Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No: 33574-MZ

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 7.3 MILLION (US10.5 MULLION EQUIVALENT)

TO THE

REPUBLIC OF MOZAMBIQUE

FOR A

FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT

November 3,2005

Finance Sector Unit Ahca Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Ef fect ive 30 September 2005)

Currency Unit = Met ica is

US1.44891 = SDR 1 Met ica is 24,550 US$1

AfDB AML AT AT1 BAu B C M BCP BIM B o M B S D CAS CCCP CFAA C I D A CQ CSD DAF DCA DFID D S A EMOSE EMPSO FATF F C I U FMP FMR F M S FSAP FSCBP FSTAP FSWG GDP G o M GTZ HIPC I C I C B I C R IDA IFAD IFB

FISCAL YEAR January 1 - December 31

ABBREVIATIONS AND ACRONYMS

Afr ican Development Bank Anti-money Laundering Tribunal Administrativo (Administrative Tribunal) Administraqzo Tributaria dos Impostos (Deparment o f Taxation) Banco Austral (Austral Bank) Banco Comercial de Moqambique (Commercial Bank of Mozambique) Base1 Core Pnnciples Banco Internacional de MoCambique (International Bank o f Mozambique) Banco de Moqambique (Central Bank) Banking Supervision Department Country Assistance Strategy Caixa Comunitaria de Crkdito e Poupanqa (Savings and Loans Cooperatives) Country Financial Accountability Assessment Canadian International Development Agency Consultant’s Qualification Central Securities Depository Financial Administration and Human Resource Department Development Credit Agreement United Kingdom Department for International Development Debt Sustainability Analysis Empresa Moqambicana de Seguros (National Insurance Company) Economic Management and Private Sector Operation Financial Act ion Task Force Financial Crime Investigation Unit Financial Monitoring Plan Financial Monitoring Report Financial Monitoring System Financial Sector Assessment Program Financial Sector Capacity Building Project Financial Sector Technical Assistance Project Financial Sector Working Group Gross Domestic Product Government o f Moqambique Gesellschaft fuer Technische Zusammenarbeit (German Technical Cooperation) Heavily Indebted Poor Countries Individual Consultant International Competitive Bidding Implementation Completion Report International Development Association International Fund for Agricultural Development Instituto de FormaqZo Bancaria (Bankers’ Training Institute)

IFRS IGF IGS N F I N S S IT KfW L D P MFD MFI MMF M o F M o J MTR NGO NORAD NPL OED PAF PARPA PDO PFMA RFSP PW PIM PIP PMR PPF PRSC QCBS RFSP RTGS SADC S IDA SISTAFE

S M E SOE TAM TOR TWG UNCDF USAID UTR

International Financial Reporting Standards Inspecqlo Geral das Finanqas (Financial Administration) Inspecqlo Geral de Seguros (Insurance Supervision) International Monetary Fund Instituto Nacional de Seguranqa Social (National Social Security Institution) Information Technology Kreditanstaltfu’r WiederauJbau (German Fund for Reconstruction) Letter o f Development Policy Monetary and Financial Systems Department (IMF) Microfinance Institution Mozambique Microfinance Facil ity Ministry o f Finance Ministry o f Justice Mid-term Review Non-governmental Organizations Norwegian Agency for Development Non-performing Loans Operations Evaluation Department Performance Assessment Framework Poverty Reduction Strategy Project Development Objective Public Financial Management Assessment Rural Finance Support Program Project Implementation Unit Project Implementation Manual Project Implementation Plan Project Monitor ing Report Project Preparation Facility Poverty Reduction Support Credit Quality and Cost-Based Selection Rural Finance Support Program Real Time Gross Settlement Southern Afr ican Development Community Swedish International Development Agency Sisterna de Adrninistraqio Financeira do Estado (Financial Management Information Systems) Small and Med ium Enterprises Statement o f Expenses Titulos de Autoridade Monetdria (Treasury Bills) Terms o f Reference Technical Working Group United National Capital Development Fund United States Agency for International Development Legal Task Force

Vice President: Gobind Nankani

Sector Manager: Antony Thompson Country Director: Michael Baxter

Task Team Leader: Sherri Archondo

REPUBLIC OF MOZAMBIQUE

Financial Sector Technical Assistance Project

CONTENTS Page

A . STRATEGIC CONTEXT AND RATIONALE ................................................................. 1 1 . 2 . 3 .

Country and sector issues .................................................................................................... 1

Rationale for Bank Involvement ......................................................................................... 2

Higher level objectives to which the project contributes .................................................... 4

B . PROJECT DESCRIPTION ................................................................................................. 6 1 . Lending instrument ............................................................................................................. 6

2 . Project development objective and key indicators .............................................................. 6

3 . Project components 7 4 . Lessons learned and reflected in the project design ............................................................ 9

5 . Alternatives considered and reasons for rejection ............................................................ 10

.............................................................................................................

C . IMPLEMENTATION ........................................................................................................ 11 Partnership arrangements .................................................................................................. 11 1 .

2 . 3 .

Institutional and Implementation Arrangements .............................................................. 12

4 . Sustainabihty ..................................................................................................................... 14

Critical r isks and possible controversial aspects ............................................................... 15

Monitoring and evaluation o f outcomes/results ................................................................ 14 . . .

5 . 6 . Credit conditions and covenants ....................................................................................... 16

D . APPRAISAL SUMMARY ................................................................................................... 17 1 . 2 . Technical ........................................................................................................................... 17

3 . Fiduciary ........................................................................................................................... 18

4 . Social ................................................................................................................................. 18

5 . Environment ...................................................................................................................... 18

6 . Safeguard policies ............................................................................................................. 19

7 .

Economic and financial analyses ...................................................................................... 17

Policy Exceptions and Readiness ...................................................................................... 19

Annex 1: Country and Sector Background .............................................................................. 20

Annex 2: Ma jo r Related Projects Financed by the Wor ld Bank and/or other Agencies .... 29

Annex 3: Results Framework and Monitoring ........................................................................ 31

Annex 4: Detailed Program Description ................................................................................... 36

Annex 5: Project Costs ............................................................................................................... 49

Annex 6: Implementation Arrangements ................................................................................. 50

Annex 7: Financial Management and Disbursement Arrangements ..................................... 54

Annex 8: Procurement ................................................................................................................ 62

Annex 9: Economic and Financial Analysis ............................................................................. 66

Annex 10: Safeguard Policy Issues ............................................................................................ 66

Annex 11: Project Preparation and Supervision ..................................................................... 67

Annex 12: Documents in the Project F i l e ................................................................................. 69

Annex 13: Statement of Loans and Credits .............................................................................. 70

Annex 14: Country at a Glance ................................................................................................. 72

Annex 15: L e t t e r of Development Policy .................................................................................. 74

MOZAMBIQUE

ASSOCIATION OTHERS Total:

F I N A N C I A L SECTOR TECHNICAL ASSISTANCE PROJECT

0.00 4.00 4.0 1.25 13.25 14.50

PROJECT APPRAISAL DOCUMENT

FY 06 07 08 09 10 11 0 0

1 Annual 0.75 I 2.95 3.50 2.00 1.00 0.30 , 0.00 0.00 Cumulative 0.75 1 3.70 7.20 9.20 10.20 , 10.50 I 0.00 0.00

AFRICA REGION

0

0.00 0.00

Date: November 3,2005 Country Director: Michael Baxter Sector Managermirector: Antony Thompson

Project ID: PO86169 Lending Instrument: Sector Investment Credit

Team Leader: Sherri Archondo Sectors: Financial Sector (80%), macroeconomic management (20%)

Environmental screening category: C Safeguard screening category: C

For Loans/Credits/Others:

Borrower: Republic of Mozambique

Responsible Agency: Ministry o f Finance Project Implementation Unit: located in Maputo, Praqa 25 de Junho, Edif icio da Geologia Nr. 380. 3rd Floor).

I s approval for any pol icy exception sought from the Board? Does the project include any critical risks rated “substantial” or “high”? Re$ P A D C.5 Does the project meet the Regional criteria for readiness for implementation? Re$ P A D D. 7 Project development objective Re$ P A D B.2, Technical Annex 3 Within the overall framework o f the multi-donor program, the project development objective (PDO) o f IDA’S contribution to the program is to improve the soundness o f the Mozambican banking sector and improve public debt management. Project description Re$ P A D B.3, Technical Annex 4

This wil l be supported by: (a) strengthening the banking sector and enhancing the capacity o f the B o M in terms o f banking supervision, management o f the banking system, and financial infrastructure, including a real time gross settlement system (RTGS); (b) improving financial accountability and transparency by introduction o f IFRS to commercial banks (first phase) and corporate entities (second phase); (c) strengthening public debt management capacity, including development o f a debt management strategy and reorganization and strengthening o f the Public Debt Department o f the MoF; and (d) improving money and government bond market efficiency and depth, including the introduction o f a central securities depository (CSD) and related assistance. Which safeguard policies are triggered, if any? none

Significant, non-standard conditions, if any, for: none Board presentation:

[ ]Yes [XINO

[XIYes [ ] N o

[ X]Yes [ 3 N o

0

0

IDA received the final LDP o n October 27,2005. Other (mainly legal) conditions were specified in the Minutes o f Negotiations dated October 14,2005.

Loadcredit effectiveness: 0 The Government has adopted the PIM in form and substance satisfactory to the

Association. The manual wil l include, but not be limited to the financial and accounting procedures to be carried out by the financial unit.

0 The PIU wil l adopt a financial management system which, in the future, wil l be converted into the SISTAFE system (procurement has begun).

0 The Government has recruited an independent auditor with TOR satisfactory to I D A (auditor has been recruited for PPFs)

Covenants applicable to project implementation: Before signing the Development Credit Agreement (DCA) (only applicable if signed in Washington), the Association must receive f rom the GoM, letters or telexes appointing a representative to execute and deliver the Development Credit Agreement and related documents for the above-mentioned project.

A report wi l l be prepared by the Government and reviewed by IDA by June 30 and December 31 o f each year, which integrates the results o f monitoring and evaluation activities in the implementation o f the project and achievements o f project objectives.

Accounts wi l l be audited annually by a qualified auditor and the audits wil l be sent to IDA n o later than June 30 o f each year (which i s the standard six months following the year-end).

Conduct in collaboration with, IDA a Mid-Term Review (MTR) o f the project no later than 30 months following effectiveness

Maintain a financial management system at the PIU in the form and with functions, staffing and resources acceptable to IDA

Six months after the end o f each financial year, annual reports o f al l licensed financial institutions wil l be sent to IDA

Every six months, the B o M Supervision Department will provide the IDA with a monitoring summary o f its on-site and off-site activities.

A. STRATEGIC CONTEXT AND RATIONALE

1. Country and sector issues

The Government o f Mozambique (GoM) i s committed to an overall objective o f poverty reduction through economic stabilization and the promotion o f economic growth. During the past decade, the Government has taken key steps to provide a stable economy, consistent and comprehensive fiscal and monetary policies, enhanced financial sector management and supervision, a gradual reduction o f government bureaucracy, strengthening o f institutional capacities, and improved governance. The Government recognizes that the scope and efficiency o f the financial sector play an important role in facilitating economic and private sector growth, and reforms in the financial sector need to continue to be pursued.

The G o M has worked closely with the International Development Association (IDA) and other donors to prepare and implement comprehensive development and investment frameworks, in particular, the Poverty Reduction Strategy (PARPA in Portuguese, 2001 -2005), which emphasizes economic growth, public investment in human capital and productive infrastructure, and institutional reform to improve the environment for private investment. IDA has, in turn, worked with the G o M to prepare its Country Assistance Strategy (CAS) in support o f the PARPA. The CAS, presented to the World Bank Board o f Directors on October 20, 2003, focuses on three areas: (i) improving the investment climate; (ii) expanding service delivery; and (iii) building public sector capacity and accountability structures. In the identified areas, the recent Financial Sector Assessment Program (FSAP) has highlighted a series o f issues to be addressed in the proposed Financial Sector Technical Assistance Project (FSTAP).

The core o f the Mozambican financial sector is the banking sector, comprised o f 12 commercial banks. The banking system became fragile following the privatization o f two large, state-owned commercial banks in 1996-1997 and liquidity crises in 2000 at both Banco Austral (BAu) and the Banco Comercial de MoFambique (BCM). This necessitated Government contributions to their recapitalization in both 2001 and 2002 amounting to about 6 percent o f Gross Domestic Product (GDP). Further strengthening o f banking supervision, as we l l as implementation o f International Financial Reporting Standards (IFRS) by the commercial banks and divestiture o f the G o M o f its remaining holdings in the banking (1 1 percent) and insurance sectors, continue to be a priority.

The macro-monetary framework needs to be strengthened. The domestic capital market is s t i l l underdeveloped and domestic debt in Meticais is small, consisting mainly o f Treasury bonds issued for the recapitalization o f the Government’s share in the B C M and BAu, Treasury bi l ls issued by the Ministry o f Finance (MoF) and short-term paper issued by the Banco de Moqambique (BoM). Money and bond markets, the mechanism that could be used for monetary management, are too narrow to be effective. In addition, the debt management framework i s weak with respect to the GoM’s authority to borrow, institutional responsibilities and overall governance structure. A comprehensive public debt management framework and related capacity building are needed to manage external and domestic debt. At this stage, the f i rst objective should be to develop the market for Government securities, thereby providing a market-driven benchmark yield-curve for the issuance o f private securities.

At the sector level, a key weakness o f the financial sector i s l imited access to financial services by Mozambican households, notably in rural areas, and by private enterprises, especially micro,

1

small and medium-sized enterprises (SMEs). Non-bank lending institutions exist, but remain relatively small and ineffective. There are currently three leasing companies, two venture capital companies, and various microfinance institutions, as well as the stock market. Institutions reside primarily in the capital ci ty with a limited corporate and household clientele, and access to financial services is inadequate. There are multiple microfinance institutions, but with the exception o f the largest, which are converting or have converted to microfinance banks, they remain largely weak and disparate, without access to services that could strengthen their operations. The legal and regulatory environment does not support prudent regulation and supervision o f the non-bank lending institutions. Domestic lending and savings environment in this segment o f the market i s vulnerable, with l o w judicial capacity, inconsistent financial reporting standards, problems in the credit information system, and weaknesses in the legal framework for bankruptcy. Sustained high interest spreads and transaction costs reflect inherent structural problems. Without improvements in the above, financial sector deepening for SMEs and in the rural sector wil l remain constrained.

Institutions that could promote greater depth in the financial sector, such as the insurance and pension sectors, are small and suffer from a lack o f transparency, as wel l as weak institutional and regulatory capacity. Currently five insurance companies operate in the sector, which i s dominated by a state company, Empresa Moqambicana de Seguros (EMOSE), with 35 percent o f the market but limited capacity. The pension sector i s dominated by the state-owned, unfunded pension scheme administered by the Instituto Nacional de Seguranqa Social (INSS) which i s under the auspices o f Ministry o f Labor.

In view o f the above challenges, the G o M has collaborated with its development partners to prepare a comprehensive program of financial sector reforms to address policy, institutional and legal constraints to encourage a more efficient operation o f the sector. The Government will give high priori ty to: (i) designing measures to support the soundness o f the banks, including financial transparency and disclosure, and a broad-based strengthening o f BoM’s regulatory and supervisory capacity; and (ii) stimulating a deeper and more vibrant market for assets denominated in Meticais, through a concerted effort to strengthen monetary, foreign exchange and debt management. The Government i s also committed to initiating reforms related to improving access to financial services (savings and credit) and the lending environment, as well as to support the development o f markets for longer-term financial obligations associated, for example, with finance o f pensions and insurance. An immediate concern in these areas is to strengthen supervisory capacity to prevent regulatory arbitrage between the relatively large, mainstream banking sector and other, considerably smaller non-bank financial intermediaries and microfinance institutions. The Letter o f Sector Development Pol icy (Annex 15) provides an in-depth description of how Government intends to address the key problems in the sector. The FSTAP, funded by IDA, jo in t ly with other development partners wil l provide critical financial and technical support to the GoM’s program (see Section B1 on Implementation, Partnership Arrangements).

2. Rationale for Bank Involvement

The World Bank (the Bank) has been involved in the Mozambican financial sector since 1993, when the country, recovering from i t s long c iv i l war, put priori ty on developing and strengthening institutions related to pol icy and institutional reforms in the financial sector. In this context, the Financial Sector Capacity Building Project (FSCBP, Cr. 2607-0, TF-20849),

2

which closed in March 2001, supported the Government’s initial efforts to transform the financial system from a mono-banking system to a market-based financial system. The project aimed at: (a) strengthening the Central Bank to enable i t to administer monetary pol icy and carry out effective regulation and supervision o f the financial sector; (b) providing a regulatory and institutional framework to deepen the financial sector; and (c) supporting the systematic issuance of Treasury bi l ls to manage liquidity. The Operations Evaluation Department’s (OED) evaluation o f the Implementation Completion Report (ICR) concluded that the project’s outcome was satisfactory. The project recorded improvements in a number o f areas, in particular in increasing the capacity o f B o M to supervise the financial sector and conduct monetary policy. There was increased capacity in other departments o f the B o M and improvements in the legal and regulatory framework for the financial sector. In addition, the Instituto de Forma@o Bancdria (IFB), the bankers’ training institute, was established under the FSCBP and continues to operate on a sustainable basis with participation from the commercial banks. A lesson drawn from OED’s audit o f Bank-financed projects was the importance o f sequencing financial sector reforms for both financial and private sector development. The proposed intervention builds on the relationship established during the FSCBP and the FSAP undertaken in 2003, whose analysis underpins much o f the work planned under the FSTAP.

The proposed operation also builds on the efforts o f the World Bank’s Economic Management and Private Sector Operation (EMPSO) which supported the Government’s program to consolidate macroeconomic stability and to lay the foundations for sustained private sector-led growth over the medium-term. The EMPSO included measures, among others, to resolve the financial difficulties o f two o f the commercial banks, strengthen licensing procedures and supervision in the financial sector, and further dilute government ownership in the financial sector.

The G o M receives a substantial amount o f external support from donors, with the trend moving from direct interventions to budgetary support. The Second Poverty Reduction Strategy Credit (PRSC2) was signed on September 16, 2005. Donor concerns in a number o f macroeconomic and financial sector areas mirror those o f the Bank, and the Mozambican authorities requested the Bank to coordinate donor interventions in these areas. This request has enabled unprecedented cooperation among development partners in the sector and i s well-aligned with the Paris Declaration. The result i s a broad-based comprehensive financial sector reform program, comprised o f three distinct projects financed by multiple donors under one umbrella. These are: (i) the proposed IDA-financed project with support from the United Kingdom Department for International Development (DFID) and the Swedish International Development Association (SIDA); (ii) a project financed by the African Development Bank (AfDB); and (iii) a project managed jo int ly by the German Technical Cooperation (GTZ) and the German Fund for Reconstruction (KfW). All o f the three distinct donor projects carry the name “FSTAP” to emphasize the coordinated nature o f the projects. The cooperation under FSTAP extends to the semi-annual Joint GovernmentDIonor Review o f the Government’s Performance Assessment Framework (PAF), undertaken by most donors active in Mozambique. This review includes a Financial Sector Working Group (FSWG), which i s co-chaired by the Wor ld Bank. Finally, the Bank i s the critical development partner working on the financial sector in Mozambique and the only institution that takes a comprehensive viewpoint o f the sector.. The Bank’s working relationship with other development partners enables maximum leverage and coordination o f disparate interests and activities in the financial sector, as well as in other vital sectors (e.g. legal reform).

3

3. Higher level objectives to which the project contributes

The proposed comprehensive program, to which the proposed IDA-financed project contributes, i s fully in l ine with the GoM’s financial sector objectives as described in its PARPA and Five- year Plan, namely: (a) modernize the expansion o f the financial system; (b) reinforce regulation and supervision and reduce vulnerability that might affect the financial system; (c) encourage and promote entry o f new financial institutions, therefore increasing competition and diversifying products o f the financial market; (d) promote measures to expand the banking services for better regional coverage with emphasis to the rural areas; (e) continue with actions that contribute to the growth o f national savings; (f) promote the emergence o f credit institutions specialized in micro-finance; (8) increase the degree o f monetization o f the national economy; (h) adopt international accounting standards; (i) expand financial services in rural areas; 6) develop financial services accessible to the medium enterprises and family aggregates; and (k) improve insurance services and social protection (pensions).

These are hr ther described in the PARPA matrix, which has actions defined for the following strategic objectives:

0 Reinforce the regulation and supervision o f the financial system in order to minimize the r isk o f financial crises;

0 Modernize and expand the financial system (new instruments, increased regional coverage etc.);

0 Increase savings on a national basis; and

0 Improve the insurance and social protection sector.

The FSTAP supports assistance toward reducing a number o f the constraints cited above, as wel l as the Government’s objectives under the PAF, which i s the mechanism through which development partners and Government jo in t ly evaluate progress on the overall reform program. The PAF matrix has three objectives related to the financial sector: (i) strengthening accountability in the financial sector; (ii) improving financial intermediation to better cater to SMEs and households without bank accounts; and (iii) improving insurance and social protection. PAF targets, which are actions related to the objectives, are established jo int ly by the Government and development partners o n a semi-annual basis. Targets for 2005 include, for example, submission o f a Bankruptcy Law to Parliament, withdrawal o f the Government from ownership in the banking sector, and carrying out o f an actuarial study o f the social security system.

These and other reforms wil l be supported by technical assistance financed by IDA and parallel projects o f other development partners as shown in the table below.

4

PARPA Matrix

Reinforce the regulation and supervision of the financial system in order to minimize the r isk o f financial crises

PA F Outcomes

Modernize and expand the financial system (new instruments, increased regional coverage etc.)

Increase savings on a national basis

Improve the insurance and social protection sector

Strengthen accountability in the banlung sector

Improve financial intermediation, including for micro, small, medium enterprises and the households without bank accounts

Improve insurance and social protection sectors

Reform Program Com portents

Strengthening the Banlung Sector [IDA]

Improving Financial Accountability and Transparency [IDA/DFID]

Strengthening Public Debt Management [IDNSIDA]

Improving Money and Debt Markets [IDA]

Micro and Rural Finance [KfW/GTZ]

Insurance [AfDB]

Pensions [AfDB]

Improving the Lending Environment [AfDB]

Anti-money Laundering [AfDBI

The proposed IDA-financed operation contributes to the objectives defined in the CAS, in particular, under the pillar o f improving the investment climate and that o f building public sector capacity and accountability. These objectives are, in turn, consistent with those defined in the PARPA and the PAF. The success o f the components financed by the IDA-financed project is dependent on delivery o f the support committed by the other develop partners (International Monetary Fund [IMF], United Kingdom Department for International Department [DFID] and Swedish International Development Agency [SIDA]). However, the r isk o f failure due to this relationship is marginal as IDA financing follows on work already delivered or ongoing. Annexes 2 and 4 provide a description o f technical assistance programs o f other development partners that are involved in the sector.

According to Mozambique’s medium-term growth strategy and the Bank’s private sector development strategy included in the CAS, one o f the three principle economic challenges facing the GoM i s the need to address constraints in the financial sector. Recommendations included: (i) expanding the scope o f financial intermediation with viable banking and non-bank financial institutions; (ii) improving the environment for commercial banks by strengthening supervisory and market oversight, payment systems, and monetary and foreign exchange management, including the introduction o f IFRS; (iii) supporting the development o f the local fixed-income

5

market by improving public debt management; and (iv) improving the legal and judicial environment for financial transactions.

B. PROJECT DESCRIPTION

1. Lending instrument

The comprehensive financial sector program was prepared with total costs estimated to be US$28.5 m i l l i on equivalent. It wil l be jo int ly funded by IDA, other development partners and the Government o f Mozambique. The IDA operation wil l be a US$10.5 million, five-year technical assistance investment credit. Other development partners include: AfDB, DFID, SIDA, GTZ and KfW. In addition, the IMF is providing technical assistance in a number o f different areas, including banking supervision. The team had explored options for basket funding, however at this time this is not feasible. The other main donor, AfDB does not have the mandate for pool ing resources and will provide parallel financing. Furthermore GTZ and KfW do not lend directly to the Government, but provide technical and financial assistance (see Section B1 on Implementation, Partnership Arrangements).

IDA opened two Project Preparation Facilities (PPFs) fol lowing requests from the G o M in amounts o f US$890,000 and US$169,800 o n November 18,2003 and July 8, 2004, respectively. The init ial PPF funds are being used to finance activities to resolve some o f the banking sector issues while the second PPF is used to finance the start-up costs o f the Project Implementation Unit (PIU).

2. Project development objective and key indicators

Within the overall framework o f the multi-donor program, the project development objective (PDO) o f IDA’S contribution to the program i s to improve the soundness o f the Mozambican banking sector and improve public debt management. This wil l be supported by: (a) strengthening the banking sector and enhancing the capacity o f the B o M in terms o f banking supervision, management o f the banking system, and financial infrastructure, including a real time gross settlement system (RTGS); (b) improving financial accountability and transparency by introduction o f IFRS to commercial banks ( f i rst phase) and corporate entities (second phase); (c) strengthening public debt management capacity at the Public Debt Department o f the M o F and other implicated agencies; and (d) improving money and Government bond market efficiency and depth, including the introduction o f a Central Securities Depository (CSD) and related assistance.

The key performance indicators at the outcome level are:

0 The percentage o f banks compliant with improved prudential regulations

0 Debt burden indicators do not signal a reasonable r i sk o f debt servicing difficulties

The above outcome indicators are complemented by the fol lowing results indicators related to specific components:

6

Strengthening of banking sector:

0 Number o f Basle Core Principles (BCP) that B o M i s in compliance with

0 Reduction o f time needed to transfer funds between banks

Improving financial accountability and transparency:

0 Percentage o f banks whose financial reporting is in accordance with IFRS

0 Percentage o f large enterprises with financial reporting in accordance with IFRS

0 Percentage o f medium enterprises with financial reporting in accordance with a simplified IFRS

Strengthened Public Debt Management

0 Annual publication o f public debt reports, including a comprehensive debt inventory

0 Publication o f regular debt forecasts

Improved Money and Debt Markets

0 Treasury security auctions held on a monthly basis

A more comprehensive results framework i s provided in Annex 3. In addition to monitoring project implementation, the project team wil l develop and monitor output indicators for the specific activities in each component on a regular basis. This will provide feedback regarding the effectiveness o f project investments and technical assistance.

3. Project components

A s noted above in part 1, “Lending Instruments”, using the FSAP as the analytical framework, IDA will fund four technical and one administrative component. Recognizing the capacity constraints which exist in Mozambique, the design o f the technical assistance is demand driven, based on in-depth discussions with counterparts. Staff training and institutional capacity building play a dominant role in the project design. Activities are prioritized to facilitate implementation and are reflected in the cost tables (costs are budgeted per year by task) and wil l be part o f the monitoring and evaluation exercise. The work program will be reviewed on an annual basis by the Technical Working Group (TWG), which i s comprised o f representatives f rom each beneficiary. I t may be necessary to adjust the priorities to the needs o f the country during the course o f implementation.

7

The IDA project cost is estimated to be US$10.5 mi l l ion equivalent, broken down as follows: (a) Strengthening the Banking Sector, including the B o M (US$4.8 million); (b) Improving Financial Accountability and Transparency (US$1.5 million); (c) Strengthening Public Debt Management (US$1.05 million), (d) Improving Money and Government Bond Market Efficiency and Depth (US$1.65 million); and (e) Project Implementation (US$1 million). US$0.50 mi l l ion wil l remain as unallocated and may be used at a future time.

Component 1 : Strengthening the Banking Sector, including improving the Institutional Capacity of BoM (US$4.8 million equivalent). This component wil l support activities to strengthen the banking sector by: (i) building institutional capacity o f the BoM, to include supporting the process o f implementing international practices in off-site and on-site supervision and improvements o f financial market infrastructure and information technology (IT); (ii) financing an advisor for the Government to assist with i t s strategy to divest f rom the banking sector; and (iii) strengthening the training capacity at the IFB.

Component 2: Improving Financial Accountability and Transparency (US1.5 million equivalent). This component will support: (i) the transition o f the banking sector to IFRS (phase 1); and (ii) the transition o f the Mozambican corporate sector to IFRS (phase 2). Additional support wil l be provided to the accounting profession, through existing public and private institutions, to modi fy the accounting curriculum to be in compliance with new international accounting standards.

Component 3: Strengthening Public Debt Management (US$l.05 million equivalent). This component wil l support efforts to introduce a comprehensive public debt management framework, which includes policies and strategies to provide, inter alia, better coordination o f the issuance o f debt between the B o M and the MoF. IDA will fol low on SIDA’s support to the GoM o f the development and implementation o f a comprehensive public debt management framework to ensure transparency and accountability in public debt management. In particular, IDA will support: (a) restructuring o f the Public Debt Department o f the M o F and strengthening procedures and controls; (b) consolidating and reconciling the debt database for al l public debt; (c) capacity building for staff o f the Public Debt Department; (d) strengthening information analysis and reporting, including debt forecasting, r i sk and cost analysis and monitoring, debt sustainability analysis, analysis o f loan agreements, and preparation o f an annual report on debt management; and (e) improving the GoM’s cash management policies and procedures in order to reduce the cost o f borrowing and simplify monetary operations. This would include the provision o f technical assistance to review procedures for management o f cash balances in commercial banks and exposure limits, improve liquidity forecasting capabilities, and extend cash-flow forecasts toward a rol l ing 12-month horizon. In addition, assistance will be provided in formulating procedures using Treasury bonds and bills.

Component 4: Improving Money and Government Bond Market Efficiency and Depth (US$1.65 million equivalent). This component will support the development o f more liquid money and debt markets, and strengthen the capacity o f the B o M to implement monetary policy by: (i) improving the efficiency o f the primary Government debt market through regular auctions; (ii) increasing the depth o f the secondary market by providing a range o f instruments; (iii) developing the repurchase (repo) and reverse repurchase (resale) markets; (iv) improving the

8

financial market infrastructure with the introduction o f a CSD; and (v) enhancing registration procedures and tracking o f private external-corporate debt.

Component 5: Project Implementation (US$l million equivalent). The PIU wil l be the focal point and coordinating unit between the development partners and the beneficiary institutions. This component wi l l provide financial support to a professional PIU established to assist in project implementation by financing PIU salaries, office facilities, operating expenses and transportation. As needed, short-term national or international specialists, including a high-level financial sector advisor who wil l assist the PIU, wil l be recruited. The auditing h c t i o n , which wil l be carried out annually by independent, external auditors, wil l also be financed under this component.

4. Lessons learned and reflected in the project design

Special attention has been given to ensure that the project design reflects both the Bank’s experience in Mozambique and that o f financial sector reform projects in other countries. In particular, project design takes into account the challenges inherent in a sector with multiple stakeholders and interests, diverse l inks with the macroeconomic framework and the real sector, long lead times for reforms to take effect, and the need for significant ski l l and capacity building. In particular:

0 The project recognizes the importance o f sequencing financial sector reforms for both financial and private sector development and builds on success o f the FSCBP.

0 The project takes into account that the implementation o f reforms has multiple steps and takes a significant amount o f time. Project implementation i s therefore anticipated to take five years, recognizing that capacity building, dialogue and decision-making among both public and private stakeholders, drafting and implementation o f new standards and regulations, and the carrying out o f studies, analysis o f findings, and decisions regarding follow-up take considerable coordination and time, and are often subject to interruptions that do not necessarily indicate lack o f commitment on the part o f beneficiaries. When such interruptions occur in individual sub-components, overall project implementation wil l be able to continue, ensuring ongoing dialogue in al l areas o f implementation. In addition, the project comprises a substantial amount o f technical assistance and takes into account the institutional constraints by prioritizing and sequencing activities according to the capacity o f the institutions to implement the various components.

0 Ultimate responsibility for project implementation lies in a single Government ministry. The M o F wil l be the principle counterpart for the project, and the PIU has been integrated into the Ministry. The PIU wil l be the focal point to work with beneficiary agencies to implement the project. Given the number o f end-beneficiary agencies, the intention is to reduce the r isk that individual sub-components are “lost” or that responsibility for results i s diffused across several agencies.

0 The project does not assume that a single intervention can affect overall financial intermediation. As a result, development partners came together to design a comprehensive financial sector program, which takes a holistic approach to addressing constraints in financial sector development, including assistance in public debt, banking

9

supervision, financial sector infrastructure, financial transparency, and micro and rural finance, the lending environment, insurance sector reforms, and changes to social security and pensions. Most importantly, the project recognizes that changes in laws and regulations are unlikely to have the desired effect without parallel technical assistance and capacity building. This unfortunately cannot guarantee that the project wil l be successful, but i t is expected that interactions among measures will have a positive impact over the long-term.

5. Alternatives considered and reasons for rejection

The scope o f the project is more limited than that initially considered. The original project design included technical assistance to a much broader range o f financial sector sub-sectors. Fol lowing the review o f the Project Concept Note, IDA’S project was reduced in scope to four areas o f intervention. However, the other sub-sectors have not been neglected. Support for other areas o f Government reform in micro and rural finance, insurance, pensions, anti-money laundering, and improving the lending environment, are supported in parallel operations from the AfDB, KfW and GTZ.

There was support within IDA for the project to include a component for judiciary reform, which directly affects the development o f the financial sector, particularly in light o f the l o w judicial capacity for enforcement o f decisions pertaining to lending and commercial activities. However, the Bank team agreed that, rather than including a component in the project, a stand-alone legal capacity project will be prepared. In addition, the AfDB has incorporated several activities into its project which are related to the legal environment, including assistance for the establishment of a financial investigations unit.

There was also notable interest within IDA for the project to include a component to support the expansion o f financial services to rural areas. However, over the last ten years, numerous development partners have supported the establishment o f microfinance institutions; several o f these have proven quite successfil, and have the potential to transition and become microfinance banks under the new Microfinance Law. Although these MFIs have l imi ted outreach in rural areas, they are increasing their efforts in this direction. Furthermore there i s already a major donor intervention in the area - a jo int AfDBhternat ional Fund for Agriculture Development (IFAD) Rural Finance Support Program (RFSP). At a total o f approximately US$30 mi l l ion equivalent, the project aims to support policy, legal and regulatory, and institutional aspects o f rural finance, as well as to finance potential rural investments. Also, GTZ and KfW which have significant experience in the sector, will (i) support the development o f a microfinance association that wil l have the capability to provide services to microfinance institutions (MFIs) and (ii) provide assistance to existing M F I s to upgrade systems and capacity as part o f their FSTAP project. Given the size and scope o f the RFSP and the GTZ and KfW intervention, IDA wil l not provide direct assistance to the micro and rural finance sector. Since there are already significant interventions in this area by other partners, i t was felt that IDA could not provide added value. In contrast, i t was feared that a rural finance component could simply increase confusion in the sector. An information sharing mechanism with the RFSP will be established to ensure close coordination and collaboration.

At the specific component level, there was some discussion on the details o f the public debt component. The identity o f the institution responsible for carrying out debt sustainability

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analysis (DSA) was discussed in detail by the World Bank team and the MoF. I t was agreed that best practice would suggest that there be a clear allocation o f responsibilities between the unit doing the D S A and that responsible for debt management. The ideal location for the unit doing the D S A is in a macroeconomic unit in the Treasury, but outside o f the Public Debt Department. However this i s not possible as the Treasury does not have such a unit. Therefore it was agreed that the DSA will be done by the middle office o f the Public Debt Department, once the department has gone through its restructuring.

The validity o f supporting a RTGS, particularly given the small financial market was also reviewed by the team. The payment system program falls within the purview o f the Southern Afr ica Development Community (SADC) and it was agreed that the Bank should support this activity under this regional initiative, o f which Mozambique i s part.

Finally, various alternatives were analyzed for project implementation. The first alternative for B o M to implement the project was rejected because the B o M indicated that the M o F should take the lead. The second alternative to use existing M o F staff to form the nucleus for project implementation was also rejected. The Minister o f Finance communicated to the Bank that i ts staff did not have sufficient capacity to implement a program which i s very complex and there remain a number o f sector issues being addressed in the program which s t i l l need to be resolved. Thus, a hybrid approach was adopted. A separate PIU that reports directly to the Minister o f Finance was established. In addition, the TWG, comprised o f the beneficiaries, was established to work closely with the PIU (see Section C.2 on Institutional and Implementation Arrangements).

C. IMPLEMENTATION

1. Partnership arrangements

In response to a request f i om the Government and in l ine with the newly signed Paris Declaration, the World Bank led the effort to coordinate and harmonize donor efforts to prepare a financial sector reform program. The h i t o f this work i s the comprehensive financial sector reform program described in Annex 4. Each development partner agreed to finance clearly- defined activities. Several jo int preparation missions were carried out and partners agreed that to the extent possible, they would harmonize program implementation and coordinate supervision missions in the field. I t i s anticipated that these supervision missions wil l also coincide with the Joint Government/Donor Review o f the PAF, which is carried out semi-annually. To further facilitate this approach, the PIU under the auspices o f the MoF, wil l be the focal point for implementation and ensuring that al l fiduciary requirements (procurement, financial management, monitoring and evaluation and reporting) are met.

A s mentioned above, pooling resources i s not a viable option for AfDB which does not have a mandate to pool resources nor for GTZ and KfW whose support i s provided in the form o f direct technical and financial assistance. S IDA and DFID provided preliminary support to the components managed by the World Bank, while AfDB, GTZ and KfW manage distinct components. The table below summarizes the financial support being provided by each o f the development partners.

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Table 1. Breakdown of Financial Sector Reform Program (by Financier)

2,000,000

In addition, the Bank team i s working closely with the Monetary and Financial Systems Department o f the IMF (MFD), which is assisting the B o M to address recommendations from the FSAP, primari ly in banking supervision, monetary pol icy and foreign exchange operations. They have agreed with Government on a two-year medium-term program.

2. Institutional and Implementation Arrangements

The GoM, on behalf o f the Republic o f Mozambique, wil l borrow US$10.5 mi l l ion equivalent f rom IDA. The project wi l l be implemented over five (5) years. Institutional responsibilities for coordinating and managing the project on a daily basis and providing procurement and accounting services to components wil l be delegated to a professional PIU. The PlU will be headed by the Project Coordinator who reports directly to the Minister o f Finance. He/she will be supported by a procurement specialist, a financial management specialist, other technical specialists (such as the financial sector advisor), and an executive assistant. The PIU will be responsible for providing the necessary guidance to beneficiaries for procurement o f consultants, goods and services, as well as monitoring and evaluation. I t wil l also provide advice o n the overall thrust o f financial sector reforms and cross-cutting issues. Wherever necessary, t imely short-term technical assistance wil l be sought to strengthen the team. This technical assistance could include, but may not be l imited to, expertise in financial sector and debt management issues, as wel l as financial management and procurement and can take the form o f specialized training or recruiting short-term consultants.

The TWG will be chaired by the Project Coordinator and includes high-level representatives f rom the beneficiary agencies. The TWG will provide overall program guidance and strategic oversight. I t w i l l be comprised o f staff f rom the beneficiary institutions who are empowered to make strategic decisions and commitments on behalf o f their agency to ensure that the project continues to advance. I t wi l l meet at least once every quarter to review the progress o f the project and agree on the next steps. Ongoing communication between the TWG and the PIU wil l be important for the success o f the project. Members o f the TWG will prepare quarterly reports on the progress o f their respective activities towards meeting project objectives that wil l be consolidated into a report and be reviewed at a quarterly TWG meeting. Once agreed at the

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TWG, the report wil l be discussed with the Minister o f Finance and a copy wil l be sent to IDA and other development partners.

The primary forum for high-level pol icy dialogue between the Government and the development partners will be the Joint Government/Donor Review o f the PAF. The PAF matrix, which comprises 50 performance indicators, serves to provide a yardstick for measuring the Government’s progress in many areas o f donor collaboration. Financial sector reform, considered a priority o f Government is included and has five indicators elaborated. The Joint Review process includes the submission o f progress reviews and proposed indicators by various sector working groups. As the FSWG i s co-chaired by the BoM, DFID and IDA, there will be close linkages between the FSWG and the FSTAP.

There will also be close collaboration with the IFAD/AFDB funded RFSP. This wil l be done with regular meetings between the project coordinators o f the two programs and information sharing on both programs across al l donors.

To maintain the bottom-up approach which began during preparation, each beneficiary will be responsible for preparing (with the assistance o f the PIU) the terms o f reference (TOR) for consultants, including required qualifications o f consultants and technical specifications for procurement o f goods. Beneficiaries wil l implement their respective components and report to the PIU on a quarterly basis, including any modifications to the procurement and/or training plans. The higher than usual capacity constraints o f the implementing institutions are a concern for successful project implementation and wil l be periodically evaluated. The detailed work plan will thus be carefully aligned to the implementation capacity o f each participating agency and carefully monitored. The work plan wil l be updated on an annual basis. The implementation period is five years which should provide ample time for the project’s execution. I t i s anticipated that there wi l l be adequate prioritization and sequencing o f activities to enable the institutions to advance at a pace which i s comfortable and will provide maximum sustainability.

As noted above, the PIU wil l be responsible for ensuring that al l fiduciary requirements (procurement, financial management, monitoring and evaluation and reporting) are successfully maintained. I t wil l be responsible for financial management and coordinate project accounting, maintain overall records and manage disbursements for the IDA project and those o f the other development partners. The PIU wil l produce quarterly financial monitoring reports and annual financial statements and ensure their timely audit in accordance with International Auditing Standards. The PIU wil l adopt a financial management system which, in the future, will be converted into the SISTAFE (Sistema de Administra@o Financeira do Estado) system, which i s the national accounting system that Government i s developing. Annex 7 provides the financial management and disbursement arrangements in greater detail.

As noted above, the PIU will be reinforced with specialized training and additional staff (as needed) to ensure that i t has the capacity to implement such a vast program involving many development partners. By building capacity in the PIU, the team wil l be able to provide qualified fiduciary services. I t i s anticipated that the program approach wil l prevent a proliferation o f PIUs which further reflects progress towards meeting Paris Declaration objectives.

To ensure that beneficiaries have the capacity to implement their components, the technical assistance program was designed based on in-depth consultation with counterparts and taking

13

into account the Government’s absorptive capacity. Consequently, substantial training and capacity building exercises have been built into the program. The challenge o f developing sustainable capacity in Mozambique (as well as many other countries in Africa) does not only rely on the design o f the program but requires that much deeper pol icy issues (such as salary scales and retention rates) be addressed at a higher political level and may not be resolved in the context o f FSTAP.

3. Monitoring and evaluation of outcomes/results

The FSTAP wil l be guided by a comprehensive results framework as agreed with the IDA and other development partners’ (see Annex 3). The IDA-financed project i s only one facet o f a global program. A s such, Annex 3 was separated into two parts: Annexes 3(a) and 3(b) provide the results framework for the IDA-financed operation. Annex 3(c) provides a comprehensive results framework o f the partners. For the ICR, implementation o f the IDA-financed project would be assessed on i t s own merit. For the majority o f the outcome and results indicators for individual components, adequate baselines and targets were established at project inception. For some indicators as specified in Annex 3, the baseline will be established and targets agreed within the f i rst year o f project implementation. I t i s anticipated that Annex 3(c) will be discussed further with the development partners as the program is implemented.

Monitoring and evaluation o f project activities are key functions that wil l be carried out by the PIU on a regular basis. A quarterly monitoring table and progress reports wil l be prepared by the PIU, approved by the Minister o f Finance and then submitted to IDA and other funding donors for review. These reports wil l assess achievements against the Project Implementation Plan (PIP), a Financial Management Plan (FMP) and overall Procurement Plan that will be prepared and incorporated into the Project Implementation Manual (PIM). The PIU will be responsible for updating the PIP on an annual basis, taking into account experiences and the strategic focus of the project. The PIM includes, among others, guidelines on al l period reporting, and monitoring arrangements. The Mid-Term Review (MTR) o f the IDA-operation wil l be 30 months into the project and wil l include an update o f the FSAP (subject to agreement with Government) that will assess progress in the reform program and provide the basis to make changes in the project. An I C R wil l be undertaken six months after the closing o f the project.

4. Sustainability

The financial sector reform program in general and the IDA project in particular, have a good basis for sustainability, being founded on the Government’s national development strategy and i t s continued commitment to strengthening the financial sector. This has been demonstrated by Government’s track record in implementing financial sector reforms during the past ten years. The Government’s request for a FSAP and then a comprehensive program based on the recommendations, highlight its continued interest in advancing the financial sector agenda. This project provides a second generation o f financial and technical assistance and associated institutional and pol icy support for a well-defined, time-bound process involving financing sector strengthening. The nature o f most o f these actions and the undisputed commitment o f the current Government on these reforms enhances the likelihood that, once implemented, they wil l be

’ T h e comprehensive results framework was extracted f i o m the project documents o f each contributing partner (AfdB, KfW, GTZ)

14

sustained. Moreover, having the inclusion under one umbrella o f different donor-supported reforms in the financial sector is an important asset to sustain ongoing reforms.

As mentioned above, the IDA- operation builds on work supported by the EMPSO and FSCBP. OED concluded that the project’s outcome was satisfactory. The project recorded improvements in a number o f areas, in particular in increasing the capacity o f B o M to supervise the financial sector and conduct monetary policy. There was also increased capacity in other departments o f the BoM, as we l l as improvements in the legal and regulatory framework for the financial sector. In addition, the IFB, which was established under the FSCBP, continues to operate o n a sustainable basis with participation from the commercial banks. A lesson drawn from OED’s audit o f Bank-financed projects was the importance o f sequencing financial sector reforms for both financial and private sector development. The project team has built upon this lesson in project design and wil l continue to work with the Government on the proper sequencing o f reforms. Given the Government’s commitment, the team is confident that actions taken under the proposed project will also be sustainable.

The capacity to analyze issues and to develop and implement strategies i s crucial to the success o f reform programs. Recognizing the weaknesses in base capacity across some o f the beneficiaries, in addition to sequencing activities, the project implici t ly includes building capacity in al l o f i ts components. More importantly, several components focus explicitly on building the institutional capacity, e.g. assistance to strengthen the Public Debt Department o f the MoF. This process had already begun as part o f the FSAP and during preparation o f the project, which was prepared joint ly by the beneficiaries and the Bank team.

5. Critical risks and possible controversial aspects

There are several risks inherent to the success o f meeting the PDO and ensuring sustainability. These include:

0 The soundness o f the banking system at the end o f the project rests o n the abi l i ty o f the B o M to enforce the new regulations and commercial banks’ capacity to implement them. Establishing more stringent regulations regarding loan classification and provisioning may meet resistance from the banking community and the BoM’s authority may be challenged. The project wil l work closely with the IMF whose Monetary and Financial Systems Department is providing technical assistance in this area. (M)

0 There are institutional and legal issues and r isks that currently keep lending interest rates high that cannot be addressed through this project. The Government i s working with IMF to improve monetary policies in an effort to provide a good economic framework for financial sector development. Several judicial initiatives are underway including the World Bank Legal Project. (S)

0 The implementation o f IFRS for the corporate sector (especially for medium enterprises) may take longer than expected since a significant amount o f preparatory work i s required. The implementation o f IFRS in al l sectors requires additional resources to update supporting infrastructure (hardware, software and human capacity). In addition, if the accounting profession i s not strengthened, i t wi l l be difficult for the public and

15

corporate sectors to implement the new accounting procedures under IFRIS. The project wi l l work on the framework and the timetable wi l l be evaluated during the MTR. ( S )

0 Capacity constraints o f implementing institutions may cause delays. T o minimize this risk, substantial capacity building and training activities as requested by the institutions (demand driven) i s included. (M)

0 The success o f the components under the proposed IDA-financed project i s dependent o n delivery o f the complementary support committed by the other develop partners (IMF-MFD, DFID and SIDA). However, the r i s k that this support wi l l not be available i s marginal for the fol lowing reasons: (a) The IMF, through MFD, i s currently providing technical assistance to the BoM in strengthening banking supervision, transition o f B o M accounting to IFRS, foreign exchange management and monetary pol icy management. These funds have been put in the medium-term program (already approved), in terms o f technical assistance over the five-year period o f the project. (b) SIDA has already provided the support for the formulation o f the debt strategy and agreed to provide support to the Department o f Debt Management in the Treasury. (c) DFID has provided support to the B o M in the project related to the transition to IFRS for the banking sector. DFID has already funded the first two phases o f this project and the third phase i s expected to begin in November 2005. The total estimated cost o f this fhding is approximately US$2 mi l l ion equivalent o f which more than US$1 mi l l ion equivalent has already been disbursed. (N)

6. Credit conditions and covenants

Conditions for Negotiations:

The following conditions for negotiations were satisfactorily completed.

0 The Government submitted a draft Project Implementation Manual in form and substance satisfactory to the Association. The document included, but not be l imited to:

- General project description; Description o f components with detailed work plan, procurement plans, training plans, budget, timetable and performance indicators and detailed job descriptions for each member o f the project team, including administrative and professional staff;

9 Clear definition o f responsibility o f focal points or beneficiaries (for TORS, specifications, evaluations, certification and supervision); . Procurement filing procedures

0 The Government submitted to IDA, by September 30, 2005, a draft Letter o f Sector Development Policy (LDP) for Financial Sector Development. This LDP was agreed upon as part o f negotiations. I t included a description o f the Government’s pol icy on financial sector reform and the process that Government wi l l fo l low to implement recommendations provided by the FSAP report.

0 The project chart o f accounts was designed in accordance with SISTAFE law.

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Conditions for Board have been satisfactorily completed:

0

0

IDA received the signed LDP on October 27,2005. Other (mainly legal) conditions that were specified in the Minutes o f Negotiations dated October 14,2005.

Conditions for Effectiveness:

0 The Government has adopted the PIM in form and substance satisfactory to the Association. The manual will include: (a) financial procedures; (b) procurement procedures; and (e) monitoring and evaluation procedures.

0 The Government has started the procurement process to recruit an independent auditor with TOR satisfactory to IDA.

Other conditions:

0 A report wi l l be prepared by the Government and reviewed by IDA by June 30 and December 31 o f each year, which integrates the results o f monitoring and evaluation activities in the implementation o f the project and achievements o f project objectives.

0 Accounts wil l be audited annually by a qualified auditor and the audits wil l be sent to IDA no later than June 30 o f each year (which i s the standard six months following the year-end).

0 Conduct in collaboration with IDA a MTR o f the project no later 30 months following effectiveness.

0 Maintenance o f the financial management system at the PIU in the form and with functions, staffing and resources acceptable to IDA

0 Six months after the end o f each financial year, audited annual reports o f al l licensed deposit-taking financial institutions will be made available to the public; otherwise the B o M would have taken appropriate measures to bring the financial institution into compliance

D. APPRAISAL SUMMARY

1. Economic and financial analyses

Given the character o f this operation, a quantitative economic and financial analysis is not an appropriate tool to assess the returns o f this project. The pace and depth o f the reforms envisioned wil l determine the ultimate economic and financial benefits o f the credit.

2. Technical

The technical merits o f the project design have been examined by Bank staff over the course o f project preparation and are considered sound and in l ine with international standards. The design

17

i s based on analytical work undertaken over the past two years, including the analysis and recommendations from the joint Bank/Fund FSAP, preparatory work undertaken in conjunction with the Bank’s proposed Legal and Judiciary Reform Project, work done in conjunction with the PRSC and the PAF. In addition technical assessments wil l continue throughout the implementation period.

Substantial preliminary work and foundations have been laid in the course o f project preparation with support o f the PPF. The beneficiaries have completed the necessary feasibility and needs assessment studies and the detailed work plans and budgets are a reflection o f this groundwork. The procurement plan was accepted by IDA on October 11,2005.

3. Fiduciary

The overall conclusion o f the financial management assessment i s that the current financial management arrangements in various beneficiaries do not fully satisfy IDA’S minimum financial management requirements. The financial management o f the project wil l therefore be centralized at the PIU and based on the systems established by the M o F in order to mitigate financial risks. The financial management team o f the PIU wil l be strengthened according to its needs. In addition, to establish an acceptable control environment and to reduce financial management risks, the Action Plan outlined in Annex 7 was agreed with IDA and will be implemented prior to project effectiveness.

4. Social

Access to appropriate financial services is a critical tool for poor households to reduce vulnerability. While the IDA-operation wil l not directly address this issue, the project will assist the Government to establish a framework for increased and more efficient access to financial services, and wil l support studies on existing constraints on demand and supply.

Overall, by reducing the fiscal drain from state involvement in the financial sector and from emergency interventions in the sector, and by improving fiscal and debt management, i t i s expected that available resources for important expenditures in health, education, water, and sanitation wil l be increased.

The project wil l coordinate its interventions with the AfDB/IFAD RFSP, where possible, to leverage information and dialogue with the Government on access o f financial services to the rural area. In addition, KfW and GTZ are providing complementary support in this.

Extensive consultations were held with a broad range o f stakeholders, including banks, corporations, and MFIs. All o f which are expected to participate in key project tasks, in particular, implementation o f IFRS, payments systems modernization, banking supervision strengthening, and capacity building in various areas. Such stakeholders wil l continue to be consulted during project implementation.

5. Environment

N o t applicable

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6. Safeguard policies

Not amlicable _________~

Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [ I [XI Natural Habitats (OP/BP 4.04) [I [XI Pest Management (OP 4.09) [I [XI Cultural Property (OPN 1 1.03, being revised as OP 4.1 1) [I [XI Involuntary Resettlement (OP/BP 4.12) [I [XI Indigenous Peoples (OD 4.20, being revised as OP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safety o f Dams (OPBP 4.37) [I [XI Projects in Disputed Areas (OP/BP/GP 7.60)* [I [XI < [X

7. Policy Exceptions and Readiness

No policy exceptions.

* By supporting the proposed project, the Bank does not intend to prejudice thej inal determination of the parties' ciainis on the disputed areas

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Annex 1 : Country and Sector Background

MOZAMBIQUE: Financial Sector Technical Assistance Project

Mozambique is one o f the world’s poorest countries, ranking 170 out o f 173 countries on the Human Development Index. The country is r i ch in under-exploited resources, and in recent years, peace, better policies, rising foreign investment and continued external assistance have al l contributed to encouraging economic performance. GDP grew an average o f 7.9 percent between 1994 and 2003, despite a sharp fall in growth in 2000 due to the devastating floods o f that year. GDP growth for 2004 was 7.2 percent and is estimated to reach 8 percent for 2006.

Medium-term prospects for Mozambique are bright, but the country faces many challenges. A key priori ty o f the Government is the reduction o f poverty through economic stabilization and promotion o f sustainable growth. During the past decade, the G o M has demonstrated i t s strong commitment and has taken steps to provide a stable economy, consistent and comprehensive fiscal and monetary policies, enhanced financial sector management and supervision, a gradual reduction o f Govemment bureaucracy, strengthening o f institutional capacities and improved governance.

Financial Sector Overview

The Mozambique financial sector is small, both in absolute and relative terms, and is dominated by the banking sector. The sector was transformed during the 1990s from a Government-owned, centrally planned system, in which two state-owned banks were essentially arms of Government fiscal policy, to a privately-owned and market-based system.

Private-owned banks now represent more than 95 percent o f the total financial system assets. The system i s highly concentrated, with the largest bank accounting for 46 percent o f total deposits, and with a five-bank ratio o f 94 percent (compared to a median o f 83 percent in sub- Saharan Afr ica and 71 percent in low-income countries). I t i s also characterized by increasing “dollarization”. In 1997, 41 percent o f deposits and 37 percent o f loans were in foreign currency, while in 2005; these figures were 45 percent and 61 percent, respectively. The system’s role in financial intermediation is quite small, and despite l o w deposits, i s highly liquid. The system i s also characterized by a high level o f non-performing loans (NPL) - approximately 21 percent as o f end-2002 - although this i s mainly driven by N P L s within the two major banks.

High levels o f N P L s in those banks were, in part, due to loans made to state-owned enterprises, and in part due to highly risky and/or fraudulent loans made fol lowing the banks’ privatizations in 1996 and 1997. Subsequent crises at BAu and B C M necessitated Govemment contributions to recapitalize in 2000 and 2001, amounting to six (6) percent o f GDP. Four years later, however, the Government has proven i ts commitment to returning the banks to private ownership. The Government i s no longer a shareholder in BAu, and it has publicly announced its intention to withdraw from Banco Internacional de Moqambique (BIM), the successor to BCM. The banks are now controlled by qualified private owners and banking supervision has been enhanced to ensure that al l financial institutions abide by the prudential regulations issued by the BoM. At the same time, the IMF i s providing technical assistance to strengthen the technical capacity o f the supervision team.

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Mozambique has a l ow level o f credit relative to GDP (18 percent). However, l ow levels of financial intermediation i s not unusual in poor countries, as saving mobilization and the marginal propensity to save, as a percentage to GDP i s generally lower in poorer countries. In addition, the level o f financial intermediation is influenced by weaknesses in the macro-economic and macro-financial environment, the overall lending environment and the weak capacity o f potential borrowers. The high credit risk to which banks are exposed results from high and volatile real lending rates and a generally poor lending environment. Real lending rates in Meticais over the period 2001-2005 averaged 16.1 percent (fluctuating between 28 percent and 9 percent). Such high rates most ly reflect large interest rate spreads (14.5 percent), partly caused by the high provisioning requirements on NPL, high operating costs and limited bank competition, which allows banks to profit from adopting the margins o f the least efficient institutions.

Weak property rights, land titling, collateral protection, and legal and judic ia l systems also contribute to l o w financial intermediation. In particular, i t i s largely not possible to pledge real property as collateral, and the unreliability o f the judicial sector in enforcing creditor or collateral r ights encourages lenders to rely on cash (for trade finance) and personal and foreign bank guarantees as the main forms o f collateral. Given the high cost o f finance, the high level of collateral required, and the procedural delays in obtaining external credit, Mozambican enterprises are severely capital-constrained. A large majori ty o f them have to rely o n their own resources to meet their investment and working capital requirements. This i s w e l l exemplified by the fact that, o n average, the 193 firms surveyed for the “2003 Investment Climate Assessment” rely on their internal funds to finance 90 percent o f their working capital and 65 percent o f their investment needs. The study hrther showed that only 29 percent o f the f irms surveyed reported having bank loans. Thus, a Mozambican enterprise’s abi l i ty to invest and conduct business may be restricted by the amount o f internal hnds available at any given moment.

Strengthening banking supervision will be crucial to improving the soundness o f Mozambique’s banking sector. Some progress has taken place in this area over the past two years, since the last assessment o f the BCP, although significant work remains to be carried out in the fol lowing five key areas. First, as most Mozambican banks are foreign-owned, the Banking Supervision Department (BSD) needs to establish regular communication with the head offices o f the banks and the banking supervisors in their countries o f domicile. Second, the current loan classification and loan loss provisioning systems need to be brought in l ine with international best practices. Third, trigger points need to be established that wil l prompt one or more legal actions once a financial institution’s capital falls below the minimum prudential requirements. Fourth, clear steps need to be taken to build the core knowledge o f supervision staff, especially to ensure their capacity to independently validate information received from financial institutions. In addition to the above recommendations, i t i s important to improve market oversight through the adoption o f IFRS for al l commercial banks, which could best be achieved with a well-structured convergence plan. Finally, o n matters o f intervention and discipline, the FSAP recommended that B o M rely more on specific restructuring actions than on monetary fines, and that B o M undertake a review o f the legal and regulatory framework for bank resolution.

Institutional and capacity in the accounting profession remains weak. The Government recognizes that without an effort to strengthen the accountancy profession, in terms o f restructuring the curriculum of the accounting courses, provide training and promote the relevant private and public institutions, i t wil l be dif f icult for the SISTAFE, as we l l as the IFRS to be

21

successfully implemented. Therefore, there i s a crucial need to better promote private accounting institutions in the country that wi l l enable the country to start developing a pool o f qualified accountants and auditors. There is currently an Association o f Professional Accountants in Beira and this effort needs to be extended to Maputo.

Related to banking supervision, the Government enacted an Anti-Money Laundering (AML) Law in February 2002, which established the legal framework for combating money laundering. Regulations under the law were approved in August ,2004. In general, the law and its regulations are considered comprehensive and in l ine with international requirements. In particular, the law complies with the recommendations o f the Financial Action Task Force (FATF) on money laundering. The law obligates financial institutions to undertake customer due diligence, obtain information on complex and/or unusual transactions and maintain good record-keeping. Financial institutions are required to report suspicious transactions to the prosecutor’s office, without disclosing the information to the customer under investigation. The law also provides for the confiscation o f property used or to be used for money laundering activities.

There are no provisions for the establishment o f special investigation unit for financial crimes which is needed for the effective implementation o f the AML law. The need i s borne out o f the fact that the nature o f financial crimes is very different from other types o f criminal activities, and therefore requires different types o f resources (skills, equipment, etc.) for investigation and prosecution. The Government has thus agreed to set up a special Financial Crimes Investigation Unit (FCIU). Technical assistance to establish the unit, train staff, and develop procedures and programs wil l be provided by the AfDB.

Monetary Policy, Public Debt Management and Development of the Money Market

The B o M conducts monetary pol icy in a dif f icult setting characterized by a high propensity to transact in cash, and shallow financial markets. This i s further complicated by the influx o f large external grants and loans (in excess o f 10 percent o f GDP) to finance the country’s large fiscal deficit and poverty reduction strategy, which injects vast amounts o f liquidity into a thinly monetized economy. Although the sharp tightening o f monetary pol icy that took place in mid- 2001 appears to have been effective in stabilizing prices and the exchange rate, i t contributed to the high level and volatility o f interest rates mentioned above. In order to reduce such volatility (of both prices and interest rates) and enhance the scope for local currency intermediation, the B o M needs to adopt a more transparent, consistent and forward-looking, monetary management.

To achieve this goal, the current monetary framework needs strengthening. The framework currently lacks transparency, and market participants apparently do not fully understand the goals or operational framework o f monetary policy. This partly reflects the need for the B o M to increase its efforts to communicate and explain i ts goals and operating procedures, as wel l as improve the operation o f its monetary instruments that send conflicting signals on the BoM’s stance on monetary policy. Acting preemptively to limit deviations f rom monetary pol icy objectives wi l l also require strengthening BoM’s analytical capacity and greater emphasis on inflation targets and liquid management. At the same time, i t is important to rely more closely on an intermediate monetary target. T o enhance transparency and avoid interfering with market signals, B o M may need to conduct its monetary operations in the overnight money market. The IMF i s providing technical support in this area.

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Domestic debt in Meticais i s small, consisting mainly o f Treasury bonds issued for the recapitalization o f banks. The money and bond market are too narrow to be effective in monetary management, Le., to provide an anchor for yields o f longer maturities and to manage aggregate demand. A credible monetary policy i s essential to anchor expectations, encourage the balanced use o f foreign and local currency for financial intermediation and promote financial deepening, particularly for longer maturity instruments. In general, enhancing the credibility o f monetary pol icy should remain a key priority.

Developing a strong government securities market is a key step towards deepening the scope o f financial intermediation and promoting the development o f a capital market. In addition, i t would help the financing o f the government deficit in a less destabilizing manner and limit the Government’s currency exposure. There are a number o f issues that need to be tackled, however, before the government securities market can be developed more fully. This includes changes to the Government’s management o f the public debt, as well as establishing the infrastructure for government bond issuance and trading, i.e., the money market.

The Government anticipates working to strengthen the management o f public debt and develop a medium to long-term strategy for the management o f both external and domestic debt. This would include: (i) developing a sound institutional and legal framework for debt management, including the preparation o f laws and regulations and o f written procedures and the clarification o f the borrowing authority; (ii) preparing a medium-term strategy aimed at post-HIPC (Heavily Indebted Poor Country) debt sustainability; (iii) building capacity for incurring and sustaining the domestic debt, which would include the development o f public securities market; and (iv) carrying out an evaluation o f the private sector foreign debt to identi fy risks and vulnerabilities to fluctuations in the exchange rates. Efforts would include a focus on improving governance and the formulation o f a debt management strategy adopted by the G o M and the development o f a comprehensive and reliable database o f public debt, which i s an essential.

A common issue for HIPC countries is where to place the responsibility for performing DSA. In a number o f sub-Sahara countries, preparing a DSA is seen as the role o f the Debt Management Unit. However, as sustainability i s mainly a fiscal pol icy issue, the macroeconomic forecasts and/or future budget surpluses, for example, wil l decide whether the debt is potentially sustainable or not, while debt management deals with the structure and risk exposure o f the debt. Whi le the risk profile is an important element in determining whether or not the debt i s sustainable, the responsibility for performing DSA should l ie outside o f the debt management office, with the Debt Management Unit providing input in the form o f projected costs to the debt under different scenarios for the government’s primary deficit and market rates. While this is best practice, the project design recognized the constraints on the ground. In Mozambique, the ideal location for the Unit should be in a macroeconomic unit in the Treasury but outside o f the Public Debt Department. This i s not possible as the Treasury does not have such a unit. Therefore i t was agreed that the DSA will be done by a middle office o f the Public Debt Department, once the department has gone through i ts restructuring.

With respect to the development o f the money market, a number o f areas need to be strengthened. Activi ty in the money market i s currently concentrated in public sector debt instruments and the overnight inter-bank market. Progress has been made in liquidity management operations, which are now carried out mainly through the use the Treasury bills and ultra-short T A M S (Titulos de Autoridad Monetaria). However, structural issues that contribute

23

to segmentation o f liquidity among banks should be addressed, including the lack o f a repurchase market and other operational risks. In addition, the Treasury bill market is shallow, in part because the volume issued at each maturity i s quite variable, which produces a fair ly discontinuous yield curve and precludes the emergence o f a stable benchmark for market rates. In coordination with the goals for public debt management, focus should be on developing security issues whose rates can be a reference point to other instruments and that also enjoy a fair level o f liquidity.

Micro and Rura l Finance

Improving access to finance for micro enterprises would also contribute to enabling micro and small business growth. The microfinance industry i s relatively young. Although it has grown rapidly and shows significant promise, i t s t i l l has a relatively small outreach, with a high concentration in Maputo. There are good prospects for i t s development in Mozambique and several best performing MFIs are already in partnership with well-known, international microfinance service providers. In general, the microfinance sector in Mozambique is st i l l at an embryonic stage with few large MFIs moving towards consolidation and the majority, main ly smaller donor-funded programs struggling to survive and grow.

The B o M recently issued a new regulation for the microfinance sector, establishing mult iple categories o f “microbancos”, or MFIs. Some fal l under the prudential regulations o f the BoM, while others require only registration with the MoF. The emergence o f this regulatory framework i s expected to elevate the status o f microfinance industry, which is becoming an essential sub-sector o f the formal financial sector in Mozambique.

Microfinance institutions can be categorized in two groups. The first group comprises the large MFIs (Novobanco, SOCREMO, Tchuma) that are making the transition to commercial sustainability and are converting to prudentially-regulated microfinance banks. These institutions are targeting the top tier o f micro-enterprises through individual lending. These programs have grown significantly, both in terms o f portfolio and outreach, with a fair ly large number o f clients and average loan sizes. The second group includes the smaller, donor-financed MFIs which are more often in secondary cities or in rural areas. These institutions are struggling to achieve operational self-sufficiency and are far from reaching financial sustainability goals. Average salary and administrative costs are high, due to the very limited supply o f qualified staff, administering relatively small loan portfolios. This group st i l l remains well outside o f the larger financial community.

The latter tend to concentrate on poorer segments o f the population, often without ongoing businesses, per se, using group methodologies. The Mozambique Microfinance Facility (MMF) is an ongoing CIDA-funded (Canadian International Development Association) project that acts, in part, as a clearinghouse for sector information. The number o f microfinance clients has remained relatively stable over the last several years (approximately 50,000 clients), whi le the total microfinance portfolio has increased substantially, from approximately US$5 mi l l ion in late 2002 to nearly US15 mi l l ion at the end o f 2004. These figures do not include extremely small MF Is generally located outside o f urban areas. There are perhaps an additional 10,000 clients and US$3 mi l l ion in outstanding portfolio from these programs.

Outside o f the largest programs, there remains a significant need to bring more professionalism and transparency to the sector. Approximately 12 M F I s are in contact wi th the MMF. However,

24

there may be as many as 20 to 30 extremely small programs supported by donors and small NGOs throughout the country. Significant funds have been directed to the sector (in many cases far more than the portfolios o f programs themselves), but this has not necessarily been accompanied by the transmission o f experience developed elsewhere. These multiple efforts have not been we l l tracked or analyzed. There i s a recognized need for good technical partners that can work with the smaller MFIs, for transparency through an accepted monitoring tool, and capacity building to improve management systems.

With only a few exceptions, microfinance does not serve rural areas due to high costs involved in service delivery. Constraints to providing financial services in rural and remote areas include: very l ow population densities, low levels o f economic development particularly weak or non- existent markets, poor physical and communication infrastructure, and l o w skills and experience. There i s economic activity extending into these areas such as in Manica, where Zimbabwean farmers are bringing skills and experience, and in the Beira corridor, infrastructure and financial services wi l l follow.

The two large M F I s servicing the rural communities are not able to achieve scale and generate sufficient profits. CCCP (Caixa Comunitaria de Crkdito e Poupanqa) and FCC operate in rural areas in northern Mozambique. However, FCC i s closing down their work in Nampula following continued poor performance and pull-out o f the United National Capital Development Fund (UNCDF) support. CCCP reports sufficiently good performance o f their associatiodgroup lending schemes in Cab0 Delgado, although i t i s not yet operationally self-sufficient. In addition, U S A l D (United States Agency for International Development) reports good performance o f commercial (non-MFI) lending to segments o f agriculture in the Beira-Nacala corridor. The commercially-oriented MFIs report that they have looked into operations in rural areas, but that until operational and commercial viability i s more likely, they will not expand into remote rural areas. There i s a strong case for increased donor investment to in i t ia l operations o f MFIs willing to expand operations to cover the under saved remote rural communities. The planned parallel AfDB and IFAD projects (RFSP), which i s under the auspices o f the Ministry o f Planning and Development, wil l assist the Government to develop and implement a strategy for rural financial development, including support to institutions interested in establishing or expanding operations into rural areas and funds for on-lending.

MFI Portfolio Information, end 2004 (US$)

Source: Mozambique Micro finance Facility (MMF)

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Few MFIs (Novobanco, SOCREMO, Tchuma) have already registered under the Banking Law, and are regulated and supervised in the same manner as commercial banks, although with lower minimum capital requirements until end-2005. Novobanco began accepting deposits approximately a year ago, and the number o f deposit-only clients is already far larger than borrowing clients. SOCREMO is slowly experimenting with deposit services as well. The success o f Novobanco in this regard points to the strong demand o f micro clients for formal savings services, which are not offered by commercial banks. Novobanco i s considering to expand its deposit-taking activities into rural areas. The new regulation appears to encourage diversification o f the microfinance industry, particularly the postal financial services and rural financial intermediation. The next tasks for both the B o M and MFIs would be to operationalize the regulations, to adapt supervisory practices to M F I s that are prudentially supervised or may fal l under the new “microbank” rules, and to bring MFI reporting to an appropriate level o f professionalism.

Insurance and Pensions

The insurance and pension sectors in Mozambique are small and suffer f rom a lack o f transparency, as wel l as institutional and regulatory capacity. This could mask sizeable contingent fiscal liabilities, as neither the state insurance company (EMOSE), nor the state pension scheme (INSS), regularly disclose reliable financial statements based o n independent actuarial evaluations. The insurance sector (regulated by the MoF) and the pension sector (regulated by the Inspeq6o Gerul de Seguros [IGS]), need to strengthen the capacity o f the regulator.

The Insurance Sector

The insurance sector in Mozambique is very small, dominated by EMOSE, and has l imited capacity. Total insurance premiums at the end o f 2001 were US$20.4 m i l l i on (0.6 percent o f GDP). L i f e insurance i s negligible, at only two percent o f the sector, mainly due to l ow income levels and adverse health conditions, as well as some technical issues such as outdated mortality statistics. Non-life insurance includes property, natural hazards, construction and engineering insurance products. The monopoly o f EMOSE was ended by the liberalization o f the sector in 1991 and currently four companies operate in the market. There are no restrictions on foreign ownership o f insurance companies and since the sector’s liberalization, a few insurance foreign insurance companies have entered the market. However, EMOSE holds the largest share in the market, valued at approximately US$30 million. As a result o f the country’s l imi ted capacity to underwrite risk, around 30 percent o f insurance premiums are reinsured abroad.

The regulatory body for the insurance industry, IGS, has been in place since July 1999. I t has seven technical staff composed o f lawyers, economists and accountants, but does not have an independent budget. Despite the improved regulatory framework for insurance supervision brought about by the new Insurance Law enacted in January 2003, several important issues remain to be addressed. It i s recommended that the new law be reviewed and revised in order to address several identified weaknesses, including the regulation o f insurance contracts, guidelines on investments, and the enabling o f proactive supervisory action against weak institutions. The IGS has yet to establish a detailed supervisory framework and prudential regulations to guide the conduct o f the sector, which it needs to do. Also, although a new chart o f accounts for insurance companies has been developed and has been in effect since mid-2005, the IGS needs assistance

26

in developing transitional measures for its implementation. In conjunction with these actions, the technical capacity o f the IGS needs to be substantially strengthened to be able to effectively supervise and enforce the laws and regulations governing the sector. Most IGS officers lack insurance supervision experience; a few officers have a background in economics and law, most lack in-depth knowledge o f insurance. There is, therefore, an urgent need to develop a robust capacity building program for the IGS if i t is to adequately perform its regulatory functions. In addition, the insurance law gives the responsibility o f supervising supplementary pension funds to the IGS. Whi le there has been discussion o f legislation for the establishment o f such funds, there is no detailed framework as yet. There is therefore a significant need to develop an appropriate framework for such funds and to develop the skills to regulate them.

T h e Pension System and the Social Security System

Pension institutions are generally good sources o f long-term funds which are made available to the financial sector. The pension sector in Mozambique, however, i s dominated by a state- owned, unfunded pension scheme administered by INSS, which is also the supervisor o f the sector. Potential quasi-fiscal contingencies need to be assessed through an actuarial evaluation. In addition to the state-owned scheme, some corporate pension schemes exist, however, these are not regulated or supervised.

The current social security system covers only the formally employed. Given that the Mozambican population i s predominantly rural and/or self-employed; the coverage o f the system relative to the economically active population is very low. For example, available data shows that there are 3 1,000 registered companies in Mozambique, employing about 300,000 workers, against an economically active population o f 9.4 mil l ion. The l o w level o f coverage raises equity questions. There is, therefore, the need for a detailed study to look at viable options to strengthen the social security system in the country.

The level o f compliance in the existing system i s very low. INSS records show that there are approximately 543,000 registered participants in the system, representing 68 percent o f salaried workers. However, more importantly, only 164,000, or about 30 percent o f the registered participants, are active contributors to the system. One reason for this l ow level o f compliance i s the weak administration which does not give confidence to the participants in the system. The processing and payment of benefits i s very slow, and beneficiaries suffer significant delays before receiving their benefits, if at all. Most o f INSS’ activities are processed manually, with l i t t le or no IT assistance. The manual processing o f large volumes o f information explains the large number o f staff o f the INSS, about 1,830, as compared to the active participants. N e w IT i s being developed for the INSS which should address some o f INSS’ administrative deficiencies. However, the INSS’s organization weaknesses go beyond lack o f technology and a complete reengineering o f the institution is recommended.

There is a need to improve the transparency and accountability o f the pension system. For instance, the INSS does not disclose its financial statements or i ts investment policies. There i s no legal reason why this should be so. The I N S S legislation requires the agency to prepare and publish its financial statements in its annual report. The INSS also needs to adopt more transparent and professional procedures in making i ts investment decisions.

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The Legal Environment for Lending

Efforts to improve the Mozambican financial system need to take into account the poor legal and judicial environment in which financial transactions take place. Lncluded in this environment are the inadequacies o f the contractual framework in Mozambique. The provision o f credit requires predictable, transparent and affordable enforcement o f both secured and unsecured credit claims by efficient mechanisms outside insolvency, as wel l as a sound insolvency framework. The procedures for enforcing rights should enable parties to rely on contractual agreements, which in turn, support confidence in lending and investments. Uncertainty about the enforceability o f contractual r i gh ts increases the cost o f credit to compensate for the increased risk o f non- performance.

Debt recovery through the courts in Mozambique i s highly inefficient (it has been estimated that i t takes o n average 540 days to resolve a case in Maputo, much more than in neighboring countries). Resolving insolvency in Maputo requires undergoing an inordinate amount o f time. Judges are perceived to have inadequate knowledge o f commercial law and to avoid commercial cases. The weak contractual framework, coupled with a number o f legal and institutional impediments to effective credit selection and recovery, leads to a weak repayment culture and undermines the development o f an efficient credit-based economy.

A number o f measures have been or are being taken to improve the lending environment. A new commercial code was drafted through a consultative process and i s st i l l awaiting enactment into law. The code o f c iv i l procedure, which dated back to 1967, has been revised and i s also awaiting enactment. The revised code has streamlined judicial processes, in order to reduce delays and perception o f corruption. A study, financed by the Norwegian Agency for Development (NORAD), on the computerization o f the commercial registry has been finalized, and implementation is underway. In addition, an arbitration center was created to resolve some o f these disputes, but despite the encouraging steps, significant measures to improve the lending environment are s t i l l required.

Additional measures include updating the legal framework for secured transactions. Land cannot be used as collateral, and there are restrictions o n pledging movables, o n using future property, and on using a changing pool o f assets, such as buildings under construction. Lack o f clear property title and inefficiency and corruption in the property and mortgage registries are also major obstacles. As next steps in these and other areas, it i s recommended that the Government tackle the development o f a new bankruptcy law, the development o f commercial judicial sections, modernization and linking o f property registries and improvements to the credit registry.

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Annex 2: Major Related Projects Financed by IDA and/or other Agencies

MOZAMBIQUE: Financial Sector Technical Assistance Project

There have been a number o f projects financed by IDA and other partners that have contributed to the development o f a sound financial and private sector. The FSTAP was designed to build upon completed reforms or complement ongoing work.

Projectsfinanced by the World Bank

The proposed project builds o n the FSCBP, which closed in March 2001. The development objective was to develop and strengthen the institutions charged with implementing the pol icy and institutional reforms in the financial sector. The project aimed at: (a) strengthening the Central Bank to enable i t to administer monetary pol icy and carry out effective regulation and supervision o f the financial sector; (b) providing a regulatory and institutional framework to deepen the financial sector; and (c) supporting the systematic issuance o f Treasury bi l ls to manage liquidity. The ICR concluded that the project’s outcome was satisfactory, recording improvements in a number o f areas, in particular in increasing the capacity o f B o M to supervise the financial sector and conduct monetary policy. There was increased capacity in other departments o f the BoM, as wel l as improvements in the legal and regulatory framework for the financial sector. In addition, the IFB, established under the FSCBP, continues to operate on a sustainable basis with participation from the commercial banks.

The project also continues the efforts o f EMPSO, which closed in July 2004. The primary objective o f 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-tern. The program included measures, among others, to resolve the financial difficulties o f two o f the commercial banks, strengthen licensing and supervision in the financial sector and further dilute government ownership in the financial sector.

The Enterprise Development Proiect (PODEMP049874), which i s ongoing., includes a credit l ine for support to Small, Medium Enterprises (SME’s). This component, due to the high interest rates in the country and conservative lending practices, has not been well-utilized. On the other hand, the technical support to the SME group, made available with a matching grant fund, has made substantial gains in strengthening SMEs to be able to compete and secure commercial bank financing.

The Legal Capacity Building Proiect (P090905) i s under preparation. The planned Board date i s February 2006. I t wi l l address three primary areas: (a) court management; (b) training o f judicial officials; and (c) access to justice. This wil l complement work being done by the AfDB o n improving the lending environment.

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Projects financed by other Development Partners

The IMF, through MFD, i s currently providing technical assistance to the B o M in strengthening banking supervision, transition o f B o M accounting to IFRS , foreign exchange management and monetary pol icy management. I t has approved a medium-term, technical assistance program o f approximately US$500,000 over the five-year period o f the project.

AfDB prepared a parallel project which would finance components 6, 7, 8 and 9 o f the broad-based FSTAP Program described in Annex 4. The total estimated cost o f this financing i s US$10.2 mi l l ion equivalent. The project was approved by AfDB Board o f Directors on October 6,2005.

SIDA has provided support to the Department o f Debt Management in the Treasury.

DFID has been providing support to the B o M in the project related to the transition to IFRS for the banking sector. DFID has already funded the f i rst two phases o f this project and the third phase i s expected to begin in November 2005. The total estimated cost o f this hnding i s approximately US$2 million equivalent.

The US$30 m i l l i on IFAD/AFDB Rural Financial Service Program (RFSP) was recently launched. This i s a comprehensive program to support rural finance. KfW and GTZ have prepared projects for the micro and rural finance sector. The combined projects are estimated to cost US$3.6 million and wil l be coordinated as part o f the broader rural development program.

C I D A has provided support to the MMF, which acts in part as a clearinghouse for micro and rural sector information.

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Annex 3: Results Framework and Monitoring

MOZAMBIQUE: Financial Sector Technical Assistance Project

PDO Outcome

[mproved soundness o f the Mozambican banking sector and improved public debt management.

Component One:

Enhanced capacity o f the B o M in terms o f banlung supervision and provision o f f inancial infrastructure.

Component Two

Improved financial accountability and transparency.

Component Three:

Strengthened public debt management capacity.

Component Four

Improved money and Government bond market efficiency and depth.

Lesults Framework (IDA only) S

Percentage o f banks in compliance with improved prudential regulations.

Percentage o f outstanding treasury Securities traded on the secondary market.

Component One:

Number o f BCP B o M i s compliant with.

Reduction o f t ime needed to transfer f i nds between banks.

Component Two

Percentage o f banks whose financial reporting i s in accordance with IFRS.

Percentage o f large enterprises with financial statements in accordance with IFRS.

Percentage o f medium enterprises with financial statements in accordance with IFRS. Component Three:

Annual publication o f publ ic debt reports including comprehensive debt inventory.

Debt forecasts are published on a regular basis.

Component Four:

Regular Treasury securities auctions held on a monthly basis.

formation

aonitoring the results indicators vi11 provide feedback regarding 3 o M enforcement capacity, and whether additional technical issistance a n d o r capacity building .s necessary.

Component One:

Monitoring the results indicators w i l l provide feedback regarding BoM enforcement capacity and strength o f f inancial infrastructure, and whether additional technical assistance a n d o r capacity building is necessarv. Component Two

Monitoring the results indicators wi l l provide feedback regarding penetration o f IFRS in financial and corporate sector. The proposed timetable m a y be adjusted, if necessary.

Component Three:

Moni tor ing the results indicators wil l provide feedback regarding GoM enforcement capacity, and whether additional technical assistance a n d o r capacity building is necessary.

Component Four:

Moni tor ing the results indicators wi l l provide feedback o n activity o f primary and secondary treasury security mkt and wil l indicate add7 capacity building requirements.

31

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Annex 3(c) Results Framework and Monitoring

M O Z A M B I Q U E : Financial Sector Technical Assistance Project

Results Framework for overall Financial Sector Reform Program'

Improved soundness o f the Mozambican financial sector, improved public debt management and increased financial intermediation.

Component One:

Enhanced capacity o f the B o M in terms o f banking supervision and provision o f financial infrastructure.

Component Two

Improved financial accountability and transparency.

Component Three:

Strengthened public debt management capacity.

Percentage o f banks in compliance with improved prudential regulations.

Percentage o f outstanding Treasury securities traded o n the secondary market.

Percentage o f credit to the private sector relative to GDP.

[nsurance premiums as a percentage o f GDP.

Percentage o f economically active population covered by social security.

Number o f rural microfinance clients.

Result

Component One:

Number o f BCP B o M i s compliant with.

Reduction o f t ime needed to transfer hnds between banks.

Component Two

Percentage o f banks whose financial reporting i s in accordance with IFRS.

Percentage o f large enterprises with financial statements in accordance w i th IFRS.

Percentage o f medium enterprises with financial statements in accordance with IFRS.

Component Three:

Annual publ icat ion o f publ ic debt reports including comprehensive debt inventory.

Debt forecasts published o n a regular basis.

' Program Development Objectives based on World Bank project development objectives and DRAFTpartner program documents. Components under the responsibility of AfDB and GTUKfW are marked as such

34

Improved money and Government bond market efficiency and depth.

Component Five (GTZ/KfW):

Improved financial intermediation through a strengthened micro and rural finance sector integrated into the financial system.

Component Six (AfDB):

Strengthened regulatory and supervisory regime for the insurance industry.

Component Seven (AfDB):

Modernized and efficiently administered social security system .

Component Eight (AfDB):

Improved Legal and judicial environment for lending activities.

Financial Crimes Investigation Unit established.

Zomponent Four:

iegular Treasury securities auctions held on a monthly )asis.

Component Five:

MFI Association operational.

Yumber of microfinance clients has increased.

Component Six:

Percentage o f insurance companies compliant with new prudential regulations.

Number o f insurance companies whose financial reporting i s according to IFRS.

Component Seven:

Percentage o f private sector workers who are registered participants o f INSS.

Percentage o f participants who are active contributors.

T ime taken for processing and payment o f benefits has been reduced.

Component Eight:

N e w Bankruptcy L a w enacted.

N e w l a w o n property registries enacted.

Number o f providers o f credit included in credit registry.

Feasibil i ty study completed.

N e w l a w for the FCIU enacted.

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Annex 4: Detailed Program Description

MOZAMBIQUE: Financial Sector Technical Assistance Project

The comprehensive financial sector reform program is comprised o f three distinct "FSTAP" projects under one umbrella. Each project wil l be funded separately, but wil l be coordinated by one PIU and supervised in a collaborative manner (wherever feasible, jo int supervision missions will be organized). The IDA project will be comprised o f four technical and one administrative component. IMF, DFID and SIDA wil l provide complementary technical assistance; these funding arrangements have already been agreed with Government. The AfDB project wil l fund four components (Nos. 6-9), and KfW and GTZ will joint ly fund the remaining component on micro and rural finance (No. 5). Below is a detailed description o f each component.

Table 2. Program Components (by Financiers)

US$ million Equivalent _I I-_x1-- r_. - ~ r-71

. . . . . . - .. .- ._ -_ 2.07 1.86

.."I__-_... .... ....

3.19 1 I ...... ._

. I 3.02 2.26

_I .......

. . . . ........

. - . ,, ."" 28.50

. .

. . . .

Component 1 : Strengthening the Banking Sector, including BoM

This component i s designed to strengthen the banking sector by addressing some o f the challenges identified in the FSAP report. I t wil l support activities to strengthen the banking sector by: (i) building the institutional capacity o f the BoM, including supporting the process o f implementing international practices in off-site and on-site supervision and improvements of the financial market infrastructure and information technology; (ii) divestiture o f Government from the banking sector; and (iii) developing the training capacity at the IFB. Project activities wi l l be undertaken in coordination with ongoing assistance from DFID and MFD. Project activities are described below.

(i) Building the institutional capacity of BoM. Specific activities include:

(a) Support to the BSD towards full implementation o f Basel I principles, including preparation o f a new inspection manual, drafting o f prudential regulations for BCP 8, 11 , 12, and 13 (including new loan classification system and consolidated supervision), and on-the-job training. This assistance i s being provided by MFD under their medium-tern program agreed with Government. The project would complement the assistance as necessary.

(b) Consultancy services to assist B o M to draft a bankruptcy law applicable to financial institutions.

(c) Addressing issues related to new financial institutions, risks, and instruments, including:

0 Preparation o f a supervisory framework and training for the supervision o f non-bank financial institutions (capital risk institutions, venture capital firms, etc.);

0 Training for the supervision o f new r isks such as AML;

Training for the supervision o f new instruments (electronic banking, leasing, and factoring); and

0 Training and technical assistance to staff in supervision techniques and procedures. In addition, the component wil l fund, as appropriate, training for staff who are supervising the stock exchange.

(d) Implementation support for the introduction o f Basel 11. This assistance would l ikely take place in the later years o f project implementation in order to allow full implementation o f Basel I principles.

(e) The Financial Administration and Human Resource Department (DAF) within the B o M i s responsible for the accounting function o f BoM. DAF i s currently receiving technical assistance (consultancy) from the IMF to implement the transition to IFRS, including the revision o f the chart o f accounts. The IDA project wil l provide support to this process by funding the changes required in BoM’s accounting software and training o f staff.

Transition o f B o M accounting to IFRS.

(0 Improvements in BoM information technology. This sub-component wi l l support the improvements in B o M information technology hardware. These hardware upgrades are related to the improvements in the payment systems, the creation o f the central securities depository and the transition to IFRS.

(g) Strengthening research and reporting. This sub-component wil l support the Economic Research Department to upgrade its capacity to monitor and analyze

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financial and monetary statistics, including economic forecasting and corporate financial information. The project w i l l finance training, equipment and software.

(h) Strengthening human resource functions. The project will support DAF in the development o f an overall strategy for human resource development, including preparation o f detailed j ob descriptions, training and development plans, and a framework for staff evaluation. In addition, the project wil l finance some o f the training programs.

(ii) The component will:

Divest the Government of its remaining shareholdings of financial institutions.

(a) Provide advisory support to G o M to divest i t s remaining shareholding o f BIM. The TORS to prepare the divestiture strategy have been reviewed and agreed with IDA. The component wil l finance a privatization advisor who wil l recommend alternative methods for i t s divestiture. Subsequently, there may be a need to support financial due diligence exercises and transaction expenditures.

(b) participation o f state-owned enterprises in the financial sector.

Finance a consultant to assist the M o F to prepare a strategy to regulate the

(iii) Develop training capacity at the IFB. In addition to formal training courses, the IFB develops customized courses and has a distance learning program in collaboration with the Banker’s Institute in Portugal. With support o f this project, the IFB will:

(a) (it currently offers a CD-rom based program);

Develop a web-based distance learning program that can easily be down-loaded

(b) Provide training to commercial banking staff in SME lending; and

(c) micro finance.

Work with the microfinance association to train trainers for programs in

Component 2: Improving Financial Accountability and Transparency

This component will support the transition to IFRS o f (i) the banking sector (phase 1) and (ii) the Mozambican corporate sector (phase 2). In addition, it wil l provide support to the accounting profession.

(i) transition to FRS for the banking sector through:

Transition of the banking sector to IFRS. DFID has been providing support

(a) chart o f accounts;

Providing assistance for the adoption o f a new technical framework including

(b) using IFRS-based regulations;

Developing and implementing a capacity building strategy for BSD staff in

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(c) use;

Revising BSD financial models to include IFRS and training o f staff in their

(d) taxation, accounting, and financial reporting; and

Supporting the review and updating o f the legal and regulatory framework on

(e) the financial sector.

Carrying out an assessment o f the fiscal impacts o f the transition to IFRS for

Once the transition has taken place in 2007, the IDA project will support the BoM’s banking supervision efforts through:

(a) Providing capacity building support; and

(b) techniques.

further refining B S D financial models and on-site and off-site supervision

(ii) One o f the challenges faced by commercial banks in lending to the corporate sector, including small and medium enterprises, i s the lack of audited financial statements. This subcomponent, to be implemented by the Administrap70 Tributdria dos Impostos (ATI), wi l l support the transition o f the corporate sector to IFRS. I t i s anticipated that the larger corporations will start making the transition by year three (3) and the medium companies will start moving to IFRS by year five (5) o f the project. In particular, the project will support the corporate sector’s transfer to IFRS by:

Transition of the corporate sector to IFRS.

(a) the chart o f accounts;

Providing assistance for the adoption o f a new technical framework including

(b) using IFRS-based regulations;

Developing and implementing a capacity building strategy for AT1 staff in

(c) Supporting information dissemination and public education efforts;

(d) taxation, accounting, and financial reporting; and

Supporting the review and updating o f the legal and regulatory framework o n

(e) the corporate sector

Carrying out an assessment o f the fiscal impacts o f the transition to IFRS for

(iii) Support to the accounting profession. Assistance wil l be provided to public and private training institutions to improve the curriculum in accounting methods. Some support may be provided towards the establishment o f the Association o f Professional Accountants.

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Component 3: Strengthening Public Debt Management

Component 3 wil l follow on technical assistance provided by SIDA and wil l support efforts to introduce a comprehensive public debt management framework, ensuring, inter alia, transparency and accountability in public debt management, improved cash management to reduce the cost o f borrowing and to simplify monetary operations, and better coordination o f the issuance o f debt between the BoM and the MoF. SIDA has been supporting the Public Debt Department with technical assistance to formulate a debt management strategy for monetary operations and government financing. SIDA wil l continue to support the MoF to formulate and update the debt strategy, as well as other activities related to this area.

IDA will fol low on SIDA’s support to the GoM for the development and implementation o f a comprehensive public debt management framework to ensure transparency and accountability in public debt management, to improve cash management and the cost o f borrowing, and to improve the coordination between BoM and MoF. Implementation o f the fol lowing activities wi l l be supported through the provision for technical advisory services, training, workshops and acquisition o f equipment:

(i) procedures and controls,

Restructuring of the Public Debt Department o f the MoF and strengthening

(ii) Consolidating and reconciling the debt database for all public debt. Implementation of a debt management strategy for monetary operations and government financing;

(iii) Capacity building for staffof the Public Debt Department;

(iv) Strengthening information analysis and reporting, including debt forecasting, risk and cost analysis and monitoring, debt sustainability analysis, analysis o f loan agreements, and preparation o f an annual report on debt management; and

(v) Improving the GoM’s cash management policies and procedures in order to reduce the cost o f borrowing and simplifying monetary operations. This would include the provision o f technical assistance to review procedures for management o f cash balances in commercial banks and exposure limits, improve liquidity forecasting capabilities, and extend cash-flow forecasts toward a rol l ing 12-month horizon. In addition, assistance wil l be provided in formulating procedures using Treasury bonds and bills.

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Component 4: Improving Money and Debt Markets and Financial Infrastructure

In close consultation with the IMF, which is working with B o M to identify measures to improve the transmission o f monetary policy, Component 4 will support the improvement o f efficiency in the primary Government debt market and increase the depth o f the secondary market, reduce segmentation in the inter-bank market by developing the rep0 market, improve financial market infrastructure through introduction o f RTGS and establishment o f a CSD, and improve the registration process in the B o M for private external debt. Activities financed in this component include:

(i) Improvements in the primary Government debt market will be supported by carrying out a demand assessment, standardization o f instruments and the establishment o f regular auctions, with a goal o f moving towards a balanced issuance program and consistent issuance in 12-month Treasury bills.

(ii) Improvements in the secondary market for Government debt will be supported by assistance in the drafting and implementation o f rules and regulations to facilitate over- the-counter trading, preparing a code o f conduct for financial institutions participating in the market, preparing an internal operations manual for supervision o f the government debt market, and preparing a benchmark strategy for Treasury bonds and an offering arrangement that wil l allow for competitive placement.

(iii) Improvement of the monetary policy framework and development of the repurchase (repo) and resale (reverse repo) markets will be supported by assistance to update the operational rules for the money market (including the rep0 and reverse markets), identifying legal, bankruptcy, tax, and reserve requirement preconditions for establishing the rep0 and resale markets, drafting a Master Repurchase Agreement, decrees, preparing an implementation plan for the rep0 and resale markets, and building capacity within the B o M to set and implement monetary policy.

(iv) Improvement of the financial market infrastructure to provide a more efficient government debt market wil l be supported by the establishment o f a CSD for Government debt instruments. Delivery versus Payment will be introduced in conjunction with RTGS to improve custody and settlement arrangements. The project wil l also finance staff and market-participant training.

(v) Establishment of effective procedures for the registration of private debt in BoM will be supported by a review o f laws and regulations with respect to external private debt to define the role o f the B o M and to review and redraft, as necessary, existing procedures for external private debt applications, define data and IT needs for debt tracking, and provide training in credit analysis to staff.

Component 5: Micro and Rural Finance

This component, which wil l be jo int ly funded by KfW and GTZ, intends to support the future expansion o f financial services through (i) providing assistance to microfinance and rural finance institutions and (ii) promoting rural expansion and the integration o f microfinance institutions in the financial system. The implementation o f this component

41

may be transferred from the M o F (implementing agency for FSTAP) to the Ministry o f Planning and Development, where i t would be managed with the other projects, including the IFAD/AfDB Project, under the broader rural development agenda. At the same time, a mechanism for coordination between the two Ministries will need to be put into place, as the rural finance s t i l l falls under the comprehensive financial sector reform program. The proposed activities include:

(i) This sub-component, totaling €2 mi l l i on (approximately US$2.6 mi l l ion equivalent), will be funded by GTZ. The agreement between the G o M and the GTZ was signed on July 7,2005. The program will finance support for the expansion and strengthening o f microfinance and rural finance institutions with technical assistance activities. Assistance would be provided:

Strengthening of micro and rural finance.

(a) To develop sustainable operations o f an association o f MFIs;

(b) For the MFI association to help the graduation and transformation o f MFIs, development o f models for the expansion o f financial services, research and dissemination o f information, promotion o f dialogue among stakeholders, and the development o f new instruments and methodologies;

(c) reporting system; and

T o link MFIs to financial system infrastructure, for example, to the credit

(d) needed basis” by request o f the M o F and/or BoM.

T o improve regulation and supervision o f microfinance institutions on an “as-

Assistance would include the provision o f a long-term international advisor to the MFI association.

(ii) Promote rural expansion and the integration of microfinance institutions in the financial system. This sub-component, totaling € 1 m i l l i on (approximately US$1.2 mi l l ion equivalent), will be funded by KfW. It will assist qualified microfinance institutions to reduce the gap between the microfinance and the commercial bank sector. Pending approval by the KfW by end-2005, assistance would be provided:

(a) To qualified microfinance institutions for the transition to IFRS. This wil l involve the preparation o f a new chart o f accounts, training o f MFI staff and a review of the effects o f the introduction o f IFRS;

(b) To qualified microfinance institutions to access the national payment system (real-time gross settlement). This will involve the financing o f hardware, software and training o f MFI staff; and

(c) This wil l involve the promotion o f out-branching (Challenge Fund) and research for the adaptation o f financial products to rural areas.

To qualified microfinance institutions to expand to rural areas.

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The AfDB Board o f Directors approved a credit on October 4, 2005 to the Republic o f Mozambique for a total o f UA6.8 mi l l ion (approximately US$10.2 m i l l i on equivalent) to finance the fol lowing four components.

Component 6: Strengthening the Insurance and Supplementary Pension System

Over the last two years, important progress has been made in developing the regulatory framework for insurance supervision in Mozambique. A new Insurance L a w was enacted in January 2003 to replace L a w 24/91 o f 1991 that had opened up the insurance market to competition. A new Chart o f Accounts for insurance companies was developed and become operational from January lst, 2005 (however the new Chart i s not IFRS- compliant). With these developments, the regulatory framework for insurance supervision has been strengthened. Despite the improved regulatory framework for insurance supervision brought about by the new Insurance Law and i t s regulations, several important issues still remain to be addressed. These are discussed in some detail below.

The new Insurance Law would require a critical review and fine-tuning in order to address some identified weaknesses. The review would focus o n the fol lowing priori ty areas that have not been adequately addressed by the new legislation:

(a) protection;

The regulation o f insurance contracts, with special attention to consumer

(b) Guidelines on investments by insurance companies to ensure r i s k diversification; and

(c) financially weak insurers, with legal protection for the IGS staff.

Empowerment o f the IGS to enable proactive action to be taken against

As noted above, the IGS has yet to establish detailed supervisory framework and prudential regulations that wil l guide the conduct o f insurance business. An insurance manual will need to be developed which would include the main processes that configure a prudential supervisory system. The IGS also needs assistance in developing an IFRS- compliant Chart o f Accounts, transitional measures for the movement o f insurance companies to IFRS, and implementation IFRS for the insurance industry

A proposed new law on the reform o f social protection envisages the establishment o f pension funds under a Supplementary Social Protection Scheme. The new Insurance L a w gives the responsibility for the supervision o f Pension Funds to the IGS. However, there is currently n o legal framework for the creation and management o f such Funds. There i s thus the need to develop appropriate legislation to provide a legal basis for the establishment o f Pension Funds in Mozambique, as wel l as developing the necessary regulatory framework for the supervision o f such Funds. A consultant wil l be recruited to work with Government with input from the Bank, AfDB and IMF. These could include, but not be l imited to: (i) the nature o f tax exemptions for supplementary retirement savings; (ii) withdrawal conditions; (iii) investment management provisions;

43

(iv) employer, employee, fund trustee and manager legal responsibilities and accountabilities; and (v) financial disclosure, regulation and oversight.

There i s an urgent for a robust capacity building and institutional-strengthening program for the IGS if it is to adequately perform i t s regulatory functions. The following activities would be financed:

(i) Recruitment of a consulting f i rm specializing in insurance/pension funds. The responsibilities o f the firm will include: (a) the development o f new legislation for the establishment o f private pension funds, and the elaboration o f a sound regulatory framework for their supervision; (b) the revision o f the new Insurance Law to address the issues raised above; and (c) assist in institutional capacity building for the IGS. This wil l include proposing and helping to organize formal training activities for IGS staff, organizing workshops and seminars which may be extended to industry participants, acquisition o f productivity equipment for the IGS, etc.

(ii) Recruitment of two (2) long-term (24 months) technical assistance experts to assist IGS to conduct its supervision responsibilities and provide on-the-job training for the IGS stafl I t i s proposed that one o f the experts be an experienced insurance supervisor, and the other an actuary. The experts would develop on-site and off-site supervisory processes for IGS, and develop an “internal manual” for use by the IGS.

Component 7: Strengthening the Social Security System

There i s a need to make pension and insurance services affordable, safe, and sustainable to cover a larger percentage o f the workforce. Deepening and broadening o f the financial sector require orderly growth and expansion o f insurance, pension, and other forms o f contractual savings. I t should be noted that extending social protection coverage in any country is a complex issue, and the scope wil l be determined according to the country’s economic resources and the administrative capacity o f the social protection system. Only a sustained economic growth, formalization o f the economy and reduction o f the relative weight o f the agricultural labor force wil l create the basis for some form o f universal coverage. This i s st i l l some way off. There i s thus the need for a detailed study o n affordable options for improving social security coverage in the country.

Beyond a more effective operational activity o f the INSS, i t is essential to perform a sound actuarial analysis to determine the level o f contributions that i s required by the scheme o f benefits to ensure that the system i s sustainable in the long-term. The lack o f reliable information in the past has made this analysis unreliable. When the new IT system becomes fully operational, the statistical information that i t will yield should improve significantly the possibilities o f carrying out such studies.

The INSS also needs to adopt more transparent and professional procedures in making its investment decisions. The fol lowing activities wi l l be financed under the project:

(i) A consulting firm will be recruited to perform the fol lowing services: (a) carry out an actuarial valuation o f the public pension scheme administered by INSS; (b) undertake a

Consultancy services to assist the reform of the social security system.

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policy evaluation exercise projecting over a 75-year period, adjusting key parameters to analyze different scenarios. Based on these results, consultants should evaluate whether a package o f parametric reforms could sufficiently improve the incentives, equity, affordability and sustainability o f the public pension system as currently designed; (c) carry out an institutional review o f the structure, staffing and governance o f the I N S S and recommend changes (including those requiring legal amendments) as appropriate; (d) review the I N S S investment management pol icy and processes and propose changes to the governance o f investment management including the composition o f an investment committee o f the Board, constitution o f an investment committee, and subcontracting investment management fbnctions to regulated financial intermediaries; and (e) drawing upon the assessment in “by’ above, the consultants should utilize actuarial projections to evaluate options for a multi-faceted pension scheme that encompasses a reformed I N S S public pension system (including reforms to the c iv i l service pension system), tax- favored individual retirement savings plans, occupational retirement schemes, and an evaluation o f fiscally sound options for providing a limited minimum pension guarantee for certain qualifying individuals (if such an option can be justified).

(ii) the reform o f INSS administration and investment management.

Recruitment of a long-term (24 months) expert in public pension systems to assist

Component 8: Improving the Legal and Judicial Environment for Financial Transactions

Any effort to improve the financial system must address the lending environment (legal and judicial) in which financial transactions take place. Indeed, a sound contractual framework i s fbndamental for the development o f a healthy financial sector. Mozambican enterprises have reported that dif f iculty in obtaining credit i s an obstacle in running their businesses. This dif f iculty i s directly related to the inadequacies in the contractual framework in Mozambique. A modem and credit-based economy requires predictable, transparent and affordable enforcement o f both secured and unsecured credit claims by efficient mechanisms outside insolvency, as wel l as a sound insolvency system. The procedures for enforcing rights should enable parties to rely o n contractual agreements, which in turn support confidence in lending and investments. Uncertainty about the enforceability o f contractual rights increases the cost o f credit to compensate for the increased risk o f non-performance.

A credit system should be supported by mechanisms that provide efficient and reliable methods for recovering debt, and sale o f immovable and movable assets. As noted above, debt recovery through the courts in Mozambique i s highly inefficient and is rarely used. A number o f measures have been or are being taken to improve the lending environment. A new commercial code was drafted through a consultative process and i s awaiting enactment into law. The code o f c iv i l procedure, which dated back to 1967, has been revised and i s also awaiting enactment. The revised code has streamlined judicial processes in order to reduce their complexity.

Additional measures include updating the legal framework for secured transactions. Land cannot be used as collateral, and there are restrictions on pledging movables, on using

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future property, and on using a changing pool o f assets, such as buildings under construction. Lack o f clear property title and inefficiency and corruption in the property and mortgage registries are also major obstacles. The recommended measures o f improvement to be financed under this component include:

(i) Bankruptcy Law;

Recruiting a consultant to provide assistance in the development o f new

(ii) Maputo and the Provinces o f Beira and Nampula;

The establishment of commercial sections in the Judicial Tribunals o f the Ci ty o f

(iii) include not only the physical registry but would include:

Modernizing and linking of the property registries electronically. This would

(a) surveying and certification o f surveys and surveyors;

Modernizing the processes for recording and updating, the process o f land

(b) movable assets (cars, trucks, commercial equipment, etc); and

Improving collateralization facilitated through the titling and registry o f

(c) Strengthening the legal claim for receivables so as to facilitate factoring; and

(iv) Enhancement .of the scope and reliability of the credit registry.

Component 9: Support for Anti-money Laundering (AML) Efforts - Establishment of the FCIU

The G o M enacted an AML law, L a w no. 7/2002 in February 2002, which established the legal framework for combating money laundering. The regulations under the law were approved in August 2004. In general, the law and its regulations are considered comprehensive and in line with international requirements. In particular, the law complies with the recommendations o f the FATF on money laundering. The law obligates financial institutions to undertake customer due diligence, obtain information on complex andor unusual transaction, and maintain good record-keeping. Financial institutions are required to report suspicious transactions to the prosecutor’s office, without disclosing the information to the customer under investigation. The law also provides for the confiscation o f property used or to be used for money laundering activities.

However, there are no provisions for the establishment o f special investigation unit for the investigation o f financial crimes. I t has been assessed that, for the effective implementation o f the AML law, there i s the need for the establishment o f such a unit. The need i s borne out o f the fact that the nature o f financial crimes is very different f rom other types o f criminal activities, and therefore requires different types o f resources (skills, equipment, etc.) for investigation and prosecution. Thus, based on the recommendations o f the IMF and other bodies, the Government has agreed to set up a special F C I U which this component will provide the necessary start-up resources.

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Component 10: Support for Project Implementation

The project will, in substance, be implemented by the beneficiaries. In addition, a professional PIU has been established to manage the program. The PIU wil l report to a technical working group, comprised o f high level public sector professionals. The PIU wil l oversee the financial management, procurement, reporting, monitoring and evaluation, audit, public information and related functions, as wel l as manage several cross-cutting sector issues, such as pensions and legal reform. While some o f the institutions have the capability to manage activities supported by the project, strong complementary implementation capacity may be needed to ensure that the project objectives are met. The credit will thus finance a team o f high calibre local professionals located at the PIU and the related support staff.

Given the coverage o f the project, and the large number o f activities to be undertaken, the PIU needs to be further strengthened. The P I U i s currently made up o f the Project Coordinator, an Administrative Officer/Accountant, a Procurement Specialist and support staff (executive secretary, driver and office assistant). Given the sheer number o f activities to be undertaken under the project, particularly with respect to procurement, i t i s proposed that the PIU be strengthened with two additional staff: an administrative officer (i.e. split the position o f Administrative Officer/Accountant) and a second procurement specialist.

Whenever necessary, technical assistance (on a punctual basis) wil l be sought to strengthen the team. This will enable a transfer o f skills f rom one project to another, including procurement and disbursement expertise. In addition, the implementation arrangements will ensure that there is an entity formally responsible for project technical coordination and monitoring and has the incentives to solve problems in a timely manner.

AfDB, with some counterpart funds from Government, wi l l provide parallel financing o f approximately US$1 mi l l ion to the PIU. In particular, it will finance: (a) supplementary procurement and financial management staff (outside o f the core team, which wi l l probably be comprised o f the financial and procurement assistants); and (b) operating costs which include: (i) rental expenses; (ii) transportation expenses, including maintenance, insurance and petrol; and (iii) utility charges.

IDA wil l finance the remaining implementation costs which include:

(i) basis;

Consultancies (i) short-term consultants to reinforce the PIU on an “as needed”

(ii) Financial advisor; and (iii) PIU core personnel (which may be comprised o f the Project Coordinator, Financial and Administrator Manager, Procurement Specialist, Secretary, Driver and Cleaner);

(iv) Training;

(v) equipment and accompanying materials, (b) any office equipment; and (c) vehicle

Goods and Equipment in the Office, including but may not be limited to: (a) IT

47

(vi) l imited to: (a) internet; (b) stationary, (c) office maintenance; and (d) insurance

Operational expenses not covered by the AjDB which include, but may not be

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Annex 5: Project Costs

MOZAMBIQUE: Financial Sector Technical Assistance Project

~

Local Foreign Total Project Cost By Component and/or Activi ty us$ million us$ million us$ million 1. Strengthening the Banking System, .60 4.20 4.80

including B o M

2. Improving Financial Accountability and .10 3.40 3.50 Transparency*

3. Improving Public Debt Management* .20 1.85 2.05

4. Improving Money and Debt Markets .15 1 S O 1.65

5. Project management* .20 1.80 2.00

Total Baseline Cost Unallocated

1.25 12.75 14.00 0.50

Tota l Project Costs' 14.50

*Funding is provided by DFID (US2 million equivalent for component 2); SIDA (US1 million equivalent for component 3) and A P B (US$I million equivalent for project management) as described in Annex 4.

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Annex 6: Implementation Arrangements

MOZAMBIQUE: Financial Sector Technical Assistance Project

The project will be implemented over a period o f about five (5) years. The project i s being implemented by the M o F which created the implementing unit under its purview. By using the programmatic approach, using only one PIU, a proliferation o f PIUs wil l be prevented. This further reflects progress towards attaining Paris Declaration objectives. The PIU, which was established with a Ministerial Off icial Memo on March 31" 2004 would be a part o f the former Ministry o f Planning and Finance General Office. The P I U will be headed by the Project Coordinator who wil l report to the Minister o f Finance. The PIU will also include a procurement specialist, a financial management team, technical specialists (such as the financial sector advisor), and an executive assistant. The PIU wil l be responsible for providing guidance to beneficiaries regarding procurement, as well as monitoring and evaluation, and wil l provide advice o n the overall thrust o f financial sector reforms and cross-cutting issues.

Details o f the implementation arrangements have been agreed and are elaborated in the PIM. Institutional responsibilities for coordinating and managing the project o n a dai ly basis, providing procurement and accounting services and ensuring that al l fiduciary requirements are met, will be delegated to a professional PIU. The capacity o f the PIU will be reinforced with specialized training and additional staff (as needed) to ensure that i t has the necessary skills to implement such a vast program involving many development partners. By building capacity in the PIU, the team wil l be able to provide qualified fiduciary services (procurement, financial management, monitoring and evaluation and reporting).

In particular, the PIU will be responsible for: (a) reviewing project proposals prepared by the beneficiary institutions; (b) undertaking quality control for TORS once a project proposal has been agreed; (c) overseeing project implementation activities; (d) administering project hnding and procurement processing (including the employment o f consultants) and managing the project and special accounts; (e) following-up on the agreed financial and legal covenants; ( f ) proposing any necessary adjustments and amendments to implementation methods; (g) providing periodic project progress reports; and (h) acting as the focal point o f contacts between the GoM, the beneficiaries and IDA and other funding donors during the project implementation period.

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I

The Project Coordinator wil l have the authority to bring beneficiaries together in a collaborative manner, and should therefore understand the financial sector reform process. He/she wil l be supported by a high level team financial sector technical specialist who wil l be capable o f assessing project priorities and needs and guide project implementation to a successfbl conclusion in a timely manner.

I

Implementation arrangements were designed to delegate the maximum feasible operational responsibility to the beneficiary institutions or Government departments. Beneficiary agencies wil l be largely responsible for implementation o f their respective components, under the overall guidance o f the PIU and the TWG. The semi-annual PAF review will be the primary forum for pol icy dialogue between the Government and the development partners. The P A F matrix, which comprises 50 performance indicators, serves to provide a yardstick for measuring the Government’s progress in many areas o f donor collaboration. Financial sector reform, considered a priority o f Government i s included and has five indicators elaborated.

Fi nancia I Manager

Each beneficiary agency will be responsible for the preparation o f the TORS for consultants, including required qualifications, and provide technical specifications for procurement o f goods. All beneficiary agencies wi l l report to the PIU o n a quarterly basis, including any modifications to the procurement and/or training plans. The procurement specialist wil l work with beneficiaries to ensure that a l l o f the Wor ld Bank Guidelines for procurement o f goods and consultant services are followed, as well as communicating the evaluations o f procurement proposals to the WorId Bank (see Annex 8, Procurement).

Procurement Fi nancia I Manager Sector

Special is t

The PIU wil l liaise closely with the various beneficiaries within the MoF, B o M and MoJ to ensure that project activities will be handled effectively, in a timely fashion and in accordance with World Bank requirements, as wel l as that adequate information i s provided for reporting purposes. I t wil l monitor project implementation on a quarterly basis, review achievements, work programs and budgets. The PIU wil l be responsible for all aspects o f financial management, including budgeting and auditing, procurement, quality assurance, monitoring and evaluation and reporting, etc. I t should be recognized

51

that, although KfW and GTZ are contributing to the FSTAP, the implementation o f their respective projects wi l l be without any procurement or financial management support. A s such, the PIU could only be responsible for attaching their progress reports as an annex to the quarterly report which wil l be submitted to IDA.

The PIU wil l also be strengthened on a continuous basis through appropriate training. As needed, short-term national or international specialists to assist in the implementation o f its work program wil l be contracted. At project closing, i t i s expected that the PIU would cease to exist, unless the Government decides to use the established capacity to implement a yet undefined project funded by IDA or another donor.

Project Financial Management. A project-specific financial management system wil l be established within the PIU. TORS for this assignment wil l be agreed with the PIU and wil l be included in the PIP. The PIU will maintain the accounting system accounts and records in accordance with IFRS. The project accounts wil l be based on a Chart o f Accounts which wil l be compliant with SISTAFE. The Chart o f Accounts will accommodate the proposed project to capture sources and uses o f funds, assets and liabilities in sufficient detail to satisfy (Performance Monitoring Report) PMR-based reporting requirements. Cash basis accounting wil l be applied. The proposed system will, in addition to producing periodic and cumulative budgeted and actual expenditures, link the financial data to procurement activities o f the project. The proposed financial management guidelines are described in detail in Annex 7.

Retroactive financing was agreed for a number o f activities, including the purchase o f equipment and training activities that had not been init ial ly provisioned under the PPF. The G o M wil l be able to advance finances under, goods, consultant services, training and operating costs, Categories (l), (2), (3) and (4) respectively, on eligible purchases made after June 30,2005. Only goods, equipment and training which have been financed since June 30, 2005 wi l l be eligible for retroactivefinancing. All goods and services wil l be procured according to the World Bank Guidelines that are described in Annex 8.

Project Monitoring and Evaluation. Monitoring and evaluation o f project activities are key functions that wil l be carried out by the PIU. As mentioned above, the comprehensive results framework in Annex 3 wil l provide the basis for jo int supervision missions and evaluation o f results. A quarterly monitoring table and progress reports will be prepared by the PIU, discussed with the TWG and be within the context o f the PAF. A draft PIP, a Financial Management Plan (FMP) and overall Procurement Plan will be prepared and incorporated into a PIM. The PIM includes among others, al l period reporting, and monitoring and evaluation throughout the project cycle. Apart f rom periodic reports and standard monitoring arrangements, an FSAP update wil l be carried out approximately 24 months into the project. This wil l afford the opportunity to assess progress in the reform program and will be used during the MTR, which i s planned for 30 months into the project. At this time, any adjustments to the project will be made. An assessment wil l be carried out one year prior to the project's closing which can be carried out by an independent consultant o r by the beneficiaries. This would provide a final opportunity to evaluate progress and, if necessary, make appropriate changes to project activities based on additional lessons learned and the realities on the ground.

52

Overall Project Organization

Development Partners

World Bank, AfDB, GTZ, KfW, DFID,

Technical Working Group

Chair: Project Coordinator Members: representative from each of the major

beneficiary organizations

Ministry of Finance Project Implementation Unit

(overall project management; M & E; technical and procurement advice, disbursements)

Project Beneficiaries

BoM MoF IFB IGS INSS UTREL MoJ FClU AT1

53

Annex 7: Financial Management and Disbursement Arrangements

MOZAMBIQUE: Financial Sector Technical Assistance Project

Country issues. A Country Financial Accountability Assessment (CFAA) was conducted for Mozambique in December 2001 and a report was prepared. The overall conclusion o f the C F A A i s that public sector financial management systems in Mozambique are very weak, as evidenced by the Report o f the Tribunal Administrutivo (AT) o f the Government General Accounts Report for 1998 and 1999. I t wi l l require substantial strengthening over several years. In the interim, r isk o f waste, diversion and misuse o f funds are assessed as high. The public sector financial environment in Mozambique denotes a situation o f high fiduciary risk: material receipts and payments are excluded from the budget and from Government accounting and reporting system; accounting systems and standards are outmoded; internal and external auditing require substantial support; and parliamentary oversight requires strengthening. Efforts have been made in recent years to reduce the fiduciary risk through (among other measures) the strengthening o f the internal audit capacity o f the Internal Auditing Department and the creation o f external audit capacity within the AT. Both o f these efforts, as wel l as others, need to be intensified because there i s st i l l a lot o f work to be done in this area.

The Public Financial Management Assessment (PFMA) was conducted by Scanteam. A group of fourteen donors and funding institutions (commonly referred to as the “G14”), that provide direct budget support to Mozambique, requested a PFMA. The principal objective o f this PFMA i s thus to provide the G o M and donors with an updated assessment o f the situation and trends with respect to fiduciary risk in Mozambique. The PFMA was jo int ly camed out between the M o F and Scanteam in September 2004. The assessment concluded that “Overall PFMA Risk in Mozambique remains “high”. Management o f the economy has been quite satisfactory, but comprehensiveness and transparency o f the budget i s poor and the medium-term planning and budgeting i s weak. Weaknesses in budget execution, accounting and reporting continue to present serious concerns. The area o f greatest concern, however, is external auditing and accountability. At the same time, PFMA reforms are moving ahead in a very structured and comprehensive manner. The trend in PFMA is therefore seen as quite positive. Successful implementation o f the new financial management information system, SISTAFE, is intended to address many o f the current weaknesses.

Project Financial Management and Disbursement Arrangements. The PIU has been responsible for managing the two PPFs. The init ial PPF f h d s are being used to finance activities to resolve some o f the banking sector issues while the second PPF i s used to finance the start-up costs o f the PIU. The implementation o f this PPF has enabled the PIU to manage the funds through i t s financial management unit, which i s staffed with a financial manager. A preliminary financial management mechanism to account for the PPF funds was established.

W h i l e some existing financial management capacity has already been put in place at the PIU, some areas s t i l l need to be strengthened. For example, as the work load increases, an extra qualified accounting technician wil l be required. In addition, an accounting information system has to be operational and capable o f producing financial reports.

The project will take a “ring-fenced” approach to financial management. This wil l help ensure that funds are used for intended purposes. This can be related to the sensitive accountability environment at Central Government level that results in delays, lack o f a comprehensive and up-

54

to-date set o f Procedures Manuals for Government budgeting and accounting that includes project financial management procedures, lack o f uniform application throughout the government systems for financial management and budgetary execution, and information systems are not sophisticated enough to produce timely and accurate information for reporting and control purposes.

Flow of funds. Funds wil l f low (see Exhibit 1) from IDA credit account to the Special Account to be opened and maintained by the PIU for the purposes o f this project. These funds wil l finance IDA’S share o f expenditures (refer to Schedule I o f the Development Credit Agreement) related to the costs o f goods, consultants and trainings. The expenditures wi l l be incurred by the PIU and beneficiary agencies. The PIU wil l process the payment for these expenditures upon confirmation f i om the beneficiary institutions that the work has been successfully completed. Funds wil l not be decentralized to these agencies. The PIU wil l submit withdrawal applications supported by Statements o f Expenditure (SOEs) and Summary Sheets, as wel l as supporting documentation for expenditures not eligible for SOE disbursement to IDA. In addition, the PIU wil l retain al l supporting documentation for audit purposes and review by the Bank and other development partners.

Responsibility for financial management matters for the project will rest with the Financial Manager, in close collaboration with the Project Coordinator. The financial management unit i s designed, and a financial manager is already o n board. Additional staff will be needed when the credit becomes effective and the number o f transactions increases. The financial unit will have the responsibility to, among other things: (a) process payments; (b) prepare project financial statements; (c) to hire auditors; (d) ensure that the accounting system i s properly updated on a timely basis; (e) review and assess the adequacy o f supporting documentation and project expenditures; (f) prepare withdrawal applications for the Bank; and (g) reconcile, o n a timely basis, banks accounts, project expenditures records with IDA disbursement records (Client Connection).

Accounting Policies and Procedures. The PIU has adopted cash basis accounting methods to record its financial operations and i s using basic accounting mechanisms through excel spreadsheets. Since this project wil l be implemented by the MoF, i t will be required to adopt SISTAFE, the overall framework for the execution o f the Government budget. However, SISTAFE i s not ready for implementation. T o avoid project delays, a transitional accounting system arrangement to account for funds wil l be put in place until SISTAFE implementation i s completed. Operational procedures for accounting and financial management which will be carried out by the financial unit are included in the PIM.

Procurement for the system has already begun.

Internal Audit. Internal auditing o f Government i s the responsibility o f the InspecqGo Geral dus Finanqas (IGF‘) at the MoF. IGF applies auditing standards promulgated by the International Organization o f Supreme audit Institutions, but none o f i t s staff holds an internationally recognized professional accounting qualification. The IGF requires substantial strengthening and does not have sufficient capacity in place to undertake internal audit work at the project level. As a result, internal audit work may not be performed for this project.

55

External Audit. Annual financial statements wil l be audited by independent auditors, satisfactory to IDA, in accordance with international auditing standards. The external audit wil l be conducted according to TORS acceptable to IDA. Auditors wil l be required to issue a single opinion on the project’s financial statements, as per the guidelines “Annual Financial Reporting and Auditing for World Bank-financed Activities”, o f June 30, 2003. Auditors will also have to produce a management letter, identifying internal control weaknesses and providing recommendations to strengthen o f the control functions. The auditor’s report wil l be submitted to IDA and other development partners, no later than six months after the closing o f the GoM’s fiscal year. The annual audit may be financed by the credit proceeds.

Reporting and Monitoring. The P I U wil l ensure the timely production o f quarterly financial monitoring reports (FMRs) and annual financial statements. These FMRs and annual financial statements wi l l be produced from the financial system. The Government plans to use Sample 1 provided in “Financial Monitoring Reports for World-Bank Financial Projects ” for this operation. I t wil l consolidate the project’s financial information for al l categories and components, including IDA funds and those o f the other partners. One financial report wil l be produced. The fol lowing items will be covered by quarterly FMRs:

(i) FMR 1A - Sources and Uses o f Funds (by disbursement category), showing actual expenditures incurred quarterly and cumulatively (project-to-date) versus planned expenditures, including a variance analysis; FMR 1B - Uses o f Funds by Project Act iv i ty or Component, showing actual expenditures incurred quarterly and cumulatively (project-to-date; year-to-date and for the period) versus planned expenditures, including a variance analysis;

(ii) Physical Progress Report: FMR 2 - MonitoringPerformance Indicators;

(iii) Procurement Report: FMR 3

56

I-.---I._.... ~

i--- Credit Account USD E - - c 1

____, i

Suppliers I__ . _._ . _ _ .

I I

Annual Financial Statements. Audited financial statements wi l l be submitted to IDA (and other development partners) within six months after the year-end. In addition to the monthly reconciliations and quarterly FMRs, the project wil l produce annual Project Financial Statements for analytical and audit purposes.

These Financial Statements wil l consist of:

(i). A Statement o f Sources and Uses o f Funds / Cash Receipts and Payments which recognizes a l l cash receipts, cash payments and cash balances controlled by the entity; and separately identifies payments by third parties on behalf o f the entity.

(ii) The Accounting Policies Adopted and Explanatory Notes. The explanatory notes should be presented in a systematic manner with items on the Statement o f Cash Receipts and Payments being cross referenced to any related information in the notes. Examples o f this information include:

0 a summary o f fixed assets by category o f assets;

0 a summary o f Statement o f Expenses (SOE) Withdrawal Schedule, l ist ing individual withdrawal applications;

A Management Assertion that IDA f inds have been expended in accordance with the intended purposes as specified in the relevant Association’s DCA.

Information System. As mentioned above, al l accounting work i s being diligently performed using excel spreadsheets. However, to strengthen its current capacity and in view o f the need to comply with SISTAFE requirements, the project wil l be required to use the Government’s information and accounting system. A transitional accounting system arrangement, however will be put in place to avoid project implementation delays and allow the PIU to account for funds received.

Disbursement Arrangements. The table below sets forth the Categories o f items to be financed out o f the proceeds o f the Credit, the allocation o f the amounts o f the Credit to each Category and the percentage o f expenditures for items so to be financed in each Category:

58

Cateeow

1,070,000

(1) Goods

(2) Consultants Services including Audits

(3) Training and Workshops

(4) Operating Costs

Amount due pursuant to (5) Refunding of Project Preparation Advance

(6) Unallocated

Total

Amount of the Credit Allocated (Expressed in

US$ Equivalent')

2,500,000

2,900,000

2,530,000

1,000,000

Yo of Expenditures to

be Financed bv the Association

100 %

100 %

100 %

100%

10,500,000 I *IDA funding wi l l be limited to those subcomponents in accordance with Schedule 1 of the Development Credit Agreement negotiated on October 25,2005

Disbursement o f the credit proceeds wil l be administered by the PW. The credit i s expected to be fully disbursed over five years. IDA would finance 100 percent o f al l expenditure categories. Disbursements from the IDA credit account would be made o n the basis o f incurred eligible expenditures, transaction-based disbursements, using SOEs as follows:

0 Goods: expenditures under contracts costing less than U$150,000 equivalent;

0 Individual consultants: contracts less than US$50,000 equivalent;

0 Consulting f i rms: contracts estimated less than US$lOO,OOO equivalent; and

0 All training, workshops and operating costs al l under such terms and conditions as the IDA shall specify by notice to the Government.

For contracts with an individual value less than those requiring IDA'S prior review, al l applications to withdraw proceeds from the credit account wil l be h l l y documented and retained at the PIU. These would be made available for review by the Wor ld Bank supervision missions and auditors.

The two methods for disbursement were considered, including (a) transaction-based and (b) report-based disbursements. The PIU does not yet have the capacity to prepare timely and reliable FMRs. During the first year, i t is anticipated that i t wil l use transaction-based

Credit is SDR 7.3 million.

59

disbursements. If they find that there i s no problem to produce the reports and the Association finds the reports to be acceptable, they wil l convert to report-based disbursements. Only the project, PROAGRI, i s using report-based disbursements. The experience has not been very good as reporting i s not done a regular basis, which has caused delays in replenishment.

Special account. In order to ensure timely provision o f funds available to finance the costs o f the project, the PIU wil l establish and maintain a Special Account in US dollars, at the BoM, under terms and conditions acceptable to IDA. Funds in an estimated amount equivalent to four (4) months o f the IDA'S share o f project expenditures will be deposited in the Special Account. The authorized allocation for the Special Account i s US$700,000; however, this Special Account will be in i t ia l ly limited to US$350,000 which the Borrower may withdraw upon effectiveness. Full allocation wil l be released once an aggregate o f SDR 1.3 mi l l ion has been processed through the Special Account or until such earlier time deemed appropriate by IDA. The Borrower may withdraw the remaining amount by submitting the relevant Application for Withdrawal. Replenishment applications should be submitted at least once per month and must include reconciled bank statements, as well as other appropriate supporting documents. Management o f the funds wil l be guided by procedures detailed in the Operational Manual.

The PIU will make payments to suppliers either by executing transfers or with a checking account, which B o M would make available. In addition, the PIU could withdraw up to US$l,OOO equivalent into Meticais from the Special Account which would be used for petty cash. Adequate financial records would be kept and the petty cash fund would be replenished against receipts.

Counterpart Funds. The Country Director has agreed that in the case o f the FSTAP, the standard country financing parameters for Mozambique would apply and al l categories would be financed at 100 percent, thus removing the risk o f lack o f counterpart funds and facilitating project execution and payment.

Action PZan. In order to establish an acceptable financial management control environment, mitigate financial management risks, and ensure that funds can be accounted for at al l times, the following actions should be put in place.

60

No. 1

2

3

4

5

Act ion To hire an additional accounting staff to assist the financial manager To design the project chart o f account in accordance with SISTAFE l a w To prepare the FMRs formats as discussed during the mission. Financial = agreed with FM Specialist Procurement = agreed with Procurement Specialist Physical Progress = agreed with TTL To put in place a financial management and accounting system designed to reflect SISTAFE law and be installed at FSTAP capable to produce FMRs, general ledgers and balance sheets To prepare an operational manual containingldescribing the financial and accounting procedures to be carried out by the financial unit To prepare the audit TOR To contract audit services as suggested below . Short l i s t submitted . . Letter o f Invitation sent

Short l i s t cleared by WB

6 7

Due Date 06/30/06

10/30/05 Done

12/30/06

02/28/06

02/28/06

12/30/05 (done) 0212 8/06

Supervision. A Bank-sponsored financial management and procurement workshop for the FSTAP Program wil l take place shortly after the project is negotiated to enable beneficiaries to begin the procurement processes. Financial management supervision missions will be undertaken at least twice a year. However, the financial systems wil l be reviewed on an ongoing basis. The responsibility for financial management supervision and client assistance wil l be also provided through the Bank’s financial management team, which wil l include assistance to the project before effectiveness.

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Annex 8: Procurement

MOZAMBIQUE: Financial Sector Technical Assistance Project

General. Procurement for the proposed project wil l be carried out in accordance with the World Bank’s “Guidelines: Procurement Under IBRD Loans and IDA Credits” dated M a y 2004; and “Guidelines: Selection and Employment o f Consultants by World Bank Borrowers” dated M a y 2004, and the provisions stipulated in the Legal Agreement. The general description o f various items under different expenditure categories are described below. For each contract to be financed by the Credit, the different procurement methods or consultant selection methods, the estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity.

Procurement of Work. No works are to be procured under this project.

Procurement of Goods. Project procurement wil l be carried out using standard Bank documents both for International Competitive Bidding and National Competitive Bidding. Once the G o M has adopted a standard set o f procurement documents acceptable to the Bank, the project wil l have the choice to use these documents for National Competitive Bidding.

(a). Procurement of Software: The software to be procured under the project includes development o f computer software for implementation o f RTGS (real- t ime gross settlement), development o f computer software for establishment o f a Central Securities Depository, software and development o f the software for economic research and statistics as we l l for monitoring o f monetary aggregates. All the mentioned software that wil l be procured by the Project wil l be used to improve money and bond markets and financial infrastructure for the BoM.

(3). Procurement of IT: The IT equipment (hardware) that wi l l be purchased with financing from the project wil l be used by the B o M to update its technology in areas such as Payment system (DEP), DOI, DEE and by DNIA, Debt Management from the MoF. The other goods to be purchased include Off ice Equipment and Office Furniture for DNIA, Debt Management Department o f the MoF. All awarded contracts wil l be required to include installation, commissioning, training and testing of the software by the suppliers.

There wil l be a total o f three software contracts (one for RTGS Software, one for the Central Securities Depository, and the last for Economic Research and Statistics f rom DEE). The contracts for RTGS and Economic Research wil l be procured under I C B (International Competitive Bidding). The contracts for Central Securities Depository software as wel l as for I T equipment wil l be procured under NCB. The remaining contracts, for office equipment and furniture wi l l be procured under the Shopping method.

Procurement of Non-consulting Services. Non-consulting services procured under the project is marginal and are essentially for communication or dissemination activities through designated media, such as radio or television broadcasting. They wil l be done by direct contracting.

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Prior Review Threshold: Procurement Decisions subject to Prior Review by the Bank as stated in Appendix 1 to the Guidelines for Procurement:

a

1.

0 2.

3.

0 4.

Procurement 0 Prior /Pos Yes/ 0 Comments Method Review no

Threshold

Equivalent 1

(US$

0 I C B 0 >150,000 yes Include (GooddEquip software, ments) hardware,

installation and training

0 NCB 150,000- * no a -

0 Shopping 50,000-0 no a -

(GoodsiEquip 50,000 ments)

(GoodsEquip ments)

0 Direct 0 >150,000 yes Dissemination Contracting through (NCS) media

a Prequalzjkation. There will be n o prequalification o f bidders.

Proposed Procedures for CDD Components (as per paragraph. 3.1 7 of the Guidelines: NIA.

a Reference to (ifany) Project OperationaUProcurement Manual: Items that will financed under this project wil l be procured in l ine with rules in the Operational Manual: NIA.

Selection of Consultants. Selection o f consulting services wil l be undertaken in accordance with the Bank’s rules “Guidelines: Selection and Employment o f Consultants by Wor ld Bank Borrowers” dated M a y 2004”. Approximately nine firms will be recruited under the project. Their selection will be through QCBS (Quality and Cost Based Selection) and LCS (Lowest Cost Selection) on the basis o f combined technical quality and price consideration, and CQS (Consultants’ Qualification Selection) and SSS (Sole Source Selection). The tasks to be performed under the consultancies include, but are not l imited to: (a) drafting the Bankruptcy Law, (b) drafting the money laundering and new financial products legislation, and (c) providing support to the IFB to: develop a web-based distance learning program and provide training to commercial banking staff in SME lending and work with the microfinance association. The consultancy wil l be conducted in collaboration with IFB o f Portugal. In addition, another firm wil l be recruited to prepare and implement a long-term strategy for expanding outreach and access to financial services. For the Central Bank, a firm will be selected to assist the B o M to strengthen its non-banking supervision operation, improving money and bond markets and financial infrastructure. For the MoF, one firm w i l l be selected to support efforts to introduce a comprehensive public debt management framework. Consulting services also include the organization o f numerous training modules and workshops as required by the respective TOR.

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The recruitment o f the external auditors wil l be done on the basis the Least Cost Selection method.

The selection o f two long-term technical assistance experts under the project will be o n the basis o f selection o f I C (Individual Consultants). One o f the experts wi l l be required to work at the PIU and which would provide advisory services to the MoF.

Whi le most o f the consultancies wil l be on a competitive basis, some NGOs and the University have been identified because o f their comparative advantage. For example, English training courses provided by the Lynden Language School and the British Council as the best qualified in the country and the language lab in South Afr ica has an accelerated English program. The final selection will be made following the finalization o f the training plans and identification o f the trainees. The Universidade Eduardo Mondlane (UEM), recognized for its economic and management programs, wi l l also be considered for training modules.

Operational Costs. Operating costs wil l be packaged whenever possible and procured through local shopping. Some items such as office supplies, communications, travel allowance o f PIU staff, vehicles, and IT equipment also may be procured under the National Shopping. Since the price and rates are fixed across the country, i t i s allowed to procure by direct contracting items such as gasoline and other items off-the-shelf o f l o w value as determined in the PIM.

Assessment of the agency’s capacity to implement procurement. Procurement activities wi l l be the responsibility o f the PIU. An assessment o f the PIU’s capacity to implement procurement actions was carried out by the Sr. Procurement Specialist, on July 8, 2005. The assessment reviewed the organizational structure for implementing the project (available in IRIS). The PIM will need to be further elaborated to state that procurement activities will be carried out only by the PIU. There should be no interaction between the project’s staff responsible for procurement and the Ministry’s relevant central unit for administration and finance. T o avoid delays in contracts processing, it is also recommended, that the Project Coordinator has clear authority to sign contracts on behalf o f the Minister.

The PIM wil l clearly state the administrative, financial and procurement management procedures. I t wil l also include templates to facilitate monitoring o f contract execution, as we l l as details on the processing o f each procurement method and (Standard Bidding Documents) SBDs and Request for Quotation form to procure goods under N C B and shopping procedures respectively. Otherwise, Bank SBDs will be used for I C B procurement and SRFP (Standard Request for Proposals) for the selection o f consultants.

The following table indicates most o f the issuedrisks concerning the procurement related to the project’s implementation that have been identified and include the corrective measures which have been agreed.

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R i s ks/Issu es Delays - in processing procurement due to focal point not availablehot diligent - in signing

Country Office

- payments

I

Record keeping equipment and space insufficient

Correctives Measures P I M wil l provide - clear definition o f responsibility o f Focal points or Beneficiaries (for TORS, Specifications, Evaluations, Certification, and Supervision) - Project Coordinator wil l be the authority to sign o n behalf o f Minister - Opedmanage a bank account in commercial bank - Adequate filing equipment and related space will be provided - PIM will include filing procedures for procurement documents - Procurement assistant wil l need to be recruited at a later stage

Lack o f support staff could have impact during project full

Implementation By negotiations

By effectiveness

By negotiations

By MTR

implementation Procurement staff do - Training to be attended by the

Procurement Officer - The PIM wil l clearly detail the procurement management processing - Country office will provide continuous support as required and PIM wil l include templates - Procurement Officer should attend procurement clinics provided by the

not have experience with large/medium size contracts Experience with bank financed projects

- By effectiveness

- By negotiations

- Continuous during project l i fe

The overall project risk for procurement is Average. Procurement supervision missions wil l be undertaken on a semi-annual basis.

Procurement Plan. The G o M has developed a Procurement Plan for project implementation which provides the basis for the procurement methods. This plan was agreed between the Borrower and the Bank o n August 4, 2005 and i s available at FSTAP - PIU, located in Maputo, Praga 25 de Junho, Edif icio da Geologia Nr. 380, 3‘d Floor). I t will also be available in the Project’s database and in the Bank’s external website. The Procurement Plan wil l be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity.

Frequency of Procurement Supervision. In addition to the prior review carried out by the Bank team, as recommended by the capacity assessment o f the PIU, supervision missions wil l take place every six months to carry out a post review o f procurement actions.

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Annex 9: Economic and Financial Analysis

MOZAMBIQUE: Financial Sector Technical Assistance Project

NOT APPLICABLE.

Annex 10: Safeguard Policy Issues

MOZAMBIQUE: Financial Sector Technical Assistance Project

NOT APPLICABLE

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Annex 11: Project Preparation and Supervision

MOZAMBIQUE: Financial Sector Technical Assistance Project

Planned Actual PCN review August 5,2003 August 5,2003 Initial PID to PIC September 10,2003 September 8,2003 Initial ISDS to PIC September 10,2003 September 5,2005 Appraisal September 27,2005 September 28,2005 Negotiations October 11,2005 October 11,2005 BoardRVP approval December 1,2005 December 1,2005 Planned date o f effectiveness Planned date o f mid-tern review Planned closing date

March 30,2006 June 30,2008 June 30,201 1

Key institutions responsible for preparation of the project:

Banco de Moqambique Ministry o f Finance

Bank staff and consultants who worked on the project included:

Name Title Unit Michael Fuchs Lead Financial Specialist AFTFS Anthony Thompson Sherri Archondo Ravi Ruparel Elizabeth Sherwood Albert0 Ninio Eduardo Brito Monica Sawyer Thordur Jonasson Brighton Musungwa Tulio Correira Joao Tinga Mohamed Khatouri Slah Ben-Halima Thomas Muller Suzanne Morris Andrea Vasquez-Sanchez Irene Chacon Antonio Borges

Sector Manager Sr. Operations Officer (TTL) Sr. Financial Sector Specialist Financial Sector Specialist Lead Legal Counsel Sr. Legal Counsel Consultant Counsel Sr. Debt Specialist Sr. Financial Management Specialist Financial Management Specialist Financial Management Specialist Sr. Monitoring and Evaluation Specialist Sr. Procurement Specialistt Young Professional Senior Finance Officer Sr. Program Assistant Operations Analyst Information Assistant

AFTFS AFTFS AFTFS AFCMZ LEGAF LEGAF LEGAF OPD AFTFM AFTFM AFTFM AFTKL AFTPC AFTFS LOAG2 AFTPS AFTPS AFTPS

67

Bank funds expended to date on project preparation:

1. Bank resources: US$211,850 2. Trust funds: 0 3. Total: U S 2 1 1,850

Estimated Approval and Supervision costs:

1. Remaining costs to approval: US$lO,OOO 2. Estimated annual supervision cost: US$100,000

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Annex 12: Documents in the Project File MOZAMBIQUE: Financial Sector Technical Assistance Project

Financial Sector Assessment Program (Aide memoire and Volume 1 - Executive Summary) Financial Sector Technical Assistance Project - Appraisal Report - AfDB, June 2005 Project Implementation Manual Project Procurement Plan

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Annex 13: Statement of Loans and Credits

MOZAMBIQUE: Financial Sector Technical Assistance Project

Mozambique IBRDDDA Statement of Loans and Credits

As of November 2,2005

Dlfference Between Expected and Actual

Disbursements’ Orlainal Amount In US$ Millions

Project ID Fiscal Year Project Name IBRD IDA GRANT Cancel. Undisb. Orlg. FnnRev’d

PO69183 2004 MZ Energy Reform and Access SiL (FY04) 0.00 40.26 0.00 0.00 41.28 9.50 PO01799 1999 MZ-Agr Sec Pep (FY99) 0.00 30 0.00 0.00 7.76 7.39 7.22 PO82618 2005 MZ-Beira Railway SIL (FY05) 0.00 110 0.00 0.00 110.38 7.50

PO73479 2002 MZ-Corn Sec Reform 0.00 14.9 0.00 0.00 9.95 7.12 PO01807 2004 MZ-Decentr Planning &Fin SIL (FY04) 0.00 42 0.00 0.00 3442 15.67

PO49874 2000 MZ-Enterprise Dev (FYOO) 0.00 26 0.00 0.00 6.87 5.90 PO78053 2003 MZ-HIVIAIDS Response SIL (FY03) 0.00 55 0.00 0.00 49.83 1.35 PO69824 2002 MZ-Higher Education SIM (FYO2) 0.00 60 0.00 0.00 36.70 4.92 PO0 1808 2001 MZ-Mineral NRMCP (FYO1) 0.00 18 0.00 0.00 4.90 2.63 PO01806 2002 MZ-Municipal Dev SIL (FY02) 0.00 33.6 0.00 0.00 21.37 18.18 2.35 PO39015 1998 MZ-Nati Water 1 (FY98) 0.00 36 0.00 0.00 6.17 4.87 -1.06

PO72080 2003 MZ-Pub Sec Reform (FY03) 0.00 25.6 0.00 0.00 26.05 21.06

PO01785 2002 MZ-Roads 8 Bridges MMP (FYO2) 0.00 162 0.00 0.00 109.42 66.50

PO70305 2000 MZ-Coastal 8 Marine Biodiv Mgmt (FYOO) 0.00 5.6 4.1 0.00 5.39 4.91 0.02

PO01786 1999 MZ-Edu Sec Strtgy Prgm ESSP TAL (FY99) 0.00 71 0.00 0.00 18.67 16.23 3.33

PO52240 1999 MZ-Natl Water 2 (FY99) 0.00 90 0.00 0.00 57.47 37.02 -1.20

PO42039 2000 MZ-Railway 8 Port Restr (FYOO) 0.00 100 0.00 0.00 36.57 31.80 4.57

PO56201 2006 MZ -Second Poverty Reduction Support Credit 0.00 120 0.00 0.00 120.00 120.00 Total: 0.00 919.96 4.1 0.00 583.19 262.55 15.22

70

Mozambique Statement o f IFC's

Held and Disbursed Portfolio As o f Date 9/20/2005

(In U S Dollars Millions)

Held Disbursed

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1998 BIM-INV 0 0.3 0 0 0 0.3 0 0

2000103 BMF 2004 ENH

199710 1 MOZAL 1999 Maragra Sugar 2000 SEF Ausmoz 1997 SEF CPZ 2000 SEF Cab0 Caju 2001 SEF Grand Prix

2000104 SEF Merec

0 0.4 0 0 0 0 18.5 0 0 0

49.65 0 58.5 0 49.65 10.3 0 0 0 0 0.72 0 0 0 0.72

1 0 0 0 1 0.58 0 0 0 0.51 0.58 0 0 0 0.39

0 0 0 0 0

0.4 0 0 0 0 0 0 58.5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Total Portfolio: 62.83 19.2 58.5 0 52.27 0.7 58.5 0

~~

Approvals Pending Commitment Loan Eauitv Ouasi Partic

71

Annex 14: Country at a Glance

MOZAMBIQUE: Financial Sector Technical Assistance Project

POVERTY and SOCIAL Mozambique

2004 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 199844

Population (%) Labor force (%)

Most recent estimate (latest year available, 199844)

Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 1,000 live births) Child malnutrition (% of children under 5) Access to an improved water source (% ofpopulation) Illiteracy (% ofpopulation age 15+) Gross primaly enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1984

GDP (US$ billions) Gross domestic investrnenffGDP Exports of goods and servicedGDP Gross domestic savingdGDP Gross national savingslGDP

3.4 11.7 4.1 -2.5 -0.2

Current account balance/GDP -14 1

Total debVGDP 42 6 Interest paymentdGDP 0 1

Total debt service/exports 7 8 Present value of debffGDP Present value of debffcurrent year exports

1984-94 199444 (average annual growih) GDP 4 1 8 3 GDP per capita 3 1 6 1 Exports of goods and services 7 6 186

19.1 250 4.8

2.0 2.1

54 27 45

101 24 37 55

110 121 100

1994

2.3 25.5 14.1 -8.4 -1.9

-30.4 2.4

323.1 28.6

2003

7.8 5.8

13.8

Sub- Saharan

Africa

719 600 432

2.2 1 .o

37 46

101

58 65 95

102 68

2003

4.8 25.9 28.3 10.1 11.3

-19.9 3.0

103.0 25.4 25.2 86.0

2004

7.2 5.3

23.8

Low- income

2,338 510

1,184

1 8 2 1

31 58 79 44 75 61 94

101 88

2004

6 1 20 1 30 0 11 8 11 9

-13 8 2 4

83 3 24 0 23 7 77 1

200448

7 0 5 2 6 5

>evelopment diamond'

Life expectancy

T

3NI Gross primary

enrollment 3er 1 \ \

:apita

I i

Access to improved water source

- Mozambique ~ Low-income group

Economic ratios.

Trade

T

Economic ratios.

Trade

Investment Domestic savings

Indebtedness

:Mozambique I Low-income group

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services

Private consumption General government consumption Imports of goods and services

Manufacturing

(average annual growth) Agriculture Industry

Services

Private consumption General government consumption Gross domestic investment Imports of goods and services

Manufacturing

1984 1994 2003 2004 1 Growth of Investment and GDP (%) 'I 20.0 16.1

.. 9.5 49.8 48.6

87.4 94.3 15.1 14.1 10.3 10.1 18.4 48.0 44.1 38.3

1984-94

2.3 -3.0

6.4

3.0 5.7 2.5 2.1

199444

5.8 17.4 18.0 6.2

4.0 9.1

12.6 8.0

2003 2004

6.5 6.0 10.2 8.6 13.6 9.6 4.8 8.0

9.9 9.1 10.8 5.0 4.4 -13.9

13.1 4.6

1 Growth of exports and imports (%) 1 60

40

20

0

-20

Note: 2004 data are preliminaly estimates. Group data are for 2003

* The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing. the diamond will be incomplete.

72

Mozambique

PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall sumlus/deflcit

TRADE

(US$ millions) Total exports (fob)

Cashew nuts and raw cashew Prawn Aluminum Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (7995=100) Import price index (1995=100) Terms of trade (7995=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income

Current account balance before grants

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$)

EXTERNAL DEBT and RESOURCE FLOWS (US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Official grants Official creditors Private creditors Foreign direct investment

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

Composition of net resource flows

1984

30.0 17.7

16.0 -3.6

-15.3

1984

96 15 28

540

110 94

117

1984

157 583

-426

-50

-476

539 -63

38 42.4

1,438 0 0

17 0 0

168 612 198

0

0 0 0 0 0 0

1994

63.1 54.7

17.9 3.0

-12.9

1994

164 15 63

3 881 53 82

201

91 91

100

1994

355 1,018 -662

-202

-864

91 7 -52

209 5.91 8.1

7,272 0

714

117 0 4

565 219

0 35

427 176

0 176

4 172

2003

13.4 9.0

16.6 2.2

-10.3

2003

1,044 9

76 568

15 1,741

159 249 400

87 91 96

2003

1,353 2,108 -756

-198

-953

1,076 -1 22

947 23,782.3

4,930 0

1,232

356 0 8

514 142

17 342

163 159

2 157

6 151

2004

12.6 12.6

15.1 1.2

-8.9

2004

1,504 29 92

880 19

2,035 188 312 737

110 101 108

2004

1,828 2,330 -503

-340

-843

1,055 -21 2

1,159 22.581.3

5,071 0

1.427

450 0 6

49 1 254 -92 241

206 197

2 195

4 191

"I 69 W 01 02 03

-"--GDP deflator -CPI

Export and import levels (US$ mill.)

2.m

1.5W

1.ow

500

0

" I 98 99 W 01 02 03

Exports Imports

1 Current account balance to GDP ("A) 0

-5

-10

-15 -20

-25

-30

Composition of 2004 debt (US$ mill.)

E: 2,352

A - IBRD 8 - IDA D - Other multilateral F . Private

E - Bilateral

73

Annex 15: Letter of Development Policy

MOZAMBIQUE: Financial Sector Technical Assistance Project

REJ?hLICA DE MOCAMsIQUE MTMSTkf.0 DA PLAMFICACAO DE DESENVOLVLMENTO

OABINETE DO MMlSTRO

No 4'256 lGtWMPDfO5 Maputo, October ,2005

H,E. Paul Wolfawk President The World Bank 1818 H Street, N. W. Washington, D,C. 20433 U.SA.

Subject: Letter of Development Policy for the Financial Sector

1. i am wFiting, on behalf of the Government of Mozambique (GoM), to request a credit in the amount of US$ 1 O S million from the International Oevelopment Association, to continue suppoFting the Government of Mozambique' s Financial Sector Development under the proposed Financial Sector Technical Assistance Project [FSTAP), together with other donors (AtD5, DFID, SIDA, GTZ and KWY).

2. The credit will contribute to improve the soundness and depth of the Mozambican Finanad Sector and increase financial intermediation. The overall effort will be supported by: (a) Strengthening the Banking Sector, including lmprovlng the Institutional Capacity of the Bank of Mozambique (BoM); (b) Improving Financial Accountability and transparency; (c) Strengthening Public Debt Management; (6) Improving Money and Debt Markets and FinandaJ Shdure: (e) ) Micro and Rural Finance; (9 Skengthenlng the Insurance and Supplementary Pension System; (9) Strengthening the Social Security System; (h) Improving the Legal and Judidal Environment for Financial Transactions; and (i) Support for Anti-Money Laundering Efforts-Establishment of the Financial Crimes investigation Unit.

Mozambican Financial Sector

3. The Mozambican financial system is young, small, bank-based, foreign-owned, concentrated, and dollarization-prone. Over the last 14 years, the Mozambican financial system has made very substantial progress, from mono-banking to a full blown market-based financial system. Yet, it is still small, with less than $2 billion in total assets, and is dominated by banks, which represent more than 95 percent of total financial system assets. Except for a recently founded small bank, all financial intermediaries are majority-owned by foreign Institutions, mostly Portuguese and South African. The banking system is highly concentrated, wrth the largest bank and five largest banks accounting for 46 percent and 94 percent, respectively, of total deposits. It is also characterized by Increasing doliaritation. While in 1997, only 41 percent of deposits and 27 percent of loans were in foreign currency, 45 percent of deposits and 61 percent of loans were in Poreign currency in June 2005.

74

75

. . . - . ., .. . . ._ . . . . . . . - . . . . . . . .

76

. - .... - - - . - . .-...--...- . - .

27-0tT-2@@5 19 42 M I N PLRNI E DEsmv€l P.06

77

26. fhe growth of the microfinance industry is constrained in part by the fact that MFls, as caner@ regulated by GoM dame 47 bswd in *t998, cannot engage in depcrslt taking nor provide payment

78

79

29. Tha GoM enacted an An$-hney Laundering law, tsW no. 712a02 Cn February 2002, which ~~~~~~~~ the legal framework for cambating approved in August 2004, In genefat, the law line with Hernational requimnts, in partic Financial Adan Task Force [FATF) on money launben'ng. Th~a law unde&ke custarner due diligence, obtain infom&m an #m&X maintain good ncoird-keeping, Financial ~ n s ~ ~ ~ ~ ~ n ~ are required to m prstsecrrtor's o%w, without discfming the information to the customer under invstigatiart. However, there are no pmvisions for the &ststabtishrnent of special investigation unit for the ~ n ~ $ ~ ~ ~ g ~ ~ ~ of financial crimes. The need is borne aut of the fad that ths nature of finandal crimes is very dtfffsmnt from other types af crllminal aetbities, and therefore requires d@%rmt types of m o u w s fskilis, ~ ~ ~ ~ ~ ~ n ~ , stc,) for ~ n v ~ ~ a t j ~ and prosecution, Thus, based cm the ~ ~ a r n ~ e n d a t ~ ~ ~ ~ d the 1MF and ofher bodies, the GoM has a g w d to set up a special Financial Crimes l ~ v ~ ~ g ~ ~ ~ Unit (FGIU).

Conclusion

,

81

TOTFIL P. 18