UPDATE October/13 Mozambique's economy grew by 8.7 percent p.a. in the second quarter of 13, after a weak first quarter National Assembly approves mid-year revision to the 13 State Budget Growth in credit to the private sector is gaining pace as the Bank of Mozambique lowers main interest rate further to 8.75 percent citing both benign inflation and a weakening external environment The Metical continues relatively stable against the USD and Euro, but it has appreciated over the past few quarters against the South African Rand Mozambique s economy grew by 8.7*percent p.a. in the second quarter of 13 Growth GDP growth reached 8.7 percent per annum in the second quarter of 13. This compares to a.3 annual growth in the first quarter. The economy has recovered from the negative effects of the extensive flooding of the Limpopo Valley in January. Agriculture registered a positive growth rate of 9.5 percent associated with the production of food in areas that were not severely affected by floods. Source: INE Extractive Industries, which is the fastest growing sector (33 percent p.a.), contributed 1.7 percentage points to growth in GDP. Other major contributors to growth were the agricultural (.8 percentage points) and transport (1.7 percentage points) sectors. The electricity and water sector as well as the hotels and restaurants sector however contracted respectively at a rate of 5. and. percent p.a. Real GDP Growth in 13 by sector (percent p.a.) Real GDP Growth Rate (y-o-y) I II III IV I II III IV I II nd quarter 1 nd quarter 13 Agriculture Fishery Extractive industries Manufacturing industry Electricity and water Construction Trade and services Hotels and Restaurants.7 -. Transport and communications Financial services Real estate and services to businesses Public administration Education Health and social protection Other services.7.5 Total GDP Growth Source: INE 1/6

2 may 1 Jul 1 Sep 1 Nov 1 Jan 13 Mar 13 may 13 Jul 13 External sector Record current account deficit by end of 1 Current Account Balance (USD million) Merchandise Trade Balance (USD million) I II III IV I II III IV I II I II III IV I II III IV I II In 1, the current account deficit grew by 73. percent to reach USD 5. billion. In the first half of 13 it reached USD 3.1 billion, compared to USD.7 billion during the same period of 1, in line with the expanding current account deficits, partly the result of a growing trade deficit, caused by imports from the large investment projects in extractive industries and infrastructure. Since most of the projects are still in the construction phase and are relatively import intensive, the large trade and current account deficits are likely to continue in the next few years. Large FDI inflows have continued in 13, amounting to over USD 3.5 billion in the first half of the year and to a large extent providing the needed external financing for the current account deficit. The current account deficit is projected to reach percent of GDP by end-year. International reserves amounted to USD.8 billion by end of August International reserves have been slowly increasing after a slight decline early in the year, and now amount to USD.8 billion. Increasing international reserves in August 13 were the result of payments of capital gains taxes by companies active in the Rovuma basin gas exploration. International reserves are projected to stay at slightly below USD 3 billion by year-end, worth almost 3 months of imports ( months if imports from mega projects are excluded). International Reserves (USD billion) 3 1 Fiscal Sector National Assembly approves mid-year revision to the 13 State Budget The National Assembly approved a mid-year revision to the 13 State Budget in August 13. State revenues increased by 6 percent to MZN 1,9 million compared to the original budget. This is largely due to unexpected capital gains from the extractive industries sector. Slightly better than expected revenue collection has also been reported by the Tax Authority and internally generated revenue from state institutions. External financing has increased due to additional credit from both concessional and nonconcessional sources. Overall, planned expenditures for 13 have increased by 8 percent to MZN 188,7 million. This is largely reflected in a 17 percent increase in investment expenditures, which is both domestically and externally financed. The bulk of increased investment spending has been allocated to post-flood reconstruction. In terms of current expenditure there has been a rise in the wage bill, which is most likely due to increased /6

3 salaries and recruitment of public sector workers, particularly in the health sector. To a large extent the one-off capital gains tax are being used to finance current expenditures, including the increase in salaries, which raises concerns over fiscal sustainability. The size of the deficit (before grants) as a proportion of GDP has increased from 8.5% to 9.6%. Mid-Year 13 State Budget Revision (millions MZN) Original budget 13 Mid-Year Budget Revision 13 Total Revenue 133,773 13,7 Tax Revenue 95,9 1,83 Other Revenue 18,7 19,66 Grants 19,811 3,3 Total Expenditures 17, ,7 Current Expenditure 98,16 1,71 Compensation of employees 8,89 5,56 Goods and Services 18,57 19,79 Interest on Debt 5,6 5,6 Transfer payments 15,5 16,6 Subsidies,67 3,37 Other 5,99 5,6 Capital Expenditure 68,55 79,983 Domestically financed 9,88 3,611 Externally financed 38,65 5,373 Financial operations 8,66 8,66 Active,5,5 Passive 3,8 3,8 Deficit 1,18,996 External financing 37,69 1,3 Domestic financing 3,573 3,573 Source: Direcção Nacional do Orçamento, Ministério das Finanças The execution rate of current expenditures is at 5 percent and the execution rate of capital expenditures is 6 percent in the first two quarters of 13. This shows minimal change compared with the same period of last year. The relatively low execution of capital expenditures is due to slow implementation of several projects. In total, the Government allocated MZN 17,79 million to priority areas in 13, which represents nearly two thirds of the budget. Of this total allocation, the budget execution rate for priority areas has been recorded MZN 39,183 million, which is 36 percent of the original allocation. The proposed budget for 1 was submitted to the National Assembly in September 13. State revenues are expected to increase to MZN 17,37 million. This is largely due to an increase in fiscal revenues, particularly from corporate income taxes and capital gains. Overall, external financing is expected to increase from MZN 6,65 million to MZN 76,885 million. Total expenditures including financial operations are expected to increase to MZN 9,7 million, due to planned increases in compensation of employees, spending on goods and services and internally financed investments. The increase in current expenditures again raises concerns over fiscal sustainability, with total spending projected over percent of GDP. Whilst the overall deficit (before grants) is expected to increase from MZN,995 million to MZN 51,97.9 million, there is minimal change in the deficit as a proportion of GDP due to an expected upward revision of GDP. 3/6

4 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Sep-1 Oct-1 Nov-1 Dec-1 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Feb-1 Apr-1 Jun-1 Aug-1 Oct-1 Dec-1 Feb-13 Apr-13 Jun-13 jun 1 aug 1 oct 1 dec 1 feb 13 apr 13 jun 13 aug 13 Inflation slows down to.5 percent p.a. in August Standing Lending Facility lowered to 8.75*percent; credit growth accelerating Inflation The annual inflation rate fell to.5 percent in August 13 after a 3-month deceleration. Inflation accelerated in the first half of the year as a result of the floods, but seems to have reached a peak in June. Further considerations, such as recovery of food production in the Chókwè-area after the floods and the relatively weak South African Rand, suggest that inflation will remain benign during the year, despite growth in government spending and the credit to the private sector as well as the monetary policy easing. Monetary Policy The Bank of Mozambique lowered its key policy interest rate, the Standing Lending Facility (SLF), to an all-time low of 8.75 percent in August 13 while maintaining reserve requirements at 8 percent. The decision to lower interest rates was based on low inflation and inflation expectations as well as a weak external environment. During the 1- months ending in August, credit to the economy has grown by 3 percent, reaching MZN 137 billion, this compares to 13 annual growth in December of 1. 1-Month Inflation (percent) Source: INE (IPC Maputo) SLF rate and credit growth 3% % 1% % Standing Lending Facility Growth in credit to private sector The Metical continues relatively stable against the USD and Euro, but it has appreciated over the past few quarters against the South African Rand The Metical has remained relatively stable against major trading partner currencies with the exception of the South African Rand, against which it has appreciated over the past few quarters. This relative stability is in line with the performance of the currency over the past two years, which has seen a slight and very gradual depreciation against the Euro and the USD. The real effective exchange rate (which compares the Metical to the Euro, US Dollar and SA Rand taking into account local inflation and weights in trade) does not reveal any significant movement of the currency over the past few years Nominal Exchange Rates, Jan 1, 1 to August 3, 13 3 MZM/USD MZM/EUR MZM/ZAR (RHS) /6

5 Economic News Government of Mozambique provides a government guarantee for a $5 million bond issued by a partly stateowned fishing company Italian Group ENI Pays Capital Gains Tax to Mozambique Forthcoming Natural Gasfired Power Plant in Ressano Garcia Mozambique moves from low to moderate risk of debt distress A recently created company with majority ownership from the Government of Mozambique (Ematum) issued a USD 5 million bond to buy a tuna fleet. The declared main purpose of the company is tuna fishing. The proceeds of the bond will go towards financing the purchase of about 3 fishing boats and patrol vessels (valued between EUR and 3 million, according to the French press), fishing infrastructure, an operations centre and related training. The government-guaranteed seven-year bond was the country's first international bond issue. It was issued privately (i.e. non competitively) at a comparatively high yield of 8.5 percent. The issuance of the bond has raised concerns about transparency, lack of adequate procurement, eroding public investment management procedures and the impact it may have on debt sustainability in Mozambique. ENI has paid USD million in capital gains taxes resulting from the sale by the Italian group of a percent stake in the Area block to the China National Petroleum Corporation (CNPC) for USD. billion. Taxation of capital gains on mining and gas transaction is quite new in Mozambique and the first significant transaction took place with the taxation of the Londonregistered company Cove Energy in 1 at a rate of 1.8 percent. In 11 no capital gains tax was paid when Rio Tinto bought coal explorer Riversdale for USD billion, leading to criticism from civil society organizations. The reception of USD 6 million in capital gains taxes so far this year has started a debate in society on how to best manage natural resource revenues. A new natural gas-fired power plant, a partnership between Mozambican state electricity company Electricidade de Moçambique (EdM) and South African group Sasol, is due to start operating in 1 in Ressano Garcia, district of Moamba, Maputo Province. EdM has a 51 percent stake in the partnership, while the remaining 9 percent is owned by Sasol New Energy, of the Sasol group. The new Ressano Garcia Thermal Plant, which requires estimated investment of USD 5 million, will be the biggest natural gas-fired plant in Mozambique and the second of its kind in the region after a power plant operated by Scottish company Aggreko started operating earlier this year. Mozambique consumes an annual average of 65 megawatts of power and demand is growing by percent a year. The new power plant, which will have a production capacity of 175 megawatts, will meet some of that new demand. In June 13 the IMF board approved a Debt Sustainability Analysis report for Mozambique which changes Mozambique s debt sustainability rating from low to moderate. The main reasons behind this deterioration of the risk rating include (i) a lower discount rate, (ii) a significant increase in debt contracted in the last two years related to an ambitious public investment program aimed at narrowing the infrastructure gap, and facilitating the development of natural resources, and (iii) large movements in the underlying balance of payments with the onset of coal exports and significant commercial investments in natural gas exploration and liquefaction. 5/6

6 Economic Prospects Recent developments show a slight weakening of economic prospects, both for global growth and commodity prices Commodity price forecast (5=1) e 13f 1f 15f Energy Agriculture Growth prospects of Mozambique s main trading partners 1 Fertilizers Metals f 1f 15f CHN EUR IND MLW ZAR ZBW Source: World Bank GEP Source: World Bank GEP In the most recent Global Economic Prospects (GEP) report, the World Bank has slightly lowered projections for key commodities for Mozambique (energy, metals). Lower commodity prices would lower inflation expectations, but it could also affect investments and exports for extractive industries in Mozambique. The latest GEP report forecasts a slow but steady acceleration of growth in the world economy, but it also lowers global growth projections for 13 to. percent (from. percent in January). This is reflected in growth prospects for Mozambique s main trading partners. While growth is projected to accelerate from 13 onwards, growth projections are now lower than they were half a year ago, suggesting a weakening of the external environment. 6/6