report no. 22985-moz mozambique public expenditure

Report No. 22985-MOZ

MozambiquePublic Expenditure Management Review

December 2001

Africa RegionMacroenonomics 1

Document of the World Bank

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Currency EquivalentsCurrency Unit: Metical (Mt)

US$1 = 22,000 Mt

MeasuresMetric System

Fiscal YearJanuary 1 to December 31

Vice President: Callisto MadavoDirector: Darius MansSector Manager: Philippe Le HouerouTask Manager: Jose E. Leandro

TABLE OF CONTENTSPage No.

EXECUTIVE SUMMARY ...................................................................... j

INTRODUCTION ...................................................................... 1PART I. AGGREGATE FISCAL ANALYSIS ..................................................................... 2CHAPTER 1. OVERALL EXPENDITURE TRENDS-LESSONS FROM THE PAST ............. ..................... 3A Overview ....................................................................... 3B. Overall Expenditure Trends ...................................................................... 3CHAPTER 2. LOOKING AT THE FUTURE-TOWARD A SUSTAINABLE FISCAL POLICY .................... 6A. The Challenge Ahead-Conditions for Fiscal Sustainability .............................................. 6B. Facing the Challenge-Toward a Sustainable Fiscal Policy and Economic Growth ....... 10C. Limiting the Risks of Contingent Liabilities ..................................................................... 14CHAPTER 3. INTERGOVERNMENTAL FISCAL RELATIONS-TAKING STOCK AND LOOKING AHEAD 16A. Background .16B. Governance .18C. Revenues .20D. Expenditures .24E. Reform Agenda: Observations and Recommendations .29PART 11. PUBLIC EXPENDITURE MANAGEMENT REVIEW .............................................................. 3 5CHAPTER 4. BUDGET FORMULATION-IMPROVING COVERAGE AND TRANSPARENCY ... ............. 36A. Improving Budget Coverage ..................................................................... 36B. Increasing Budgetary Transparency-A New System of Budget Classification ............... 45C. Enhancing Expenditure Planning and Budgeting ... ........................................................ 46CHAPTER 5. BUDGET EXECUTION-INCREASING EFFICIENCY . ..................................................... 53A. Accounting and Reportingfor Better Management .......................................................... 53B. Cash Management-Saving the Government Money .... .................................................. 60CHAPTER 6. BUDGET EVALUATION AND AUDIT-IMPROVING ACCOUNTABILITY ANDCOMPLIANCE ....................................................................... 69A. Internal Auditing ..................................................................... 69B. External Auditing ..................................................................... 71C. Budget Evaluation ..................................................................... 72CHAPTER 7. TOWARD A MODERN PUBLIC FINANCE MANAGEMENT SYSTEM . . 74A. Improving the Legal Framework-The New Public Finance Management Law ............. 75B. Integrated Financial Management Information Systems (IFMIS) .................................... 77C. Action Plan for a More Efficient, Transparent and Accountable Budget Management

System ..................................................................... 78

Annexes .............................................................. 83

Annex 1: Statistical AnnexAnnex 2: Scenario for Fiscal Sustainability................................................................................Annex 3: Intergovernmental Fiscal Relations.............................................................................Annex 4: The Process of Budget Formulation.............................................................................Annex 5: The Process of Budget Execution ................................................................................Annex 6: Towards an Integrated Financial Management System in Mozambique-Keys

to the Successful Implementation of the SISTAFE ....................................................

References ........................................................................................................................

Tables:

Table 1. I Gov ernment Finance - 1992-2000 .................................................................... 4Table 2.1 Sustainable Primary Balance (in percent of GDP ........................................................ 8Table 2.2 Sustainable Primary Balance (in percent of GDP) ....................................................... 8Table 2.3 Mozambique Government Finance: 1987-2002 .......................................................... 10Table 2.4 PARPA - Government Finances: 2002-2010 ............................................................. 12Table 2.5 Government Finances (assuming 6 percent of GDP growth after 2005) ..................... 13Table 2.6 Government Finances (assuming 8 percent growth after 2005) .................................. 13Table 3.1 Functions, Revenue, and Expenditures at the Provincial, District and Municipal

Levels: A Summary Comparison .................................................................. 17Table 3.2 Central Government Transfers to Municipalities, 200 ................................................. 21Table 3.3 Municipal Arrears .................................................................. 24Table 3.4 Provincial and Non-Priority Capital Expenditures as a Percentage of the Total

Capital Budget .................................................................. 25Table 3.5 Per Capita Provincial Expenditures (Recurrent and Capital), 1998 and 2000 (Mts) ... 27Table 4.1 Summary of Proposed Framework for Own Source Revenue Reform ........................ 42Table 4.2 Budgeted and Actual Investment Spending by Functional Classification, 1999 and

2000 (Mt billions) .................................................................. 43Table 7.1 Summary of Pressing Actions for Reform .................................................................. 79Table 7.2 Summary of Priority Actions for Reform .................................................................. 80Table 7.3 Summary of Actions for the Medium-Run .................................................................. 82

Boxes:

Box 2.1 Theoretical Underpinnings of Debt Sustainability applied to Mozambique .................. 6Box 2.2 Seignorage as a Source of Deficit Financing ................................................................. 9Box 3.1 Popular participation is a critical ingredient to successful decentralization ................... 29Box 4.1 The Financial Management of User Fees: An International Perspective ...................... 40Box 4.2 Concerns About PIPs and Proposals to Address Them .................................................. 48Box 4.3 Good Practice in MTFF Design and Implementation in Sub-Saharan Africa ................ 49Box 5.1 Principles of Good Reporting and Types of Internal and External Reports ................... 59Box 5.2 Alternative Models of a Treasury Single Account ......................................................... 63

Figures:

Figure 1.1 Revenue and expenditure as a percentage of GDP ..................................................... 5Figure 3.1 Provincial Recurrent Expenditures as a Percentage of the National Recurrent

Budget .................................................................. 26Figure 5.1 Proposed Model for Treasury Single Account in Mozambique ................................. 66

ACRONYMSBCM Banco Comercial de MogamnbiqueBM Bank of MozambiqueCGE Conta General do EstadoCFAA Country Financial Accountability AssessmentCFMIP Medium Term Fiscal FrameworkCOFOG Classifications of the Functions of GovernmentDflD Department for International DevelopmentDNCP National Directorate for Public AccountingDNIA National Directorate for RevenueDCI Department of International CooperationDP Provincial DirectorateDNPO National Directorate for BudgetDPPFs Provincial Directorate for Plan and FinanceDSA Debt Sustainability AnalysisDNT National Directorate of TreasuryEC European CommissionEMRS Expenditure Management Reform StrategyESRP Economic and Social Rehabilitation Program (ESRP)FCA Autarkic Compensation FundFDF Fishing Development FundFIIL Local Investment FundGDP Gross Domestic ProductHIPC Highly Indebted Poor CountriesIGF Finance Inspectorate GeneralIFMIS Integrated Financial Management Information SystemLMF International Monetary FundMAE Ministry of State AdministrationMFL Municipal Finance LawMICAS Ministry of Coordination for Social ActionMINED Ministry of EducationMISAU Ministry of HealthMOPH Ministry of Public Works and HousingMPF Ministry of Planning and FinanceMTC Municipal Tax on Commerce and IndustryMTFF Medium Term Fiscal FrameworkNGOs Non-Governmental OrganizationsOE State BudgetPARPA Programa de Ac,co para a Redu,co da Pobreza AbsolutaPEMR Public Expenditures Management ReviewPES Economic and Social PlanPRGF Poverty Reduction and Growth FacilityPRSP Poverty Reduction Strategy PaperPSIs Integrated Sectoral ProgramsPTIP Three Year Investment ProgramSIDA Swedish International Development AgencySIPs Sector Investment ProgramsSISTAFE Integrated Financial Management SystemUTRAFE Technical Unit for the Financial ReformVAT Value Added Tax

ACKNOWLEDGEMENTS

The Public Expenditure Management Review (PEMR) in Mozambique is a jointeffort between a core government team of experts, the World Bank and a group of donorsinvolved in public finance in Mozambique. The government core team, led by JoseSulemane, National Director for Budget and Planning, included Armindo Matos,National Director for Public Accounting, Ant6nio Laice, National Director for Treasury,Amade Aziza, National Director for Revenue and Auditing and Domingos Lambo,Deputy-Director for Budget. Mr. Carlos Jessen, Director of the Technical Unit for theFinancial Reform of the State (UTRAFE) led the discussions on the new Public FinanceManagement Law. Very useful information and insight was provided by experts inpractically all departments in the Ministry of Planning and Finance.

The group of economists from donor agencies consisted of Jose Carlos Nunes(EC), Nick Highton (DFID), Maude Svensson (SIDA) and Martin Roland (TheNetherlands). Their extensive knowledge of public finance issues in Mozambique wasextremely valuable. This report has also greatly benefited from the contributions byDavid Andrews (IMF-AFR), Alvaro Manoel (IMF-FAD) and Arnim Schwidrowski (IMFResident Representative in Mozambique).

The World Bank team was led by Jose Leandro (Task Manager and Team Leader,Macroeconomics) and included Peter Moll (Macroeconomics), Robert Taliercio(Macroeconomics), Dipac Jaiantilal (Macroeconomics, Country Office), Maria TeresaBenito-Spinetto (Macroeconomics) and Helene Grandvoinnet (Public Sector). Technicaladvice for the drafting of the new Public Finance Management Law was provided byClidio Soares (World Bank consultant). Preliminary data research was undertaken byJoao Van Dunem.

This report was prepared under the supervision of Philippe Le Houerou, SectorManager Macroeconomics 1. He offered overall conceptual guidance, provided criticalanalytical advice and ensured quality control and management support. Darius Mans,Country Director, supported the process and provided the major guidelines.

The reviewers of the report are Vinaya Swaroop, Jehan Arulpragasam andMichael Stevens. They offered valuable advice and critical input. Helpful comments andadvice were also received from Jorge Arauijo, Fahrettin Yagci and Delfin Go. LigiaMurphy assisted with managing the PEMR budget and provided editorial assistance.

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EXECUTIVE SUMMARY

Improving budget management in Mozambique requires a set of actions in the area offiscal policy at the macroeconomic level, as well as specific measures to deal withcontingent liabilities and to address issues related to intergovernmental fiscal relations.At the same time, a new round of reforms in the way the budget is formulated, executed,controlled and accounted for is also required to improve efficiency, transparency andaccountability in the use of public resources.

AGGREGATE FISCAL ANALYSIS

i. Goodfiscal management has played a central role in Mozambique's recoveryover the last decade. A prudent fiscal stance, accompanied by substantial externalassistance, contributed to relatively low deficits after grants, at least until 2000.Combined with a careful monetary policy, especially since 1996-97, and a program ofstructural reforms based mainly on privatization, tax and customs reform and tradeliberalization, this resulted in low inflation, high private investment and high growthrates. At the same time, a shift in resources in favor of health, education and agriculturetook place after 1998, reflecting an increasing anti-poverty focus. Education, health andagriculture increased their combined share in total budgetary allocations from 29 percentin 1998 to 39 percent in 2001.

ii. Nevertheless, fiscal imbalances remain and the fiscal position has deteriorated,particularly since 1996. Despite the progress so far, fiscal policy continues to sufferfrom stubbornly high deficits before grants. After a considerable fiscal adjustment effortbetween 1992 and 1995, little change has taken place since then and the overall budgetdeficit before grants remained high at around 13 percent of GDP over the period 1995-99.Underlying these results was a significant expansion of expenditures initiated in 1996.This expansionary trend was aggravated in 2000, when expenditures rose by 16 percentin real terms compared to the previous year. This increase was only partly linked to floodreconstruction, which has taken place mostly in 2001. Other important factors included(i) the recapitalization of a former state-owned bank, Banco Comercial de Moqambique(BCM), which could have been avoided if banking supervision rules had been stringentlyenforced and the state did not maintain a significant share of ownership in the bankingsector; (ii) a significant increase in the civil service wage bill; and (iii) higher socialspending made possible by HIPC debt relief. The fiscal position is projected todeteriorate even further in 2001 as a result of the combination of post-floodreconstruction expenditures and the cost of restructuring Banco Austral (BA), anotherbank with 40 percent government participation that collapsed in 2001.

iii. The current fiscal position is unsustainable and, if not corrected, may become athreat to macroeconomic stability and growth. For 2002, the projected primary deficit(defined as the overall deficit after grants minus interest on public debt) is above thesustainable level, meaning that, if not corrected, it is likely to lead to an increasing debt-to-GDP ratio. Until now, these levels of deficit have been possible only because ofexceptionally high levels of foreign grants. External assistance is not likely to drop

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significantly in the short run, at least as long as Mozambique implements sound policiesand improves governance and accountability. However, relying on the current levels ofexternal aid over the medium run would be a dangerous choice. Over time grants arelikely to converge towards the average in Sub-Saharan Africa, which is around 4 percentof GDP (against 12 percent of GDP in 2000 in the case of Mozambique). Therefore, inthe absence of fiscal adjustment, the maintenance of a high budget deficit will only bepossible through higher public debt and/or increased reliance on domestic bank financing,running contrary to the objectives of the initiative for Highly Indebted Poor Countries(HIPC) and raising the threat of higher inflation and lower growth

iv. Gradualfi scal adjustment should become a priority of government policy.While it was wise during the last decade to avoid an excessively rapid fiscal adjustmentthat would have hampered reconstruction, it is now urgent to address these imbalancesand to evolve gradually toward a more sustainable fiscal position over the next 10 years.The need to develop a post-HIPC strategy on public debt also militates in favor of such afiscal adjustment. Recognizing this fact, the fiscal scenario underpinning the Programade Acqdo Para a Reducdo da Pobreza Absoluta (PARPA, or PRSP) includes a significantfiscal adjustment that could lead to a sustainable fiscal position by 2005. However,should the conditions be less favorable than anticipated in the PARPA in terms ofeconomic growth and external assistance, a longer period before reaching sustainabilitymay be necessary. In any case, the gradual fiscal adjustment that has now becomeinevitable will require the combination of a demanding revenue effort with measures torestrain expenditures. This should be accompanied by a re-focusing of publicexpenditures in priority areas while improving the efficiency and poverty-incidence ofpublic intervention.

v. Contingent liabilities, especially in the financial sector, including insurance,and the pension system, are a threat to fiscal stability. As Mozambique will beengaging in this renewed effort to achieve a more sustainable fiscal stance, the risksassociated with further bank failures must be dealt with in a swift way. The lessons fromthe recent bankruptcy of BA and the difficulties that BCM faced in 2000 should lead tothe urgent reinforcement of banking supervision, the active recovery of bad loans and thewithdrawal of the state from the financial sector. In parallel, the state-owned insurancecompany, EMOSE, should launch an independent audit and be subject to supervision andstrict prudential rules. There are strong signs that the civil service pension scheme isunder-funded. The authorities should ensure that the actuarial study covering both thisscheme and the National Institute of Social Security (INSS, which covers employees ofprivate and parastatal enterprises) is completed soon. As part of the actions to beimplemented over the short run, fiscal risks should be fully disclosed and effectivelymonitored. Government guarantees to financial and non-financial companies should beregulated and subject to strict limits to minimize moral hazard.

vi. Decentralization and deconcentration are important issues for the improvementof fiscal management and service delivery in Mozambique. In a country as vast anddiverse as Mozambique, effective fiscal management entails some degree ofresponsibility by sub-national levels of government to plan, implement and overseepublic intervention. Finding the right balance of fiscal empowerment that maximizes the

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effectiveness of public action and service delivery at each level of government, whileminimizing the risks of fiscal instability and guaranteeing the degree of accountabilitythat is required by democratic regimes, is the major challenge facing policymakers in thisarea. The process has started and has gained impetus, particularly since the 1998municipal elections and the creation of 33 municipalities. Decentralization inMozambique remains, however, politically very sensitive and a gradualist approach hasbeen followed so far.

vii. Fiscal responsibilities at provincial and district levels remain smal compared tooverall levels of public expenditures and revenues. Provincial own revenues representless than 3 percent of national revenue. On the expenditure side, provincial capitalexpenditures in 2000 represented also around 3 percent of total national capital budget.Provincial recurrent expenditure has averaged 3 8 percent of total national recurrentspending, but the great majority of this is employee compensation. This low level ofresources is strongly linked to low execution capacity at the provincial level. Fiscalresponsibilities at the district level are even less important and the district budget has nolegal standing. As opposed to provinces and districts that are simple deconcentratedbodies of the central government mainly covering rural constituencies, municipalitiesenjoy political, administrative and fiscal autonomy.

viii. The roles ofprovinces and districts should be redefined, and accompanied bythe strengthening of technical capacity, as well as by the creation of mechanisms forgreater local participation. In a country as vast as Mozambique, suffering from poorcommunications and a dearth of capacity in public administration that is especially acuteoutside Maputo, the gradualist approach that has been followed so far regarding theextension of responsibilities to provinces and districts seems appropriate. The moment is,however, opportune for a reconsideration of the role of provinces vis-a-vis the centralgovernment and the districts. The current system of dupla tutela of provincialdirectorates both to their sectoral ministry and the governor creates difficulties and shouldbe reconsidered. At the district level, the rethinking of dupla tutela should beaccompanied by a redefinition of the role of the districts. A clear set of functions shouldbe defined for districts before the assignment of revenues and expenditures in order toavoid the risk of unfounded mandates. This should be accompanied by the creation ofmechanisms for greater participation of local populations in the decision-making processat the district level. The strengthening of the administrative capacity of districts is apriority in this context, particularly in the area of budget management and procurement.

ix. Devolution of responsibilities is seriously constrained by the low revenue baseof these rural constituencies. So far, the strategy of reform of the state has been pursuedboth in terms of fiscal decentralization, in the urban zones, and deconcentration, in therural zones (in pursuit of the twin goals of "democratization and integration"). From afiscal perspective, this seems an appropriate model in the specific case of Mozambique.Indeed, the creation of the municipalities as autonomous levels of local government withthe capacity to raise their own revenues deprived most districts and provinces of theirmain revenue base (as most "taxable" economic activities are concentrated in cities andtowns).

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x. As far as municipalities are concerned, a set of issues will have to be faced inthe nearfuture in orderfor Mozambique to consolidate its important yetfragiledecentralization process . First, as more substantive functions are transferred tomunicipalities considerably more resources will be required, in particular when functionsheavy in personnel costs, such as education and health, will be fully transferred.Currently, funding under the Autarkic Compensation Fund (FCA) is below the minimum1.5 percent of national tax revenues required by the law, reflecting the fact thatmunicipalities are still not fully operational. As more responsibilities and resources aretransferred to municipalities, a more equitable formula of redistribution should beapplied. Second, in order to ensure efficiency in tax collection and to benefit fromeconomies of scale, the current system under which Provincial Finance Directorates(DPPF) collect municipal taxes, should be maintained, or, alternatively, a municipal taxadministration agency with tax raising authority could be established. Third, there iswidespread concern regarding the low capacity of municipalities to appropriatelyimplement good fiscal management principles. Training in this area should be a priority.Fourth, given the acute lack of administrative capacity and the generally low level ofmunicipal revenues, the authorities should consider the definition of a set of minimumcriteria to be met by each municipality before additional functions and responsibilities aretaken up. These criteria should be transparent and purely technical. Finally, for thedecentralization process to gain some depth, municipalities should be given full controlover their personnel (whose wage bill represents the majority of municipal recurrentexpenditures), subject to a basic regulatory framework established at the national level.

PUBLIC EXPENDITURE MANAGEMENT REVIEW

xi. Signifrcant progress was achieved after the launching of the ExpenditureManagement Reform Strategy (EMRS) in 1997. Progress was particularly noticeable inexpenditure planning and budgeting thanks to the enactment of the Budget FrameworkLaw in 1997 and the launching of the Medium Term Fiscal Framework (MTFF) in 1998.Overall, the existing fiscal management system provides for good aggregate control ofexpenditures within years and there is no apparent problem of expenditure arrears.

xii. However, the budget system continues to suffer from inadequacies that hinderefficiency, transparency and accountability. Incomplete coverage even of ownresources and expenditures, inappropriate functional classification, outdated accountingprocedures, weak cash management and deficient controls and audits are among thecritical areas negatively affecting budget management in Mozambique.

xiii. The reform process is underway but must be given new impetus and depth. Theauthorities share these concerns and improving the efficiency, transparency andaccountability in the management of public funds are among the six priority areas in thePARPA. Recent initiatives, some of which were introduced during the course of thisPublic Expenditure Management Review, have contributed to improve the situation, suchas the decision to introduce a more detailed budget functional classification in 2002; theapproval by Parliament of a new Public Finance Management Law (Lei da Administra aoFinanceira do Estado) introducing modem concepts of budget management; thepublication, since May 2000, of quarterly budget execution reports; and the creation of a

unit (UTRAFE) in the Ministry of Finance in charge of coordinating and steering budgetmanagement reforms. However, substantially more needs to be done and deepening thereform process will require a strong and sustained commitment at the political andtechnical levels.

xiv. Improving budget formulation, coverage and transparency, reforming publicaccounting and cash management, and enhancing internal control and auditingshould all be part of this new phase of reforms. Below is a summary of therecommendations included in Part II of this report. A possible action plan and time framefor reform is proposed in chapter 7.

Budget formulation

Issues

xv. The budget offers only a partial view of public revenue and expenditures,violating the principles of universality and integrality, and undermining the effectivenessof the budget as a tool of public policy.

xvi. Transparency of public intervention, a fundamental issue in a democratic regimeand an important factor in a market economy, is impaired by the use of a functionalclassification that is too aggregated and that does not offer a sufficiently detailed view ofresource allocations among sectors.

xvii. Budget formulation, which currently involves the preparation of four distinctdocuments, needs to be streamlined. Consideration should be given to bringing theoverriding objective of macroeconomic stability explicitly into the budget process. Therole of Parliament would also need to be made more specific in the law, reinforcing itsposition as a check on government while limiting its discretionary powers with regard tomajor changes in the budget.

Recommendations

xviii. Budget coverage. Own source revenue. As a general principle, the emphasisshould be on capturing the information in the budget rather than the funds themselves.More specifically, the following actions are recommended:

* Specific criteria for institutions with administrative and financial autonomyshould be defined and the authorities should also determine which user feescurrently collected should continue to be raised.

* Autonomous institutions (most of them offering services with some positiveexternalities) should charge their own rates on the basis of partial cost-recoveryand sould be allowed to retain revenue collected. All revenue and expendituresshould be reported in the budget.

* Central service provision and regulatory agencies (e.g. Mozambican EngineeringLaboratory or the Fishing Development Service) offering private goods: ratesshould be set by decree annually on the basis of full cost recovery. Agencies

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should be allowed to retain the share of revenue necessary to cover costs. Allrevenue and expenditures should be reported in the budget.Local social service delivery agencies (e.g. schools, clinics, hospitals, etc.)offering services with substantial positive externalities or public goods: ratesshould be set by the sectoral ministry on the basis of limited cost recovery andupdated annually. All revenues should be retained by the collecting institution.Information on collection and expenditures incurred should be reported to thesectoral ministry on a quarterly basis.

xix. Donor funding. The level of information on donor funded activities should beincreased both in the budget and in the budget execution reports. In particular, anannex should be added to the quarterly budget execution report with information ondonor-funded actual expenditures.

xx. Tax expenditures. A tax expenditure is the revenue foregone because ofpreferential provisions of the tax structure, including exemptions, deductions, credits,deferrals and reduced tax rates. This issue is particularly important in Mozambiquegiven the large number of fiscal incentives that are currently applied and the absenceof public information on the estimated consolidated revenue loss associated withthem. In particular, no information on this issue is provided in the budget. Taxexpenditures should be subject to an explicit trade-off against new spendinginitiatives and should be as transparent as possible. A consolidated assessment of alltax expenditures should be attached to the budget document.

xxi. Budget transparency. The government has decided in March 2001 tointroduce a new, more detailed functional classification following the UN COFOGclassifiers. The 2002 budget will formulated according to this new classification.

xxii. Budget formulation process. (i) The investment plan (PTIP) should beabandoned as a stand alone document since it reflects many of the shortcomingsassociated with dual budgeting. (ii) The Economic and Social Plan (PES) should bereinforced and could be used as one of the instruments for the monitoring of thePARPA. (iii) The budget should be formulated and executed in current prices. Inaddition, (iv) the Medium-Term Fiscal Framework (MTFF) should be reinforced asan instrument of budget planning. In particular, it should be enshrined in thelegislation and made available to the general public. Its management structure shouldprovide multiple and overlapping points of responsibility and technical assistanceshould continue to be utilized to produce adequate sectoral expenditure frameworks.(v) The objective of macroeconomic stability should be brought into the process ofbudget formulation in a more explicit form. One possible way would be to use theMTFF as the vehicle that sets the overall budget deficit target for the budget year, aswell as the projected targets for the subsequent years. The budget year target shouldbe considered a ceiling not to be exceeded, while the deficit for subsequent yearswould be provided on an indicative basis, subject to adjustment each year. TheNational Assembly would not be allowed to approve changes in the budget that wouldlead to a higher budget deficit. (vi) The National Assembly should receive more andbetter information from the executive, both during budget approval and during

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execution. In particular, Parliament's involvement and role could be increased bysplitting the process of budget approval into two stages: first, a discussion wouldfocus on the macroeconomic and sectoral projections, policies and assumptionsunderpinning the budget. The MTFF and the PES would provide the main basis forthis discussion. In a second stage, the discussion would focus on the detailed scrutinyof revenue and resource allocations, based on the budget proposal. Finally, (vii) thetechnical capacity of the National Assembly to analyze the budget and to monitor itsexecution needs to be reinforced, both by increasing the budgetary allocation in favorof the Parliament's Planning and Budget Committee and through capacity buildingwith the support of the donor community.

Budget execution

Issues

xxiii. Budget execution in Mozambique suffers from poor accounting, partialreporting and weak cash management. Mozambique's accounting system is currentlyone of the weakest components of the expenditure management system. It iscumbersome, offers only a partial view of financial transactions, and it is no longercapable of handling the accounting needs of an evolving public sector. With regard tothe reporting function, recent progress has taken place with the publication ofquarterly budget execution reports, the issuance and external auditing of the 1998 and1999 State accounts (Conta Geral do Estado), and the implementation of an interimtracking system to monitor actual expenditures in those areas that have benefited fromHIPC-related savings. However, reporting remains partial, and has not beendeveloped into an effective tool of policy planning, formulation and monitoring.Finally, cash management is hampered by the existence of multiple treasury accounts,deficient cash flow projections and ineffective integration between accounting andcash management functions, which lead to a waste of government resources andundermine the efficient and smooth execution of budget expenditures.

Recommendations

xxiv. Public accounting. (i) The current system of single-entry accounting shouldbe replaced by double-entry bookkeeping. Implementation of this new system willrequire a substantial training program, which should be launched urgently. (ii) Thecash basis accounting system currently in use should be abandoned and replaced bymodified accrual accounting (as provided for under the new Public FinanceManagement Law). Under this technique, revenues are recorded on a full cash basis,while expenditures are recorded on a commitment basis, irrespective of when cash ispaid. Training on this technique could take place simultaneously with training ondouble-entry accounting. (iii) Introduction of the modified accrual accountingsystem should be accompanied by the elimination of the current complementaryperiod of 3 months after the end of the year during which payment of expenditurescan still take place. (iv) The so-called treasury operations ("Operac6es deTesouraria") should be suppressed, as they can be the source of extra-budgetary

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operations. (v) A new chart of accounts should be implemented simultaneously withthe introduction of double entry and modified accrual accounting. (vi) DNCP shouldbe freed of all activities not directly related to public accounting and reporting.

xxv. Reporting. (i) Quarterly budget execution reports, although representing asignificant improvement over the past, need to be further improved. These reportsshould show, for each item in the budget classification, the initial allocation and therevised allocation (if any)-hence providing a consolidated view of the adjustmentsintroduced to the budget during the execution phase-as well as actual expenditures.More and better information on donor-funded expenditures should also be included inthe reports. In addition, it will be very important to ensure that, starting in 2002,reporting on budget execution follows the detailed function classification that will beintroduced. (ii) Currently, financial reports, other than the Conta Geral do Estado,are not published. In addition to the consolidated State accounts published since2000, financial reports should be regularly produced and made available, starting with(a) a report on short and medium-term external and domestic debt, (b) a report onlending and on-lending, (c) reports on cash flows and (d) a report on tax expenditures.

xxvi. Cash management. (i) Reducing the number of existing bank accounts andimposing strict rules of discipline on the way spending agencies open and operatethose accounts for purposes of budget execution, are the two most urgent tasks thatthe treasury must face. A three-step approach is proposed in this report. (ii) Atreasury single account ("Conta Unica"), following the model of an active treasuryaccount, should be introduced. This is an account, or set of linked accounts, throughwhich the government transacts all inflows and all outflows of funds. (iii) A new,automated treasury payments system, integrated into the new National PaymentsSystem being developed by Banco de Mocambique, should be introduced. (iv)Financial planning needs to be improved with the development of annual cash plans,budget implementation plans and monthly cash plans. (v) Revenue collection needsto be rationalized by allowing commercial banks to act as government agents in thecollection of revenue, and a single document (Documento Unico) for the collection ofall taxes should be introduced.

Budget evaluation and auditing

Issues

xxvii. Budget evaluation and auditing-both internal and external-are weak inMozambique. A dearth of trained personnel and resources undermine the auditingfunction of the Finance Inspectorate General (IGF)-the internal controldepartment- and the Administrative Tribunal (TA)-a court of law entrusted withexternal auditing. Performance evaluation is not required by law and it is notpracticed in any systematic way. In spite of these limitations, recent progress must benoted. For the first time since independence, the 1998 government accounts (ContaGeral do Estado) were audited by the Administrative Tribunal in 2000 and its reportwas discussed at the National Assembly, giving rise, for the first time in

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Mozambique, to a public debate on government accountability, or lack thereof. The1999 accounts have also been examined by the Administrative Tribunal in 2001.

Recommendations

xxviii. Internal auditing. (i) The role of IGF needs to be given the institutional andpolitical backing that it deserves. In particular, specific budget lines for IGF shouldbe introduced and allocated with sufficient resources (ii) Internal audits should betransformed into a management tool and should be primarily the responsibility of thespending units. (iii) The bulk of internal audits should be focused on assessingexpenditure management systems, and conducting spot checks and specialinvestigations. IGF, in the Ministry of Planning and Finance, should be responsiblefor overseeing the quality of the internal audits in the spending units, and to provideguidance and technical support when necessary. It should also be responsible fordrafting the legislation needed for internal control and audit procedures and forregularly updating the Manual of Auditing Procedures for the Public Service.

xxix. External auditing. (i) There is a serious mismatch between the wide powersaccorded to the Administrative Tribunal (TA), on the one hand, and the means at itsdisposal to perform them on a meaningful way, on the other. Therefore, there is aneed to provide the institution with increased financial, human and operational means.(ii) In order to attract and retain qualified personnel, and reduce the risk of corruptionand misconduct among its officials, the Tribunal should be granted greaterindependence in setting salary scales for its staff. (iii) With a view to compensate itslack of capacity, partnership agreements should be made with reputable privateauditing firms operating in Mozambique, which would provide guidance, know-howand support to the Administrative Tribunal. In addition, twinning arrangements couldbe made with a foreign-based Supreme Audit Institution. (iv) Finally, all necessarysteps should be taken to ensure that the current period of 20 months for the productionof audited government accounts is reduced to 12 months (in accordance with the newPublic Finance Management Law).

xxx. Budget evaluation. The development of a sophisticated evaluation functionis not a priority in Mozambique presently. More pressing issues-improving budgetcoverage, increasing transparency and reforming public accounting, cashmanagement and auditing-must be faced first. However, the introduction of thisfunction would certainly improve budget management and should therefore remain amedium-term objective. Primary responsibility for evaluation should rest with thespending agencies, under the coordination of a central department in the Ministry ofPlanning and Finance. The possibility of contracting out at least part of this functionto specialized firms and academics, as it is the case in several countries, should beseriously explored.

xxxi. The recent approval by Parliament of a new Public Finance ManagementLaw is a welcome development that deserves special emphasis. It is now urgent todevelop the rules and regulations for its implementation if it is to be put into practice

in 2002, as planned. Technical advice was offered for the drafting of the law as partof this Public Expenditures Management Review, and most of the recommendationswere taken into account. Some issues, however, are not adequately addressed andwill continue to be part of the on-going dialogue with the authorities. Specifically:(i) the law does not mention macroeconomic stability among the overriding objectivesof fiscal policy; (ii) government borrowing guarantees are not clearly regulated andrestricted to specific cases, and clear rules toward full disclosure of information arenot mentioned; and (iii) the role of Parliament in the budgetary process continues tobe loosely defined. It is hoped that at least some of these issues can be addressed inthe rules and regulations to be developed in the next few months.

xxxii. The introduction of an integratedfinancial management information system(IFMIS) is a complex operation and it is not the panacea many would think Withthe development of the Public Finance Management law, Mozambique is creating thebasis for a new approach to fiscal management that integrates more closely thedifferent functions of the fiscal process-budgeting, accounting, cash and assetmanagement and auditing. Article 1 of the new law establishes the introduction of theSistema de Administracdo Financeira do Estado (SISTAFE), or integrated fmancialmanagement system. This is an important step in the right direction. The effectiveintroduction of such systems is, however, a very demanding exercise and experiencearound the world calls for extreme caution in their implementation. Basically, astrong and sustained commitment at the political and technical levels, coupled with agradualist approach that takes into account capacity constraints and avoids costlytechnological solutions, are key to the successful introduction of IFMIS. Above all,the basic problems affecting the current system, especially in the areas of budgetcoverage, accounting, cash management and auditing, must be addressed first in orderto create a sound basis for the successful introduction of the SISTAFE.

INTRODUCTION

Improving efficiency, transparency and accountability in the use of public funds hasemerged as a clear top priority in Mozambique, and improving budget management isamong the six priority areas in the Programa de Acqdo para a Reduqdo da PobrezaAbsoluta (PARPA, or PRSP). Therefore, this Public Expenditure Management Review(PEMR) was decided as part of the government's efforts to improve fiscal management.In a subsequent stage, it is planned that a sectoral analysis of expenditures will take place,which will review issues of efficiency and incidence of public expenditures in majorareas of public intervention.

This PEMR took place simultaneously with a Country Financial AccountabilityAssessment (CFAA), whose conclusions and recommendations, particularly in the area ofauditing, were taken into account. A Public Expenditure Tracking Survey in the healthsector has been agreed and will be implemented with assistance from the Department forInternational Development (DffD). Its conclusions will be published separately.

This review was launched in September 2000 as a collaborative effort between a coreteam of government officials from the Ministry of Planning and Finance, under theleadership of the National Director for Planning and Finance, the World Bank and agroup of donors most involved in public finance in Mozambique-the EuropeanCommission, The Netherlands, Sweden and the UK. Close collaboration andcoordination was maintained with the Africa and Fiscal Affairs departments in the IMFduring this process.

Conceived more as a results-oriented process than as a report-driven exercise, theanalysis and discussions that took place during this review are already leading to changesin some areas. This is the case with the government's decision in March 2001 tointroduce a new budget classification system in 2002, as well as the development of anew public finance law, approved in November 2001, which introduces modern conceptsof fiscal management and for which short term technical assistance was provided by theWorld Bank in the context of this review.

The first part of this report offers an analysis of fiscal topics at the aggregate level anddiscusses cross-cutting issues-recent trends of fiscal policy, medium-run sustainability,contingent liabilities and intergovernmental fiscal relations. Part II deals with the budgetmanagement system, covering budget formulation, execution, evaluation and audit.Issues related to public accounting, reporting, cash management and internal control andauditing are reviewed in this context. It describes the current system, highlights themajor issues, describes government's efforts to address them and proposes concreterecommendations for further action.

PART I

AGGREGATE FISCAL ANALYSIS

1. This part of the report will discuss cross-cutting issues starting, in chapter 1, withan analysis of major fiscal trends since 1992, which highlights the major past features offiscal policy and draws lessons for the near future. Chapter 2 looks at the challengesahead and, based on a fiscal sustainability analysis, underlines the need to urgentlycorrect fiscal imbalances in order to ensure fiscal sustainability. The issue of contingentliabilities, a source of potential fiscal instability, is also discussed in this context. Finally,chapter 3 presents the main features of the decentralization process in Mozambique,looking at the policy functions and fiscal characteristics of sub-national levels ofgovernment-provinces and districts-as well as those of municipalities, which enjoyfiscal, administrative and political autonomy. It takes stock of the current situation andmakes suggestions for improvement.

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CHAPTER 1

OVERALL EXPENDITURE TRENDS-LESSONS FROM THE PAST

A. Overview

2. Strong economic growth, single-digit inflation and high private investment havecharacterized Mozambique's performance since the mid-nineties, with the exception of2000 when severe floods dramatically affected economic activity. Prudent fiscal policieshave played a central role in this achievement (see selected economic indicators in Annex1).

3. Mozambique's budget continues to suffer from high deficits before grants,however, and aid dependence continues to be a major issue. Although over the lastdecade the budget deficit before grants was notably reduced, it remains high and haspractically not improved between 1995 and 1999. Underpinning these results was asignificant increase in expenditures, particularly since 1996. As a result, Mozambiquehas been able to swiftly expand its spending program in the latter half of the 1990s whileimproving macroeconomic stability thanks to the high levels of donor assistance (externalassistance still cover around 60 percent of total expenditures). This expansionary trendwas accentuated in 2000, when expenditures increased by 16 percent in real termscompared to the previous year.

4. This chapter illustrates these trends and provides the basis for understanding whya gradual, but steady, fiscal adjustment will be necessary in order to ensure fiscalsustainability, an issue that will be discussed in chapter 2.

B. Overall Expenditure Trends

5. The central aim of fiscal policy in Mozambique during the 1990s was to rebuildthe country's economic and human infrastructure and stimulate growth while reducingdomestic financial imbalances. To reconcile these objectives, the government sought toeliminate monetary financing of the budget deficit and curtailed leakages associated withthe banking sector through privatization, thus reducing quasi-fiscal pressures.Simultaneously, budgetary expenditures increased to support the postwar rehabilitation ofthe economic and social infrastructure.

6. A considerable fiscal adjustment effort took place between 1992 and 1995. Theoverall deficit before grants fell from its wartime high of 21 percent of GDP in 1992 to13 percent of GDP in 1995 (Table 1.1) and the primary deficit-which serves as ameasure of the current fiscal effort since interest payments are predetermined by the sizeof previous deficits, and it is an indicator of fiscal sustainability-remained below 2percent of GDP for most of the period.

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7. However, over the period 1995-99, little adjustment took place, and the budgetdeficit before grants remained stubbornly high at around 13 percent of GDP.

Table 1.1. Government Finance -- 1992-2000

1992 1993 1994 1995 1996 1997 1998 1999 2000

In constant 2000 Meticais(x 10A12):

Total expenditure and net 9.5 10.4 11.3 9.2 8.4 11.1 11.7 14.4 16.7lending

of which: current 4.9 5.3 5.5 3.9 3.8 5.0 6.1 7.1 7.8expenditureTotal revenue 4.2 4.9 4.4 4.3 4.3 5.3 6.2 7.0 7.5Budget balance before grants -5.3 -5.5 -6.9 -4.9 -4.1 -5.8 -5.5 -7.4 -9.2Grants plus net external 4.8 5.1 7.3 5.2 4.5 7.0 6.9 7.8 9.1borrowing

As a % of GDP:Budget balance before grants -21 -19 -23 -13 -10 -12 -10.5 -13.2 -16.1Grants 17 15 17 9.8 7.1 9.1 8.1 11.7 11.6Budget balance after grants -4.4 -4.4 -6.1 -3.1 -3.1 -2.6 -2.4 -1.5 -4.5Primary balance -0.3 -1.0 -4.2 -1.6 -1.4 -1.3 -1.4 -0.8 -4.3Financing:

Net extemnal borrowingc 2.6 3.2 7.3 3.8 4.3 5.7 4.6 1.8 2.8Net domestic financing 1.8 1.2 -1.2 -0.8 -1.2 -3.1 -2.3 -0.3 -0.8

See Annex I Table 2 for the complete table, including nominal figures and the CPI.Source: Ministry of Planning and Finance.Notes:a Projection.b Excludes unallocated expenditure'Net foreign borrowing = project & non-project disbursements - cash amortization

8. Underlying these results is a significant expansion in expenditures, especiallysince 1996. Real expenditure peaked in 1994 owing to food aid and other assistance afterthe end of the civil war. As food aid declined after 1994, both current and totalexpenditure declined to what might be called the "non-war normality". But after 1996expenditures picked up again, and real total expenditures grew at a vertiginous 20 percentannually during the period 1996-99, against a negative annual growth of -3 percentbetween 1992 and 1996. On the other hand, revenues rose at a slower pace-i 8 percentannually-during the period 1996-99. The increase in spending in the latter half of thenineties was supported by swift growth of concessional assistance (grants plus netexternal borrowing): 20 percent per year from 1996 to 1999.

9. GDP also grew strongly during the latter half of the 1990s, though not as swiftlyas did expenditures. Figure 1.1 below illustrates these trends.

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Figure 1-1. Revenue and expenditure as a percentage of GDP

40- -Ttlepedtr and ne ledn

\ ~~~~~~~~~~~of which: current expenditure30 - - - - - -Total revenue

Q)

eD 20-

EL 10 - _. - - - - - - ---------

10

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: Table 1. 1

10. The expansionary trend initiated in 1996 was aggravated in 2000, whenexpenditures rose by 16 percent in real terms compared to the previous year. Thisincrease is only partly related to flood reconstruction as these expenditures are takingplace mostly in 2001. Other important factors included (i) the recapitalization of aformer state-owned bank, Banco Comercial de Moqambique (BCM), which could havebeen avoided if banking supervision rules had been stringently enforced and the state didnot maintain a significant share of ownership in the banking sector; (ii) a significantincrease in the civil service wage bill resulting from the introduction in 1999 of the newcareer system with the associated rise of lower level salaries, accompanied with theadmission of 14,356 new civil servants; and (iii) higher social spending made possibleby HIPC debt relief. The fiscal position is projected to deteriorate even further in 2001 asa result of the combination of post-flood reconstruction expenditures and the cost ofrestructuring Banco Austral (BA), another bank with 40 percent government participationthat collapsed in 2001.

11. In sum, Mozambique has been able to swiftly expand its spending program in thelatter half of the 1990s while improving macroeconomic stability thanks to the highlevels of donor assistance, while revenues have remained relatively flat as a percent ofGDP since 1995. In 2000, a significant deterioration of the fiscal position took placeresulting from an increase of expenditures partly linked to post-flood reconstruction, butwhich was the culmination of an expansionary period that started in 1996. For the future,the fact that donor assistance is unlikely to continue growing at the pace of the last five tosix years, and the need to develop a post-HIPC public debt strategy, militate in favor of amore forceful fiscal adjustment that will improve fiscal sustainability in the medium run(see chapter 2).

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CHAPTER 2

LOOKING AT THE FUTURE-TOWARD A SUSTAINABLE FISCAL POLICY

A. The Challenge Ahead-Conditions for Fiscal Sustainability

12. Fiscal sustainability is achieved when the levels of domestic and externalborrowing necessary to finance the budget deficit are not likely to lead to a debt crisisover time and/or rising interest rates that crowd out private investment and stifleeconomic growth. Box 2.1 provides the conceptual framework for a debt sustainabilityanalysis from a fiscal perspective, describing the theoretical underpinnings of debtdynamics and its links with economic growth, the level of real interest rates and the paceof money creation.

Box 2.1: Theoretical Underpinnings of Debt Sustainability Applied to Mozambique

The identity (1) below, derived from a typical budget constraint equation, shows thedeterminants of the change in public debt (defined to include both net external and domesticdebt) expressed as a share of GDP:

(1) Change in d = p - s + (r - g). d

Where p is the non-interest deficit (overall deficit minus interest) -- or primary deficit -- s isthe amount of seignorage the Government can mobilize by printing money, r is the averagereal interest rate on total public debt (domestic and external), g is the GDP growth rate and dis the debt to GDP ratio. Basically, this identity shows that public debt as a percentage ofGDP will rise indefinitely in case the primary deficit exceeds the amount of seignorage andthe real interest rate is higher than GDP growth. The level of the primary balance (deficit orsurplus) required to keep the debt to GDP ratio constant is given by identity (2), derived from(1):

(2) p = (r-g). d-s

Applying this rather simple conceptual framework to the case of Mozambique, requires someadjustments to the concept of primary deficit. While in the literature the primary deficit willonly include tax and non-tax receipts in total revenue, in the case of Mozambique we will alsoconsider external grants among the regular sources of fiscal revenue, thereby recognizing thevital role external assistance will continue to play in Mozambique's fiscal policy even in thelong-run. Therefore, for the purpose of the current analysis, the primary deficit taken intoaccount is defined as the overall fiscal deficit after grants minus interest on total public debt(net domestic and external).

13. An important distinction must be made between this type of approach and thedebt sustainability analysis (DSA) performed in the context of the HIPC initiative. Thelatter adopts a balance of payments perspective, trying to determine whether a country isfacing an unsustainable debt situation after the full application of the traditional debtrelief mechanisms. In the HIPC framework, a debt-to-export ratio of no more than 150percent (on NPV terms) is considered sustainable. The analysis performed here adopts a

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fiscal perspective, trying to determine the level of the fiscal deficit that would allow thedebt-to-GDP ratio to remain constant over time. However, despite these analyticaldifferences, the two approaches are related, since both assess sustainability taking intoaccount underlying macroeconomic policies. Thus, the DSA that was presented at theHIPC completion point in September 2001 points to a continuing steady decline in theratio of the NPV of debt-to-exports over the next twenty years, assuming theimplementation of sound policies. The analysis in this fiscal approach to sustainabilityprovides an assessment on the sound policies needed for combined external as well asfiscal sustainability.

14. Perhaps the best way to analyze this issue is through the so-called accountingapproach. In this framework, a simple and intuitive concept, is the fact that the non-interest budget deficit has to be financed with new debt to the extent that this deficitexceeds the amount of money creation by the central bank. In case the government isrunning a non-interest deficit higher than the amount of seignorage it can obtain, and ifthe real interest rate on public debt exceeds the growth rate of the economy, total publicdebt will increase as a share of domestic income. Over time, this will lead to anunsustainable fiscal position, in which excessive budget deficits require higher debt,leading to higher debt service expenditures, which, in turn, will result in higher budgetdeficits. At this stage, the country is in a "debt-trap" (the so-called "Ponzi scheme",where debt is financed through additional debt). At some point, this will lead to a debtcrisis in case of foreign borrowing, or a situation in which the government will be unableto sell its debt in case of excessive domestic borrowing, and the process will have to bebrought to an halt by cutting the budget deficit.

15. Applying this framework to the case of Mozambique helps to illustrate thechallenges faced by the country's fiscal policy to avoid the re-emergency of excessivedebt. Assuming that the debt-to-GDP ratio (D/GDP) considered acceptable is the oneresulting from the HIPC initiative, the question is then to determine the level of theprimary deficit (defined as the overall fiscal deficit after grants minus interest on totalpublic debt') required to stabilize D/GDP in the medium-long-term, given realisticassumptions on economic growth, the real interest rate and the level of resources that canbe mobilized through seignorage.

Note that this definition of the primary deficit is different from the one traditionally used by the IMFin the PRGF program, which is defined as revenue minus non -interest current expenditures minuslocally financed capital expenditure and locally financed net lending.

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Table 2.1: Sustainable Primary Balance (in percent of GDP) (a)Debt/GDP =34 percent (HIIPC-projected debt-to-GDP ratio in 2005)

Interest rate on public debt (b)Annual GDP growth -3.0% -2.0% -1.0% 0% 2.5% 5.0%

4% -2.3 -2.2 -1.8 -1.5 -0.6 0.25% -2.7 -2.5 -2.2 -1.8 -1.0 -0. 16% -3.0 -2.8 -2.5 -2.2 -1.3 -0.47% -3.3 -3.2 -2.8 -2.5 -1.6 -0.88% -3.7 -3.5 -3.2 -2.8 -2.0 -1.19% -4.0 -3.9 -3.5 -3.2 -2.3 -1.510% -4.4 4.2 -3.9 -3.5 -2.7 -1.811% -4.7 4.5 -4.2 -3.9 -3.0 -2.212% -5.1 -4.9 -4.5 -4.2 -3.3 -2.5

Source: World Bank staff estimates(a) Seignorage at 0.1 percent of GDP. Based on data provided by BM on transfers of profits to government.(b) Estimated as the weighted average interest rate on external debt from disbursing debtors in dollar terms, deflatedwith the projected US annual inflation rate. A negative real interest rate means that the weighted average interest rateon Mozambique's serviced debt in nominal terms is lower than the projected US inflation rate. Currently, it is around-2 percent.

Table 2.2: Sustainable Primary Balance (in percent of GDP) (a)Debt/GDP =22 percent (HllPC-projected debt-to-GDP ratio in 2010)

Interest rate on public debt (b)Annual GDP growth -3.0% -2.0% -1.0% 0% 2.5% 5.0%

4% -1.5 -1.4 -1.2 -1.0 -0.4 0.15% -1.7 -1.6 -1.4 -1.2 -0.6 -0. 16% -1.9 -1.8 -1.6 -1.4 -0.9 -0.37% -2.1 -2.0 -1.8 -1.6 -1.1 -0.58% -2.4 -2.3 -2.0 -1.8 -1.3 -0.79% -2.6 -2.5 -2.3 -2.0 -1.5 -1.010% -2.8 -2.7 -2.5 -2.3 -1.7 -1.211% -3.0 -2.9 -2.7 -2.5 -1.9 -1.412% -3.2 -3.1 -2.9 -2.7 -2.1 -1.6

Source: World Bank staff estimates(a) Seignorage at 0.1 percent of GDP. Based on data provided by BM on transfers of profits to govemment.(b) Estimated as the weighted average interest rate on extemal debt from disbursing debtors in dollar terms, deflatedwith the projected US annual inflation rate. A negative real interest rate means that the weighted average interest rateon Mozambique's serviced debt in nominal terms is lower than the projected US inflation rate. Currently, it is around-2 percent.

16. The tables above show the primary balance that would be required to keepconstant the public debt-to-GDP ratio projected under the HIPC initiative for 2005 and2010, given different hypothesis of real interest rates and economic growth. Thesimulations assume seignorage at 0.1 percent of GDP2 (see Box 2.2 below for adiscussion of seignorage as an instrument to finance budget deficits).

17. The results show that the higher the GDP growth rate and the lower the realinterest rate, the higher the primary deficit the government would be able to afford forany given level of D/GDP ratio. For example, in 2010 the government would have to

2 Seignorage is estimated as the GDP share of central bank annual profits that are transferred to thetreasury.

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limit the primary deficit to -2.3 percent of GDP if it were to keep the HIPC-projectedD/GDP ratio constant over time at 22 percent, assuming annual economic growth ofaround 8 percent and an average real interest rate on public debt of -2 percent. Shouldthe annual growth rate fall to 6 percent, a primary deficit of no more than -1.8 percent ofGDP would be required. Keeping the D/GDP ratio constant while running a higherprimary deficit is only possible, for any given levels of growth and interest rates, throughhigher levels of seignorage, which may lead to higher inflation3 .

Box 2.2: Seignorage as a Source of Deficit Financing

According to the traditional monetary theory, the printing of money at a rate that exceeds thedemand for it at the current price level will create excess cash balances in the hands of the public.The public's attempts to reduce excess cash holdings will eventually lead to an increase in prices,until equilibrium is restored. The amount of revenue that the government can expect to obtainfrom the printing of money -- in other words the amount of seignorage -- is determined by thedemand for high-powered money in the economy (i.e. currency and bank deposits), the real rateof growth of the economy, and the elasticity of the demand for real balances with respect toinflation and income (S. Fisher and W. Easterly, 1990). Governments can mobilize revenue --without generating higher inflation -- by printing money to the exact rate necessary to satisfy theadditional demand for money that is generated by economic growth (assuming, for the purpose ofsimplicity, that the income elasticity of demand for money is unity). Beyond that level, assuminga stable demand function for money, inflation will result. During a certain period of time, higherlevels of seignorage are possible at increasing rates of inflation. However, as the public startsshifting its money holdings to foreign currency because of currency depreciation associated withrising inflation, demand for high-powered money declines as the inflation rate rises. As a result,government's revenue from seignorage eventually reaches a maximum. In other words,seignorage follows a typical Laffer curve, and in the extreme cases, reliance on seignorage as asource of deficit financing inevitably leads to hyper inflation.

Source: S. Fisher and W Easterly, "The Economics of the Government Budget Constraint", TheWorld Bank Research Observer, Vol.5, No.2 (July 1990), pp. 127-142

3 An alternative to higher seignorage as a means to finance a higher budget deficit is to use foreignexchange reserves. By running down reserves rather than printing money, a Government can hope toput off the inflationary effects of a deficit. However, such a policy results in the appreciation of theexchange rate in the short run and, over time, inevitably leads to a balance of payments and a currencycrisis that will require a reduction in the budget deficit.

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B. Facing the Challenge-Toward a Sustainable Fiscal Policy and EconomicGrowth

18. Since the beginning of the reform program in 1987, fiscal policy has been drivenby the need to rebuild Mozambique's economic and human infrastructure, and tostimulate growth in a non-inflationary environment. Reflecting this stance, between 1987and 1998, aggregate government expenditures increased by an average rate of about 6percent a year, while the average increase in fiscal revenues was just below 7. Thus, theoverall deficit before grants declined from -12.3 percent of GDP in 1987 to -10.5 percentin 1998 (see table 2.3 below). Reflecting this trend, the primary deficit-defined as theoverall deficit after grants minus interest on total public debt-declined from around -6percent of GDP in 1987 to -1.4 percent in 19984, an outcome that was only madepossible thanks to the high levels of foreign assistance. In 2000, however, these trendswere reversed and fiscal policy became largely expansionary. As a result, the overallbudget deficit before grants increased from -13.2 percent of GDP in 1999 to -16 percentin 2000, and is estimated to reach -19.3 percent in 2001. Likewise, the primary deficitexceeded -4 percent of GDP in 2000 and 2001, and is projected to increase to -7 percentin 2002. Underlying the fiscal expansion in 2000 is a 16 percent real increase inexpenditures, related partly to flood reconstruction, but also to an important increase insalaries, the recapitalization of BCM, and an increase in social spending over and aboveHIPC-related interest savings.

Table 2.3: Mozambique Government Finance: 1987-2002(In percent of GDP)

1987 1998 1999 2000 2001 2002(a)

Total Revenue 9.5 11.4 12.0 12.7 12.5 12.8Expenditure and net lending 21.8 21.6 24.7 28.4 31.8 31.4

Overall deficit before grants -12.3 -10.5 -13.2 -16.1 -19.3 -18.6Grants 5.4 8.1 11.7 11.6 14.5 10.1Overall deficit after grants -6.9 -2.4 -1.5 -4.5 -4.9 -8.4

Primary deficit (b) -5.8 -1.4 -0.8 -4.3 -4.2 -7.1Sustainable primary deficit (c) -5.1

Source: World Bank staff(a) Budget proposal(b) Overall deficit after grants minus interest on total public debt(c) Notional primary deficit that would have been necessary to keep constant over time the HIPC-projected debt-to-GDP ratio

4 The overall primary deficit declined to -0.8 percent of GDP in 1999, but this result is largelyunrepresentative as it is linked to a large World Bank-financed adjustment program (EMRO) that tookthe form of a grant rather than a traditional loan.

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19. Comparing the primary deficit projected for 2002-i.e. -7.1 percent of GDP-with the notional deficit that would have been necessary to stabilize over time the HIPC-projected D/GDP ratio-i.e. -5.1 percent of GDP-offers an indication of howunsustainable the current fiscal position is. Clearly, the sharp deterioration of the primarydeficit in 2001 and 2002 is directly linked to the cost of bank restructuring, projected toreach 3 percent of GDP in 2002. After netting out these exceptional expenditures, theprimary deficit would be above the sustainable level in 2002. However, it would stillshow a considerable deterioration when compared with 1998.

20. Until 1998-99, this policy, made possible by the high levels of foreign aid, wasappropriate at a time when the demands for reconstruction were high and the potentialrevenue from a weak economy were relatively low. In face of the significant level ofexternal assistance the country has enjoyed since the mid-nineties, and the sizable debtreduction that took place under the HIPC initiative since 1999, some may be led tobelieve that this situation can be perpetuated and that Mozambique can continue topostpone the need to adjust its fiscal policy to more sustainable levels. This would be adangerous choice. Indeed, even though external assistance is not likely to dropsignificantly in the short run-at least as long as Mozambique continues to implementsound policies and makes serious efforts to improve governance and accountability-over time it is likely that assistance will converge towards the average in sub-SaharanAfrica, which is around 4 percent of GDP5. Therefore, in the absence of a strong fiscalconsolidation strategy, the maintenance of a high budget deficit would only be possiblethrough higher public debt and/or increased reliance on seignorage. As discussed above,given that private domestic savings and demand for money are unlikely to increasesignificantly in the short-to-medium-run, such a policy would inevitably lead to higherinterest rates and inflation, crowding-out private investment, crippling economic growthand undermining the fight against poverty. In addition, the need to develop a post-HIPCstrategy on public debt also militates in favor of such a fiscal adjustment. Engaging inthe path of a gradual-but steady- adjustment effort should therefore be considered apriority of government policy over the next decade. The current high levels of externalassistance and the substantial debt relief delivered under the HIPC initiative are favorableconditions that would facilitate early action.

21. Recognizing this fact, the fiscal scenario underpinning the PRSP (or PARPA,Programa de Ac,do para a Reducqdo da Pobreza Absoluta) includes a significant fiscaladjustment that could lead to a sustainable fiscal position already by 2005 (see table 2.4below). This scenario is based on the assumption that GDP growth will remain high overthe period (above 9 percent a year), that an ambitious tax collection effort will take placein the short-run and that the current high level of external assistance will continue indollar terms over the next decade (although declining as a share of GDP).

5 2000 World Development Indicators

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Table 2.4: PARPA - Government Finances: 2002-2010(In percent of GDP)

2002 (a) 2005 (b) 2010 (b)Total Revenue 12.8 15.4 16.7Expenditure and net lending 31.4 27.1 25.0Overall deficit before grants -18.6 -11.7 -8.3Grants 10.1 8.7 6.3Overall deficit after grants -8.4 -3.0 -2.0Primary deficit (c) -7.1 -2.4 -1.4

Memorandum items:Sustainable primary deficit (d) -5.1 -2.9 -2.0Real GDP growth 10.0 9.3 7.9Source: PARPA (Table 3.1, p.29)(a) Budget proposal(b) Projection(c) Overall deficit after grants minus interest on total public debt(d) Notional primary deficit that would have been necessary to keep constant over time the HIPC-projected debt-to-GDP ratio

22. Should the conditions be less favorable than anticipated in the PARPA in terrns ofeconomic growth and external assistance, a longer period before reaching a sustainablefiscal deficit may be necessary. Two alternative scenarios are discussed below (tables 2.5and 2.6. See also Annex 2 for detailed data). They assume GDP growth rates of 6 and 8percent a year after 20056, as well as a realistic, although demanding, tax effort and alower level of external assistance consistent with HIPC projections 7. The results showthat under these circumstances sustainability would not be reached before 2010, asopposed to 2005 in the PARPA, unless a sharp contraction in expenditures takes placethat could jeopardize the PARPA's objective to reduce poverty incidence to below 50percent by 2010.

6 Until 2005 both scenarios assume the same annual GDP growth.

7 HIPC projections assume grants will remain constant at US$350 million per year after 2004.

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Table 2.5: Government Finances (assuming 6 percent GDP growth after 2005)(In percent of GDP)


Memorandum items:Sustainable primary deficit (d) -5.1 -3.2 -1.8Real GDP growth 10.0 6.6 6.0Source: World Bank staff estimates (see Annex 2 for detailed data)(a) Budget proposal(b) Projection(c) Overall deficit after grants minus interest on total public debt(d) Notional primary deficit that would have been necessary to keep constant over time the HIPC-projected debt-to-GDP ratio

Table 2.6: Government Finances (assuming 8 percent GDP growth after 2005)(In percent of GDP)


Memorandum items:Sustainable primary deficit (d) -5.1 -3.2 -2.3Real GDP growth 10.0 6.6 8.0Source: World Bank staff estimates (see Annex 2 for detailed data)(a) Budget proposal(b) Projection(c) Overall deficit after grants minus interest on total public debt(d) Notional primary deficit that would have been necessary to keep constant over time the HIPC-projected debt-to-GDP ratio

23. The gradual fiscal adjustment that has now become urgent will inevitably requirea combination of a demanding revenue effort and measures to restrain expenditures,accompanied by reforms aimed at re-focusing public expenditures on priority areas whileincreasing the efficiency and the poverty incidence of public intervention. On therevenue side, gains could be achieved mainly through the continued improvement inrevenue collection-which could be accomplished primarily through the broadening ofthe tax base rather than through a general increase in tax rates-as well as through therationalization of tax incentives. Efforts in revenue collection should primarilyconcentrate on corporate and individual income tax, as well as on VAT on domestic and

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imported products, as these categories are likely to yield the highest results in terms ofhigher total revenue. Increasing the revenue from the corporate tax must go hand in handwith the maintenance of a favorable climate for foreign direct investment. At the sametime as efforts are deployed to raise budget revenue, strict policy rules should guaranteethe regular transfer of profits by the central bank to the treasury.

24. On the expenditure side, a reduction from the very high levels of 2000-2001 toaround 24 percent of GDP by 2010, is required. Current expenditure should remain closeto 14 percent of GDP over the period to 2005 and decline gradually to around 12 - 13percent of GDP by 2010, accompanied by a shift of budgetary resources toward poverty-related programs, in accordance with the PARPA, as resources are freed from debtservice by the HIPC initiative. The wage bill in particular should not go beyond 6 to 7percent of GDP, which would allow for sufficient annual increases in salaries and wouldbe in line with the regional average. Capital expenditure should return to its pre-floodlevel of around 12 percent of GDP over the period 2002-2010.

25. Implementation of this strategy should be accompanied by an improvement in thefiscal management system-encompassing budgeting, accounting, cash and debtmanagement, as well as internal and external control-together with measures to improvethe transparency and accountability in the way public resources are managed (this issue isthe subject of Part II of this report). In addition, an export oriented development strategy,based on high external competitiveness and aggressive export promotion, should also bepursued in order to improve external sustainability.

C. Limiting the Risks of Contingent Liabilities

26. As Mozambique will be engaging in this renewed effort to achieve a moresustainable fiscal stance, the risks associated with contingent liabilities must be dealt within a swift way. Typically, contingent government liabilities-obligations made by thegovernment outside the budget that can be triggered by a discrete but uncertain event-are associated with major hidden fiscal risks. Therefore, fiscal adjustment that targets thebudget deficit and debt reduction does not necessarily prevent fiscal instability.Contingent liabilities can be explicit, when defined by law or contract-e.g. stateinsurance schemes, guarantees for borrowing, guarantees for trade, exchange rate risksand private investment risk. Contingent liabilities can also be implicit, when theyconstitute moral obligations, not legal ones, based on public expectations or politicalpressures, such as bank failures, natural disasters and defaults of public or private entitieson non-guaranteed debt (World Bank, 1998).

27. In Mozambique, the main sources of contingent liabilities are associated withfailures in the financial sector, the pension scheme and natural disasters. Regarding thefinancial sector, the lessons from the recent collapse of Banco Austral (BA) and thedifficulties that Banco de Mocambique (BCM) faced in 2000 should lead to the urgentreinforcement of banking supervision, the withdrawal of the state from the financialsector and the active recover of bad loans. In parallel, the state-owned insurance

- 15 -

company, EMOSE, should launch an independent audit and be subject to supervision andstrict prudential rules.

28. There are indications that the civil service pension scheme (covering both civiland military personnel) is not fully funded. The scheme, managed by the Ministry ofPlanning and Finance, is a defined benefit, financed through a 7 percent tax on grosssalaries. At present, the civil part of the scheme has generated a surplus on a cash basis,while the military part suffers from a large deficit resulting from the benefits paid to themilitary demobilized after the 1992 peace agreement. Also, the pensions of theemployees of some of the large public enterprises such as CFM (railways), LAM(national airline), TDM (telecommunication), Correios de Moqambique (postal services)and Aeroportos de MoVambique (airports) are currently included in this scheme, as alegacy of their previous status as civil servants. As a first step to address the problems,the authorities should ensure that the actuarial study covering both the public sectorscheme and the National Institute of Social Security (INSS, which covers employees ofprivate and parastatal enterprises) is completed soon, that its conclusions aredisseminated and an action plan is developed to solve the problems.

29. The implementation of an effective disaster prevention strategy must be a priorityin Mozambique. Such a strategy has to take into account the regional dimension of thethreats facing the country and adopt a multi-sector approach. Such a strategy has beenprepared, but it must be followed by an implementation plan.

30. As part of the actions to be implemented over the short run to address the threatsassociated with contingent liabilities, fiscal risks should be fully disclosed and effectivelymonitored. The creation of budgetary reserves (beyond the ones currently in place) thatwould be mobilized only in very specific cases should be considered. Finally,government guarantees to financial and non-financial companies should be regulated andsubject to strict limits in order to minimize moral hazard.

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CHAPTER 3INTERGOVERNMENTAL FISCAL RELATIONs-TAKING STOCK AND

LOOKING AHEAD 8

A. Background

31. The purpose of this chapter is two-fold. First, it describes and analyzesMozambique' s recent experience with fiscal reforms focusing on deconcentration anddecentralization. The analysis highlights the overall fiscal impact of these reforms andidentifies fiscal constraints on further reforms. Second, the chapter providesrecommendations and guidelines for further fiscal deconcentration and decentralizationreforms.

32. Much like the Portuguese model, Mozambique is currently governed by twoparallel systems at the sub-national level, one for rural areas, the other for urban areas(including some rural conurbations).9 In the rural sub-national system the governnenthas pursued a modest policy of deconcentration, while in the urban sub-national system ithas carried out a more radical policy of decentralization. In rural areas the centralgovernment has deconcentrated a limited amount of power to both provincial and districtadministrations.10 In urban areas the central governnent has devolved power to thirtythree autonomous municipalities (autarquias) in cities and towns, which are run byelected officials (in effect, the municipalities are small islands of decentralized municipalgovernments surrounded by deconcentrated provincial and district administrations). Inneither case, however, have the reforms been unequivocal; both deconcentrating anddecentralizing reforms have been subject to impediments and reversals. Table 3.1 belowsummarizes the functions and revenue and expenditure powers of the provinces, districts,and municipalities.

8 See Annex 3 for a more detailed analysis.

9 At the village and community level there is a third system in operation: traditional authoritystructures.

10 There are presently ten provinces, 128 districts, and 393 administrative posts.

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Table 3.1: Functions, Revenues, and Expenditures at the Provincial, District, andMunicipal Levels: A Summary Comparison

Level Functions Revenues ExpendituresProvince Territorial planning and Small amount of own Small amount of

oversight of all sectoral source revenues (taxes discretionary capitalprograms in the and mostly fees); less expenditures; about 2%province than 3% of total national of total national capital

revenues budgetDistrict Territorial Small amount of own Small amounts of

administration and source revenues discretionary funds foroversight of all sectoral (National non-wage recurrentprograms in the district Reconstruction Tax, expenditures and fixed

market and bicycle term contract laborduties, and rental fees)

Municipality Economic and social -Transfers from central Authorized to makedevelopment; Govemment(FCA and recurrent and capitalenvironment, basic FIIL) expenditures in all areassanitation, and quality of -Own source taxes of competencelife; public services; (Municipal Head Tax,health; education; Property Tax, Economicculture, leisure, and Activity Tax, Tax onsport; policing; and Commerce and Industry,urban infrastructure, and Income Tax) andconstruction, and fees (market fees, publichousing service fees, parking

fees, registration, fees,__________________________ ~~ ~~etc .)_ _ _ _ _ _ _ _ _ _ _ _ _ _

33. Decentralization and deconcentration are typically undertaken to increase levelsof local participation in governance and thereby improve service delivery to localcommunities. At the same time decentralization and deconcentration must be undertakenin such a way that make them fiscally sustainable. This chapter draws three mainconclusions about Mozambique's deconcentrating and decentralizing reforms in light ofthe goal of improved service delivery and the imperative of fiscal sustainability. First,neither the deconcentrating nor the decentralizing reforms pose risks for the aggregatefiscal balance at present. Neither the deconcentrated provinces and districts nor thedecentralized municipalities have unsustainably large entitlements to central governmentresources. Moreover, current municipal debt is modest and largely short term (andregulated by the MPF). Second, both district and municipal capital and recurrentexpenditures are in line with their corresponding revenues. At present, there does notappear to be a risk of budget deficits at either the district or municipal levels (based onavailable data, which is unfortunately quite limited). Third, however, furtherimprovements in the quantity and quality of service delivery at the district and municipallevel will be constrained by available own source revenues as well as central governnenttransfers. Districts have seen their tax and fee bases lost to municipalities, whileprovinces have seen their discretionary investment budgets decline as resources havebeen shifted back to central ministries (as part of the Integrated Sectoral Programs).Municipalities have had difficulty delivering the services for which they are currentlyresponsible, and the transfer of new functional responsibilities to the municipalities has

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been slow, both of which are due to low administrative capacity and, in some cases,limited fiscal resources and (the former is clearly related to the latter). Thus, there arecontradictory tendencies at both the provincial/district and municipal levels. One thing isclear, however. If not addressed, fiscal issues have the potential to be the Achilles heel ofthe government's deconcentration and decentralization programs.

B. Governance

Provinces, Districts, andAdministrative Posts

34. The provinces, which function as deconcentrated governance structures, areformally administered by governors appointed by the President. I Governors, who areregarded as having the same rank as ministers, are jointly responsible with the sectoralministries for provincial implementation of the government's program. At the provinciallevel most ministries have a provincial directorate (DP) responsible for their sectoralprograms. These DPs are responsible to both their parent ministries as well as thegovernor. This dual authority structure is known as the dupla tutela.

35. The principal function of the provincial government is territorial planning, whichis supposedly done in conjunction with the sectoral planning for which the centralministries are responsible. Some sectors, namely the "priority" ones, are characterized bycentrally conceived Integrated Sectoral Programs (PSIs): education, health, agriculture,water, and roads (the judicial and prisons sectors are also considered priority in someinstances). In general, however, territorial planning is subordinate to sectoral planning.

36. The exact role of the governor at the operational level is further clouded by thefact that he is allocated a very small professional staff; most governors have only acouple of technical advisors. In practice, the dupla tutela fosters confusion anduncertainty about powers and responsibilities, though the balance of power betweengovernors and sectoral directors varies from province to province. In sum, thoughgovernors are formally vested with many powers and responsibilities, in practice they arenot very powerful, given that budgeting, revenue collection, planning, and personnel arecontrolled by other entities.

37. Provinces are divided into districts, which are run by district administrators. The"district government" is the executive council, which, as at the provincial level, iscomposed of the administrator and sectoral district directors, who are accountable to theirprovincial sectoral directors. The dupla tutela structure is thus replicated at the districtlevel. The district administrator, who is appointed by the Ministry of StateAdministration (MAE), has nominal authority over the sectoral district directors. Themain function of the district administrator is that of general territorial management. Thecoupling of numerous responsibilities, however, with few resources and little

11 Each provincial government has a provincial assembly to which it is supposed to be accountable.However, these assemblies, which pre-date the constitutional reform of 1990, are now defunct inpractical terms. Thus, provincial govermments are not directly accountable to provincial citizens.

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administrative capacity means that the district administrator's role in service delivery isquite limited.

38. Districts also have some specific licensing and regulatory responsibilities,including, for example: land use (approving new construction, new crop plantings),commerce (licensing informal sector activities, logging), transportation (licensingbicycles), education (granting exemptions from school fees), public health and sanitation(issuing fines for littering), and public order (gun licensing).

39. District administration is deconcentrated at the local level to administrative posts,run by chefes de posto, who are accountable to the district administrator. The posts,which are sub-divided officially into localities, serve as communication links betweenrural communities and district administrations. Postos also play a limited role in taxcollections, and business regulation and licensing of very small scale activities.

Municipalities 12

40. Through the promulgation of a series of laws in 1997 (Laws No. 2/97 and 4/97-11/97), thirty three initial autarquias were created and elections were held in 1998.Municipalities are governed by an elected legislative organ, the Municipal Assembly, andby an elected executive officer, the Council President, together with his MunicipalCouncil. The Municipal Council is appointed by the Council President, who must choseat least two of his city councilors (vereadores) from the ranks of the assembly. Assemblymembers and the president both serve five year terms.

41. Autarquias have autonomy over a wide range of sectoral governmental functions,as well as responsibilities for financial management (both revenues and expenditures),personnel, and procurement (see Table 1). The laws assume, however, that at the outsetmunicipalities will not be able to exercise authority in all sectors. Therefore, the legalframework provides for the gradual transfer of functions and revenues over time asmunicipalities are ready to assume them. Presently, many municipalities only exerciseauthority in a limited number of sectors, notably policing and sanitation.

42. Tutelary authority over the autarquias is vested in the MAE for administrativematters and the MPF for financial matters (ministers can, however, delegate oversightauthority to the respective provincial governor). 13 Municipalities are supposed tocoordinate their work with their neighboring district and provincial governments, as wellas with the sectoral ministries.

43. Municipalities inherited their staffs from the central government, as civil servantswere simply transferred to the municipality. Municipal civil servants are subject to thesame civil service system as state employees, which means that in practice municipalitieshave limited autonomy to manage their personnel complements. Given thatmunicipalities were born with full staff complements regulated by the civil service, they

12 Much of this section is based on Law No. 2/97 and Elanlon (1997).

13 See Law No.7/97, "Tutelage of Local Autarkies."

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presently have little room to maneuver. These constraints, coupled with the scarcity ofqualified professionals at the local level, have handicapped municipalities in terms ofqualified professional staff.

44. At the same time the central government has reserved a panoply of powers thateffectively fence in the municipal governments on a number of fronts. These powers arediscretionary; it is up to the central government to invoke them. In the best sense thesepowers would only be used to thwart corruption and malfeasance. In the worst sense theywould be used to continue to intervene in municipal affairs. It remains to be seenwhether these powers are used for legitimate or illegitimate purposes. There is a sensewithin the government that the municipal decentralization reform has reached its limitsfor now (in terms of extension to new municipalities). There is concern that there are noobvious candidates for further municipalization (the next autarquias would have to besmall villages).

C. Revenues

Provinces, Districts, and Administrative Posts

45. The provincial government, like the district administration, collects taxes andfees.14 The province as a unit of government has only a very small amount of own sourcerevenues, however. In fact, total provincial own source revenues averaged 2.8 percent oftotal national revenues over the period 1995-2001. Over the same period tax revenuesaccounted for only 15 percent of total collections, while non-tax revenues made up thevast majority. While there was some detail provided on non-tax revenues in pre-1998budgets, subsequent budgets provide no detail on the types of non-fiscal revenuescollected by the provinces.

46. The district as a unit of government collects a panoply of low yield taxes, duties,and fees, though there is no legislative framework governing public finance at the districtlevel. The main tax collected by the districts is the National Reconstruction Tax; of theduties and fees, market duties are the main revenue generators. There are no specializedrevenue generation units and district tax administration capacity appears highly limited.Non-compliance seems to be widespread as districts have limited capacity to enforcecompliance. Since districts do not fully comply with the treasury regulations to deposittheir IRN collections in central accounts, and since districts are responsible for their ownduty and fee collections, there are no central government estimates of the amounts offunds actually collected by districts. Nor is there an established financial system formanagement of revenues, which seems to vary according to the district and province.Districts do, however, prepare statements of revenues and expenditures, though thesestatements are rudimentary and are not standardized.

47. In addition to the severe limitations on district tax administration capacity,districts face another serious problem: many of the most important districts lost their

14 However, neither provinces nor districts are autonomous budget entities and capital budget allocationsare not determined by local revenue collections.

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revenue bases to the municipalities. That is, the thirty three largest tax bases at thedistrict level now fall under the jurisdiction of municipalities. In the affected districts,revenues have declined significantly. Though these thirty three municipalities onlyrepresent about 25 percent of the total number of districts, they represent a much largerpercentage of the total district tax base. The shifting of the tax base from districts tomunicipalities is problematic because it calls into question the potential fordecentralization to district administrations. Unless decentralized district administrationswere to rely largely on transfers from the central government, resources would simply notbe available to finance local service delivery. Current fiscal constraints suggest thatdeconcentration to sectoral district directorates would be more appropriate thandevolution to district administrations. From a pure fiscal perspective the scope fordevolution to the district level is thus quite limited.

Municipalities 15

48. Municipalities have two main sources of income: transfers from the centralgovernment and own source revenues. Transfers from the central government come fromthe Autarkic Compensation Fund (FCA) for recurrent expenditures and the LocalInvestment Fund (FIIL) for capital expenditures. Both funds provide untied block grantsto the municipalities. According to the law, funds are allocated according to thefollowing allocation criteria: municipal population, municipal area, index of municipaltax performance, and weighted index of development. In practice, the only criterion usedso far has been the municipal population. Funds from the FCA, which are dividedbetween the thirty three municipalities, are to be set between a minimum of 1.5 percentand a maximum of 3 percent of annual national tax revenues, though in practice less thanthe minimum has so far been allocated (see Table 3.2). The FIIL, which providesfunding for capital expenditures, may be used at the discretion of the municipality, giventhat expenditures are in line with national budget priorities. Though there are no setcriteria in the law for the allocation of these funds, allocations have thus far been basedon municipal population. The FIIL is financed by parliamentary appropriations on anannual basis.

Table 3.2. Central Government Transfers to Municipalities, 2000(Millions of Meticais)

Budgeted tax collections 6,958,000Actual tax collections 6,915,747FCA Total 95,000FIIL Total 44,000FCA as a Percentage of Collections 1.37%FIIL as a Percentage of Collections 0.63%

Source: Orcamento Geral de Estado, 2000.

49. In addition to transfers from the central government, municipal finance alsodepends on the following own source revenues: municipal taxes, a share of national

15 Municipal financial management is governed by the Municipal Law (2/97), the Municipal TutelageLaw (5/97), and the Municipal Finance Law (5/97), or MFL. In addition municipal revenue collectionis regulated by the Municipal Tax Code (12/00), which complements the Municipal Finance Law.

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taxes (including surcharges), licenses, user fees, fines, inheritances and other gifts, andreceipts from own assets, including the sale of assets. The Municipal Finance Law(MFL) 16 authorizes municipalities to collect the following taxes: (1) the Municipal HeadTax (Imposto Pessoal Autarquico), (2) the Municipal Property Tax (Imposto PredialAutarquico), levied on land and buildings, (3) the Economic Activity Tax (Taxa porActividade Econ6mica), which applies to commercial and industrial activity and is paidby those firms that previously paid the corporate income tax (Sections A and B) and arenot required to pay any of the taxes listed below, (4) the Municipal Tax on Commerceand Industry (Imposto Autdrquico de Comercio e Industria), which applies to smallbusinesses subject to the corporate income tax, Section C, and other activities, and (5) theIncome Tax, Section B, which is paid by small businesses, mostly cooperatives andfarmers. Municipalities are also authorized to receive 75 percent of the national vehicletax, which is not currently being collected.' 7 Tax rates, which are set by the municipalassemblies, are limited by the MFL.

50. The MTC indicates that with the exception of the Municipal Head Tax and theEconomic Activity Tax, all other taxes and surcharges will be collected by the MPF,which will then transfer the net revenues (after deducting administrative costs) to themunicipalities. Presently, municipalities are only collecting the head tax. The MPF iscollecting the Municipal Tax on Commerce and Industry and the Income Tax, Section B,as well as the head tax withheld on public sector workers' salaries (as of early 2001).Municipalities are authorized to take responsibility for tax collection when they areprepared to do so. 18

51. Municipalities may issue and charge for activity licenses in fifteen areasincluding: (1) infrastructure, equipment, construction, subdivision of lots, and use of landand buildings; (2) delivery of public services; (3) use of reserved lots in markets andfairs; (4) street vending; (5) vehicle parking; (6) commercial advertising; (7) use of publicfacilities; (8) cemetery and funeral fees; (9) health inspection; and (10) registrations.Licensing fees are set by the municipal assemblies. Municipalities are also authorized tocharge for direct public service provision in the following areas: (1) water andelectricity, (2) garbage and sewerage collection and treatment, (3) public transport, (4)slaughterhouse use, (5) garden and market maintenance, and (6) road maintenance.Municipal assemblies set the rates for user fees.

52. Detailed revenue data are available for the five largest municipalities (Beira,Maputo, Nampula, Pemba, and Quelimane) from 1998-2000 (see Annex 3)*19 The datamust be interpreted cautiously, given that municipalities began to function independently

16 Lei No. 11/97, Financas e Patrim6nio das Autarquias Locais (May 31, 1997).

17 Reports indicate that one municipality is already collecting the vehicle tax and listing it under "Other"collections in its account reporting.

18 Note that the Municipal Tax on Commerce and Industry and the Municipal Property Tax are notcollected in other parts of the country, which is appropriate given that autarkies are expected toprovide more and better services than, say, district administrations.

19 Detailed data from Brockman and Wojtyla (2000).

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in 1998 and that their accounts are not audited (the data, therefore, may be moreestimates than actuals). Furthermore, data for 2000 are projections and estimates basedon the first six months of the year. In addition it should be pointed out that Maputo'sshare is very large in comparison to the other cities. In fact, Maputo accounted forapproximately 40 percent of the total revenues and 66 percent of expenditures of the fivelargest cities. In terms of revenue composition for the five cities as a whole, ownsource revenues made up approximately one third of total revenues, while two thirdscame from central government transfers in 1999 and 2000. Own source revenues werelargely composed of three sources: taxes, fees and licenses, and other operatingrevenues.21 In 1999 and 2000 taxes, fees, and licenses accounted for nearly three quartersof the total. In terms of fiscal transfers, grants from the FCA and FIIL made up 43percent of total transfers. Another 43 percent of total transfers came from "other capitalfunds."22 Housing Authority Rentals (APIE counterpart funds) provided fourteen percentof total transfers, about the same level of funding as from the FIIL. The data show thatthe grant system provides less than half of the total amount of transfers and less than onethird of total revenues. If own source revenues increase, FCA and FIIL grants willamount to an even smaller share of revenues. Overall, while taxes, fees, and licenseshave been increasing, other operating revenues have been decreasing, leading to a netreduction in total own source revenues in nominal terms (this result, however, is drivenlargely by Maputo; see Annex 3). At the same time revenues from other capital fundshave increased 57 percent from 1999 to 2000, while FCA grants increased modestly.

53. Municipalities may also borrow short term funds (due the same fiscal year), theamounts of which may not exceed ten percent of the amount of their grants from theFCA. Longer term borrowing, while permissible, must be approved by the MPF.Borrowing by autonomous municipal departments and municipal public companies is tobe regulated by the Council of Ministers. At present the cities do not appear to have anybank loans. In practice, even access to credit from local merchants is quite restricted, dueto the cities' poor credit ratings, though the provision of supplier credit seems to beincreasing. Table 3.3 shows the five largest municipalities' financial obligations.

20 These five largest cities accounted for 49 percent of central govermment transfers in 1999 and 2000.

21 This includes capital receipts, earmarked receipts, and other non-fiscal revenues.

22 This category is based on the assumption that positive year end balances from the previous year werecarried over to the current year. Given, however, the likelihood that positive year end balances werelargely the result of poor reporting of actual expenses, and not actual carry-overs, this category shouldbe analyzed with a grain of salt.

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Table 3.3: Municipal Arrears

Municipality Amount (Mts. '000,000) Type

Beira 2,617 Borrowed from government tocover operating expenses; duein 2000.

Nampula 2,464 Short-term loanPemba 100 Short-term loanQuelimane 1,412 Supplier creditsMaputo No data at municipal level.Total 6,593Source: Wojtyla (2000).

54. Presently, tax administration seems to be just as much of a challenge formunicipalities as for districts, though the problem is of greater importance for themunicipalities. Most municipalities do not have specialized tax units. It is unclear whenmunicipalities will begin to collect the taxes due themselves, given the technicalcomplexities of revenue administration. Nor is it clear how municipalities will addressthe problem of compliance with taxes, licenses, and fees. Though compliance data at themunicipal level are not available, anecdotal evidence suggests that non-compliance isconsiderable. It would seem then, under present conditions, that municipalities face aserious challenge in increasing their tax revenues. To the extent that municipal revenuesdo not increase considerably (assuming fiscal transfers will not increase greatly in theshort term), improvements in the quantity and quality of service delivery will becompromised. The risk for the municipal decentralization program is that limitedrevenue raising capacity will act as the binding constraint on the transfer ofresponsibilities from the central government to the autarquias, thus stalling the program.

55. Another concern, which is held by some high level government officials, is thatmunicipalization has created inequalities vis-a-vis the districts (for example,municipalities are perceived to have received favored status at the local level). Criticsbelieve that the amounts of funding channeled to the municipalities through the FCA andFIIL are too high and that the districts have suffered in comparison. The equity problemis especially pronounced in the towns, as opposed to the large cities. In many rural areasthere are not many noticeable differences between towns and districts, except that theautarkic towns receive more funding, and have more control over it, than the districts.

D. Expenditures

Provinces, Districts, and Administrative Posts

56. Provinces, much the same as sectoral ministries, are assigned a portion of theannual national budget (OGE), including investment funds through the national PublicInvestment Program (PIP)23, which permits provinces to develop provincial PIPs.24 The

23 The first PIP, formerly known as the Triennial Public Investment Program (PTIP), was developed in1993. The name was changed when the PTIP became part of the MTFF.

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provincial budget as such may be thought of as having two components: priority (PSI)and non-priority sectors. The priority sectors' budgets, both capital and recurrent, aredetermined by the sectoral ministries at the central level, thus provincial levelgovernment has limited input into the budget formulation process in these sectors(sectoral provincial directorates have some input into their parent ministries' budgetformulation process). The non-priority sector capital budget is formulated by theprovincial government, that is, the sectoral directorates in conjunction with the governor.The non-priority sector recurrent budget is largely determined by decisions about civilservice staffing levels made at the center, and in practice tends to be formulated in termsof an increment over the previous year's budget.

57. In the non-priority sectors the capital budget formulation process begins wheneach sectoral provincial directorate submits a proposal to the DPPF.2 5 At the same timethe MPF sets the aggregate provincial capital budget ceiling and sectoral ceilings for thePSI sectors. The residual, or difference between the provincial ceiling and the sum of thePSI sector ceilings, is allocated to the non-priority sectors. Based on the sectoralproposals and the total ceiling, the DPPF then prepares a proposal for the allocation offunds to the remaining sectors. The DPPF's recommendation is taken up by theprovincial council with the governor presiding. The council then makes a final decisionon non-priority sectoral allocations.

Table 3.4: Provincial and Non-Priority Capital Expenditures as a Percentage of the TotalCapital Budget

1995 1996 1997 1998 1999 2000 2001Provincial capital budget 2.3% 2.7% 6.1% 2.3% n/a 2.8% 8.6%as a percentage of totalcapital budgetProvincial capital budgetas a percentage of totalcapital budget (excludingdonor funding) 7.0% 8.1% 18.3% 6.9% n/a 8.4% 25.9%Non-PSI (discretionary) 1.5% n/a 2.0% 2.0%provincial capital budgetas a percentage of totalcapital budgetSource: OGE for 1995-1998 and 2001, execution report for 2000, and World Bank staff estimates.Note: PSIs were introduced in 1998.

58. Discretionary capital spending by provinces in Mozambicue remains very low,reflecting the highly centralized nature of the Mozambican state.16 Table 3.4 shows that

24 The inter-provincial allocation decision is based on several general criteria, including regionalredistribution, provincial population, and the existing project portfolio.

25 To the extent that district directorates participate in the budget formulation process it is by makingproject proposals to their provincial directorates.

26 Discretionary spending is defined as the amount allocated by the provincial level Government duringbudget formulation.

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discretionary provincial spending averaged 3.7 percent over the pre-PSI period, 1995-1997, and 1.8 percent during the post-PSI period, 1998-2001 (excluding 1999).27 That is,discretionary provincial spending, which was quite low, has shrunk even further. Thedata supports the argument that the PSIs in the priority sectors had the effect ofreconcentrating authority at the central level by diminishing the percentage of budgetfunds allocated at the provincial level. In fact, the PSIs led to an average reduction indiscretionary provincial spending (as a percentage of total spending) of nearly 50percent.2 8 The table also shows that the non-priority sectors are not benefiting (in relativeterms) from the large increase in provincial-level spending programmed for 2001. In realterms, however, the non-priority sectoral allocation grew by 53 percent from 1998 to2000 and by an additional 27 percent from 2000 to 2001. The growth spurt in 2001reflects the govermnent's intention to increase allocations to the provincial level as partof its "decentralization" program. In addition, the increase reflects the use of additionalHIPC funds in the priority sectors at the provincial level. Thus, in real terms, the amountof the discretionary capital budget allocated to the provinces has increased. The relativeamount, however, as a percentage of the total capital budget, has fallen over the period,resulting in a re-centralization of the budget process.29

Figure 3.1. Provincial Recurrent Expenditures as a Percentageof the National Recurrent Budget

20% _ W,xs % l , + !-;6 l

10% 1lM

1995 199E 1997 19E 199 2000 2001

-4-- Provincial Wages as a % of National Wages- Provincial Non-wage Recurrent as a Percentage of National Non-wage Recurrent

59. Provincial recurrent spending has averaged 38 percent of total national recurrentspending over the period 1995 to 2001 (not including 1999), though it has ranged from 27percent to 46 percent (see Figure 3.1). A steep decrease in the ratio of provincialrecurrent expenditures to total national recurrent expenditures occurred in 1998, thoughthe ratio has inched up since then. From 1995 to 1997 provincial spending on wagesaccounted for a hefty two-thirds of the total national wage bill. Due to a massive increase

27 If one excludes donor funding from the calculation, the average discretionary share rises to 5.2% overthe period 1995-2001 (excluding 1999).

28 At the same time, it seems that in some provinces and in some priority sectors there is somedeconcentration of decision making to the territorial level of government. The real impact of thisdeconcentration, in terms of the control of resources, is unknown.

29 These figures, however, should be interpreted with caution, given the serious problem of budgetcoverage in Mozambique (see section on off-budget funds).

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in the central government wage bill in 1998, the provincial share dropped to 47 percenton average over the period 1998 to 2001. A similar trend is evident in non-wageprovincial recurrent expenditures. Recurrent spending at the provincial level is largelydevoted to personnel costs, which are programmed according to civil servicecomplements at the central level. Furthermore, once the PSI sectors are removed fromtotal non-wage recurrent expenditures (the health, education, agriculture, and publicworks sectors accounted for 58 percent of total provincial recurrent spending in 2000, forexample), only a small percentage is left for allocation at the provincial level.

Table 3.5. Per Capita Provincial Expenditures (Recurrent and Capital), 1998 and 2000 (Mts)

1998 2000Cidade Maputo 169,717 Cidade Maputo 274,954

Sofala 115,509 Maputo 266,444Maputo 90,686 Sofala 258,793Niassa 89,273 Niassa 248,561Manica 84,383 Manica 230,981

Inhambane 83,152 Tete 210,484

C. Delgado 82,701 Gaza 209,127Average 78,348 Average 188,410

Tete 78,219 C. Delgado 183,492Gaza 74,643 Inhambane 177,018

Nampula 57,597 Nampula 138,027Zambezia 43,661 Zambezia 118,408

Source: OGE and INE.

60. The process by which the government allocates expenditures to the provinciallevel is not transparent. There does not seem to be a clear set of technical criteria used tomake these allocative decisions. As Table 3.5 shows, per capita provincial expendituresvary enormously. Over the two years examined, Maputo, Sofala, and Niassa wereconsistently the most favored, while Nampula and Zambezia consistently received theleast in per capita terms. The question of inter-provincial allocation merits furtherattention, especially if the government intends for its deconcentration reforms to have aredistributional impact.

61. Recurrent expenditures allocated to districts are determined both centrally andlocally (legally, the district budget has no legal standing). The civil service personnelcomponent of district recurrent expenditures is determined centrally by the civil servicesystem (districts may also use their own revenues plus any subsidy available to hiretemporary contract workers, which most districts do). On the other hand districtsthemselves are responsible for developing the goods and services component of theirrecurrent budgets, such as they are, mainly because they are responsible for financingtheir own non-wage recurrent expenditures.

62. Districts are also allocated a very small share of the development budget. Eachyear as part of the annual budget process, the district administration submits capitalexpenditure proposals to the DPPF. As part of the deliberations about the provincialbudget, district development allocations are determined. Districts are then informed of

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the approved projects and their allocations. Some districts do not actually administertheir allocated funds; rather, funding is transferred to the implementing agency. Due tothe lack of a legislative framework, however, there is no uniform process at the districtlevel.

63. District budget management capacity is thus quite limited. Districts neithermanage the capital budget nor the civil service component of the recurrent budget.Districts, for the most part, manage their own source revenues for the acquisition ofgoods and services, though they also have some control over the hiring of contractworkers.

Municipalities

64. Municipalities are required to prepare annual budgets according to the legislationgoverning the national state budget (OGE). Municipalities must use the same structureand classification system as used in the OGE. The intent of the MFL is to makemunicipal budgets compatible with the national budget and to generate uniform budgetdocuments and processes across municipalities. The MPF provides municipalities with abudget methodology guide as well as yearly templates; both the guide and templates mustbe followed by the municipalities. 30 The cities' treasury system, which is independent ofthe national system, is operated according to the caixa zunica or single account model.

65. In terms of the expenditures of the five largest autarquias, recurrent costsabsorbed about two thirds of total expenditures in 1999 and 2000 (see Annex 3Appendices 1 and 2). Personnel costs were 36 percent of the total, while goods andservices accounted for 27 percent. Though goods and services costs have remainedsteady in nominal terms, personnel costs have increased by 43 percent from 1999 to2000, due, in large part, to recent civil service salary increases. Similarly, other operatingexpenditures have increased by over 300 percent (in nominal terms) from 1999 to 2000.There is little information on capital expenditures, except that they were made on"municipal projects," the costs of which increased by 42 percent from 1999 to 2000.Donor funded projects accounted for less than 1 percent of total expenditures, accordingto the available data. In all likelihood, however, donor funding at the municipal levelaccounted for a larger share.

66. In terms of oversight, annual municipal accounts are first reviewed by theMunicipal Assembly and then sent to the Administrative Court and the IGF. The IGF issupposed to issue a formal opinion to the court, which would then review the accounts.Furthermore, the government is charged with inspecting municipal financial and assetmanagement at least twice per electoral term. As of July 2000, none of the cities hadbeen audited since their founding in 1998. Between July 2000 and mid-2001, only sevenmunicipalities have actually been audited, though the IGF plans to complete audits of allmunicipalities by the end of 2001.

30 See "Metodologiapara a elaboraVao daproposta de or amento do estado: Autarquias,"DNPO/MPF, May 2000. Note that the guide provides a four digit functional classification system aswell as a program-based classification system.

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E. Reform Agenda: Observations and Recommendations

67. The Mozambican government's reform program can indeed be described as oneof gradualismo. The program has been pursued both in terms of devolution in the urbanzones and deconcentration in the rural zones. Both strategies are characterized by greaterlocal participation, though much more in municipalities than districts. At the municipallevel the president and assembly are elected, while at the district level pilot projects havestressed the development of representative district consultative councils.31 Given thatlocal participation is one of the key ingredients for successful decentralization (see Box3. 1), the government has clearly adopted the right strategy by coupling participation withdecentralizing reforms, and should continue to link the two, especially at the districtlevel. The strategies also stress integrated planning as both municipalization and thedistrict-level pilot projects aim to integrate sectoral planning with territorial planning.The reforms are oriented toward fostering greater urban devolution and ruraldeconcentration in Mozambique.

Box 3.1: Popular participation is a critical ingredient to successful decentralization

Decentralization is typically regarded as a means to make the public sector more responsiveto citizens' needs. However, decentralization will only make the public sector moreresponsive if it allows citizens to hold public servants accountable and provides for broadparticipation in the local development process. The quality of public services increaseswhen elected officials and administrators are held more accountable to their localconstituents and clients than to their hierarchical superiors.

Moving programs closer to users and allowing them to participate in program design andimplementation has many potential benefits. For example, a study in South Africa foundthat grassroots participation improved the cost-effectiveness of transferring resources to thelocal poor. Another study in Nicaragua found that schools with greater local autonomyperformned better on test scores than schools with little or no autonomy.

International experience suggests that in order to maximize the potential benefit ofdecentralization, participation should not be limited to election time. In Bolivia and thePhilippines grassroots associations play a formal (legally-mandated) role in policy makingand administration. In Porto Alegre, Brazil a participatory budget-making process hasenhanced the effectiveness of municipal resource allocation for local development.

At the same time the central government has an important support role to play in thedecentralization process. Central government support is necessary to ensure compliancewith national policies and safeguards, especially in the area of financial management, and tocoordinate activities between levels of government. Moreover, central authorities shouldplay a major role in providing the training necessary to foment local administrative capacity,which is the sine qua non of successful decentralization.

Source: World Development Report, 2000

31 Local councils (conselhos de localidade), which would promote democracy at the sub-district level,are also presently under consideration.

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68. The intentions of the reforms notwithstanding, there have been problems in boththe urban and rural spheres. The municipalities have limited fiscal resources at theirdisposal, and it is unclear to what extent municipal revenue performance will improveover the short to medium term. The districts' revenue-raising capacity is also limited andunlikely to improve over the medium term. Moreover, fiscal constraints limit thedevelopment of district and municipal administrative capacity. The risk is that fiscalbottlenecks will constrain service delivery at the local level. Furthermore, there isanother risk that poor revenue performance will lead to bailouts from the centralgovernment, which would exert increased pressure on the nation's fiscal balance andraise concerns about the fiscal sustainability of the decentralization program. Thefollowing recommendations, supported by international good practice, are intended toaddress these concerns.

Provinces and Districts: Recommendations

Recommendation: The functional roles of the provincial and district administrationsneed to be redefined vis-a-vis the sectors in the context of reform of the "dupla tutela"system.

69. Thus far, in many cases the territorial provincial government (i.e., the provincialgovernor) has played a very limited role in the deconcentration program, though in someprovinces and in some sectors territorial planning has played a more important role thanin others. The role of the territorial provincial government, which is limited by thenational constitution, seems to have been further reduced, perhaps unintentionally, as aresult of the PSIs. However, the reform program will have to rethink the role of theprovinces vis-a-vis the districts. One option would be for the provinces to take on thedirect oversight of the districts. For example, the provinces could be charged withholding districts accountable for good administrative and financial management practices.Provinces could also provide technical support at the district level. Provinces could alsotake on responsibilities for coordinating district and municipal development initiatives.Given the status of both the municipal and district level reforms, the moment isopportune for a reconsideration of the role of the provinces vis-a-vis both the central andlocal governments.

70. The role of the provinces will depend, in part, on the role of the districtadministrations. Although reform of the districts is proceeding apace with discussions ofdistrict assemblies and budgets, there is a fundamental question that has beensidestepped: the functional role of the district administration. Given the structure of thedupla tutela, even if districts are given assemblies and budgets, they will still besubordinated to the sectoral ministries. Thus, districts should first be assigned functionalroles. Once functions were devolved, appropriate areas of expenditure could then beestablished; revenue needs could then be assessed based on expenditure assignments.3 2

To some extent the government is putting the cart before the horse by reforming theapparatus of the district without reforming the functional division of responsibilities

32 Transferring revenues before functions raises the specter of unfunded mandates.

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implied by the dupla tutela. There thus has to be a fundamental rethinking of the duplatutela, and with it, the functional role of the district administrations.

71. Central to this point is the definition of the responsibilities of the districtadministrations (i.e., the district administrator) vis-a-vis the district sector directorates.The government has two basic choices: devolution or deconcentration. The fiscalanalysis shows that devolution at this time is seriously constrained by the small size ofthe average district tax base and low administrative capacity to raise revenues at thedistrict level. The present fiscal constraint thus limits the extent of decentralization thatcan be undertaken. From the fiscal perspective deconcentration would seem to bepreferred to devolution at the district level.

Recommendation: District revenue administration needs to be overhauled.

72. Presently, districts are authorized to collect a myriad of taxes and fees. Somehave very low yields and are costly to collect. Others, like the market fee, have a highyield, though they are undermined by low rates of compliance. In some cases the legalbasis for collecting these fees is unclear. Therefore, the legal foundation of districtrevenue collection needs to be updated and harmonized across all districts. Moreover,district tax administration needs to be strengthened. Specialized collection personnelneed to be trained and deployed, standardized forms need to be produced anddisseminated, and the central govermment needs to provide the districts with the legalauthority necessary to enforce compliance. It would seem that developing this complexadministrative capacity across all of rural Mozambique would be a daunting challengecharacterized by high administrative costs. For this reason, two considerations should bekept in mind. First, the district tax and fee structure should be simplified as much aspossible: taxes and rates should be few and exemptions should be scarce. Second,district revenues should focus more on fees for services and less on direct taxation, giventhat the tax base of most districts is likely to be quite small (and the informal sector quitelarge), especially in light of the municipalization reform. A study on the district tax basemay be necessary to determine the extent that districts should also rely on taxes onimmobile factors, such as property. Moreover, to the extent that taxpayers perceive theyare getting something in return for their contributions, compliance will be easier topromote. Given these considerations, the govermment should consider establishing adistrict tax administration agency. The role of the agency would depend on the needs ofthe govermnent, but it could range considerably. At a minimum the agency couldprovide standardized forms and manuals for tax collectors and taxpayers and imparttraining courses for district administrators. Or, the agency could take on actual taxcollections for the districts, which would each contribute a percentage of their taxcollections to its operations. Either option should reduce the total administrative costs ofdistrict taxation. Whatever the decision, urgent action needs to be taken.33

33 Centralizing tax administration would also eliminate the need to rely on tax farming practices, ill-regarded in the literature, at the local level.

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Recommendation: District personnel andfinancial management capacity, especially inthe areas of accounting and budget management, should be strengthened.

73. Districts need to readjust the ratio of technical to support staff, not only byincreasing expenditures for technical personnel but also by reducing expenditures foradministrative personnel (especially those who act as the personal staff of theadministrator). The districts also need technical assistance in developing sound financialmanagement practices. In many, if not most, districts financial management isrudimentary. District financial management, including revenue collection andexpenditure, needs to be standardized. A guidebook along the lines of the budgetingguide developed for the municipalities should be developed and promulgated by theMPF. Strengthening public expenditure management at the district level would be aidedby granting the district budget legal status and integrating it fully into the national andprovincial budget process.

Municipalities: Recommendations

Recommendation: Municipal tax andfee administration need to be overhauled,especially if municipalities are going to assume additionalfunctional responsibilities andimprove municipal service delivery.

74. Currently, municipal revenue collections are quite low and there is no evidencethat municipalities, especially the smaller ones, are ready to assume additional taxresponsibilities. In order to mitigate these problems, it is imperative that the governmenthelp improve revenue raising capacity at the municipal level. Though the governmenthas provided the municipalities with ample regulations, it has not provide the materialsand tools necessary to develop administrative capacity in this area. Presently, the DPPFsare assuming municipal tax collection responsibilities, which makes sense in the currentcontext. DPPFs should continue to collect municipal taxes until the municipalities areready to assume them. However, there are legitimate concerns about whether the smallermunicipalities will develop the necessary expertise in the short to medium term. Giventhat municipalities will have to collect a wide range of personal, corporate, and propertytaxes, administration will be costly and complicated. Creating thirty three municipal taxadministrations, many of which would have to be established in very small towns, doesnot seem the best way forward. It might make more sense, in terms of capacity andadministrative costs, for the DPPFs to collect municipal revenues indefinitely.4Alternatively, a municipal tax administration agency could be established to handleselected aspects municipal tax administration. The responsibilities of the municipal taxagency could range from producing common publications (forms and guides) toproviding data processing and property valuation services to outright tax collection (theagency could be funded by a percentage of its collections). Several countries followvariations of this model. In China there is a tax agency responsible for all localcollections. In Peru other municipalities contract out collections for a fee to the Lima

34 This option would look more appealing if the national internal revenue administration were toundergo a major reform in the near future.

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municipal tax agency. The government thus has a number of specific options to considerfor improving municipal tax collections.

Recommendation: The government should comply with the funding and legalrequirements of the fiscal transfer system and should consider increasing transfers as themunicipalities assume new functions.

75. Presently, fiscal transfers from the central government account for the major shareof municipal income (for the five major cities), which is consistent with the ratio oftransfers to own source revenues experienced by sub-national governments in mostdeveloping countries. In addition, the sum of transfers plus own source revenues isgreater than the amount of recurrent expenditures, which is again consistent withinternational experience. The appearance of the current financial situation is, however,clouded by the fact that municipalities have yet to become responsible for manyfunctions. Once social service functions are transferred to the autarkies, the financialpicture will look more worrisome. As more substantive functions are transferred to theautarkies, considerably more resources will be required. Transferring additionalfunctions heavy in personnel costs, such as education and health, might also lead to animbalance in the amount of recurrent expenditures as compared to revenues. Even givensubstantial improvement in revenue collections, additional transfers might be required inorder to match revenues to expenditures. Currently, funding for the FCA is below theminimum 1.5 percent of national tax revenues required by law and funds are transferredonly according to population, in spite of provisions in the law for transfers based onadditional factors (such as socio-economic status). As the government transfers moreresponsibilities, especially for major social functions, to the municipalities it should alsomove forward with its plans to allocate fiscal transfers according to redistributive criteria,in order to introduce an equity-enhancing component to its decentralization program.The MPF should be able to develop a simple decision rule based on the available data.

Recommendation: Municipal public expenditure management should be strengthened,especially in the areas of accounting, budgetformulation, and auditing.35

76. Fiscal management is also inadequate at the municipal level. There is widespreadconcern that many, if not all, municipalities are not following the law in this area. Thereis a clear need for a program of training and auditing. The MPF recently launched a threeday program in this area at the municipal level. This is a welcome start, but much moreis needed. The MPF should develop a follow-up program immediately after thecompletion of the training program. In addition, the World Bank-funded municipalproject should play a role in identifying and addressing specific financial managementdeficiencies. Initial needs identified include: accounting practices, budget classification(for both revenues and expenditures), and sectoral planning. The MPF, together with theTribunal Administrativo, should also launch a high-profile program of municipalauditing. Audits would initially need to be corrective, but could shift to a sanctioningmode after an initial trial period.

35 For further details, see World Bank Country Financial Accountability Assessment, 2000.

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Recommendation: The transfer of revenue and expenditure powers to the municipalitiesshould be rationalized and regulated.

77. The assumption of revenue and expenditure responsibilities by the autarkies hasbeen left completely to the autarkies themselves, according to the law. The governmentshould ensure, however, that as the decentralization program goes forward, autarkiesmatch revenues with their expenditure responsibilities. The government might establishsome idea of a timetable for progress. The government should clarify the requirementsfor the transfer of functions and responsibilities. There should be clear, transparent,technical criteria by which the appropriateness of responsibility transfers to the municipallevel could be judged. Without some sense of a timetable with technical criteria, thereform could flounder unnecessarily.

Recommendation: Municipalities should be empowered to manage their own personnelaccording to a set of municipal civil service regulations developed by the centralgovernment.

78. Another important constraint on municipal decentralization concerns centralgovernment control over municipal civil servants. Autarkies inherited civil servantcomplements without any regard for the match with their functions, expenditures, andrevenues. Given that the central government effectively controls staff complements, andthat municipal employees are subject to the same civil service system as central civilservants, municipalities do not have control over their own staffs. This means that, forexample, if civil service wages increase, municipal wages increase as well, even thoughthe considerations that support central civil service wage increases may not coincide withthe situation at the level of the municipalities. Since the municipal wage bill accounts forthe majority share of recurrent expenditures, municipalities have no control over theirsingle largest expenditure item. Effectively this means that the central government has anundue influence in municipal expenditure management. For the decentralization reformto gain some depth, municipalities should be given full control over their personnel,subject to a basic regulatory framework established by the central government.International experience on this question varies: some countries have separate civilservices for subnational governments, while in other countries subnational publicemployees are part of the national civil service system. The particularities of theMozambican case merit serious consideration of a subnational civil service system.

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PART II

PUBLIC EXPENDITURE MANAGEMENT REVIEW

79. In 1997, the government embarked on a comprehensive Expenditure ManagementReform Strategy (EMRS) covering the areas of budgeting, expenditure programming andaid management, budgetary execution, accounting, debt management, and auditing.Based on a multi-year, phased fiscal management review supported by the World Bankand other donors, the central objectives of the EMRS were to increase the coverage andtransparency of the process of public expenditure management, to ensure the efficiencyand effectiveness of public expenditure programs in supporting policy objectives, and toguarantee the long-term fiscal sustainability of fiscal programs3 .

80. Significant progress was achieved in expenditure planning and budgeting, mainlyas a result of the approval of the Budget Framework Law in 1997 and the launching ofthe Medium Term Fiscal Framework (MTFF) in 1998. Overall, the existing systemprovides for good aggregate control of expenditures within years and there is no apparentproblem of expenditure arrears.

81. However, the budget system continues to suffer from inadequacies that hinderefficiency, transparency and accountability. Incomplete coverage even of own resourcesand expenditures, inappropriate functional classification, outdated accounting procedures,weak cash management and deficient controls and audits are all issues that thegovernment intends to address as part of a new round of reforms, some of which werelaunched recently during the period of this Public Expenditure Management Review.

82. Following the budget cycle (formulation, execution, control and auditing), thispart of the report will review major issues confronted by the Mozambique expendituremanagement system. Chapter 4 focuses on the improvement of budget coverage andtransparency-two major issues in Mozambique-recommends ways to streamlinebudget formulation and to bring the objective of macroeconomic stability more explicitlyinto the process of budget formulation. In this context, this chapter also discussespossible ways to clarify the role of Parliament in the budgetary process. The followingchapter examines budget execution and recommends concrete actions to improve publicaccounting, reporting and cash management, three of the weakest links in the budgetarychain. Chapter 6 assesses budget evaluation and audit mechanisms and recommendsspecific actions to improve accountability and compliance. Finally, chapter 7 discussesthe introduction of the Public Finance Management Law (Lei de AdministradaoFinanceira do Estado) and the development of an integrated financial managementinformation system (IFMIS). Based on the recommendations in this report, this chapteroffers also a possible road map of specific actions for the creation of a more efficient,transparent and accountable budget management system in Mozambique.

36 The strategy document's stated aims are "to support the socio-economic objectives defined by theGovernment" and "to ensure a high degree of efficiency in the use of public resources as well as thefinancial sustainability of Government-funded activities".

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CHAPTER 4BUDGET FORMULATION-IMIPROVING COVERAGE AND TRANSPARENCY

83. Budget formulation and expenditure planning are the areas where progress is mostvisible since the launching of the Expenditure Management Reform Strategy in 1996/97.Following the adoption of the Budget Framework Law in 1997, the budget document wasgreatly improved, the fiscal year was unified for current and investment expenditures anda set of four consistent budget classifications was introduced. All budgets since 1998have been discussed and approved by the National Assembly before the beginning ofeach fiscal year (except in 2000 due to the floods).

84. However, the budget offers only a partial view of public revenue andexpenditures, violating the principles of universality and integrality, and undermining theeffectiveness of the budget as a tool of public policy.

85. Transparency of public intervention, a fundamental issue in a democratic regimeand an important factor in a market economy, is impaired by the use of a functionalclassification that is too aggregated and that does not offer a sufficiently detailed view ofresource allocations among sectors.

86. Budget formulation, which currently involves the preparation of four distinctdocuments, needs to be streamlined in order to optimize the use of limited technicalcapacity, while at the same time improving the presentation of the budget document andreinforcing the role of the medium-term fiscal framework. Consideration should be givento bringing the overriding objective of macroeconomic stability explicitly into the budgetprocess. The role of Parliament would also need to be made more specific in the law,reinforcing its position as a check on government while limiting its discretionary powerswith regard to major changes in the budget.

A. Improving Budget Coverage

87. The fact that the budget does not fully reflect all government revenue andexpenditures is certainly among the most serious issues confronting the Mozambiquebudget system. This practice breaks two fundamental principles of budgetarymanagement-integrality and universality- both of which are already stated in theBudget Framework Law since 1997, but obviously not implemented in practice.

88. The principle of integrality requires that revenues and expenditures be presentedin a single document (the budget), which according to the principle of universality mustalso include all revenues and expenditures. Adherence to these principles ensures fulldemocratic control of government activities by the Parliament and the public in general.It also guarantees that all government activities are scrutinized and subject to the samerules of fiscal discipline, equity and efficiency.

89. As in many other developing countries with evolving budget managementsystems and heavily dependent on external assistance, there are two major sources of

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extra-budgetary operations in Mozambique: own source revenues (and correspondingoutlays) and donor-financed expenditures. Tax expenditures represent another importantarea that has been kept outside the scope of the budget.

Own source revenues

90. Substantial flows of own source revenues are currently unaccounted for inMozambique's budget system. These own source revenues, or user fees, derive from thesale of goods, services, and real estate, as well as the interest earned on these funds. Thischapter focuses on user fees, that is, funds generated by the organization in question,though there are also other types of own source funds in existence, including earmarkedtax revenues. Own source revenues are collected by a wide range of ministries andautonomous institutions, at the provincial, district and central levels, including ministerialdepartments, commissions, institutes, special funds, and local service providers, includingschools, clinics, hospitals, and public utilities. User fees are collected for social andinfrastructure service provision (e.g. health care, education fees, sewerage services),direct service provision (e.g. technical training, civil engineering services, laboratorytesting), regulatory service provision (e.g. construction licenses and fines) and for goods(medicines, water provision, maps).

91. The only known source of information on the magnitude of the off-budgetproblem in Mozambique was a study done in 1999 commissioned by the MPF("Identificaq o dos "Off-Budgets " e Mecanismos para a sua Integraf ao no Or amentodo Estado "; Austral), which covered the Ministry of Coordination for Social Action(MICAS)37 , the Ministry of Public Works and Housing (MOPH), and the Ministry ofHealth (MISAU). At the provincial level it covered Sofala and Zambdzia. The ministriesof agriculture and education declined to participate in the study at the central level,though some information on their activities was collected at the provincial level.

92. There is little available information about the use of own source revenues. In thesectors examined in the 1999 study some revenues are used as salary supplements, whileothers are used to purchase materials. There is a dearth of knowledge about the use ofthese funds precisely because there are no uniform accounting practices, which, in turn,would make auditing problematic. Furthermore, in some cases own source revenues aredeposited in accounts meant for budgetary funds, which complicates the task of budgetexecution reporting, thereby reducing accountability.

93. The Austral study estimated that the MOPH's own off-budget user feesrepresented 107 percent of its recurrent budget in 1998 (excluding autonomousinstitutions and public enterprises), equivalent to about US$ 791,500. MISAU isestimated to collect about US$ 3,805,000 in intra-ministerial off-budget own sourcerevenues, which represented about 34 percent of its 1998 budget. Compared with itsAfrican neighbors, Mozambique has one of the highest ratios of user charge collections torecurrent expenditures in health-out of 16 countries surveyed, Mozambique had the

37 MICAS did not report having any own revenues at the central level, though apparently there are ownrevenues collected at the district and provincial levels (in nurseries, childcare centers, etc.).

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fourth highest ratio (Shaw and Griffin, 1995). In the education sector, the ministry didnot provide detailed information on off-budget user fees, though it did estimate that two"subordinate institutions" received about US$ 1.3 million which represented about 7percent of the sector's 1998 recurrent budget. The amount of user fees collected byschools is unknown. Similarly, the Ministry of Agriculture and Fishing did not providemuch information on own source revenues.

94. At the provincial level, user fees are similarly large with respect to the recurrentprovincial budgets.38 In Sofala off-budget user fees are equal to 136 percent of on-budgetuser fees and 38 percent of the total provincial recurrent budget. In absolute terms, off-budget own source revenues were equivalent to nearly US$ 400,000 in 1998. InZambezia off-budget user fees were equivalent to 80 percent of on-budget fees and 33percent of the total provincial recurrent budget (more than US$ 490,000 in 1998).

95. Most own source revenues have no legal basis for their collection or expenditure.For example, the National Directorate of Water has no legal authority to charge for thesewerage services it provides in Maputo City. Similarly, neither the National Directorateof Construction nor the Civil Works Registration Commission have a legal basis forcharging professional licensing fees. Likewise, the "Special Clinic" of the MaputoCentral Hospital, which collected approximately US$ 2 million in user fees in 1998, hasno legal authority to charge for its services (Austral; Table 3). The Regional Center ofSanitary Development, which collected an estimated US$ 220,000 in 1998 in user feesfor food and lodging of trainees, collects own source revenues without any legal authority(Austral; Table 2). Furthermore, some educational user fees, which are among the mostimportant own source revenues from the point of view of the average citizen, have nolegal foundation.

96. Some own source revenues do have a legal foundation, though most of these arecollected by autonomous institutions. Of the eleven legal user fees collected in the publicworks sector, only one (the percentage of the fuel tax earmarked for the road maintenancefund) is reported in the budget (Austral). The fact that some user fees are legal, therefore,does not at all mean that they are reported in the budget, given the special budgetarystatus of autonomous institutions.

97. There is another set of user fees with legal standing that are collected byministerial line departments and similar administrative entities (i.e., non-autonomous).The most prominent of these are health service fees, including fees for consults,medicines, and hospitalization, which are collected by hospitals, clinics, and health posts.

98. Legally, all own source revenues, including earmarked fees with legalfoundations, are required to be deposited in central government accounts39 . In practice,

38 In Sofala, off-budget flows represented 94 percent of total provincial receipts (recurrent and capital),though off-budget user fees only accounted for 8 percentage points (the other 86 percent was due tooff-budget donor financing). The significance of off-budget user fees in Zambdzia is even smaller.

39 This is based on Law No. 15/97 (July 10, 1997), Govermment Decree No.7/98 (March 10, 1997), andthe Instructions on the Execution of the State Budget (October 2000) issued by the accountingdepartment at the MPF.

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though, few are. Even when own source revenues are deposited in central governmentaccounts and later requisitioned, practices vary inter- and intra-sectorally, and fromprovince to province. Some departments provide data neither to the MPF nor their parentministry about collections and expenditures of user fees (e.g. the National Directorate ofConstruction). Some other fees are deposited directly by the users in private banks. Thusthere are a multiplicity of payment, deposit, transfer, requisitioning, and reportingpractices.

99. The government has taken measures to address this problem. In addition to theinformational study done in 1999, the Ministry of Planning and Finance issued a set ofinstructions in October 2000 ordering ministries to comply with the law on own sourcerevenues, namely that all revenues should be first deposited in central governmentaccounts and subsequently requisitioned4 0.

100. However, the new instructions, which are based on the existing legal framework,raise a number of questions about the appropriateness of the current system. For one, thedeposit/requisition process does not distinguish between agencies with financialautonomy and those without autonomy (except that financially autonomous agencies donot have to report on previous expenditures before receiving new transfers). Theprocedures seem overly burdensome, especially for agencies with financial autonomy andfor the management of earmarked revenues.

101. Discussions with three line ministries (public works and housing, education, andhealth) revealed that the instructions are not being followed. There are two rationalesgiven by the sectors for their flouting of the law. The first is that the existing treasurysystem is riven with administrative problems and shortcomings. There is a very realsense that, once deposited, funds would be very difficult to reclaim, and even if fundswere returned to the collecting departments, the requisition process would not becompleted in a timely manner. The second rationale is that user fees are considered asessential resources, given that the budget does not cover the recurrent costs of operation.It would seem that unless these arguments were addressed substantively, it would bedifficult to secure the voluntary cooperation of the sectors.

102. Guidelines for reform. The challenge is to include own source revenues in thebudget in a way that minimizes the potential disruption to service provision and elicits thecooperation of line ministries. If, due to inadequacies in the public accounting andtreasury systems, user fees were not returned quickly, without undue bureaucratic burden,and in the correct amounts to the appropriate line ministries, important social servicesmight be disrupted. If service delivery, especially in the health and education sectors,were disrupted significantly, the greater budget coverage attained would be offset bypotentially high social costs. The government, however, does not have to trade off socialservice provision for greater budget coverage; these two objectives do not need to bemutually exclusive.

40 Instrucoes sobre a Execuqdo do Orcamento do Estado (Outubro de 2000), Sections 10 and 11.

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103. The intersections of these financial management, institutional capacity, andservice delivery questions are such that the MPF may have to rethink its approach to theproblem. In general terms, the MPF should consider changing the instructions and/or lawso that some own source revenues do not have to be deposited in central accounts, butcan be retained by the ministries for direct service provision. In lieu of having to depositrevenues in central accounts, however, the ministries would be required to report alltransactions involving the collection and expenditure of own source revenues, thusbringing them on-budget.

104. Any recommendations in this area, however, must be tempered by practicalconsiderations: there cannot be a "one size fits all" solution to the problem of own sourcerevenues. This differentiated treatment would be consistent with common practice inSub-Saharan Africa as well as the rest of the world (see Box 4.1 below).

Box 4.1: The Financial Management of User Fees: An International Perspective

The basic rationale for the retention of user fees at the point of collection is that localretention will stimulate increased collections, thereby leading to better service provision that willdisproportionately benefit the poor. Several studies have examined each link in this chain oflogic. In terms of increasing collections, the argument is simple: officials have better incentivesto collect fees when they retain them (Shaw and Griffin, 1995: 45). Laurent (1982), cited inAinsworth (1984: 35), argues that "the level at which fees are retained may have some effect onthe incentive to collect user fees." Laurent shows that average receipts per bed in Rwandanhospitals that retain user fees amounted to 1.9 to 2.7 times more than receipts in hospitals thatremit fees to the ministry of health (similar results were obtained in Togo). A recent study of theZimbabwean health sector reports that, since hospitals' budget allocations are unaffected by theirrevenue performance, they have little incentive to improve billing and collections (Hecht et al.,1992: 24); consequently, only a percentage of user fees are actually collected. In fact, poor costrecovery rates in many countries may be due, in part, to requirements that user fees be remitted tocentral ministries (Ainsworth, 1984: 35).

In addition, this literature argues that local retention will benefit users by improving servicequality and fostering greater equity. Shaw and Griffin (1995: 26) argue that local facilities sufferdisproportionately from disruptions and malfunctions in the budget process. Given that localfacilities serve mostly poor clients, improving service quality in these facilities will have a pro-poor bias. This argument is supported by McInnis (1993), cited in Shaw and Griffin (1995), whostudied local fee retention schemes in Cameroon, the Central African Republic, and Swaziland.According to Shaw and Griffin (1995: 26) and McInnis (1993), "Facilities that retain revenuesgenerally performed substantially better than facilities that sent all their revenues to the treasury."

Lastly, local retention arrangements allow for greater decentralization in revenue collectionsand expenditure management. In highly centralized systems, collection and management of ownsource revenues is a sensible first step toward greater decentralization. Local agencies wouldacquire useful experience in financial management, which could serve as a base for subsequentfiscal and administrative decentralization.

It is not surprising, then, that Ainsworth (1984: 40), Hecht et al. (1992: 27), and Shaw andGriffin (1995:52) all recommend retention of some or all user fees by local health facilities. Ofcourse care would have to be taken to ensure local compliance with revenue collectionprocedures. Audits carried out by central bodies would be an instrumental component of thereform.

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Recommendation: Autonomous institutions

105. These institutions would charge their own rates based on the principle of partialcost recovery, given that some autonomous institutions provide services that havesubstantial positive externalities (housing, roads, etc.). They would retain all collectionsfor their own use and make their own decisions on internal allocation of expenditures, asunder current law. They would report on all collections and expenditures directly to theMPF on a quarterly basis, unlike the current situation. In addition, third party reporting(i.e., by banks holding their accounts) would be used to cross-check information provideddirectly by the institutions. The goal is for these institutions to have authentic financialand managerial autonomy yet to include information on their financial activities in thebudget. The treatment of autonomous institutions would be easiest in the context of thecurrent legal framework.

Recommendation: Central service provision and regulatory agencies

106. This category of organizations includes agencies that operate at the central andprovincial levels and provide either regulatory services or services to discrete categoriesof private users. This category includes, for example, the Mozambican EngineeringLaboratory, the Civil Works Registration Commission, the National Health Institute, theRegional Center of Sanitary Development, and the Fishing Development Service. Whatdistinguishes these agencies is that they provide discrete goods and services, includingregulatory services, to a self-defined set of users largely in the private sector. Theprinciple guiding rate setting here should be full cost recovery, since benefits accruemostly to private users. Rates would be set by the corresponding ministry throughdecrees updated annually. In order to give these agencies positive incentives to collect,they should also be allowed to retain a percentage of user charges. That is, some ofthese agencies' receipts should be deemed earmarked revenue ("receitas consignadas").The rate of retention should be set to ensure full cost recovery only. Additional revenuesaccruing beyond cost recovery should revert to the treasury. This is an importantqualification, given that many regulatory activities (e.g., granting fishing licenses) willgenerate revenues much above what it is needed for cost recovery.

Recommendation: Local social service delivery agencies

107. This category of organizations includes schools, clinics, hospitals, and daycarecenters. Services are provided to the general public (e.g., health) and in some cases aremandatory (viz., education). Many of these services have substantial positiveexternalities and some are public goods. Many of these services have a direct impact onpoverty, so rate setting for this category is based strictly on limited cost recovery (a highlevel of subsidy would continue to come from the state budget). Rates would be set by thecorresponding ministry through decrees updated annually. One hundred percent of theseuser fees would be retained directly by the collecting institutions (schools, clinics, etc.).Fees would be deposited in bank accounts exclusively for that purpose and informationon account movement would be provided by the bank to the MPF. Expenditures wouldbe allocated by sectoral ministries in order to ensure commensurate levels and quality of

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services across regions. Information on their collections and budget execution would bereported on a quarterly basis to the sectoral ministry.

108. Table 4.1 below summarizes these proposals.

Table 4.1: Summary of Proposed Framework for Own Source Revenue ReformRate Setting Collections Expenditures

Autonomous Set internally based on Retained; data on Allocated internally;Institutions partial cost recovery collections remitted to data on expenditures

MPF sent to MPFCentral Service Set centrally based on Retained; data on Annual budgetProvision/ full cost recovery and collections remitted to allocations by sectoralRegulatory Agencies regulatory sectoral ministry ministry

considerationsLocal Social Service Set centrally based on Retained; data on Annual budgetDelivery Agencies partial cost recovery collections remitted to allocations by sectoral

sectoral ministry ministry

109. In August 2001, as a direct result of the discussions that took place during thisPEMR, the Minister of Finance has sent letters to all other ministers requiringinformation on all revenue being raised by their departments and all subordinatedinstitutions, their legal basis and the amounts raised in 1999 and 2000. This is a welcomedevelopment and a first step in the establishment of a full inventory, which is necessary arequirement. However, the following steps should also be undertaken in addition to therecommendations above:

* Specific criteria for institutions that will enjoy administrative and financial autonomyshould be defined.

* The legal-administrative status of each public sector entity (for example,commissions, institutes, laboratories, funds, administrations, etc.) should be clarifiedaccording to the criteria above, as well as the treatment of each category in the statebudget. All public entities, including autonomous institutions, should report onrevenues and expenditures using the economic and functional classifications.

* There is an urgent need to determine which of the user fees currently collected shouldcontinue to be collected (given that many fees collected have no legal basis). Thosewith no legal foundation deemed unworthy of collection should be abolished.

* New instructions should be issued allowing for retention of fees by autonomousinstitutions and local social service delivery organizations, following therecommendations above.

Donor funding

110. An estimated two-thirds of total investment expenditure in Mozambique is donor-funded. This share has been declining in recent years (from 78 percent in 1998 to 66percent in 2000) as the government increases its own contribution, but remains high,highlighting the level of aid dependence. The investment budget offers a relativelycomprehensive view of total investment expenditures projected for the year. Indeed, 80

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percent of the estimated total investment (both internally and externally financed), wasincluded in the budget in 2000. In 2001, this proportion increased to 94 percent. Hence,as opposed to many other developing countries heavily dependent on external aid, andcontrary to a commonly expressed view, Mozambique's budget seems to provide a goodcoverage of public investment at the aggregate level.

111. There are however two issues regarding the budget treatment of donor funding:first, even though the great majority of these expenditures are reported in the budget atthe aggregate level (i.e. according to the economic classification), it is almost always thecase that donor funding in specific functional areas (e.g. higher education, housing orbasic health care) and at the provincial level is not fully reflected in the budget. Second,most externally financed outlays-an estimated 90 percent-are executed outside thenormal budgetary procedures, following donor-specific disbursing channels,classifications, procurement and reporting requirements, and therefore are not capturedby the public accounting system.

112. These problems are best illustrated by comparing planned and actual investmentspending by major function (see Table 4.2).

Table 4.2: Budgeted and Actual Investment Spending by Functional Classification, 1999and 2000 (Mt billions)

1999 2000Investment account Budgeted Actual Budgeted ActualAgriculture 479 75 1,042 33Health 711 110 1,015 55Prim./Sec.Education 612 180 793 114Higher Education 153Ilnfrastructure 2,488 401 2,269 353All Other Ministries 1,094 1,025 1,004 807Total investment 5,384 1,791 6,276 1,362

Sources: Planned from the budget books of 1999 and 2000. Actuals from Conta Geral do Estado 1999 (Mapa 09)and from Relat6rio de Execuqdo do Orcamento 2000 (Mapa 4).a Higher education is listed separately where possible. When it is not possible, it is incorporated in the figures forprimary and secondary education.

113. In all sectors, and for the total, the reported execution of the investment budgetwas far less than budgeted. This is because the reported executed amounts reflectbasically the domestic contribution to investment, omitting most of externally financedexpenditures. Hence the investment account numbers are not of great value. The policyconclusion to be drawn from this analysis is that serious efforts must be made both bygovernment and donors to better report on execution of donor-funded investmentprojects.

114. Increasing the share of external assistance that is disbursed and used through thenormal budgetary procedures and avoiding the proliferation of parallel donor-drivenarrangements, has been one of the major objectives of the govermuent for a number of

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years. The advantages of such a move have been thoroughly discussed, in Mozambiqueand elsewhere41 , and are now generally accepted. However, while recognizing theseadvantages, donors remain cautious and stress the need to ensure that the fiduciary risksassociated with increased budget support are dealt with. This is one of the reasons whygovernment has decided to step up reforms of the budget management system,particularly those directly affecting transparency and accountability, to which therecommendations in this report will contribute.

115. Recommendation. For those donor-financed outlays that are not captured by theaccounting system (because they are executed outside the normal budgetary procedures),an annex should be added to the quarterly budget execution reports with information ondonor-funded actual expenditures, based on information to be provided by donors andsector ministries.

Tax expenditures

116. Tax expenditures are an instrument of fiscal policy. Like government lending andcontingent liabilities (see chapter 2), they should be included in the budget. A taxexpenditure is the revenue foregone because of preferential provisions of the taxstructure, and covers the following: (i) exemptions, which exclude the revenues of aspecial group of taxpayers from the tax base; (ii) deductions, which reduce the tax baseby some expenses or a lump sum; (iii) credits, which are deducted from the tax due (asopposed to deductions which reduce tax income); (iv) deferrals, or postponements of thedeadline to pay taxes, without interest or penalties; and (v) reduced tax rates for certaincategories of taxpayers or activities (Schiavo-Campo and Tommasi).

117. This issue is particularly important in the case of Mozambique given the largenumber of fiscal incentives that are applied under the form of total or partial taxexemptions to a wide range of activities. Most tax expenditures are associated withinvestment incentives, but other activities benefit also, such as the imports of cars by themembers of Parliament.

118. A recent study undertaken by the IMF at the request of the MPF42 provides anestimation of the revenue foregone and offers recommendations for the rationalization ofthe current system of tax incentives. According to this report, around 20 percent of totalpotential import tax revenue was forgone in 1998; in 1999 this amounted to 12 percent.Of all foregone import tax revenue in 1999, 20 percent is due to the imports of cars bymembers of Parliament. Regarding the corporate income tax (contribuicdo industrial), itis estimated that tax exemptions amounted to around 53 percent of the total potentialrevenue from this tax in 1998.

41 Particularly at the Strategic Partnership for Africa (SPA), a donor coordination forum in which thisissue has received particular attention.

42 Gorman, Sab and Ramos, Racionalizacdo dos Incentivos Fiscais, IMF Fiscal Department, August2000.

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119. These fiscal incentives are regulated by around 30 laws, decrees and specificgovernment decisions, and no official estimate of their consolidated revenue cost is madepublic. In particular, no information on this issue is provided in the budget document,hindering transparency and accountability, and reducing the scope for meaningfulscrutiny of these activities by the Parliament and the public in general.

120. Recommendation. Tax expenditures should be subject to an explicit trade-offagainst new spending initiatives and should be as transparent as possible. Ideally, as inthe case of government lending, the direct impact of tax expenditures should be budgetedin gross terms both on the revenue side and on the expenditure side. However, as theexplicit budgeting of tax expenditures may be difficult in some cases, a consolidatedassessment of all tax expenditures should be attached to the budget document. Somecountries (France, Spain and the United States) require the executive to present to thelegislature such a consolidated statement, even though it is not subject to a vote byParliament.

B. Increasing Budgetary Transparency-A New System of BudgetClassification

121. There are four types of budget classifications used in Mozambique: economic,functional, institutional and territorial. The economic classification follows the standardinternational nomenclature generally used to classify public revenue and expenditure.The institutional classification reflects government structures, while the territorialclassification presents the ten provinces plus Maputo city and the central administration.The functional classification specifies only 14 "sectors" (e.g. defense, education, health,etc) and remains quite broad.

122. The problems associated with the functional classification have long been arecurring issue in the dialogue with the MPF and ranked high among the issues treatedover the course of this Public Expenditure Management Review. These are thefollowing: first, it does not provide the detail necessary to analyze public intervention inthe areas considered to be priority by the government, such as primary education, ruralroads or primary health care. This results in a loss of political visibility for thegovernment, and makes it difficult for the legislature to compare government politicalobjectives and programs with the allocation of public funds. Second, and related to theprevious point, it reduces fiscal transparency, and when associated with limited orincomplete reporting on actual expenditures, it contributes to a loss of accountability.Third, the lack of detailed information on the allocation and use of budgetary resourcesreduces donor confidence in the budget, undermining the government's strategy togradually increase the share of external assistance executed through direct budgetsupport. Finally, the broad classification used hinders the efforts to effectively measurethe efficiency and poverty incidence of public expenditures, therefore neutralizing thenecessary monitoring of the impact of public intervention and the use of techniques ofperformance-based budgeting.

123. In addition, while the law provides for the use of four different types of budgetclassifications, ministries are required only to submit their expenditure proposals

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according to the economic classification. Therefore, even though the budget documentpresents expenditures according to the four classifications, the functional classification ismerely derived from the institutional one. Likewise, during execution, expenditurereturns by line ministries as well as the accounting process in the MPF (executed by theDirecado Nacional da Contabilidade Publica, DNCP) are exclusively performed on thebasis of the economic classification. Budget execution data by government functions istherefore not captured by the accounting system, and is simply calculated by aggregatingthose monthly expenditure returns submitted by line ministries along sectoral lines(education, health, etc).

124. Recognizing these shortcomings, the government decided in March 2001 tointroduce a new and more detailed functional classification, which will be used in allstages of the fiscal management process-budgeting, accounting, reporting and control -starting with the 2002 budget (government decree No. 10/2001 of March 20, 2001). Thiswill represent a major step forward in terms of greater fiscal transparency. It is also adecisive move to improve donor's confidence in the budget, thus helping the authoritiesin their strategy to increase the share of external assistance directly executed through thenormal budgetary mechanisms.

125. The new functional classification will be introduced following the standardizednomenclature recommended by the United Nations (Classifications of the Functions ofGovernment, COFOG, which is identical to the IMF's Government Financial Statistics),adjusted marginally to reflect the specificities of Mozambique. The COFOG will beintroduced in its full detail allowing for a breakdown along functional-programmaticcategories. The COFOG classification contains three levels of detail - major groups (1 to14, which are the ones currently used in Mozambique 43 ), groups (61) and sub-groups(127).

126. As international standards on budget classifications tend to evolve4 4, it isimportant to ensure that the nomenclatures used in Mozambique are regularly revised andupdated.

C. Enhancing Expenditure Planning and Budgeting

The budget preparation process

127. Budget formulation is the annual most important process in the translation ofgovernment policies and programs into resource allocations. It must reflect a clearoverall policy strategy, as defined in government's political program and mandate; itmust be compatible with and support the annual monetary and exchange rate policies, as

43 The 14 major groups currently in use are: General public services; Defense; Public order andsecurity; Education; Health; Social security and social action; Housing and community services;Sporting, recreational, cultural and religious services; Fuel and energy; Agriculture, forestry, fishingand hunting; Mining and mineral resources; Transport and communication; Other economic services;Expenditures not specified.

44 For example a revised version of the COFOG is already being prepared and will be published soon.

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well as the structural reforms to be implemented; and it must be embedded into amedium-term fiscal strategy that takes into account the projected overall resourceenvelope and that promotes fiscal sustainability. It is therefore a demanding process,which beyond the technical work necessary to collect information, process it and draft thenecessary documents, often entails complicated negotiations and compromises, requiringthe full consideration of decision-makers, both at the political and the technical levels.

128. Budget formulation in Mozambique involves the preparation of four documentseach year: the medium-term fiscal framework (MTFF or Cendrio Fiscal de MedioPrazo), the investment plan (Plano Trienal de Investimento Puiblico, PTIP), the economicand social plan (Plano Economico e Social, PES) and finally the budget document itself(Or,amento do Estado, OE) (see Annex 4 for details). The drafting of these documentsdemands the mobilization of considerable human resources and expertise in a publicservice where technical and administrative capacity are scarce, and diverts the attentionof decision-makers from the policy debates that should be at the core of the budgetingprocess.

129. The investment plan in particular seems superfluous. The PTIP, as in many otherdeveloping countries highly dependent on external aid, does not provide an accurateestimate of capital expenditures because it also includes recurrent outlays, and reflectsmany of the shortcomings associated with dual budgeting, even though the budgetingprocesses for recurrent and investment expenditures are now combined in theory. Thedisadvantages associated with this type of plans are now widely accepted (see Box 4.2).

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Box 4.2: Concerns About PIPs and Proposals to Address Them

Public Investment Programs (PIPs) have long been a staple of developing countries. Theyattempt to provide a mechanism to manage investment projects more effectively, bothstrategically and operationally. They also play a role in managing external donor financing.

Despite these good intentions, PIPs have, in practice, been associated with many of thedysfunctional budgeting, resource allocation, and financial management practices around theworld. In particular, PIPs are associated with dual budgeting - the separation dejure or defactofrom the regular current budget, often under the pressure from donors for whom this separationbrought both visibility and facilitated aid coordination. Of even greater concern is that PIPsusually encourage countries to focus on projects, with policy and program often an after thought.The result is an expansionary thrust to spending, leading to unsustainable over-commitment ofgovernment funds and instability in all three levels of budgeting - aggregate fiscal discipline,resource allocation and use based on strategic priorities, and efficiency and effectiveness ofprograms and service delivery.

A new paradigm of the PIP

Thinking and practice on PIPs has shifted over the years as a reaction to inherent weaknesses.Several issues have come now to the forefront in the new approach to PIPs:

* There is greater recognition that projects should be selected by reference to a range ofcriteria, both economic and non-economic and, in particular, the chosen role ofgovernment within a sector. Getting the latter clarified will improve the selection ofprojects;

* There is greater emphasis now on the recurrent budget as the starting point. Related tothis, there is a recognition that the PIP and the recurrent budget should be integrated intoa medium-term fiscal framework in which the resource envelope is defined by centralgovernment, not donors.

* More emphasis tends to be placed now on clarifying what should and should not be in thePIP (e.g., decisions on whether to include TA projects, direct donor-financed projects,entirely government-financed projects, local government projects, parastatal projects,etc.). In deciding what to include, the criteria have shifted from an economist's view ofwhat constitutes public investment to a more managerial interpretation of the PIP as atool to manage public expenditures and, in particular, external financing.

Source: Freely adapted from Public Expenditures Management Handbook. World Bank,Washington, DC, 1998

130. With regard to the MTFF, its introduction in 1998 was intended to rectify theabsence of a link between medium term sectoral expenditures and overall resources,given the projected macroeconomic framework, as well as to improve the link betweenmulti-annual sectoral expenditure objectives and the annual budget. However, the MTFFto date has been disjointed from the budget process. It has been quite difficult for thegovernment to link the MTFF effectively with the annual budget-at present the MTFF isseen as more of a technical document than a public expenditure management tool.According to high level officials, the MTFF "does not have much influence" over thebudget process because it is not seen as "credible." One of the reasons for this is the fact

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that, like the budget, a significant share of revenues and expenditures is not captured (seeSection A above). Moreover, the opinion exists within parts of the government that notdeveloping the MTFF does not carry "grave consequences." That is, the value added ofthe MTFF approach, given its cost in time and resources, is not readily apparent withinthe government.

131. These problems are not unique to Mozambique, and while the introduction of aMTFF has been advised in several countries, its effective implementation remainsdifficult and requires managerial changes, political support and technical training (seeBox 4.3).

Box 4.3: Good Practice in MTFF Design and Implementation in Sub-Saharan Africa

Management: While budget offices should take responsibility for the overall MTFF, other actorsshould also play an important role in bringing the process together. In South Africa MTFFreview teams, composed of sector and Ministry of Finance officials, as well as consultants,prepare the sector expenditure frameworks, which are then evaluated by the Department of StateExpenditures before being passed on to the Minister's Committee on the Budget. The entireprocess is overseen by a Medium Term Expenditure Committee. These overlapping, yet distinctcommittees reinforce responsibility for the MTFF at each stage. In Tanzania the permanent PERWorking Group manages the overall process. Sector working groups, composed of governmentofficials, donors, IFIs, academia, and the private sector, develop the sector expenditureframeworks. Relying on technical experts as well as civil society groups in the context of an on-going PER has helped reinforce the importance of the MTFF.

Political Support: The MTFF needs to be recognized as an important expenditure managementtool, and to attain this status it needs high level political backing. At the very least the MTFFshould be subject to high level political approval as a signal of its importance. For instance, inKenya the MTFF, which is released a few months before the budget, is approved by both thecabinet and the parliament. In South Africa the Medium Term Budget Policy Statement, which ispublished three months before the budget, is presented by the minister of finance to theparliament.

Technical training: Given the challenges of launching a government-wide MTFF, training iscritical. Moreover, training cannot be a one-shot event; it must be continuous, adapting to needsas they arise. In Ghana workshops were held for all central and sectoral ministries on strategicplanning. In addition, an MTFF technical guide and user manuals were developed. In Tanzaniathe Ministry of Finance provides the sectors with the format for their sectoral expenditureframeworks.

132. In Mozambique, annual budgets are approved and published in constant prices(previous year prices). During execution, the MPF adjusts budget allocations by decree,adjusting for projected average inflation (in the case of internally financed expenditures)and expected average exchange rate depreciation (for externally financed outlays, mainlyinvestment). The modified limits are communicated to spending agencies but are notpublished. This fact makes it difficult to compare budget allocations (published inconstant prices) and actual expenditures (recorded in current prices) and thereforereduces transparency. This is aggravated by the fact that adjustments are not uniform andmay vary widely between budgetary categories. For example, in 1998 the allocation for

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the Office of the Prime Minister was adjusted upwards by 85 percent, while that for theMinistry of Foreign Affairs was increased by only 0.4 percent (although the totaladjustment remained close to projected annual inflation).

133. Recommendations. The following concrete actions should be implemented toimprove the process of budget formulation.

Recommendation: The PTIP should be abandoned while the PES should be reinforcedand used as a document for the monitoring of the PARPA (Plano de Ac do para aReducdo da Pobreza Absoluta, or PRSP).

Recommendation: The budget should beformulated and executed in currentprices. 45

Recommendation: The content of the budget (OE) should be improved The OE shouldbetter spell out the policy and program objectives underpinning the proposed allocationof resources. In particular, the OE should be more specific regarding the annual programtargets and monitoring indicators, at least for the PARPA priority sectors. The links inthe budget document between fiscal policy objectives and monetary, exchange rate andstructural policies, should also be reinforced.

Recommendation: The MTFF needs to be reinforced A number of steps can be takenfor this purpose: first, the MTFF needs to be incorporated formally into the budgetprocess. The authorities could take advantage of the new public finance law (see Chapter7) to enshrine the place of the MTFF in the budget process and give it a legal andinstitutional basis. It should also become a public document. Second, the MTFF needs tobe seen as having high level political support, including support from line ministries. Forthis purpose, authorities should consider the possibility for the MTFF to be discussed andformally approved by cabinet. Third, the management structure of the MTFF needs to bereformulated so that it provides multiple and overlapping points of responsibility. Fourth,technical assistance should continue to be utilized to produce adequate sectoralexpenditure frameworks.

The objective of macroeconomic stability and the role of Parliament

134. Bringing the fundamental objective of macroeconomic stability squarely into thebudget formulation process is an issue that has started to receive particular attention inmany countries around the world. Several countries now use some sort of specific targetsfor the overall budget deficit (expressed as a share of GDP, in absolute value or as anannual rate of change). Once properly determined, the overall budget deficit and itsmode of financing are considered immutable ceilings, not to be reopened at each stage ofthe budget process. These variables must be based on solid macroeconomic projectionsand be consistent with price and exchange rate stability.

45 This view is shared by the Administrative Tribunal who advised against this practice in its opinion onthe 1998 and 199 State accounts.

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135. In Mozambique, such constraints have not been built into the budgetary processand this issue has not received particular attention. There are at least two reasons for thisfact: first, the overall budget deficit has mirrored the targeted level agreed beforehandwith the IMF and therefore is taken almost as exogenous to the budgetary process;second, the Parliament has had until now a limited role in budget formulation, basicallyapproving the annual budget proposed by the executive with few or no changes.

136. The Parliament's role in the budget process is only loosely defined in the BudgetFramework Law of 1997. Article 18 only specifies that the National Assembly mustdecide on the budget before December 31 of each year, and adds that after approving thebudget the Assembly cannot take initiatives that would increase expenditures or reducerevenue.

137. Recommendations. As the conditions that have prevailed until now will tend toevolve, it would be important to address this issue. One possible way would be to use theMTFF as the vehicle that sets the overall budget deficit target for the budget year, as wellas the projected targets for the subsequent years. The budget year target should beconsidered a ceiling not to be exceeded, while the deficit for subsequent years would beprovided on an indicative basis, subject to adjustment each year. As a corollary, theMTFF's role in the budget formulation process must be reinforced along therecommendations proposed above.

138. The National Assembly would not be allowed to approve changes in the budgetthat would brake the deficit ceiling. Increased expenditures in one area would only bepossible if matched by offsetting savings in another or an increase in revenue. Ifexceptional developments during the course of the execution of the budget so require(e.g. in case of a natural disaster such as floods or a severe drought), the deficit targetcould be revised, but a new budget law would have to be submitted by the executive tothe Assembly.

139. In order to compensate for this limitation on its own discretionary powers, theNational Assembly should receive more and better information from the executive, bothduring budget approval and during budget execution. The detailed functionalclassification that will be introduced in 2002 will help addressing the first issue, while thepublication of quarterly execution reports showing actual expenditures according to thisdetailed classifier should help addressing the second.

140. In addition, the procedures for discussion and approval of the budget by theAssembly could also be revised in order to improve its involvement and reinforce its roleas a counterweight to the executive. The process could be split into two stages: first, adiscussion would focus on the macroeconomic and sectoral projections, policies andassumptions underpinning the budget. The MTFF and the PES would provide the mainbasis for this discussion. This first stage could take place earlier in the budgetaryprocess, depending on whether it is decided to submit these documents ahead of thebudget document itself. In a second stage, the discussion would focus on the detailedscrutiny of revenue and resource allocations, based on the budget proposal.

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141. Finally, the technical capacity of the National Assembly to analyze the budget andto monitor its execution must be reinforced. This could be done both by increasing thebudgetary allocation in favor of the Parliament's Planning and Budget Committee andthrough capacity building with the support of the donor community.

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CHAPTER 5BUDGET EXECUTION-INCREASING EFFICIENCY

142. Budget execution is the phase where resources are used to implement policiesincorporated in the budget. It is possible to implement a well formulated budget badly; itis not possible to implement a badly formulated budget well. Hence the importance of awell conceived budget, based on strong macroeconomic assumptions and includingrealistic revenue and expenditure objectives. However, this is not to say that budgetexecution comes down simply to mechanisms for ensuring compliance with initialprogramming. It is a demanding exercise, which requires (i) that the budget beimplemented in conformity with the authorizations granted in the law, in both thefinancial and policy aspects; (ii) that adjustments to unexpected new developmentsarising during the fiscal year are included in a transparent and efficient way; and finally,(iii) that efforts are made, throughout the whole execution phase, to maximize savingsand to ensure relevant and timely reporting (Schiavo-Campo and Tommasi).

143. Overall, the existing system in Mozambique provides for good aggregate controlof expenditures within years-there have not been significant over-runs ofexpenditures-and there is no apparent problem of expenditure arrears. The systemsuffers, however, from major weaknesses that hinder efficiency and transparency in theuse of public funds.

144. Strengthening budget execution in Mozambique will require a set of actions toaddress two main challenges. First, reforming public accounting and transforming it intoan effective management tool capable of generating, managing, and analyzing highquality accounting information on a timely basis. Second, establishing a cashmanagement system that ensures the cost-effective use of resources and saves thegovernment money irrespective of the efficiency of spending.

A. Accounting and Reporting for Better Management

The public accounting system

145. The current system. Mozambique's accounting system is based on a manual,single-entry, cash-based system whose main features date back to an 1881 accountingregulation.

146. The system relies on single-entry registration of payments or receipts, managedthrough a system of three books that must be kept manually: Livro de ControlOrcamental or budget control book, where expenditures are recorded through all theirphases (verification, commitment and payment); Livro Numerador de Requisicoes, thebook where only requisitions, or commitments, are registered; and finally Livro deControl Bancario, which registers all checks issued for payment and the reconciliationwith bank statements. Expenditures are recorded following the economic classification.Therefore, the accounting system reflects simply the registration of the successive stagesin a purchasing process: the pro-forna invoices, the issuing of checks and bank

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reconciliations. Before the 1 Oh of each month, spending agencies must send to theNational Directorate of Accounting (DNCP), or the Provincial Finance Directorate(DPPF) for those expenditures executed at the provincial level, a summary of all theirexpenses (balancete), following a pre-determined format set by DNCP46 as well as bankstatements. This information is then entered into a database operated by DNCP at thecentral level and by DPPFs at the provincial level.

147. The recording system currently used is the so-called "modified cash system",which registers operations-receipts and expenditures-on a cash basis, but allows for acomplementary period up to three months after the end of the fiscal year for theliquidation and payment of expenditures committed before 315 December4 7. No newexpenditures can in principle be incurred during this time. Often, however, spendingagencies use this period to continue incurring new expenditures by simply backdatingsupporting documents.

148. In addition to accounting for budgetary fumds, the accounting system at the centrallevel also allows for "treasury operations", or Operaq5es de Tesouraria. Treasuryoperations should, in principle, constitute temporary movements of funds, payments orreceipts, that within a certain period of time should be settled with a balancing transactionin the opposite direction. At the end of the fiscal year, these operations are then re-postedto the respective budgetary code and cannot, in principle, be higher than the budgetaryallocation 48. However, treasury operations have also been used to finance various non-budgeted expenditures on the assumption that they will eventually be approved and thatbudgetary funds will be made available to settle these advances. Treasury operations canamount to a significant share of total budgetary outlays - in 2000, they represented 11and 50 percent of actual current and domestically financed investment expenditures,respectively.

149. In addition to performing its normal accounting functions, including production ofthe State accounts (Conta Geral do Estado) for the National Assembly and theAdministrative Tribunal, the accounting department, DNCP, is also responsible formonitoring execution, processing monthly transfers to spending agencies, and producingthe quarterly budget execution reports. Moreover, DNCP also manages the whole publicsector pension system, covering civil servants and all the military personnel. To performthese functions, DNCP employs 144 people and is the biggest department in the Ministryof Planning and Finance.

46 According to DNCP, spending agencies are not required to send the balancete on paper; they can sendit on a disk, as long as it follows the specified format. However, this information is contested bysome line ministries, who claim that a hard copy, in large A3 paper sheets, is always required byDNCP officials, which makes the process extremely paper-intensive and cumbersome.

47 The complementary period runs until end-February for expenditures administered at the provinciallevel and until end-March for those administered at the central level.

48 An example of a treasury operation is the initial two-twelfths advanced to spending agencies at thebeginning of the year and which are settled at the end of the fiscal year. Another example are theadvances to civil servants for medical treatment abroad, which are only settled once the finalstatement of expenditures is entered by the beneficiaries.

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150. Major issues. Mozambique's accounting system is currently one of the weakestcomponents of the expenditure management system. Its main characteristics are that it iscumbersome, offers only a partial view of financial transactions, and it is no longercapable of handling the accounting needs of an evolving public sector. The inability toproperly account and monitor the use of government funds is undermining the usefulnessof the budget as a tool for fiscal management. Furthermore, weak governmentaccounting contributes to donors avoiding the use of budgetary support and encouragesthe setting-up of parallel extra budgetary systems, undermining the reform effort ingeneral.

151. Significant effort and resources have been used to improve the system, and DNCPhas been implementing a program of training and computerization with donor assistancefor a number of years, but without changing the fundamentally flawed nature of thecurrent system. The government shares these concerns and a consensus exists amongdecision makers on the main direction and the nature of the reforms that must beintroduced. Recently, reform efforts have been intensified and a plan for the reform ofpublic accounting has been prepared.

152. Five broad problems characterize the government's accounting system. First, theaccounting system is out of date, with a proliferation of rules and regulations introducedover the years having compounded the problems of an archaic accounting frameworkintroduced in 1881. Incomplete information flows and obsolete procedures, together withthe omnipresent problem of weaknesses in technical capacity, contribute to make itdifficult for government to reconcile and close its accounts on a timely basis.

153. Second, the accounting system is prone to inaccuracy. The single entry system,with manual entry for the most part, has made it virtually impossible to prevent and checkfor mistakes. The problem is exacerbated in a country such as Mozambique whereexecution is relatively decentralized, with many payments being made at the provinciallevel, for example, rather than all through the central Treasury. Unnecessary accountingroutines and reporting procedures also contribute to slow reporting on budgetaryexecution.

154. Third, although since 1998 budget accounts also include financial assets andliabilities linked to flows of funds into and from the central treasury account, the systemis not set up to capture assets and liabilities that are not the result of financial flows, suchas fixed assets and receivables. Hence it cannot show, for example, a change in the stockof government debt due to exchange rate movements, or a change in the value ofgovernment buildings due to price fluctuations.

155. Fourth, the coverage of government accounts-like the budget-has not beencomprehensive, either with respect to types of institutions or types of transactions. (i)The accounting system has excluded certain public institutions. Autonomous sectoralfunds, established by government with the objective that they would raise their ownrevenue and finance sectoral expenditures, continue to be financed largely by the centralbudget, but accounting information on these expenditures frequently escape thegovernment's accounting system. (ii) Similarly, certain types of transactions, in

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particular on-lent funds to public-enterprises, and revenue from state assets or the sale ofprivatized state companies, are not covered by the accounting system. Expendituresgenerated by certain revenues, such as specialfundos consignados (earmarked funds) andsome special levies (such as for land concessions) are not captured by governmentaccounting, as they are administered through special accounts.

156. Fifth, and a constraining factor in the efforts to fill the lacunae above, is again thelack of trained, qualified personnel in the area of accounting. Few of the 144 staff inDNCP have a post-secondary school level degree or a background as trained accountants.There are no Mozambican chartered accountants. The lack of capacity and appropriatesystems is the same, or more serious, in each of the upstream spending agencies that feedaccounts to DNCP.

157. Recommendations for fundamental change. Accounting is the primary sourceof financial information linked to the operations of the government. The quality andtimeliness of accounting information is critical for an efficient fiscal management system.It constitutes the basis for decisions regarding budgeting (e.g. resource reallocationsamong budget categories based on information on actual expenditures) and cash and assetmanagement, and may have a tremendous impact on public sector resources-wrong oruntimely decisions based on poor accounting information may lead to important financiallosses, or have a negative impact on the efficiency of public expenditures. The followingreforms are recommended to improve the situation.

Recommendation: Introduce double-entry bookkeeping.

158. The current system of single-entry accounting should be replaced by double-entrybookkeeping. Implementation of this new system will require a substantial trainingprogram, both at the central and provincial level, which should be launched urgently. Itis suggested that the on-going technical assistance program to DNCP, which includes aconsiderable training component, should be reformulated and used for this purpose.

Recommendation: Introduce modified accrual accounting

159. The cash basis accounting system currently in use should be abandoned andreplaced by modified accrual accounting 49 (training on this technique could take placesimultaneously with training on double-entry accounting). Under this technique,revenues are recorded on a full cash basis, while expenditures are recorded on acommitment basis, irrespective of when cash is paid. By doing so, income is brought inline with actual cash available to pay the bills, while assuring that the recording ofexpenditures cannot be manipulated by simply delaying until the bill is paid. In additionto the advantage of recognizing expenditures from the verification stage, the modified

49 This is also provided for in the new Public Finance Management Law.

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accrual accounting systems also offer an adequate framework for assessing assets andliabilities (including possible expenditure arrears) 50.

Recommendation: Eliminate the complementary periodfor payment of expenditures.

160. Introduction of the modified accrual accounting system should be accompaniedby the elimination of the complementary period. With the introduction of this newrecording system, the complementary period necessary to close accounts becomessuperfluous because revenues are recorded on a full cash basis, while expenditures arerecorded starting from the valuation stage. In other words, there is no need to wait untilthe actual payment takes place to capture those expenditures. Under such a system,annual accounts are closed on December 31 st of each year, and payments effected afterthis date are recorded under the category "exerciciosfindos " or finished exercises.

Recommendation: The so-called treasury operations ("Operaqoes de Tesouraria")should be suppressed.

Recommendation: The chart of accounts should be revised.

161. A new chart of accounts should be implemented simultaneously with theintroduction of double-entry and modified accrual accounting.

162. A chart of accounts is a classification of transactions and events (expenditures,revenues, losses, etc.) according to their economic, legal or accounting nature. It definesthe organization of the ledgers kept by the accountants. The budget classification system,in particular, defines the structure of the specific accounts or sub-accounts of the chart ofaccounts that are related to budgetary operations. Hence the need to synchronize theimplementation of a new chart of accounts with the introduction of the new functionalbudget classification. Under a cash accounting system, as the one currently used inMozambique (but which it is proposed here to abandon in favor of modified accrualaccounting), the chart of accounts is often limited to budgetary accounts for payments. Inthe particular case of Mozambique, budgetary accounts capture expenditures only afterthe moment of payment, failing to record the stages of expenditures previous to that -verification and commitment. As a result, there is no accounting information on possibleexpenditure arrears.

Recommendation: DNCP shouldfocus exclusively on accounting and reporting.

163. DNCP should concentrate exclusively on managing, generating and analyzinghigh quality accounting information on a timely basis, as well as on monitoring andreporting on government financial operations, particularly those related to the budgetexecution. All other functions currently performed by DNCP should be transferredelsewhere. This means, for example, that management of the public sector pensions

50 Although requisitions, or commitments, are registered by spending agencies, no consolidatedinformation seems to be kept of the total amount of commitments and how they relate to actualpayments. In particular, the quarterly budget execution reports do not present such information.

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system, currently under DNCP responsibility, should be transferred to another service,within or outside government.

The reporting function

164. Until recently, reporting in the Mozambique budget system was not considered animportant function and no reports on budget and financial government transactions weremade available by the executive, even though the need to report quarterly to the NationalAssembly on budget execution is clearly established in the Budget Framework Law since1997 51. Since 2000, however, this has started to change and some welcomedevelopments have taken place. The consolidated State accounts (Conta Geral doEstado), covering the 1998 fiscal year, were established for the first time sinceindependence and submitted to the National Assembly and the Administrative Tribunalfor information and external auditing. The 1999 accounts have also been produced andthe opinion of the Administrative Tribunal issued. Since 2000, budget execution reports,comparing budget allocations and actual expenditures, have been issued by DNCP on aquarterly basis, which is a major step forward in terms of transparency. For 2001, aninterim tracking system was established to monitor execution of expenditures in the areasthat have benefited from HIPC-related savings. This system shows actual expenditures inmore detail than the existing functional classification and it is expected that it will begeneralized to all sectors once the new classification is introduced in 2002 (see Chapter 4,section B for a discussion on the budget classification).

165. In spite of this progress, reporting remains partial, and has not been developedinto an effective tool of policy planning, formulation and monitoring. This should comeas no surprise given the weakness of the existing accounting system, which is at thesource of the budget and financial information to be used in the reports. Reforms need tobe implemented in order to improve the situation (Box 5.1 offers an overview of the mainreporting requirements in a well-functioning budget system).

51 Lei No.15/97, Art. 31

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Box 5.1: Principles of Good Reporting and Types of Internal and External Reports

Meaningful intemal and external financial reporting mechanisms are essential features of aperforming accounting function. The relevance of external reporting in particular isincreasingly recognized as a key factor affecting decisions by foreign investors, which has ledcountries, such as Argentina, to post quarterly financial reports on the internet. Access to suchinformation can have an impact on the risks investors associate with a country and the interestrates at which they are prepared to lend funds.

Reports prepared by the government for internal and external use must be governed by thefollowing basic principles: (i) completeness (they should cover all aspects of the reportingentity's mission); (ii) legitimacy (they should be appropriate for the intended users andconsistent in form and content with accepted standards); (iii) user-friendliness (reports shouldbe understandable, presented in a way as to permit information to be captured quickly andcommunicated easily); (iv) reliability (the information should be verifiable and free of bias,including for data that is not certain, like projections); (v) relevance (information provided inresponse to a specific need); (vi) consistency (consistency is required internally and overtime; in case of changes in the methods or coverage of the report, this should be explicitlymentioned); (vii) timeliness.

Acceptably good reporting must involve the production of budget execution reports andfinancial reports. Budget reports must show, for each item in the budget classification, theinitial appropriation, the revised appropriation (if any), the amount apportioned, as well ascommitments, expenditures at the verification stage, payments or (at least) arrears andpayment. With regard to financial reporting, the following reports would be required:consolidated accounts; statement on stock and flows of domestic arrears; report on medium-term external debt; report on short-term borrowing; report on grants; report on lending andon-lending; statement of forward commitments; statement of cash flows; statement of taxexpenditures; statement on other liabilities and contingencies and statement on physicalassets.

166. Recommendations. The quarterly budget execution reports, althoughrepresenting a significant improvement over the past, need to be further improved. Thesereports present actual expenditures, both recurrent and investment, compared to thebudget allocation (as modified during the year) according to the economic and territorialclassifications. Actual expenditures are also reported following the functional andinstitutional classifications, but no comparison is provided with the correspondingbudgetary allocation under these two classifications. Hence it is not easy to assessbudgetary performance for, say, health, education or infrastructure, since the simplecomparison with the budget figures published in the budget document may be misleadingdue to the adjustments introduced during the fiscal year. The minor effort required toaddress this problem would be more than compensated by the increase in transparencythat it would generate. In addition, the reports should also include information on fundsand institutions that benefit from financial autonomy. In addition, execution reports didnot provide information on the complementary period, an issue the authorities havealready agreed to address.

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167. Since budget coverage remains partial (see Chapter 4, section A), the executionreports are also incomplete. As extra-budgetary operations are included in the budget,they should also be mentioned in the reports. In addition, it will be very important toensure that, starting in 2002, reporting on budget execution follows the detailed functionclassification that will be introduced. Finally, quarterly budget execution reports shouldshow, for each item in the budget classification, the initial appropriation and the revisedappropriation (if any), hence providing a consolidated view of the adjustments introducedto the budget during the execution phase.

168. Currently, financial reports, other than the Conta Geral do Estado, are notpublished. This situation should be corrected as soon as possible. In addition to theconsolidated State accounts published since 2000, the following reports should be madeavailable: (i) report on short and medium-term external and domestic debt (an issueincreasingly pertinent given the recent increase in domestic debt); (ii) report on lendingand on-lending (showing loans contracted and extended, and stock and flow of arrears bybeneficiary); (iii) statement on forward commitments (in fulfillment of accountability tothe Parliament, showing forward commitments and the projected payment schedule byline ministry/agency); (iv) statement of cash flows (this monthly statement should showflows of cash revenues and cash payments, and opening and closing balances; it shouldcover all cash and bank accounts); (v) statement of tax expenditures (by sector/functionand type of tax concession); (vi) statement of other liabilities and other contingentliabilities (in addition to debt reports, it should show other liabilities and contingencies,such as pensions and insurances); (vii) statement on physical assets (showing the mostsignificant assets, infrastructure and others). Reports (i), (ii) (iv) and (v) should be givenspecial priority.

B. Cash Management-Saving the Government Money

169. Poor cash management is one of the major issues faced by the Mozambiqueexpenditure management system. Multiple treasury accounts, deficient cash flowprojections and ineffective integration between accounting and cash managementfunctions lead to a waste of government resources and undermine the efficient andsmooth execution of budget expenditures.

170. The authorities are aware of these problems and since 1999 the treasurydepartment in the Ministry of Finance (DNT) has embarked on a process of reform withtechnical assistance support from the European Commission. A wide-ranging program ofactivities has been devised to address the most pressing issues, covering therationalization of bank accounts, the streamlining of payment mechanisms and theintroduction of more effective cash flow projections. This is the first time acomprehensive reform process has been put in motion seeking to modernize the treasuryfunction. However, given the seriousness of the deficiencies that must be addressed andthe tremendous lack of technical capacity available-all linked to the fact that thetreasury had for a long time been seen as simply the disbursing office for the governmentrather than the center for efficient cash management-the reform plan has suffered froma rather slow start, but seems now to be gaining pace.

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The current system

171. Bank accounts. Every fiscal year, each ministry or spending agency with abudgetary allocation is required to open two bank accounts in Banco de Moqambique(BM ) - for current and for investment expenditures - to which monthly transfers(duod&cimos) are then made by the treasury. According to the legislation and theinstructions issued by the MPF5 2, each financial department in line ministries is requiredto instruct BM to close these accounts before May 1 of the following fiscal year.However, there seems to be little compliance with this rule, and line ministries keepaccounts opened from one fiscal year to the next, with no effective central control overtheir balances. This results in a snowball effect, by which accounts opened one fiscalyear are kept operating during the next fiscal year and are added to new accounts. At theprovincial level, accounts are also opened by the Direc,ces Provinciais, most of the casesin Banco Comercial de Mo,ambique (BCM) since BM only has two provincial branches,in Beira and Nampula. While it was not possible to ascertain the exact situationprevailing at the provincial level, it is unlikely to differ much from the one existing at thecentral level.

172. This means in practice that there is no effective cash management. According toinformation received in the Banco de MoVambique, there are currently more than 2,000bank accounts in BM only53 over which the treasury has no control and no information ontheir holdings. As a result, the treasury controls only the central treasury account (Caixado Estado), which it manages directly, but has no effective control over all availableresources.

173. Beyond the fact that it reflects a lack of financial discipline on the part of lineministries and the lack of a pro-active stance on the treasury side to actively address theproblem, this situation raises questions regarding the necessary compatibility betweenbudget balances on one hand and financial results on the other. Indeed, in the absence ofa timely closure of bank accounts, it is difficult to understand how budget and financialexecution data are reconciled.

174. Finally, there seems to be a lack of clarity regarding the legal basis for the controlby DNT over bank accounts opened by spending agencies, which in turn is used as anexplanation by the treasury for the current unsatisfactory situation. Indeed, no bankaccount can in principle be opened by line ministries without prior formal authorizationby DNT. This rule is routinely disregarded, however, and bank accounts are opened inthe name of spending agencies without prior treasury agreement.

175. DNT is aware of these problems and is making efforts to address them (forexample, an inventory of bank accounts is already under way), but these efforts have notbeen enough and a more pro-active stance must now be adopted both at the technical

52 Circular No. 002/GAB-DNCP/99, Direccao da Contabilidade Puiblica, Maputo, 22.10.1999

53 This number is higher than the one indicated by the treasury (around 1,000) because it also includesaccounts managed by public enterprises and possibly other institutions.

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level and through the explicit intervention of the Minister of Finance. All legal meansalready at the disposal of the MPF must be used to swiftly impose discipline.

176. Plans are also being developed for the introduction of a single treasury account,and the principle of a consolidated treasury account has already been included in the newpublic finance management law (Lei da Administraqdo Financeira do Estado,) recentlyapproved by Parliament (see chapter 7). To minimize borrowing costs or maximizeinterest-bearing deposits, operating cash balances must be kept to a minimum. Incountries where funds are released through an imprest system, as in Mozambique,spending agencies often accumulate idle balances in their bank accounts at variousmoments during the fiscal year. These idle balances increase the borrowing needs of thegovernment, which must borrow or, alternatively, reduce central government deposits, tofinance the payments of some agencies even though other agencies may have excess cashbalances. The introduction of a treasury single account that allows for a consolidatedview of all government holdings at any point in time, is the solution that is being adoptedby a growing number of countries.

177. Several models exist for the implementation of the notion of a treasury singleaccount (see Box 5.2), but a unifying feature is always the consolidated management ofcash balances that cover all government agencies and transactions. The feasibility oftheir implementation depends mainly on the level of technological development of thebanking sector, as well as on the degree of decentralization of budget executionprocedures. Poor banking and technological infrastructure in some developing countriesis often an obstacle to combining centralization of cash balances with decentralizedbudget execution mechanisms, in which case a realistic compromise must be accepted.

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Box 5.2: Alternative Models of a Treasury Single Account

A variety of methods have been used to centralize transactions and cash management. Thesecan be grouped very broadly into two categories:

1. Passive treasury single accountThe treasury single account consists of several bank accounts linked between them. Periodiccash limits are set for each spending agency, in accordance with the budget implementationplan, and payments are made directly by spending agencies, each of which manages one sub-account linked to the treasury central account. These accounts are cleared every day and theirbalances are transferred to the treasury central account.

This variant has the advantage of making the spending agency responsible for internalmanagement, while keeping control of cash. It requires, however, a well developed computernetwork in order to ensure the daily clearing.

2. Active treasury single accountThe main difference compared to the previous model is that spending agencies do not operatebank accounts and do not make payments directly. Payment orders are issued by spendingagencies within the limits of their cash ceilings, but payments are effected by the treasury. Inorder to avoid the risk of fraudulent transactions, such a system requires a separation betweenthe accounting and the payment functions. Accounting would be performed by the spendingagencies, and centralized by the public accounting department in the ministry of finance,while the actual payments are performed by the treasury from the single treasury account.

This system has the advantage of avoiding the proliferation of bank accounts, whilecombining the advantages of centralized cash management with decentralized budgetexecution procedures.

178. The system to be implemented in Mozambique must consider all these issues,particularly the degree of technological development and integration in the bankingsector. DNT is currently developing the overall concept for the implementation of thetreasury single account in consultation with other departments in the MPF and with BM.

179. Financial planning. Cash flow plans are prepared by DNT, seeking to matchbudget allocations and global fiscal targets on one side, and expected revenue inflows andplanned expenditure outflows, on the other. These plans are elaborated by DNT based onthe budget and the fiscal program agreed under the PRGF. They are prepared forspending agencies at central level and for each province and are used to informgovernment borrowing decisions, especially since 1999 when government short-termtreasury bills for budget financing were first introduced. The accounting and treasurydepartments are supposed to meet on a weekly basis to compare actual budget executionwith cash flow projections and to introduce the necessary adjustments.

180. Financial planning and cash flow forecasts suffer from major shortcomings thathinder the effective execution of the budget and the efficient use of governmentresources. First, budget implementation plans, which must be consistent with the budgetand offer the projected rhythm of budget execution both for revenues and expenditures,

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are poorly prepared or not at all. The use of the system of duod&cimos, by which eachspending agency is entitled to spend one-twelfth of its budget allocation each month, isused as the defacto budget implementation plan together with the quarterly fiscal targetsset under the PRGF (but which are not appropriate for this purpose since they areprepared at a fairly aggregated level). However, fluctuations in revenue inflows andexpenditure outflows do not coincide during the fiscal year: peak revenue intake periodsare in the last two quarters of the year, due in large part to the payment of taxes oncompany profits in October, whereas expenditure payments usually peak in the firstquarter of the year. This often results in cash-flow problems in certain months,particularly in the first half of the year. With salary payments and debt servicingobligations given highest priority in any given month, it is expenditures on goods andservices, particularly for implementing the investment program, that are curtailed if cashis short. When combined with the lack of a consolidated treasury account, poor financialplanning often leads to delays in the transfer of programmed monthly resources tospending units5 4. Although sequestering 5 5 and cash rationing do not seem to be a majorissue in Mozambique, delays in the release of funds sometimes lead to stalledimplementation of activities.

181. Revenue collection. Revenue is collected by 27 tax offices, of which 5 arelocated in Maputo, administered by the Direccao Nacional de Impostos e Auditoria(DNIA), or national directorate for taxes and auditing. All cash collected is deposited ontreasury accounts (there are 27 revenue accounts, in Maputo and the provinces) on a dailybasis. When tax payments are made by check, however, these are deposited first intransitory accounts, managed by DNIA, until the checks are cleared, and only then arethese funds transferred to a treasury account.

182. Every month, DNIA sends information to DNT on all revenue collected andtransferred to treasury accounts for reconciliation purposes. This information is also sentdirectly to the office of the Minister of Finance. DNIA is also responsible for theaccounting of all revenue, including customs, following the economic classification, andtransmits this information to DNCP on the 1 oth of each month for the previous month.

183. According to DNIA, the treasury national directorate, DNT, has access to thetransitory accounts, and should therefore be able to determine, on a daily basis, the exactamount of revenue collected. In practice, however, transmission of this informationbetween DNIA and DNT is deficient and the latter has difficulties assessing the aggregaterevenue position on a timely basis. These difficulties are compounded by the fact that allprovinces except two-Sofala and Nampula-are allowed to retain fully the revenuecollected in the province to help paying provincial expenditures, which is therefore nottransferred to the central treasury account5 6. According to DNT, inforrmation on

54 Delays in reporting on expenditures by spending units also contribute to delays in replenishment ofaccounts.

55 Sequestering is the withholding of appropriations by the Ministry of Planning and Finance.

56 Sofala and Nampula are the only two provinces that generally have a surplus of revenue overprovincial expenditures, mainly because of the taxes collected at the ports of Beira and Nacala.

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provincial revenue may take a minimum of 5 days to reach the treasury. Recognizingthese difficulties, both directorates intend to issue shortly ajoint circular regulating theexact time span for the transmission of data as well as the circuit to be followed for thedeposit of receipts and their transmission to the treasury.

184. The payment system. For those spending agencies benefiting from a budgetaryallocation, transfers of funds are made by DNT on a monthly basis, after issuance byDNCP of titulo de liquidacao, or imprest document. These documents are issued for theexact amount to be reimbursed to spending agencies on the basis of their justification ofexpenditures incurred the previous month. These transfers are made to the sector bankaccounts, both at the central and the provincial levels. For those institutions withfinancial autonomy, which are entitled to earmarked revenues (e.g. the road maintenancefund), transfers are also made on a monthly basis. The payment instrument consists onan imprest document, M3V/P, that is deposited in the bank account of the beneficiaryagency. Automatic bank transfers are not used.

185. The system currently used for treasury payments is bureaucratic, time-consuming,obsolete and does not satisfy the needs of an efficient budget management. It is alsoincompatible with good financial programming and cash flow management. In addition,the imprest documents used are prone to falsifications and can be the source of fraudulentfinancial operations, in spite of safeguard measures introduced by the treasury.

Recommendations for reform

186. Together with budgeting and accounting, the cash management function is at thecore of a well functioning fiscal management system. The treasury, responsible for cashmanagement, must be seen as the government agency responsible for managing the flowof government resources in such a way as to minimize net borrowing costs, maximizeinterest income and at the same time assure that the functions of government have thecash resources required on a timely basis. To accomplish this, cash management must beclosely integrated with the other components of the fiscal management system,particularly budgeting and accounting.

Recommendation: Rationalize the number and operating procedures of existing bankaccounts.

187. Reducing the number of existing bank accounts and imposing strict rules ofdiscipline on the way spending agencies open and operate those accounts for purposes ofbudget execution, are the two most urgent tasks that DNT must face. The followingactions could be taken as a matter of priority (these actions could be taken first at thecentral level, and later extended to the provinces) and represent a necessary step beforethe introduction of a treasury single account:

* Finalize the inventory of al bank accounts operated by public institutions both in theBanco de Moqambique and in commercial banks.

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* Take all the necessary steps to ensure that all accounts relating to past fiscal gyears areclosed and their balances are properly transferred to the central treasury account .

* Urgently issue new instructions stating that, starting with the 2002 fiscal year, allbank accounts opened by government departments (i) will require the explicit priorauthorization from DNT, who must be one of the co-holders and (ii) will be automaticallyclosed by DNT on March 31 st of the following year in accordance with currentlegislation.

Recommendation: Introduce a treasury single account ("Conta Unica").

188. Cash balances must be centralized through a treasury single account. This is anaccount, or set of linked accounts, through which the government transacts all inflowsand all outflows of funds.

189. The figure below illustrates a possible model for the treasury single account inMozambique, based on the model of an active treasury single account (see Box 5.2above).

Figure 5.1: Proposed Model for a Treasury Single Account in Mozambique

Central Treasury

Budget Execution | Eiternal AsisisqceL SubA count Sub-Account j Sub-Account l

190. The main characteristics of this type of single account are the following:

* The single treasury account would be composed of one central account and threesub-accounts: one for revenue, one for the execution of the budget and a third for externalassistance. All accounts would be held at the BM or in a cormmercial bank in thoseprovinces where BM has no branches.

57 Article 35, para.1, of Decree 7/98 of March 10, 1998 provides the legal basis for such intervention bystating that "the bank accounts of all institutions relating to the current fiscal year will be closed bythe National Directorate of Treasury (DNT) or by the Provincial Directorates for Planning andFinance (DPPF), depending on the specific case, on March 31st of the following fiscal year at thelatest". This provision has obviously not been followed and spending agencies have been allowed,first, to open accounts without previous authorization from the treasury, and then to keep them openfrom one fiscal year to the next without control.

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Spending agencies would no longer open and operate bank accounts. Instead,monthly notional spending limits (which could coincide with the duodecimos),compatible with budget implementation plans and with cash flow projections, would beset for each spending agency. The latter would commit expenditures according to theirbudget allocations, but would no longer pay suppliers directly. Instead, they would issuepayment orders up to their monthly spending limits. Actual payments to the supplierswould be effected directly by the treasury from the single treasury account. The treasury,acting as the effective banker of the State, would centralize all payments linked tobudgetary operations, which will require the introduction of a new, automated, paymentssystem.

Recommendation: Develop a new treasury payments system.

191. An automated payments system should be developed and managed by thetreasury. It must be integrated into the new National Payments System being developedby the Banco de Moqambique, which will allow for electronic payments and financialcompensation in real time. Close coordination between the MPF and BM technical teamswill be necessary during the development of this new payment mechanism.

Recommendation: Improve financial planning andforecasts.

192. Effective financial planning methods should be introduced by DNT. These wouldconsist on the preparation of three types of forecasting instruments: an annual cash plan,a budget implementation plan and monthly cash plans.

193. Annual cash plans, setting out projected quarterly revenues, expenditures andfinancing requirements, are currently prepared by DNT at the beginning of the fiscal yearon the basis of fiscal targets agreed with the IMF. However, they must be updated on amonthly basis and revised every quarter. This requires close coordination between thetreasury, revenue and budget departments as well as with the central bank.

194. A budget implementation plan, derived from the budget, should be prepared at thebegnning of the fiscal year in close collaboration with spending agencies. An effectiveplan should take into account the timing of cash inflows and outflows and be rolled overquarterly to allow for changes in the macroeconomic environment and progress in budgetexecution.

195. Monthly cash plans should be derived from the budget implementation plan.They should show forecasts of financial flows before new borrowing, includingreimbursement of loans or bills due, repayment of arrears and drawings on loans alreadycontracted. These monthly plans should be prepared on a pure cash basis and take intoaccount, inter alia, movements of interest rates and exchange rates, changes in thepayment schedule of investment projects of significant size and outstanding obligations.These monthly cash plans would be the principle guide for determining monthly cashlimits by spending agency.

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Recommendation: Rationalize revenue collection and improve consolidation.

196. Commercial banks with wide national networks should be used to collect revenueagainst a negotiated fee, and should gradually replace the existing tax offices. Revenuecollected by these banks should be transferred to the treasury accounts, both at the centraland provincial levels, according to strict schedules, ideally on a daily basis. In addition,in order to rationalize tax administration, a single document for the collection of all taxesshould be introduced, along the lines of the Documento UInico used by the customsadministration.

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CHAPTER 6BUDGET EVALUATION AND AUDIT-IMPROVING ACCOUNTABILITY AND

COMPLLANCE

197. An effective fiscal management system performs three compliance functions.First, internal control and audits by a government agency checks the legality ofdisbursements. Second, external audits (ex-post) by an independent institution (or onethat responds exclusively to the legislative branch of government) verify the legality andcorrect use of funds by spending agencies in the executive branch. Third, evaluations ofbudget programs by various institutions emphasize outcomes and performance toimprove the effectiveness of government expenditure. These three modes of compliancereviews are complementary and mutually reinforcing (World Bank, 1996).

198. Recent developments in budget management have led to a change of emphasisabout compliance. While the traditional meaning of conforming to budget appropriationsand government financial rules is still important, compliance has evolved to include alsoconformance with explicitly stated performance-based criteria, among others.

199. Budget evaluation and audit-both internal and external-are weak inMozambique. A dearth of trained personnel and resources undermines the auditingfunction of the Finance Inspectorate General-the internal audit department- and theAdministrative Tribunal-a court of law entrusted with external auditing. Performnanceevaluation is not required by law and it is not practiced in any systematic way.

200. In spite of the severe limitations faced by the auditing institutions, some progresshas taken place recently. For instance, for the first time since independence, the 1998government accounts (Conta Geral do Estado) were audited by the AdministrativeTribunal in 2000 and its report was discussed at the National Assembly, giving rise, forthe first time in Mozambique, to a public debate on government accountability. The 1999accounts have also been audited in 2001.

201. This chapter, largely based on a recent Country Financial AccountabilityAssessment (CFAA), presents an overview of the current systems of internal and externalaudit and proposes actions for improvement58 . It also offers a brief discussion on themain concepts associated with budget performance evaluation and suggests possible waysof introducing them in Mozambique over the medium run.

A. Internal Control

202. The Finance Inspectorate General (IGF), attached to the MPF, is responsible forauditing of all public institutions. Its mandate, organizational structure and keyoperational policies are defined in the Decree No.40/99 of June 28, 1999. IGF is stillbeing organized and is far from achieving its required level of coverage or professional

58 For more details on the auditing function see World Bank, "Mozambique: Country FinancialAccountability Assessmenf', 2001.

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capacity. Although every spending unit is supposed to have an internal audit department,only a few actually have them. Despite its weaknesses, the IGF was, until a few yearsago, Mozambique's representative at the International Organization of Supreme AuditInstitutions (INTOSAI). Its 1999 statute places it squarely within the MPF as an internalorgan of that Ministry.

203. IGF applies INTOSAI auditing standards, and has a detailed Manual of AuditingProcedures for the Public Service, which describes in detail such matters as: concepts andtypes of audits; objectives of financial auditing; auditing standards; INTOSAI auditingstandards; planning and execution of an audit; review of internal control; risks andmateriality, evidence; audit reporting; as well as a detailed audit program. It also has amanual for the audit of state enterprises. IGF does not systematically feed results of itsaudits into the external audit, but only provides the Administrative Tribunal with suchinformation as it requests.

204. IGF suffers from a lack of qualified staff and a dearth of financial resources,transport means and computers that undermine its proper functioning. It has 60professional staff. None of the staff holds an internationally recognized qualification,such as Chartered Accountant (ACA), or Certified Public Accountant (CPA). IGF iscurrently receiving technical assistance from the Swedish Development Agency (SIDA),and an action plan that seeks to ehhance IGF capacity and to assert its role is beingimplemented.

205. Recommendations. First of all, IGF's role needs to be given the institutional andpolitical backing that it deserves. In particular, specific budget lines for IGF should beintroduced and allocated with sufficient resources.

206. Some other reforms could also help improving the internal audit function:

* Internal audits should be transformed into a management tool. Internal audits shouldbe primarily the responsibility of the spending units and they should be designed tohelp management.

* The bulk of internal audits should be focused on assessing expenditure managementsystems, and conducting spot checks and special investigations. IGF, in the Ministryof Planning and Finance, should be responsible for overseeing the quality of theinternal audits in the spending units, and to provide guidance and technical supportwhen necessary. It should also be responsible for drafting the legislation needed forinternal control and audit procedures and for regularly updating the Manual ofAuditing Procedures for the Public Service.

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B. External Auditing

207. The independent audit of government accounts and financial statements is theresponsibility of the Administrative Tribunal (TA). The TA derives its auditing mandatefrom Article 173 of Section III of the Constitution of the Republic of Mozambique,which requires the TA to: (i) adjudicate acts dealing with legal controversies arisingfrom administrative acts and procedures; (ii) adjudicate appeals against decisions oforgans of State, their office holders, agents, and employees; (iii) examine the accountsand records of the state; and (iv) exercise other powers that may be attributed by law.

208. The Administrative Tribunal is part of the Mozambique's judiciary, and is theonly court in its category. Its head, who represents Mozambique at the InternationalOrganization of Supreme Audit Institutions (INTOSAI), is appointed by the President fora term of five years. The National Assembly ratifies the appointment. The TA'sPresident can only be dismissed or suspended from his office because of proven physicalor psychological incapacity, or for serious reasons of a moral nature. According to LawNo. 16/97 of July 10, 1997, the TA is "the supreme, independent body responsible forexternal control over the legality of public revenue and expenditure, the judgment ofaccounts submitted to it by law and the enforcement of financial liability for financialinfractions". Therefore, unlike Anglo-Saxon type Superior Audit Institutions, which canonly report their findings and hope the government will take prosecuting and/or punitiveaction against offenders, the TA actually has the power, not only to investigate and reportfinancial misconduct, but also to apply sanctions and impose punishment. Its jurisdictionextends throughout the Mozambican territory, including services and representationoffices abroad. Institutions covered include: the state and all its services; autonomousState services and organizations; local representative state bodies; municipalities; publicenterprises in which the state has total or majority ownership; collectors, treasurers,receivers, payers, and other persons responsible for the safe keeping or administration ofpublic funds; persons handling or managing funds, loans, guarantees, subsidies, grants ordonations from international organizations; administrative councils or commissions.

209. The TA's report and opinion on the government account (Conta Geral do Estado)are published. However, the extended period provided by the current legislation for theauditing of government accounts-audited accounts are available only 20 months afterthe end of the corresponding fiscal year5 9 -largely reduces their relevance and is one ofthe factors that seriously limits accountability.

210. There is a serious mismatch between the wide powers and prerogatives accordedby the law to the Administrative Tribunal on the one hand, and the means at its disposalfor carrying them out, on the other. As of March 31, 2001, the TA had only 13 staffassigned to the post-audit function, of whom only eight had a formal accountancy orauditing qualification. The staff is not only too small and under-qualified, but it is also

59 The government annual financial statement is supposed to be lodged with the TA by December 31 ofthe following fiscal year. The TA is required to submit its report and opinion on the statements to theNational Assembly by August 30 the following year, i.e. 20 months after the end of the fiscal year.The Assembly has then 4 more months to study the report, extending the overall period to 24 months.

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under-paid, with salaries said to be below those paid to the staff of the government'sinternal audit department, IGF, in the Ministry of Finance.

211. Recommendations. The responsibilities and powers accorded to theAdministrative Tribunal are adequate and well specified in the legislation. What isneeded now is to provide the institution with the financial, human and operational meansto operate and to fulfill its mandate in an acceptable way.

212. In order to attract and retain qualified personnel, and reduce the risk of corruptionand misconduct among its officials, the Tribunal should be granted greater independencein setting salary scales for its staff.

213. With a view to compensate its lack of capacity, partnership agreements should bemade with reputable private auditing firms operating in Mozambique, which wouldprovide guidance, know-how and support to the Administrative Tribunal. A twinningagreement with a foreign-based Supreme Audit Institution would also be useful in thisrespect.

214. Finally, the current period of 20 months before the production of auditedgovernment accounts should be reduced to 12 months (to be reflected in the new PublicFinance Management Law. See Chapter 7).

C. Budget Evaluation

215. Budget evaluation has become an integral part of budget management in manycountries, complementing the more traditional functions of internal and external auditing.It takes a more global perspective on compliance by examining the effectiveness ofpublic expenditure programs. Evaluation relies on the use of scientific and systematictechniques to quantify the direct and indirect effects of a budget program in relation to setexplicit and implicit objectives and the means provided for their accomplishment. Inother words, evaluation compares the stated objectives of specific expenditure programswith the outputs, as well as the relation between the resources allocated and theobjectives. The wealth of information produced by the evaluation function can be avaluable tool for the improvement of decision making and resource allocation, as long asit is properly integrated into the budget cycle60.

216. Several countries have chosen to assign responsibility for evaluation to theirSupreme Auditing Institution, which in the case of Mozambique would be theAdministrative Tribunal. In other countries this responsibility was assigned to the budgetdepartment, while in others it is performed by a variety of different organs.

217. The development of a sophisticated evaluation function is clearly not a priority inMozambique at this point. More pressing issues-improving budget coverage, increasing

60 For details on different budget evaluation techniques and the experience of several countries aroundthe world, see for example T. Carlyle and A. Premchand, "Public Expenditure Management", Chapter9, IMF, 1993, or S. Schiavo-Campo and D. Tommasi, "Managing Government Expenditure", Chapter9, Asian Development Bank, 1999.

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transparency and reforming public accounting, cash management and auditing-must befaced first. However, the introduction of this function would certainly improve budgetmanagement, as long as it is properly performed and its findings are integrated into thebudget formulation process and used as a management tool for decision making. Itsintroduction should therefore remain a medium-term objective.

218. Primary responsibility for evaluation should rest with the spending agencies,under the coordination of a central department in the Ministry of Finance. Over time, asthis function is developed and gradually introduced, along with the resources necessaryfor its effective implementation, a set of evaluation techniques to be used (mid-termevaluations, ex-post evaluations, etc), as well as a clear set of criteria guiding the use ofthese techniques according to the specific nature of the programs to be evaluated, shouldbe developed. This function could be contracted out to specialized firms, as it is the casein several countries.

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CHAPTER 7TOWARD A MODERN PUBLIC FINANCE MANAGEMENT SYSTEM

219. The government embarked on an Expenditure Management Reform Strategy in1997. As explained earlier, most of the progress took place in the area of budgetformulation and expenditure planning, with the introduction of the Budget FrameworkLaw in 1997 and the Medium Term Fiscal Framework in 1998. By contrast, relativelylittle progress was achieved in public accounting, cash management and auditing, whichare all areas where reform is typically more difficult. One of the major reasons has beenthe absence until recently of a central unit in charge of fostering, steering andcoordinating budget management reform.

220. Transparency, efficiency and accountability in the use of public funds hasemerged as a clear priority in government, and improving fiscal management is amongthe six priority areas in the PARPA. A renewed effort is currently under way to addressthe main challenges faced by the budget system in all its dimensions-budgetformulation, execution and auditing. This Public Expenditure Management Review isintended to support this process.

221. As part ofthis new emphasis, the government has decided to improve the legalframework underpinning the whole budget system. A new public finance managementlaw (Lei da AdministraVdo Financeira do Estado), was developed in 2001 and approvedby the National Assembly. At the request of the authorities, the World Bank, in closecoordination with the IMF and other donors, has provided technical advice for thedrafting of this new law during 2001. A new technical unit for the financial reform of theState (Unidade Tecnicapara a Reforma da Administrapao Financiera do Estado,UTRAFE), was created in March 2001. It is directly attached to the office of the Ministerof Finance and its mandate is to coordinate the reform of the budget management system.This is a very welcome development that fills an important lacuna.

222. This chapter offers an overview of the budget legal framework and proposesrecommendations for the drafting of the new law, most of which have been taken intoaccount in the government proposal to Parliament. Since the stated objective in the newlaw is the development of an integrated financial management information system(IFMIS), this chapter also discusses briefly the main requirements for the successfulimplementation of such systems and provides a note of caution regarding itsimplementation in Mozambique. Finally, a possible action plan for reform is proposed,based on all the recommendations made in Part II of this report. It distinguishes reformsaccording to their degree of priority, identifying first those actions that are consideredurgent and which should be implemented within the next few months.

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A. Improving the Legal Framework-The New Public Finance ManagementLaw

223. Until 1997, the budgetary framework in Mozambique was based on a budget lawdating from 1901, overlaid with a proliferation of fiscal directives and regulations issuedsince then. Layered with legacies from the colonial administration and a commandeconomy, the budget system was based on separate recurrent and investment budgets,each following different fiscal years, the budget classification system was not internallyconsistent, and the budget instrument failed to capture much of the actual flow of publicfunds, even those financed domestically.

224. Among the changes introduced by the Budget Framework Law, two importantimprovements stand out: (i) it unified the budget years for the investment and recurrentbudget and shifted the fiscal year to correspond to the calendar year and (ii) it introduceda budget classification system-standardized along economic, functional, institutional,and territorial lines-to be used for revenues and expenditures, both recurrent and capital.In addition, the law sets out the basic public finance principles that generally underpinbudgetary policy: annuity, unity and universality (i.e. the budget must include all grossrevenues and expenditures of State institutions, except those with administrative and/orfinancial autonomy, municipalities and public enterprises 61 ), non-earmarking of revenue(as a general rule, revenues cannot in principle be earmarked for specific expenditureswithout legal exceptions 62), and specificity of both revenues and expenditures (the budgetspecifies the minimum projected revenues and the maximum limits on expendituresaccording to the classifiers).

225. In spite of these positive developments, the present legislative framework isincomplete and suffers from some critical weaknesses. The Budget Framework Lawregulates only partially public finances. It does not offer a comprehensive normativebasis for the effective integration of all the subsystems that are part of the fiscalmanagement process-budgeting, accounting, cash and asset management, internalcontrol and auditing. In particular, the law does not specify what are the exact stages inthe expenditure process

226. Recognizing this fact, the government has decided to prepare a new law, Lei daAdministraqdo Financiera do Estado, or Public Finance Management Law, aiming atregulating the whole financial administration of the State and providing the basis to movetoward an integrated financial management system (Sistema Integrado de Administraado

61 However, according to the law, the budget document must include in annex all the informationnecessary for the assessment of the financial situation of autonomous institutions, municipalities andpublic enterprises.

62 Notable exceptions currently are the maintenance of roads and bridges (financed in part by the RoadFund which is funded by a share of petroleum taxes) and hospitals (financed in part by consultingfees).

63 From Decree No.7/98, one can assume that these stages are: verification, commitment and payment,but they are not clearly specified.

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Financeira do Estado, SISTAFE). UTRAFE was charged with the drafting the new lawand the implementation regulations.

227. Recommendations. All the recommendations in this section have been part ofthe dialogue with the government and most of them have been included in the lawsubmitted to Parliament; others, however, have not been taken into account and willcontinue to be part of the on-going dialogue with the authorities.

Recommendation (included in the law): The new law should replace the 1997 BudgetFramework Law. The new law is intended to become the major legal instrument in thearea of public sector financial management. As such, and in order to avoid possibleconfusion and conflicts of interpretation with the existing Budget Framnework Law (Leide Enquadramento Or,amental, No. 15/97), the new law should replace it.

Recommendation (partly included in the law): The law should clearly state thefundamental objectives offiscal policy. Macroeconomic stability, resource allocation anduse based on strategic priorities, and the efficiency and effectiveness of public sectorprograms and service delivery, should all be stated as the fundamental objectives of fiscalpolicy. (Macroeconomic stability has not been mentioned among the fundamentalobjectives stated in the law).

Recommendation (included in the law): The fundamental principle of a single, unifiedtreasury account should be unarnbiguously stated in the law (see Chapter 5 Section B fora detailed discussion on this issue).

Recommendation: Other specific issues to be considered are the following:

* The current period of 24 months allowed under the Budget Framework Law for theproduction of audited financial accounts should be reduced to 12 months (included inthe law);

* The provision in the Budget Framework Law allowing for price adjustments duringthe fiscal year should be suppressed. The budget should be prepared and executed incurrent prices (included in the law);

* The law should clearly state the specific stages for the execution of expenditures -verification that sufficient budget allocation is available (cabimento), commitmentand payment, and it should specify that no expenditure can be incurred without priorcabimento (included in the law);

* The type and periodicity of reporting on budget execution should be specified(included in the law);

* Government borrowing guarantees should be clearly regulated and restricted tospecific cases, and clear rules toward full disclosure of information on this issueshould be specified (not included in the law);

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* The introduction of modem accounting techniques (double-entry accounting andmodified accrual accounting) should be specified (see Chapter 5 Section A for ananalysis of public accounting) (included in the law);

* The role of Parliament in the budgetary process should be specified, in particular anyrestrictions to its discretionary power to increase the overall budget deficit beyond thegovernment's proposal, as well as the specific nature and periodicity of informationon actual expenditures it is entitled to receive from the executive (see Section Cabove) (not included in the law);

* Modifications by the executive to the budget during the execution phase should besubject to prior approval by the Assembly, except if they do not entail a change in theoverall limits set by Parliament (included in the law).

B. Integrated Financial Management Information Systems (IFMIS)

228. With the development of the new public finance management law, Mozambiqueis creating the basis for a new approach to fiscal management that integrates more closelythe different functions of the fiscal process-budgeting, accounting, cash and assetmanagement, and auditing. This is a desirable objective since one of the problems withthe existing system is precisely the lack of effective communication between thesefunctions. Article 1 of the law clearly establishes the creation of an integrated financialmanagement system, which it calls Sistema de Admininistra,do Financeira (SISTAFE).

229. The introduction of such systems is a very demanding exercise and experiencearound the world calls for extreme caution in their implementation. Annex 6 offers anoverview of integrated financial management systems and provides advice on the steps tobe taken for their introduction. Basically, a strong and sustained commitment at thepolitical and technical levels, coupled with a gradualist approach that takes into accountcapacity constraints and avoids costly technological solutions, are key to the successfulintroduction of IFMIS.

230. Above all, the basic problems affecting the current system, especially in the areasof budget coverage, accounting, cash management and auditing, must be addressed firstin order to create a sound basis for the successful introduction of the SISTAFE.

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C. Action Plan for a More Efficient, Transparent and Accountable BudgetManagement System

231. This section summarizes the recommendations made in Part II of this report. Itprovides a road map to reach the final objective stated in the PARPA-the creation of amore efficient, transparent and accountable budget management system.

232. While the action plan proposed here should be considered as a comprehensivepackage of reforms that reinforce and complement each other-and as such should beimplemented fully-its implementation must be phased. Thus, the actions recommendedhere are phased according to their degree of priority: pressing measures, which areurgent and should be implemented before end-2001; priority measures, which should beimplemented within a 12 months period; and medium-term measures, whoseimplementation will require a longer time frame. Implementation of this set of actions,designed to create the basis for the future introduction of an integrated financialmanagement system (Sistema Integrado de Administraqao Financeira do Estado,SISTAFE), should not take longer than two to three years.

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233. Pressing measures. The table below summarizes the actions considered urgent.They lay the foundations for the introduction of more fundamental reforms later in theprocess. Implementation of these actions within the time frame proposed wouldconstitute a clear sign of commitment and progress on the way to a better budgetmanagement system.

Table 7.1: Summary of Pressing Actions for Reform

Area Recommendations Time CommentsFrame

Budget * Submit the 2002 budget using the new, more Before Fulfilledformulation detailed budget functional classification. end-2001

* Formulate the budget in current prices, Fulfilledstarting with the 2002 budget.

Legalframework * Draft the implementation regulations of the 2001- On-goingnew public finance management law (Lei da MarchAdministra9do Financeira do Estado). 2002

Cash and asset * Issue new instructions on bank accounts Beforemanagement managed by public institutions stating that, end-2001

starting in fiscal year 2002, all accountsopened by spending agencies (a) will requirethe explicit prior authorization from thetreasury (DNT) who must be one of the co-holders and (b) will be automatically closedby DNT on March 31 st of the following yearaccording to current legislation.

Public accounting * Implement all necessary actions to ensure 2001that the 2002 budget execution is consistentwith the new budget functional classification.

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234. Priority actions. The following actions (Table 7.2) should be considered aspriority by govermnent and should be implemented within a 12 month period. Basically,priority actions consist of those reforms that are considered important to improvetransparency and accountability. Their timely implementation should raise theconfidence level in the quality of budget management, thus helping to create theconditions for increased budget support as an alternative to project aid, an importantgovernment objective.

Table 7.2: Summary of Priority Actions for Reform

Area Recommendation Time CommentsFrame

Budget coverage * Take all the necessary steps to ensure that a 2002 Firstsignificant share of own source and instructionsearmarked revenues currently outside the issued inbudget are included in the 2003 budget. A August 2001.plan of action for that purpose has alreadybeen formulated by the MPF.

* Include in the budget documents submittedannually to the National Assemblyinformation on tax expenditures startingwith the 2003 budget.

Reporting * Quarterly budget execution reports should 2002present (i) the initial budget allocation, (ii)the revised appropriation (if any) and (iii)all actual expenditures according to the newbudget functional classification.

* Include an annex to the budget executionreports with information on donor-fundedactual expenditures according to the actionplan prepared by the MPF.

Legalframework * Implement the new public finance 2002management law through the approval andimplementation of the regulations andaccording to a time-bound action plan.

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Public Issue instructions to all spending units Beforeaccounting informing that the complementary period October

for the 2002 fiscal year will be reduced by 1 2002month and announcing its suppressionsimultaneously with the introduction ofmodified accrual accounting.

Launch a training program on double-entry March-accounting and modified accrual accounting April

2002

Cash and asset * Finalize the inventory of all bank accounts Beforemanagement operated by public institutions both in the March

Banco de Mocambique (BM) and in 2002commercial banks.

* Close all bank accounts not related to the Before2002 fiscal year. June

2002* Create globalizing bank accounts for 2002

revenue and expenditures in BM.

* Create task force composed of MPF and JanuaryBM staff to monitor the introduction of the 2002treasury single account and the newpayments system.

Internal control * Introduce specific budget lines for the 2002 Inand auditing internal audit department (IGF) in the 2003 accordance

budget and allocate an appropriate level of withresources. Continue to implement reforms ministerialto raise IGF's capacity. decision.

* Increase budgetary allocation in favor of the The actionsAdministrative Tribunal (TA) and grant the related to theTA the ability to set its own salary scale. TA go

beyond* The Administrative Tribunal should government's

establish partnership agreements with responsibilityreputable private audit firms operating in and must beMozambique and a twinning arrangement treated at thewith a foreign Supreme Audit Institution appropriateshould be sought. institutional

level.

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235. Actions for the medium-term. Table 7.3 below presents the reforms that areconsidered necessary to complete the transformation of the current budget managementsystem into a modem structure capable of responding to the needs of an evolving publicsector in an emerging market economy.

Table 7.3: Summary of Actions for the Medium-Term

Area Recommendation Time CommentsFrame

Budget I Reinforce the MTFF by (i) creating its 2003 The decreesformulation legal basis and (ii) making it a public regulating the

document. implementationof the Lei da

* (i) Eliminate the Three-Year Investment AdministracdoPlan (PTIP) as a stand alone document Financeira doand treat investment expenditures within Estado providethe normal budget formulation process. the MTFF with(ii) Develop the Economic and Social a legal basis.Plan (PES) into one of the instruments toinform on the implementation of thePARPA.

Public * Launch the gradual introduction of 2003-accounting double-entry accounting and modified 2004

accrual accounting.

* Free the accounting department (DNCP) To beof all activities not related to accounting implemented inand reporting. parallel with

theorganizationalreform in theMPF.

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Reporting * Develop and make available on a regular 2003- The specificbasis, financial reports in addition to the 2004 format andConta Geral do Estado, starting with (i) a content are stillreport on short and medium-term external to be defined.and domestic debt, (ii) a report on lendingand on-lending, (iii) reports on cash flowsand (iv) a report on tax expenditures.

Cash and asset * Introduce a treasury single account 2003-management simultaneously with the new payments 2004

system.

* Improve financial planning with the On-goingintroduction of annual cash plans, budgetimplementation plans and monthly cashplans.

* (i) Extend the current mechanism of VATcollection through the banking system toother taxes after assessing its feasibilityby banks operating in Mozambique. (ii)Introduce, whenever possible, a singledocument (Documento Unico) for thecollection of all taxes.

Internal control * Ensure that the state accounts (Conta 2004-and auditing Geral do Estado, CGE) are audited within 2005

12 months after the end of the fiscal year,starting with the 2003 CGE.

a Launch budget evaluation function.

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LIST OF ANNEXES

1. STATISTICAL ANNEX

2. SCENARIOS FOR FISCAL SUSTAINABILITY

3. INTERGOVERNMENTAL FISCAL RELATIONS

4. THE PROCESS OF BUDGET FORMULATION

5. THE PROCESS OF BUDGET EXECUTION

6. TOWARDS AN INTEGRATED FINANCIAL MANAGEMENT SYSTEM IN

MOZAMBIQUE-KEYS TO THE SUCCESSFUL IMPLEMENTATION OF THE SISTAFE

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Annex 1Table 1: Selected Economic and Financial Indicators (1998-2002)

Actuals Estimated ProjectedIndicators 1995 1996 1997 1998 1999 2000 2001 2002

Output, income, and prices (Annual growth rates)Real GDP 4.3 7.1 11.0 12.6 7.5 1.6 14.8 10.0Real GDP per capita 1.7 4.4 8.4 10.4 5.4 -0.3 12.9 8.1Real consumption per capita -13.4 4.7 4.8 4.8 7.1 4.5 7.9 8.9Inflation (period average) 54.4 44.6 6.4 0.6 2.9 12.7 7.1 9.2

External sector (In million US$)Imports(c.i.f)atcurrentprices 727 783 760 817 1,200 1,157 1,352 2,131Exports (fo.b.) at current prices 174 226 230 245 284 364 744 778Termns of trade (decline- ) -1.0 -0.4 -0.1 -1.5 1.5 1.7 0.9 0.8

Real effective exchange rate(end of period) -21.8 12.5 9.4 -7.7 2.0 2.3(depreciation -)

(Annual change in percent of beginning-period broad money, unless otherwise specified)Money

Net domestic assets .. 11.8 9.3 23.9 11.6 10.2 12.4of which: credit to govemment .. -23.0 -16.0 .. 4.1 0.3 8.1

credittotherestofthe economy .. .. 31.0 17.8 22.9 30.1 26.0 19.0M2 growth rate 54.7 21.1 24.4 17.6 35.1 42.4 31.0 18.8

Public finances (In percent of GDP)Central govemment revenue(excluding grants) 11.3 10.6 11.5 11.4 12.0 12.7 12.5 12.8

Tax revenue 10.4 9.8 10.4 10.5 11.0 11.6 11.4 11.6Nontax revenue 1.0 0.9 1.1 0.8 1.0 1.1 1.1 1.2

Expenditure incl. Net lending 24.2 20.7 23.9 21.6 24.7 28.4 31.8 31.4Unallocated expenditures 0.0 0.0 0.4 -0.2 -0.4 -0.4 0.0 0.0Overall deficit (-) -12.9 -10.1 -12.0 -10.5 -13.2 -16.1 -19.3 -18.6

Primary balance (excluding grants) I/ -1.6 -1.4 -1.3 -1.4 -0.8 -4.3 -4.2 -7.1

Savings and investment (In percent of GDP)Gross national savings 8.7 6.3 10.0 12.2 14.3 18.2 15.3 15.1

Public sector .. 4.8 3.1 3.7 5.1 4.4 5.5Private sector . . 5.2 9.1 10.6 13.1 10.9 9.6

Gross domestic fixed capital formation 22.8 20.9 18.7 23.2 31.9 33.7 31.6 60.0Public sector 12.0 103 12.1 9.8 11.6 13.3 14.5 13.2Private sector 10.8 10.7 6.6 13.4 20.3 20.4 17.1 46.8

Extemal current account balance (after grants) -14.1 -14.6 -8.6 -11.0 -17.5 -11.8 -16.3 -44.1

Other Indicators (In percent of exports of goods and services)Net present value of total external debt outstanding 2/ ... ... 710.8 549.1 212.0 194.4 113.8 101.6External debt service (nonfinancial public sector)

Scheduled, before HIPC Initiative assistance (Naples terms) 20.0 26.1 25.2 21.9 17.9Scheduled, after original HIPC Initiative assistance ... ... ... ... 15.3 5.5 4.4 8.6Scheduled, after enhanced HIPC Initiative assistance . .. ... 2.5 2.8 6.2Scheduled, after additional bilateral assistance ... . ... ... 2.7 5.2

(In millions of U.S. dollars, unless otherwise specified)Gross official reserves

In millions of US$ 225 383 532 625 670 745 729 740In months of imports of goods and services 3.0 4 8 6.8 7.8 5.5 6.1 5.5 3.7

Exchange rate- period average (local currency/ US$) 8890 11294 11546 11850 12689 15689 20606 23852Current GDP (in US$ billions) 2.4 2.9 3.5 4.0 4.1 3.8 3.5 3.7

Sources Mozambican authorities; World Bank and IMF staff estimates and projections.1/ Defined as overall balance after grants excluding interest payments.2/ Public and publicly guaranteed, in percent of the three-year average of exports. Data for 1998 reflect the impact of applyingtraditional debt relief mechanisms (Naples terms). The data for 1999-2000 includes the impact of total debt relief underthe original HIPC Initiative. Data for 2001-02 include the impact of total debt relief under the enhanced HIPC, additionalbilateral assistance, and new borrowing.

FINAL December 6,01

Annex 1Page 2 of 3

Table 2: Revenue and Actual Expenditure, 1992-2000

1992 1993 1994 1995 1996 1997 1998 1999 2000Nominal (Mt 10^9)

Total actual expenditure and net lending 1,483 2,305 4,097 5,157 6,773 9,521 10,141 12,815 16,735of which: current expenditure 757 1,167 1,978 2,188 3,077 4,295 5,268 6,332 7,836

Total revenue 661 1,093 1,577 2,413 3,479 4,586 5,324 6,207 7,463

Real (constant 2000 Mt 10^9)

Total actual expenditure and net lending 9,521 10,400 11,333 9,238 8,389 11,086 11,742 14,388 16,735of which: current expenditure 4,862 5,268 5,471 3,919 3,811 5,001 6,100 7,109 7,836

Total revenue 4,243 4,930 4,362 4,322 4,309 5,340 6,165 6,970 7,463

Percentage of GDP

Total actual expenditure and net lending 38.5 36.4 37.7 24.2 20.7 23.9 21.6 24.7 28.4of which: current expenditure 19.7 18.4 18.2 10.3 9.4 10.8 11.2 12.2 13.3

Total revenue 17.2 17.2 14.5 11.3 10.6 11.5 11.4 12.0 12.7

Memorandum items

GDP (Mt 10^9) 3,852 6,336 10,860 21,267 32,719 39,819 46,908 51,915 58,896

Sources: Mozambique Government.

Annex 1Page 3 of 3

Table 3: Expenditure by economic classification, 1992-2000

1992 1993 1994 1995 1996 1997 1998 1999 2000Nominal (Mt 10^9)

Total expenditure and net lending 1,483 2,305 4,097 5,157 6,773 9,521 10,141 12,815 16,735Current expenditure 757 1,167 1,978 2,188 3,077 4,295 5,268 6,332 7,836

Compensation to employeesa 321 526 852 854 1,210 1,445 2,097 2,995 3,844Goods and servicesb 253 360 839 780 989 1,334 1,834 1,928 1,976tnterestonpublicdebtc 113 199 151 344 473 530 463 324 118Transfer payments (including "other")d 70 83 135 210 405 986 874 1,085 1,664

Investment expenditure' 688 1,097 2,119 2,863 3,669 4,816 4,575 6,001 7,826Net lendingf 37 40 0 106 27 410 298 482 1,073

Real (constant 2000 Mt 10A9)

Total expenditure and net lending 9,521 10,400 11,333 9,238 8,389 11,086 11,742 14,388 16,735Current expenditure 4,862 5,268 5,471 3,919 3,811 5,001 6,100 7,109 7,836

Compensation to employees 2,060 2,373 2,358 1,530 1,499 1,683 2,428 3,362 3,844Goods and services 1,626 1,623 2,322 1,397 1,225 1,553 2,123 2,165 1,976Interest on public debt 728 896 416 616 586 617 536 364 118Transfer payments (including "other") 449 376 375 376 502 1,148 1,012 1,218 1,664

Investment expenditure 4,418 4,952 5,862 5,129 4,545 5,607 5,297 6,738 7,826Net lending 240 180 0 189 33 478 345 541 1,073

Memorandum item

Ratio of goods and services to employee 79 68 98 91 82 92 74 55 51compensation (%)

Sources: Ministry of Planning and Finance, Mozainbique, as supplied to various Bank and Fund missions. Data for 2001 are projections done in late 2000.a Compensation to employees: wages & salaries + salary bonus.bGoods and services: civilian goods and services + a proportion of military expenditures. Up to 1997 military expenditures were not split between goods and services on the onehand and compensation to employees on the other. The figures for military expenditures were therefore split up using the proportion of these items in the 1998 data which has thebreakdown.s Interest on public debt: domestic and external.d Transfer payments: pensions + price subsidies + public enterprise subsidies + social welfare + political parties' subsidies + special expenditure. The "other" category and the netfloat (from last year's budget + to next year's budget) are also added to this category.eInvestment expenditure: External project grants + extemal project loans + locally-financed investment expenditure + direct commodity aid + net float.f Net lending: On-lending to public enterprises + non-collection of counterpart funds + equity in privatized banks + other capital subscriptions + bank restructuring costs.

Annex 2Page lof 4

Table 1: Mozambique: Government Finance-Scenario for Fiscal Sustainability,1998-2010(Billon Mt)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Actual Actual Actual 1/ Estimate Projection

Total revenue 5,324 6,207 7,463 9,087 11,183 13,170 15,645 18,913 21,897 25,427 29,605 34,602 40,631Tax revenue 4,932 5,733 6,857 8,250 10,109 12,009 14,365 17,475 20,387 23,842 27,940 32,854 38,795

Taxes on income and profits 963 867 1,008 1,378 1,665 2,219 3,041 3,996 5,111 6,549 8,392 10,754 13,780Taxes on goods andservices 2,882 3,638 4,331 5,103 6,092 7,142 8,477 10,166 11,528 13,073 14,825 16,812 19,064Taxes on intemational trade 937 1,046 1,297 1,565 2,112 2,374 2,531 2,957 3,345 3,762 4,205 4,701 5,284Othertaxes 150 183 221 204 240 274 316 355 403 457 518 588 666

Nontax revenue 392 474 606 837 1,074 1,161 1,280 1,438 1,510 1,586 1,665 1,748 1,835

Total expenditure and net lending 10,141 12,815 16,735 23,147 27,405 27,791 31,411 34,609 38,296 42,372 46,853 51,775 57,410Current expenditure 5,268 6,332 7,836 10,428 13,051 14,142 16,129 17,927 19,685 21,592 23,657 25,887 28,291

Compensation to employees 2,097 2,995 3,844 5,166 6,032 6,809 7,792 8,722 9,891 11,216 12,719 14,424 16,217Goods and services 1,834 1,928 1,976 2,498 3,152 3,597 4,173 4,734 5,440 6,169 6,996 7,933 8,878Interestonpublicdebt 463 324 118 515 1,133 724 736 679 775 830 891 960 1,036

Domestic 21 6 14 270 737 306 306 306 348 394 447 507 575Extemal 442 318 104 245 396 417 430 373 427 436 444 453 462

Transfer payments 874 1,085 1,664 2,249 2,734 3,013 3,427 3,791 3,579 3,377 3,051 2,571 2,160

Capital expenditure 4,575 6,001 7,826 10,543 11,557 13,156 14,775 16,159 18,182 20,456 23,012 25,887 29,120Of which: locally financed 993 1,765 2,532 2,814 3,060 3,483 3,912 4,279 4,814 5,416 6,093 6,854 7,710 x

Net lending 298 482 1,073 2,176 2,797 493 507 523 429 325 184 0 0 00Of which: locally financed -291 -6 914 2,123 2,627 493 507 523 429 325 184 0 0

Unallocated revenue (+Yexpenditure (-) 2/ -106 -220 -221 0 0 0 0 0 0 0 0 0 0

Overall balance before grants -4,923 -6,828 -9,493 -14,060 -16,222 -14,621 -15,766 -15,696 -16,398 -16,945 -17,248 -17,173 -16,780

Grants received 3,818 6,073 6,855 10,503 8,858 9,560 9,113 9,432 9,615 9,802 9,993 10,187 10,384Project 1,894 2,787 3,810 5,591 6,112 6,596 6,288 6,508 6,635 6,763 6,895 7,029 7,165Nonproject 1,924 3,287 3,045 4,912 2,746 2,964 2,825 2,924 2,981 3,039 3,098 3,158 3,219

Overall balance after grants -1,105 -755 -2,638 -3,557 -7,364 -5,061 -6,652 -6,264 -6,783 -7,143 -7,256 -6,986 -6,396

Overall primary balance after grants 3/ -642 -430 -2,520 -3,042 -6,231 -4,337 -5,916 -5,584 -6,008 -6,313 -6,365 -6,027 -5,359

BM transfer of HIPC assistance by the IMF 4/ 0 0 485 609 463 307 309 419 433 448 464 480 496

Net extemal borrowing 2,172 910 1,674 2,896 4,619 4,656 6,231 5,718 6,206 6,532 6,608 6,298 5,662

Netdomestic financing -1,067 -156 479 52 2,282 98.5 112.8 126.2 143.2 162.3 184.1 208.8 236.7

Memo item:GDP real growth rate 12.6 7.5 1.6 14.8 10.0 7.5 9.0 6.6 8.0 8.0 8.0 8.0 8.0

Sources: Mozambican authorities; IMF and World Bank staff estimates and projections.1/ The figures for 1999 exclude, and those for 2000 include, wage outlays that were payable in 1999 but delayed until 2000 pending re-certification of civil servants.2/ Statistical discrepancy between the fiscal and the monetary accounts.3/ Defined as overall balance after grants excluding interest payments.4/ In 2000, figures include also a transfer of Mt. 161 billion from other multilaterals under the original HIPC Initiative.

Annex 2 Page 2 of 4

Table 1(a): Mozambique: Government Finance-Scenario for Fiscal Sustainability,1998-2010

(As percent of GDP)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Actual Actual Actual I/ Estimate Projection

Total revenue 11.4 12.0 12.7 125 12.8 13.4 13.9 15.0 15.3 15.7 16.1 16.6 17.2

Tax revenue 10.5 11.0 11.6 11.4 11.6 12.2 12.7 13.8 14.2 14.7 15.2 157 16.4

Taxes on income and profits 2.1 1.7 1.7 1.9 1.9 2.3 2.7 3.2 3.6 4.0 4.6 5.2 5.8

Taxes on goods and services 6.1 7.0 7.4 7.0 7.0 7.2 7.5 8.1 8.1 8.1 8.1 8.1 8.1

Taxes on international trade 2.0 2 0 2.2 2 2 2.4 2.4 22 2.3 2 3 2.3 2.3 2.3 2.2

Othertaxes 0.3 0.4 04 0.3 0.3 0.3 0 3 0.3 0.3 0.3 03 03 0.3

Nontax revenue 0.8 0.9 1.0 1.2 1.2 1.2 1.1 1.1 1.1 1.0 0.9 0.8 0.8

Total expenditure and net lending 21.6 24.7 28.4 31.8 31.4 28.2 278 27.4 26.8 26.1 25.5 24.8 24.3

Current expenditure 11.2 12.2 13.3 14.3 14.9 14.4 14.3 14.2 13.8 13.3 12.9 12.4 12.0

Compensation to employees 4.5 5.8 6.5 7.1 6.9 6.9 6.9 6.9 6.9 6.9 6.9 6.9 6.9

Goods and services 3.9 3.7 3.4 3.4 3.6 3.7 3.7 3.8 3.8 3.8 3.8 3.8 3.8

Interest on public debt 1.0 0.6 0.2 0.7 1.3 0.7 0.7 0.5 0.5 0.5 0.5 0.5 0.4

Domestic 0.0 0.0 0.0 0.4 0.8 0.3 0.3 0.2 0.2 0.2 0.2 0.2 0.2

External 0.9 0.6 0.2 0.3 0.5 04 0.4 0.3 0.3 0.3 0.2 0.2 0.2

Transfer payments 1.9 2.1 2.8 3.1 3.1 3.1 3.0 3.0 2.5 2.1 1.7 1.2 0.9

Capital expenditure 9.8 11.6 13.3 14.5 13.2 13.4 13.1 12.8 12.7 12.6 12.5 12.4 12.3

Of which: locally financed 2.1 3.4 4 3 3.9 3.5 3.5 3.5 3.4 3.4 3.3 3.3 3.3 3.3

Net lending 0.6 0.9 1.8 3.0 3.2 0.5 0.4 0.4 0.3 0.2 0.1 0.0 0.0 O

Of which: locally financed -0.6 0.0 1.6 2 9 3.0 0.5 0 4 0.4 0.3 0.2 0.1 0.0 0.0

Unallocated revenue (+)/expenditure (-) 2/ -0.2 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Overall balance before grants -10.5 -13.2 -16.1 -19.3 -18.6 -14.8 -14.0 -12.4 -11.5 -10.4 -9.4 -8.2 -7.1

Grants received 8.1 11.7 11.6 14.5 10.1 9.7 8.1 7.5 6.7 6.0 5.4 4.9 4.4

Project 4.0 5.4 6.5 7.7 7.0 6.7 5.6 5.2 4.6 4.2 3.7 3.4 3.0

Nonproject 4.1 6.3 5.2 6.8 3.1 3.0 2.5 2.3 2 1 1.9 1.7 1.5 1.4

Overall balance after grants -2.4 -1.5 -4.5 -4.9 -8.4 -5.1 -5 9 -5.0 -4.7 -4.4 -3.9 -3.3 -2.7

Overall primary balance after grants 3/ -1.4 -0.8 -4.3 -4.2 -7.1 -4.4 -5.2 -4.4 -4.2 -3.9 -3.5 -2.9 -2.3

BMtransferofHIPC assistance by thelMF 4/ 0.8 0.8 0.5 0.3 0.3 0.3 0.3 0.3 0.3 0.2 0.2

Net extemal borrowing 4.6 1.8 2.8 4.0 5.3 4.7 5.5 4.5 4.3 4.0 3.6 3.0 2.4

Netdomestic financing -2.3 -0.3 0.8 0.1 2.6 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Memorandum items:Target: sustainable primary deficit -5.1 -4.1 -4.1 -3.2 -3.2 -2.9 -2.7 -2.5 -2.3

Nominal GDP (in billions ofmeticais) 46,908 51,915 58,896 72,684 87,308 98,549 112,789 126,245 143,162 162,345 184,100 208,769 236,744

Sources: Mozambican authorities, IMF and World Bank staff estimates and projections.I/ The figures for 1999 exclude, and those for 2000 include, wage outlays that were payable in 1999 but delayed until 2000 pending re-certification of civil servants.

2! Statistical discrepancy between the fiscal and the monetary accounts.3/ Defined as overall balance after grants excluding interest payments.4/ In 2000, figures include also a transfer of Mt. 161 billion from other multilaterals under the original I-PC Initiative.

Annex 2 Page 3 of 4Table 2: Mozambique: Government Finance-Scenario for Fiscal Sustainability,1998-2010

(Billon Mt)


Totalrevenue 5,324 6,207 7,463 9,087 11,183 13,170 15,645 18,913 21,542 24,593 28,148 32,334 37,302Taxrevenue 4,932 5,733 6,857 8,250 10,109 12,009 14,365 17,475 20,032 23,007 26,484 30,586 35,467

Taxes on income and profits 963 867 1,008 1,378 1,665 2,219 3,041 3,996 5,030 6,326 7,956 10,006 12,585Taxes on goods and services 2,882 3,638 4,331 5,103 6,092 7,142 8,477 10,166 11,315 12,594 14,017 15,601 17,363Taxes on international trade 937 1,046 1,297 1,565 2,112 2,374 2,531 2,957 3,284 3,631 3,993 4,391 4,852Othertaxes 150 183 221 204 240 274 316 355 403 457 518 588 666

Nontax revenue 392 474 606 837 1,074 1,161 1,280 1,438 1,510 1,586 1,665 1,748 1,835Total expenditure and net lending 10,141 12,815 16,735 23,147 27,405 27,791 31,411 34,609 37,587 40,817 44,298 48,045 52,504

Current expenditure 5,268 6,332 7,836 10,428 13,051 14,142 16,129 17,927 19,320 20,800 22,367 24,022 25,767Compensation to employees 2,097 2,995 3,844 5,166 6,032 6,809 7,792 8,722 9,708 10,805 12,026 13,384 14,770Goods and services 1,834 1,928 1,976 2,498 3,152 3,597 4,173 4,734 5,339 5,943 6,614 7,362 8,086Intereston public debt 463 324 118 515 1,133 724 736 679 769 815 867 923 985

Domestic 21 6 14 270 737 306 306 306 341 380 423 470 523External 442 318 104 245 396 417 430 373 427 436 444 453 462

Transfer payments 874 1,085 1,664 2,249 2,734 3,013 3,427 3,791 3,505 3,237 2,860 2,353 1,926

Capital expenditure 4,575 6,001 7,826 10,543 11,557 13,156 14,775 16,159 17,845 19,705 21,758 24,022 26,737Of which: locally financed 993 1,765 2,532 2,814 3,060 3,483 3,912 4,279 4,725 5,217 5,761 6,361 7,079

Net lending 298 482 1,073 2,176 2,797 493 507 523 422 313 174 0 0Of which: locally financed -291 -6 914 2,123 2,627 493 507 523 422 313 174 0 0

Unallocated revenue (+Yexpenditure (-) 2/ -106 -220 -221 0 0 0 0 0 0 0 0 0 0

Overall balance before grants -4,923 -6,828 -9,493 -14,060 -16,222 -14,621 -15,766 -15,696 -16,044 -16,225 -16,150 -15,711 -15,202

Grants received 3,818 6,073 6,855 10,503 8,858 9,560 9,113 9,432 9,615 9,802 9,993 10,187 10,384Project 1,894 2,787 3,810 5,591 6,112 6,596 6,288 6,508 6,635 6,763 6,895 7,029 7,165Nonproject 1,924 3,287 3,045 4,912 2,746 2,964 2,825 2,924 2,981 3,039 3,098 3,158 3,219

Overall balance after grants -1,105 -755 -2,638 -3,557 -7,364 -5,061 -6,652 -6,264 -6,429 -6,422 -6,158 -5,525 -4,817

Overall primary balance after grants 3/ -642 -430 -2,520 -3,042 -6,231 -4,337 -5,916 -5,584 -5,660 -5,607 -5,291 -4,601 -3,832

BM transfer of HIPC assistance by the IMF 4/ 0 0 485 609 463 307 309 419 433 448 464 480 496

Net extemal borroving 2,172 910 1,674 2,896 4,619 4,656 6,231 5,718 5,855 5,818 5,520 4,851 4,105

Net domesticfinancing -1,067 -156 479 52 2,282 98.5 112.8 126.2 140.5 156.4 174.1 193.7 215.6

Memo item:GDPrealgrowthrate 12.6 7.5 1.6 14.8 10.0 7.5 9.0 6.6 6.0 6.0 6.0 6.0 6.0

Sources: Mozanbican authorities; IMF and World Bank staff estimates and projections.I/ The figures for 1999 exclude, and those for 2000 include, wage outlays that were payable in 1999 but delayed until 2000 pending re-certification of civil servants.2/ Statistical discrepancy between the fiscal and the monetary accounts.3/ Defined as overall balance after grants excluding interest payments.4/in 2000, figures include also a transfer ofMt.161 billion from other multilaterals under the original HIPC Initiative.

Annex 2 Page 4 of 4

Table 2(a): Mozambique: Government Finance-Scenario for Fiscal Sustainability,1998-2010(As percent of GDP)


Total revenue 11.4 12.0 12.7 12.5 12.8 13.4 13.9 15.0 15.3 15.7 16.2 16.7 17.3Taxrevenue 10.5 11.0 11.6 11,4 11.6 12.2 12.7 13.8 14.3 14.7 15.2 15.8 16.4

Taxes on income and profits 2.1 1.7 1.7 1.9 1.9 2.3 2.7 3.2 3.6 4.0 4.6 5.2 5.8Taxes on goods and services 6.1 7.0 7.4 7.0 7.0 7.2 7.5 8.1 8.1 8.1 8.1 8.1 8.1

Of which: on petroleum products 1.6 1.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0VAT 5.8 8.3 8.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Consumption tax 1.0 1.5 1.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Taxes on intemational trade 2.0 2.0 2.2 2.2 2.4 2.4 2.2 2.3 2.3 2.3 2.3 2.3 2.3Other taxes 0.3 0.4 0.4 0,3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3

Nontax revenue 0.8 0.9 1.0 1.2 1.2 1.2 1.1 1.1 1.1 1.0 1.0 0.9 0.9

Total expenditure and net lending 21.6 24.7 28.4 31.8 31.4 28.2 27.8 27.4 26.8 26.1 25.5 24.8 24.4Current expenditure 11.2 12.2 13.3 14.3 14.9 14.4 14.3 14.2 13.8 13.3 12.9 12.4 12.0

Compensation to employees 4.5 5.8 6.5 7,1 6.9 6.9 6.9 6.9 6.9 6.9 6.9 6.9 6.9Goods and services 3.9 3.7 3.4 3.4 3.6 3.7 3.7 3.8 3.8 3.8 3.8 3.8 3.8Interest on public debt 1.0 0.6 0.2 0.7 1.3 0.7 0.7 0.5 0.5 0.5 0.5 0.5 0.5

Domestic 0.0 0.0 0.0 0.4 0.8 0.3 0.3 0.2 0.2 0.2 0.2 0.2 0.2External 0.9 0.6 0.2 0.3 0.5 0.4 0.4 0.3 0.3 0.3 0.3 0.2 0.2

Transfer payments 1.9 2.1 2.8 3.1 3.1 3.1 3.0 3.0 2.5 2.1 1.6 1.2 0.9

Capital expenditure 9.8 11.6 13.3 14.5 13.2 13.4 13.1 12.8 12.7 12.6 12.5 12.4 12.4Of which: locally financed 2.1 3.4 4.3 3.9 3.5 3.5 3.5 3.4 3.4 3.3 3.3 3.3 3.3

Net lending 0.6 0.9 1.8 3.0 3.2 0.5 0.4 0.4 0.3 0.2 0.1 0.0 0.0Of which: locally financed -0.6 0.0 1.6 2.9 3.0 0.5 0.4 0,4 0.3 0.2 0.1 0.0 0.0

Unallocated revenue (+Yexpenditure (-) 2/ -0.2 -0.4 -0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Overall balance before grants -10.5 -13.2 -16.1 -19.3 -18.6 -14.8 -14.0 -12.4 -11.4 -10.4 -9.3 -8.1 -7.1

Grants received 8.1 11.7 11.6 14.5 10.1 9.7 8.1 7.5 6.8 6.3 5.7 5.3 4.8Project 4.0 5.4 6.5 7.7 7.0 6.7 5.6 5.2 4.7 4.3 4.0 3.6 3.3Nonproject 4.1 6.3 5.2 6.8 3.1 3.0 2.5 2.3 2.1 1.9 1.8 1.6 1.5

Overall balance after grants -2.4 -1.5 -4.5 -4.9 -8.4 -5.1 -5.9 -5.0 -4.6 -4.1 -3.5 -2.9 -2.2

Overall primary balance after grants 3/ -1.4 -0.8 -4.3 4.2 -7.1 -4.4 -5.2 -4.4 -4.0 -3.6 -3 0 -2.4 -1.8

BM transfer of HIPC assistance by the IMF 4/ 0 0 0.8 0.8 0.5 0.3 0.3 0.3 0.3 0.3 0.3 0.2 0.2

Net external borrowing 4.6 1.8 2.8 4.0 5.3 4.7 5.5 4.5 4.2 3.7 3.2 2.5 1.9

Netdomesticfinancing -2.3 -0.3 0.8 0.1 2.6 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Memorandum items:Target: sustainable primary deficit -5.1 -4.1 -4.1 -3.2 -2.6 -2.4 -2.2 -2.0 -1.8Nominal GDP (in billions of meticais) 46,908 51,915 58,896 72,684 87,308 98,549 112,789 126,245 140,511 156,388 174,060 193,729 215,620

Sources: Mozambican authorities; lMF and World Baik staff estimates and projections.1/ The figures for 1999 exclude, and those for 2000 include, wage outdays that were payable in 1999 but delayed until 2000 pending re-certification of civil servants.2/ Statistical discrepancy between the fiscal and the monetary accounts.3/ Defined as overall balance after grants excluding interest payments.4/In 2000, figures include also a transfer ofMt.161 billion from other multilaterals under the original HIPC Initiative.

- 92 -Annex 3

Page 1 of 35

ANNEX 3

INTERGOVERNMENTAL FISCAL RELATIONS-TAKING STOCK ANDLoOKING AHEAD

I. Introduction

1. The purpose of this Annex is two-fold. First, it describes and analyzesMozambique's recent experience with fiscal reforms focusing on deconcentration anddecentralization. The analysis highlights the overall fiscal impact of these reforms andidentifies fiscal constraints on further reforms. Second, the chapter providesrecommendations and guidelines for further fiscal deconcentration and decentralizationreforms.

2. Much like the Portuguese model, Mozambique is currently governed by twoparallel systems at the sub-national level, one for rural areas, the other for urban areas(including some rural conurbations).' In the rural sub-national system the Govermmenthas pursued a modest policy of deconcentration, while in the urban sub-national system ithas carried out a more radical policy of decentralization. In rural areas the centralGovernment has deconcentrated a limited amount of power to both provincial and district

2administrations. In urban areas the central Government has devolved power to thirtythree autonomous municipalities (autarquias) in cities and towns, which are run byelected officials (in effect, the municipalities are small islands of decentralized municipalgovernments surrounded by deconcentrated provincial and district administrations). Inneither case, however, have the reforms been unequivocal; both deconcentrating anddecentralizing reforms have been subject to impediments and reversals. Table 1summarizes the functions and revenue and expenditure powers of the provinces, districts,and municipalities.

I At the village and community level there is a third system in operation: traditional authoritystructures.2 There are presently ten provinces, 128 districts, and 393 administrative posts.

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Table 1: Functions, Revenues, and Expenditures at the Provincial, District, and Municipal Levels: ASummary Comparison

Level Functions Revenues ExpendituresProvince Territorial planning and Small amount of own Small amount of

oversight of all sectoral source revenues (taxes discretionary capitalprograms in the and mostly fees); less expenditures; about 2%province than 3% of total national of total national capital

revenues budgetDistrict Territorial Small amount of own Small amounts of

administration and source revenues discretionary funds foroversight of all sectoral (National non-wage recurrentprograms in the district Reconstruction Tax, expenditures and fixed

market and bicycle term contract laborduties, and rental fees)

Municipality Economic and social -Transfers from central Authorized to makedevelopment; Governient; about 2% recurrent and capitalenvironment, basic of national revenues expenditures in all areassanitation, and quality of (FCA and FIIL) of competencelife; public services; -Own source taxeshealth; education; (Municipal Head Tax,culture, leisure, and Property Tax, Economicsport; policing; and Activity Tax, Tax onurban infrastructure, Commerce and Industry,construction, and and Income Tax) andhousing fees (market, public

service, parking, andregistration fees)

3. Decentralization and deconcentration are typically undertaken to increase levelsof local participation in governance and thereby improve service delivery to localcommunities. At the same time decentralization and deconcentration must be undertakenin such a way that make them fiscally sustainable. This chapter draws three mainconclusions about Mozambique's deconcentrating and decentralizing reforms in light ofthe goal of improved service delivery and the imperative of fiscal sustainability. First,neither the deconcentrating nor the decentralizing reforms pose risks for the aggregatefiscal balance at present. Neither the deconcentrated provinces and districts nor thedecentralized municipalities have unsustainably large entitlements to central governmentresources. Moreover, current municipal debt is modest and largely short term (andregulated by the MPF). Second, both district and municipal capital and recurrentexpenditures are in line with their corresponding revenues. At present, there does notappear to be a risk of budget deficits at either the district or municipal levels (based onavailable data, which is unfortunately quite limited). Third, however, furtherimprovements in the quantity and quality of service delivery at the district and municipallevel will be constrained by available own source revenues as well as central governmenttransfers. Districts have seen their tax and fee bases lost to municipalities, whileprovinces have seen their discretionary investment budgets decline as resources havebeen shifted back to central ministries (as part of the Integrated Sectoral Programs).Municipalities have had difficulty delivering the services for which they are currentlyresponsible, and the transfer of new functional responsibilities to the municipalities hasbeen slow, both of which are due to low administrative capacity and, in some cases,limited fiscal resources and (the former is clearly related to the latter). Thus, there are

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contradictory tendencies at both the provincial/district and municipal levels. One thing isclear for both, however. If not addressed, fiscal issues have the potential to be theAchilles heel of the Government's deconcentration and decentralization programs.

II. Governance

4. The two ministries most involved in sub-national governance are the Ministry ofPlanning and Finance (MPF) and the Ministry for State Administration (MAE). TheMPF's Provincial Directorates of Planning and Finance (DPPFs) manage revenues andpublic expenditures, including procurement, at the provincial and district levels.3 TheMAE has two National Directorates, Local Administration (DNAL) and MunicipalDevelopment (DNDA), which are responsible, respectively, for overall local andmunicipal management issues. The MAE also has Provincial Directorates of Support andControl (DPACs), which provide administrative support to the governor and the districts.In addition, DPACs serve as a communication conduit between the governor and the sub-provincial levels of government. The MPF and MAE also provide financial andadministrative oversight, respectively, of deconcentrated and decentralized entities. BothDPPFs, the DNDA, and the DNPO also have some interaction with the autonomousmunicipalities, and, though the engagement is limited, these units are the only centralgovernment offices that interact with the municipalities.

A. Provinces, Districts, and Administrative Posts

5. The provinces, which function as deconcentrated governance structures, are4formally administered by governors appointed by the president. Governors, who are

regarded as having the same rank as ministers, are jointly responsible with the sectoralministries for provincial implementation of the government's program. At the provinciallevel most ministries have a provincial directorate (DP) responsible for their sectoralprograms. These DPs are responsible to both their parent ministries as well as thegovernor. A provincial executive council, composed of representatives from each centralgovernment ministry that maintains a provincial directorate, advises the governor. Thegovernor and his executive council are considered the "provincial government." Thisdual authority structure is known as the dupla tutela.

6. The principal function of the provincial government is territorial planning, whichis supposedly done in conjunction with the sectoral planning for which the centralministries are responsible. Territorial planning is supposed to take as its starting point theproblems and resources that characterize a particular region, and is supposed to be basedon sectoral development strategies and inputs from local constituents, including thedevelopment plans produced at the sub-provincial (i.e., district) level. At the samne time,provincial plans are intended to sensitize sectoral programs to the needs and priorities ofthe province. Some sectors, namely the "priority" ones, are characterized by centrally

3. DPPFs house several departments, including the following: Provincial Physical Planning Service(SPPF), Department of Planning and Budgeting (DPO), and the Department of State Assets (DPE).4 Each provincial government has a provincial assembly to which it is supposed to be accountable.However, these assemblies, which pre-date the constitutional reform of 1990, are now defunct in practicalterms. Thus, provincial govermnents are not directly accountable to provincial citizens.

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conceived Integrated Sectoral Programs (PSIs): education, health, agriculture, water, androads (the judicial and prisons sectors are also considered priority in some instances). AsMPF points out, "The majority of resources for financing state interventions at theprovincial level are channeled through the sectoral programs. Therefore, the mobilizationof financing for actions considered priority by the provincial government will depend onits capacity to negotiate with the responsible ministries through their respectiveprovincial directorates. The basis of this negotiation should be a clear strategy for thedevelopment of the province, consistent with sectoral strategy."5 These orientaq5esclearly recognized the subordinate role that territorial planning plays to sectoral planning.Interestingly, they indicate that the provincial government should negotiate with theprovincial directorates, which is another way of saying that the governor must negotiatewith the sectors in order to obtain funding for territorial priorities (given that theprovincial government is composed of the sectoral representative plus the governor). ThePSIs effectively limit the planning role of the governor to the non-priority sectors.

7. The exact role of the governor at the operational level is further clouded by thefact that he is allocated a very small professional staff. Most governors have only acouple of technical advisors. Governors do have a large administrative and service staff,which is responsible for maintaining the governor's official home. Most governors thushave no specialized expertise on which to draw in their dealings with the sectors.Governors, then, must rely on the sectoral directorates for technical and administrativesupport. Given the thinness of gubernatorial capacity, governors basically serve to"coordinate" provincial activities to a limited extent.

8. In practice, the dupla tutela fosters confusion and uncertainty about powers andresponsibilities. The balance of power between governors and sectoral directors variesfrom province to province. Informally, some governors are able to influence theprovincial allocation of public resources more than others. According to a recent report(Helling, 1999), the importance of the province as a decision-making unit has grown, andseveral governors have resolved the ambiguous nature of their power in practice byexerting leadership through the promotion of regional development strategies andregional investment. However, recent constitutional reform proposals did not advocatedecentralization to the provincial level.

9. Provincial governors have nominally gained some competencies over personnelmanagement. The National Civil Service Council deconcentrated (Decree #49/94)control over less than mid-level staff, representing about 95 percent of provincially-basedstaff, to the provincial governor. The decree empowered the governor to hire, fire,promote, discipline, and transfer civil servants within the framework of centrally-mandated personnel ceilings. However, given that the governor's office does not havethe staff to handle the provincial civil service, the DPACs have for the most part takenover the personnel management function for all sectoral ministries at the provincial level.

5 Planifica,do Estrategica: Orienta,ces Para os Governos Provincias, MPF-DNPO, June 1999,p.9.

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10. In surn, though governors are formally vested with many powers andresponsibilities, in practice they are not very powerful, given that budgeting, revenuecollection, planning, and personnel are controlled by other entities. With the possibleexception of a minor coordinating role, at present the real value added of the governors isnot clear, especially given very scarce resources.

11. Provinces are divided into districts, which are run by district administrators. The"district government" is the executive council (conselho executivo distrital), which, as atthe provincial level, is composed of the administrator and sectoral district directors, whoare accountable to their provincial sectoral directors. The dupla tutela structure is thusreplicated at the district level. The district administrator, who is appointed by the MAE,has nominal authority over the sectoral district directors. The main function of thedistrict administrator is that of general territorial management. In addition, theadministrator is responsible for a myriad of functions in the following sectors: civilauthority, infrastructure (including water supply, electricity, and public works), economicdevelopment, housing, agriculture (including livestock and fisheries), commerce andtourism, industry, health, education, culture and sports, environmental protection, naturaldisaster management, transportation and communications, social action, and civilregistry. The coupling of numerous responsibilities with few resources and littleadministrative capacity means that the district administrator's role in service delivery isquite limited.

12. In practice, then, the administrator serves two purposes. First, he engages ingeneral territorial management, which includes resolving disputes, negotiating withtraditional leaders, undertaking ad hoc initiatives (for example, mobilizing the populationfor agricultural or vaccination campaigns, or hiring contract workers to clean up a sectionof the district), and overseeing the implementation of sectoral programs through thedistrict's Socio-Economic Plan. The administrators are also responsible for coordinationwith the administrative post chiefs (chefes de posto), who represent the administrator atthe sub-district level. Second, the administrator also plays a role in the sectors that arenot represented by ministerial district directorates (direcc5es distritais). Most ministriesoperate directorates at the district level, though Planning and Finance, Commerce,Industry, and Tourism, and Public Works and Housing do not.6

13. The absence of the finance and commerce sectors at the district level means thatthe district administrators have some responsibilities for revenue collection, licensing,and other regulatory activities, as well as provision of select services. Specific licensingand regulatory responsibilities include, for example: land use (approving newconstruction, new crop plantings), commerce (licensing informal sector activities,logging), transportation (licensing bicycles), education (granting exemptions from schoolfees), public health and sanitation (issuing fines for littering), and public order (gunlicensing).

14. The government recognized that the role and functions of the districtadministrator were ambiguous, not only because the legislation on district administration

6 Public Works and Housing operates a very small number of district directorates.

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was vague in some cases, but also because some administrators were not familiar with theapplicable legislation and did not have records of it in the district offices (due, in part, todestruction caused by the civil war). For this reason the MAE published a guide fordistrict administrators in 1997.7 The guide contains much of the relevant legislation aswell as templates of the administrative documents most used. The purpose of the guidewas to standardize district administration across the country. Given the lack of trainingand resources, though, it is doubtful whether standardization has taken place.

15. District administrators may fashion more or less of a role for themselvesdepending on their own initiative and support staff. One administrator reportedinstructing workers on building a school, including where to put the doors and windows.One reported resolving disputes that the police could not handle. The administrator alsoserves as an authority figure at the local level. Some administrators consider themselvesthe representative of the president in the districts. Administrators seem to commandsome respect from the local population (for example, it is not uncommon for citizens togreet and stand up when the administrator passes by). Administrators reside inpalacios,which is usually a colonial-era building, some of which are quite large. Thus, they seemto be important local authority figures.

16. In addition to the district palace, district administrations also have offices in thedistrict seat. Generally, these offices are not well-equipped. Many do not have anycomputers. Telephones, typewriters, photocopiers, air conditioners, and furniture aresparse. Districts do maintain radios to communicate with the posts at the sub-districtlevel. Some districts have an official vehicle, but as many are in disrepair, districtadministrators often use their own private vehicles or seek transportation by other means.Given the large distances between posts, and between posts and the districtadministration, intra-district transportation and communications are serious problems.

17. Administrators do have staff under their control, though their administrativeemployees greatly outnumber their technical ones, and no sectorally specializedorganizational units or personnel operate at the district level. Many administrators have afew chefes de secretaria, who are responsible for specialized administrative functionslike accounting, land demarcation, tax collection, and a large number of support staff,including chauffeurs, radio operators, mechanics, gardeners, cooks, and domesticemployees.8 The district administrator, along with his staff, are technically civil servantsmapped to the MAE. The staff complements are determined centrally by the civil servicesystem. Administrators may also hire contract workers (funded out of own source districtrevenues), whose numbers can be quite high. In one district the contract workforce wasequal to more than 50 percent of the civil service staff complement, while in another itexceeded 100 percent. District staffs are not necessarily small, though they seem to beheavily skewed toward administrative support functions, which means that the districtlayer of government is fairly thin in terms of technical capacity. Moreover, training andeducation seem to be very serious problems at the district level. Given small, ill-trainedtechnical staffs and the concentration of licensing, revenue raising, and regulatory

7 Guia do Administrador do Distrito, MAE, December 1997.8 Many of the domestic support staff work in the administrator's palacio.

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responsibilities at the central and provincial levels, the district has little authority, andthus little capacity, to govern.

18. The district government is also responsible for developing the districtdevelopment plan (PDD). The district is considered the base level in the planningsystem, given that the district is the level of government "closest to the population." Therole of the district council in planning is four-fold: to define territorial developmentstrategies; to promote the participation of civil society in the development andimplementation of the plan; to coordinate the actions of various levels of government;and to organize the use of local physical space with respect to development ofinfrastructure and use of natural resources.9 Once the PDD is approved by the districtcouncil, it is then sent to the provincial government for approval. Districts areresponsible for initiating their own plan and for its financing. The orientagdes instructthe districts to rely on the following sources of financing for the plan: own sourcerevenues, transfers from the provincial budget, sectoral provincial budgets, NGO anddonor financing, and in-kind contributions from civil society. The orientaq5es alsorecommend that the PDD be approved, informally, by the relevant municipality.

19. In practice, most PDDs are little more than the aggregation of centrally-determined sectoral plans, especially in the PSI sectors. Moreover, the districtadministrator plays a minor role in developing the plan, given his lack of administrativecapacity. The PDD is more likely to reflect the sectoral, as opposed to territorial,planning agenda. The lack of effective coordination in planning is matched by a lack ofcoordination in implementation. Many sectoral district directorates operate without muchtechnical input from the district administration. Provincial directorates and centralministries have more control over sectoral district directorates than district administratorshave.

20. District administration is deconcentrated at the local level to administrative posts,run by chefes de posto, who are accountable to the district administrator. The posts,which are sub-divided officially into localities, serve as communication links betweenrural communities and district administrations. Postos also play a limited role in taxcollections, and business regulation and licensing of very small scale activities. Manyadministrative posts do not yet have offices, so post chiefs work out of their homes ormake other arrangements.

21. The existence of the dupla tutela at the district level means that MAE's DPACsshare normative and supervisory responsibilities regarding district administrations withthe provincial governors. DPACs, as their name suggests, play two roles with respect tothe districts: support and control. They provide administrative support to the districts,including, for example, help with the census and electoral matters as well as generalorientation when necessary. DPACs also communicate district-level concerns to thegovernor and represent district issues at the provincial level. In addition, DPACs auditdistrict administrations for compliance with financial and administrative regulations,

9 Plano Distrital de Desenvolvimento: Orientaq6es Para Elaboragdo e Implementagao, MAE/MPF,September 1998, p. 7.

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including procedures, use of funds, personnel issues, and revenue collection. Periodicvisits to district administrations serve to reinforce DPACs' audit presence. The role ofthe governor in district supervision is ad hoc and varies by province.

22. There is another level of government at both the provincial and district level: theassembly. Both provincial and district assemblies are elected bodies that are supposed tobe responsible for overseeing the provincial and district governments. These assembliesare responsible for approving provincial and district development plans, as well asapproving the accounts (prestaqdo de contas) of the provinces and districts. In practice,the assemblies meet infrequently and do not seem to play much of a role in sub-nationalgovernance.10 Moreover, given that elections for the provincial assemblies were last heldmore than 20 years ago, many assembly members are quite old and some are deceased.

B. Municipalities"l

23. The first glimpse of decentralized municipalities can be gleaned from the revised1996 national constitution, which defined the concept of "Local Authority (Poder Local,articles 188-198)." The constitution defines two types of local autarkies: themunicipality, which includes cities and towns, and the village, which includesadministrative posts. Through the promulgation of a series of laws in 1997 (laws # 2/97and 4/97-11/97), thirty three initial autarquias were created and elections were held in1998. The initial set of autarquias included Maputo city plus all ten other provincialcapitals'2 as well as the twelve remaining cities and ten of the nation's towns.13 Villageshave yet to be included in the group of autarquias.

24. Municipalities are governed by an elected legislative organ, the MunicipalAssembly, and by an elected executive officer, the Council President, together with hisMunicipal Council.' 4 The Municipal Council is appointed by the Council President, whomust chose at least two of his city councilors (vereadores) from the ranks of theassembly. The size of the assembly and council are based, respectively, on the number ofelectors and citizens residing in the autarquia.15 Assembly members and the presidentboth serve five year terms. Assemblies elect presidents and vice-presidents to presideover themselves.

10 In spite of this, a line item allocation for the provincial assemblies exists in both the capital andrecurrent budgets for the past several years.11 Much of this section is based on Law # 2/97 and Hanlon (1997).12 These are: Matola, Xai-Xai, Inhambane, Beira, Chimoio, Tete, Quelimane, Nampula, Lichinga,and Pemba.13 The twelve remaining cities (Montepuez, Cuamba, Angoche, Ilha de Mozambique, Nacala,Gurue', Mocuba, Manica, Dondo, Maxixe, Chibuto, and Chokwe') and the ten additional towns selected(Mocimboia da Praia, Metangula, Monapo, Milange, Catandica, Marromeu, Vilankulo, Mandlakazi,Manhica, and Maatize), one in each province, brought the total to thirty three.14 Formerly, Executive Councils administered the cities with the exception of Maputo, which wasconsidered a province.15 The minimum sizes of the assemblies and councils are 13 and 5 (including the president),respectively.

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25. Autarquias have autonomy over a wide range of sectoral governmental functions,as well as responsibilities for financial management (both revenues and expenditures),personnel, and procurement (see Table 1). The municipalities' substantive mandateincludes: (1) economic and social development; (2) environment, basic sanitation, andquality of life; (3) public services; (4) health; (5) education; (6) culture, leisure, and sport;(7) policing; and (8) urban infrastructure, construction, and housing. The laws assume,however, that at the outset municipalities will not be able to exercise authority in allsectors. Therefore, the legal framework provides for the gradual transfer of functions andrevenues over time as municipalities are ready to assume them. Presently, manymunicipalities only exercise authority in a limited number of sectors, notably policingand sanitation.

26. Tutelary authority over the autarquias is vested in the MAE for administrativematters and the MPF for financial matters (ministers can, however, delegate oversightauthority to the respective provincial governor). 16 Municipalities are supposed tocoordinate their work with their neighboring district and provincial governments, as wellas with the sectoral ministries.

27. Municipalities inherited their staffs from the central government, as civil servantswere simply transferred to the municipality. Municipal civil servants are subject to thesame civil service system as state employees, which means that in practice municipalitieshave limited autonomy to manage their personnel complements. In addition, the centralgovernment is authorized to ratify municipal personnel charts. Given that municipalitieswere born with full staff complements regulated by the civil service, they presently havelittle room to maneuver. There seems to have been little staff turnover caused by theadvent of municipal independence. Municipalities do have the authority to hire contractworkers as their resources permit. These constraints, coupled with the scarcity ofqualified professionals at the local level, have handicapped municipalities in terms ofqualified professional staff (for example, in engineering, finance, planning, etc.).

28. Municipal office holders are entitled to a remuneration package that includessalaries or honoraria, travel expenses, and medical care. In addition, the councilpresident is entitled to housing, protocolar travel expenses, and representation expenses.The autarkic legislation sets limits on the relative and absolute remuneration thatmunicipal office holders can eam. The municipal assembly, in determining monetaryremuneration packages, must ensure that remuneration does not exceed 30 percent ofown source revenues collected by the municipality. At the same time the absolute salarylevels, which are established in the autarkic legislation, must not exceed the limits set inaccordance with the government salary scale. In addition, the salaries of the municipalstaff are set according to the civil service salary scale.17

29. The planning function is carried out by the autarquia through the municipaldevelopment plan and the territorial organization (ordenamento) plan, both of which must

16 See Law #7/97, "Tutelage of Local Autarkies."17 This means that civil service salary increases, such as those in 1999 and 2001, also affect themunicipal wage bill.

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be submitted by the president to the assembly and subsequently ratified by the centralgovernment. In addition, the president must submit reports to the assembly at each of itssessions on progress to date in fulfilling the annual plan of activities.

30. At the same time the central Government has reserved a panoply of powers thateffectively fence in the municipal governments on a number of fronts. These powers arediscretionary; it is up to the central Government to invoke them. In the best sense thesepowers would only be used to thwart corruption and malfeasance. In the worst sense theywould be used to continue to intervene in municipal affairs. It remains to be seenwhether these powers are used for legitimate or illegitimate purposes. There is a sensewithin the Government that the municipal decentralization reform has reached its limitsfor now (in terms of extension to new municipalities). There is concern that there are noobvious candidates for further municipalization (the next autarquias would have to besmall villages).

III. Revenues


31. The provincial government, like the district administration, collects taxes andfees.'18 The province as a unit of government has only a very small amount of own sourcerevenues, however. In fact, total provincial own source revenues averaged 2.8 percent oftotal national revenues over the period 1995-2001 (see Table 2 below). Over the sameperiod tax revenues accounted for only 15 percent of total collections, while non-taxrevenues made up the vast majority. While there was some detail provided on non-taxrevenues in pre- 1 998 budgets, subsequent budgets provide no detail on the types of non-fiscal revenues collected by the provinces. The DPPF and its Finance Divisions(Repartiq5es de Finanqas) also collect taxes and fees at the provincial level, but these areconsidered revenues of the central government; they are not earmarked for the provinciallevel. Note that own-source provincial revenue collections are not related in any way tothe province's budgetary allocations.' 9 Sectoral directorates also collect own sourcerevenues, but these are for the most part considered central government revenues (seesection on off-budget own source revenues). Though provinces also receive largeamounts of capital expenditures from donors, there is very little information on thisfunding at the provincial level (see section on off-budgets for more detail).

18 However, neither provinces nor districts are autonomous budget entities and capital budgetallocations are not determined by local revenue collections.19 At the level of treasury management, most provinces (except two), through their DPPFs, actuallyretain collected revenues as a credit of sorts toward their budget allocations.

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Table 2: Provincial RevenuesNominal TermsMillions of Mts. 1995 1996 1997 1998 1999 2000 2001Tax Revenues 15,000 17,000 23,000 34,450 39,520 9,703 9,000Non-Tax Revenues 1,000 1,000 2,300 120,350 128,000 178,569 159,000Own Source 62,000 96,000 114,700 n.a. n.a. n.a. n.a.RevenuesProvincial Total 78,000 114,000 140,000 154,800 167,520 188,272 168,000

National Total 2,745,000 3,753,000 3,593,000 5,479,000 6,111,070 7,489,902 8,481,000Provincial/National 2.8% 3.0% 3.9% 2.8% 2.7% 2.5% 2.0%

32. The district as a unit of government collects taxes, duties, and fees, though thereis no legislative framework governing public finance at the district level. The main taxcollected by the districts is the National Reconstruction Tax (Imposto de ReconstruadoNacional). The IRN is an annual head tax (with several exemptions) of Mts. 5,000 whichyielded Mts. 3.3 billion in 1999 and is projected to yield 3.5 billion in 2000. Exactfigures on collections at the district level are unknown, though on a per capita basis(excluding exemptions) the IRN was estimated to have yielded less than Mts. 300 (aboutUS$ 0.01) at the district level in 2000.20 The IRN is collected by the districtadministration as well as the administrative posts, which are able to retain a smallpercentage (between five percent and 25 percent seems to be the norm in some areas); theremainder is transferred to the district. What the district does with its collections is amatter of controversy. Officially, districts are required to deposit all tax collections incentral government accounts (in the DPPF or Finance Divisions). These revenues (thatis, 100 percent) are then to be returned to the districts through a requisitioning process.Some districts, however, report retaining all collections (minus the fees paid to thecollectors). One DPPF also reported district non-compliance with the transfer ofrevenues. Other districts reported retaining a percentage of revenues, and transferring thedifference to the DPPF. Some districts reported that only a fraction of the centrallydeposited revenues are returned to the district, which might explain, to some extent, theproblems of non-compliance.

33. Districts also collect a variety of duties and fees. The most important revenuegenerator among these are the market duties, which are levied according to whether theoperator has a permanent or an informal establishment. Informal operators are chargedMts. 2,000 per day, while formal operators are charged between Mts. 50,000-65,000 permonth.21 According to some district administrators, formal establishments are supposedto pay more than informal operators, but are unwilling to do so. Non-compliance seemsto be the norm as districts have little capacity to enforce compliance. Revenues from

20 The amount is even less due to the fact that the IRN is withheld from public sector salaries at thesource. Estimate made based on the population residing in the districts as compared with an estimate of thecollections of the IRN in the districts.21 Data based on interviews in the Gaza province. It is likely that taxas vary from district to districtand province to province. It is not known whether legislation setting these duties exists.

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market duties are highly seasonal, which means that districts suffer cash constraintsduring non-harvest time.

34. Districts also receive an operating subsidy from the provincial budget. Thesubsidy covers basic personnel costs. Since the staff complement is determined centrally,neither districts nor provinces have much influence over the amount of this subsidy.Districts also report income from rentals of buildings and equipment. Although the legalbasis for this activity is not clear, rental income seems to be an important source offinancing for current expenditures (see Box 1).

35. There is no specialized district collections unit. Market duties are collected on adaily and monthly basis by the administrator's asistentes, while IRN collections arefarmed out to administrative post chiefs at the sub-district level and are handled either bythe asistentes or support staff of the administration at the district level. Other fees,including those deriving from licensing activities, are for the most part collected when acitizen comes in to the district offices to transact some other business, as othertransactions are made contingent on payment of taxes, duties, and fees owed to thedistrict. Given this self-declaration system, it would be difficult to estimate compliancelevels. One district has, however, estimated non-compliance with the IRN. The districtof Mecubuiri estimates that 74 percent of (non-exempt) citizens are non-compliant withthe IRN.2 2

36. Since districts do not comply with the treasury regulations to deposit their IRNcollections in central accounts, and since districts are responsible for their own duties andfee collections, there are no central government estimates of the amounts of fundsactually collected by districts. Districts do, however, prepare statements of revenues andexpenditures, though these statements are rudimentary. One district, for example, reportsits own source revenues by four categories: IRN, duties and fees, rental income, andother. Another district reports revenues using a more detailed classification scheme (tengeneral categories with 17 subcategories). Thus, at this point it would be impossible toenter into detail on the composition of revenues.

22 Assumptions: about 83% of the total population is exempt from paying the tax; the district retains25% of tax revenues.

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Box 1: The Districts of Bilene, Mandlakazi, and Mecuburi:Own Source Revenues, 2000/2001

Bilene, a rural district with a population of about 135,000 in the Gaza province, reported collectingMts. 781,934,392 in 2000 (annualized from 11 months of data), which yielded a per capita collection ratioof about Mts. 6,000 per year; Mandlakazi, also in Gaza, estimated collections of Mts. 578,926,500 in 2001.The bulk of Bilene's collections came from two sources: duties and fees (72 percent) and rental income(23 percent). The IRN only provided two percent of annual own source revenues. Though no data wereavailable on specific duties and fees, the market duties were believed to account for the largest share of thatcategory of revenues. In Mandlakazi, rental income accounted for the largest share of total revenues (48percent), while fees, duties, and others accounted for 35 percent. The IRN accounted for 17 percent. Bothdistricts received slightly more in subsidies from the province than they collected in revenues (Bilene andMandlakazi received, respectively, Mts. 830,365,460 and Mts. 578,926,500).

The district of Mecubuiri in Nampula reported collecting Mts. 94,326,834 in 1997, a per capitayield of Mts. 790 (in 2000 prices). Over 38 percent of district revenues came from rental of a tractor, 43percent from fees (bicycle registration and market fees), and 7 percent from the IRN.

Source: District documents.

37. District revenue generation is thus characterized by a panoply of small taxes,duties, and fees. The assessment system is mixed: taxes and duties are assessedadministratively, while fees are collected under a de facto self-declaration system. Thereare no specialized revenue generation units. Nor is there an established financial systemfor management of revenues, which seems to vary according to the district and province.It is clear, though, that current treasury requirements are not being followed.

38. In addition to the severe limitations on district tax administration capacity,districts face another serious problem: many of the most important districts lost theirrevenue bases to the municipalities. The introduction of the decentralized municipalitieshas had an adverse effect on district revenues. In most cases the creation ofmunicipalities hived off the most urban parts of the districts, thus transferring importantsegments of the revenue base from the districts to the municipalities. Given theimportance of market fees in district revenue composition, district own source revenueshave been reduced significantly. In the affected districts, revenues have declinedsignificantly. Though these thirty three districts only represent about 25 percent of thetotal number of districts, they represent a much larger percentage of the total district taxbase. The shifting of the tax base from districts to municipalities is problematic becauseit calls into question the potential for decentralization to district administrations. Unlessdecentralized district administrations were to rely largely on transfers from the centralgovernment, resources would simply not be available to finance local service delivery.Current fiscal constraints suggest that deconcentration to sectoral district directorateswould be more appropriate than devolution to district administrations. From a pure fiscalperspective the scope for devolution to the district level is thus quite limited.

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B. Municipalities2 3

39. Municipalities have two main sources of income: transfers from the centralgovernment and own source revenues. 24 Transfers from the central government comefrom the Autarkic Compensation Fund (FCA, Fundo de Compensaqdo Auttirquico) forrecurrent expenditures and the Local Investment Fund (FIIL, Fundo do Investimento deIniciativa Local) for capital expenditures. Both funds provide untied block grants to themunicipalities. According to the law, funds are allocated according to the followingallocation criteria: municipal population, municipal area, index of municipal taxperformance, and weighted index of development. In practice, the only criterion used sofar has been the municipal population. Funds from the FCA, which are divided betweenthe 33 municipalities, are to be set between a minimum of 1.5 percent and a maximum of3 percent of annual national tax revenues, though in practice less than the minimum hasso far been allocated (see Table 3). The total amount and allocation is presented andapproved each year in the national budget.

Table 3. Central Government Transfers to Municipalities, 2000(Millions of Meticais)

Budgeted tax collections 6,958,000Actual tax collections 6,915,747FCA Total 95,000FIIL Total 44,000FCA as a Percentage of Collections 1.37%FIIL as a Percentage of Collections 0.63%

Source: Orgamento Geral de Estado, 2000.

40. The FIIL, which provides funding for capital expenditures, may be used at thediscretion of the municipality, given that expenditures are in line with national budgetpriorities. Though there are no set criteria in the law for the allocation of these funds,allocations have thus far been based on municipal population. Given that both the FCAand the FIIL are allocated according to population, there is a fixed ratio of recurrent tocapital expenditure transfers at the municipal level. The available data (for 1999 and2000) show that the ratio has averaged about 2.3. The FIIL, which began disbursementsin 1999, is financed by parliamentary appropriations on an annual basis. Law 11/97 alsoallows for project specific and other investment grants for municipalities, though nogrants have yet been made under these mechanisms. The project specific grant provisionis for projects approved by the national government, while the other investment grantprovision is to reimburse municipalities for expenses related to national projects. Thesegrants would be made annually as part of the national budget. Furthermore,extraordinary grants for emergency purposes (e.g., floods) can be released by the Councilof Ministers. Law 1 1/97 also authorizes the government to fund new responsibilities

23 Municipal financial management is governed by the Municipal Law (2/97), the MunicipalTutelage Law (5/97), and the Municipal Finance Law (5/97), or MFL. In addition municipal revenuecollection is regulated by the Municipal Tax Code (12/00), which complements the Municipal FinanceLaw.24 This section draws from Levy (2001) on municipal finance law and Wojtyla (2000) and Brockmanand Wojtyla (2000) on municipal financial management.

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transferred to the municipalities as necessary. Lastly, municipalities are authorized toreceive funds from the housing authority (APIE) for rents collected on municipalproperties. All municipalities receive fifteen percent of APIE housing receipts, exceptMaputo, which receives 30 percent.2 5

41. Some municipalities report delays in receiving grant funds, especially during theearly part of the year. In some municipalities both the FCA and FIIL are disbursed threetimes per year (March, June, and September) by the corresponding DPPF (municipalitiesdo not utilize the duoddcimo system). In others, however, the FCA is disbursed monthly.

42. In addition to transfers from the central government, municipal finance alsodepends on the following own source revenues: municipal taxes, a share of nationaltaxes (including surcharges), licenses, user fees, fines, inheritances and other gifts,receipts from own assets, including the sale of assets, and other receipts established bylaw. The Municipal Finance Law (MFL) 26 authorizes municipalities to collect thefollowing taxes: (1) the Municipal Head Tax (Imposto Pessoal Autarquico), applicableto residents between the ages of 18 and 60 who are able to work, but exempting thehandicapped, members of the military, students, retirees, and domestic women, (2) theMunicipal Property Tax (Imposto Predial Autarquico), levied on land and buildings,excluding agriculture, (3) the Economic Activity Tax (Taxa por Actividade Econ6mica),which applies to commercial and industrial activity and is paid by those firms thatpreviously paid the corporate income tax (Sections A and B) and are not required to payany of the taxes listed below, (4) the Municipal Tax on Commerce and Industry (ImpostoAutdrquico de Comercio e Industria), which applies to small businesses subject to thecorporate income tax, Section C, and other activities, including street vending andartisanal activities, and (5) the Income Tax, Section B27, which is paid by smallbusinesses, mostly cooperatives and farmers. Municipalities are also authorized toreceive 75 percent of the national vehicle tax, which is not currently being collected.2 8 Inaddition, municipalities were supposed to receive 30 percent of the Tourism Tax, thoughit has since been repealed. Tax rates, which are set by the municipal assemblies, arelimited by the MFL: the Municipal Head Tax may not exceed two-tenths of theminimum monthly industrial wage (about US$ 7.25), the Municipal Property Tax must beset between 0.2 percent and 1 percent of the asset value, the Economic Activity Tax mustbe below twenty times the monthly minimum national industrial wage per businesslocation (a maximum of about US$ 720), and the Municipal Tax on Commerce andIndustry is also set with reference to the minimum industrial wage.29 In general, theMunicipal Tax Code provides highly detailed regulations on how the municipalities are toadminister their taxes, leaving little room for discretion.

43. The MTC indicates that with the exception of the Municipal Head Tax and theEconomic Activity Tax, all other taxes and surcharges will be collected by the MPF,

25 APIE funding is declining in line with continuing property sales.26 Lei #11/97, FinanVas ePatrimonio dasAutarquiasLocais (May 31, 1997).27 The MPF, not the municipalities, are empowered to grant exemptions from this tax.28 Reports indicate that one municipality is already collecting the vehicle tax and listing it under"Other" collections in its account reporting.29 The minimum monthly industrial wage was set at Mts. 665,706 in May 2001.

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which will then transfer the net revenues (after deducting administrative costs) to themunicipalities. Presently, municipalities are only collecting the head tax. The MPF iscollecting the Municipal Tax on Commerce and Industry and the Income Tax, Section B,as well as the head tax withheld on public sector workers' salaries (as of early 2001).The MPF transfers the revenues to the municipalities on an irregular basis (the MPF hasnot retained a percentage for administrative costs). Municipalities are authorized to takeresponsibility for tax collection when they are ready, and may do so by notifying theMPF of their intention by December in anticipation of the new fiscal year. Note that theMunicipal Tax on Commerce and Industry and the Municipal Property Tax are notcollected in other parts of the country, which is appropriate given that autarkies areexpected to provide more and better services than, say, district administrations.

44. Municipalities may issue and charge for activity licenses in fifteen areas,including: (1) infrastructure, equipment, construction, subdivision of lots, and use of landand buildings; (2) delivery of public services; (3) use of reserved lots in markets andfairs; (4) street vending; (5) vehicle parking; (6) commercial advertising; (7) use of publicfacilities; (8) cemetery and funeral fees; (9) health inspection; and (10) registrations.Licensing fees are set by the municipal assemblies. While there are no specificrestrictions imposed by the MFL, all licensing fees must meet the standards ofproportionality and ability to pay.

45. The MFL also authorizes municipalities to charge for direct public serviceprovision in the following areas: (1) water and electricity, (2) garbage and seweragecollection and treatment, (3) public transport, (4) slaughterhouse use, (5) garden andmarket maintenance, and (6) road maintenance. Municipal assemblies set the rates foruser fees unrestricted by the MFL, which only encourages that rates be set on a costrecovery basis. Municipalities may also create autonomous municipal departments(servi os aut6nomos) and municipal public companies to deliver services. The advantageof an autonomous department is that it could be managed on commercial terms; it wouldthus have more administrative and financial autonomy.

46. Presently, compliance with taxes, licenses, and fees seems to be just as much of aproblem for municipalities as for districts. Though compliance data at the municipallevel are not available, anecdotal evidence suggests that non-compliance is considerable(see Box 2).

Box 2: Tax and Fee Compliance in the City of Mandlakazi, Gaza Province

The president of the Mandlakazi Municipal Council recently had to lower his estimatedtax collections because the city was unable to collect as much of the Municipal Head Tax as hadbeen budgeted. At the same time the city is having trouble collecting market fees from certaintypes of businesses. Many established businesses, which are supposed to pay higher market feesthan informal vendors, are refusing to do so. The problem, according to the president, is that"people don't understand what the money is for." The city's strategy is to introduce the feesslowly, so as to avoid "violence."

47. Municipalities may also finance themselves by borrowing short term funds (duethe same fiscal year), the amounts of which may not exceed ten percent of the amount of

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their grants from the FCA. Longer term borrowing, while permissible, must be approvedby the MPF. Borrowing by autonomous municipal departments and municipal publiccompanies is to be regulated by the Council of Ministers. At present the cities do notappear to have any bank loans. In practice, even access to credit from local merchants isquite restricted, due to the cities' poor credit ratings, though the provision of suppliercredit seems to be increasing. Table 4 shows the five largest municipalities' financialobligations.

Table 4: Municipal Arrears

Municipality Amount (Mts. '000,000) TypeBeira 2,617 Borrowed from government to

cover operating expenses; duein 2000.

Nampula 2,464 Short-term loanPemba 100 Short-term loanQuelimane 1,412 Supplier creditsMaputo No data at municipal level.Total 6,593Source: Wojtyla (2000).

48. Appendices 1 and 2 show detailed total revenue and expenditures for the period1998-2000 for the five largest cities: Beira, Maputo, Nampula, Pemba, and Quelimane.3 0

The data must be interpreted cautiously, given that municipalities began to functionindependently in 1998 and that their accounts are not audited (the data, therefore, may bemore estimates than actuals). Furthermore, data for 2000 are projections and estimatesbased on the first six months of the year. In addition it should be pointed out thatMaputo's share is very large in comparison to the other cities. In fact, Maputo accountedfor approximately 40 percent of the total revenues and 66 percent of expenditures of thefive largest cities. In terrns of revenue composition for the five cities as a whole, ownsource revenues made up approximately one third of total revenues, while two thirdscame from central government transfers in 1999 and 2000. Own source revenues werelargely composed of three sources: taxes, fees and licenses, and other operatingrevenues. 32 In 1999 and 2000 taxes, fees, and licenses accounted for nearly three quartersof the total. In terms of fiscal transfers, grants from the FCA and FIIL made up 43percent of total transfers. Housing Authority Rentals (APIE counterpart funds) providedfourteen percent of total transfers, about the same level of funding as from the FIIL. Themajor share of transfers (43 percent) came from other capital funds.33 The data show thatthe grant system provides less than half of the total amount of transfers and less than onethird of total revenues. If own source revenues increase, as they are expected to, FCAand FIIL grants will amount to an even smaller share of revenues. Overall, while taxes,

30 Detailed data from Brockman and Wojtyla (2000).31 These five largest cities accounted for 49% of central government transfers in 1999 and 2000.32 This includes capital receipts, earmarked receipts, and other non-fiscal revenues.33 This category is based on the assumption that positive year end balances from the previous yearwere carried over to the current year. Given, however, the likelihood that positive year end balances werelargely the result of poor reporting of actual expenses, and not actual carry-overs, this category should beanalyzed with a grain of salt.

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fees, and licenses have been increasing, other operating revenues have been decreasing,leading to a net reduction in total own source revenues in nominal terms (this result,however, is driven largely by Maputo; see below). At the same time revenues from othercapital funds have increased 57 percent from 1999 to 2000, while FCA grants increasedmodestly.

49. Excluding Maputo from the analysis allows for a sharper focus on the smallercities (Appendices 3 and 4). On the revenue side the data show that 40 percent ofrevenues were generated by the municipalities while the remainder was transferred by thecentral government. Fees and licenses comprised 30 percent of total revenues while taxesonly accounted for two percent, though taxes quadrupled between 1999 and 2000, whilefees and licenses increased by only nine percent. Though other operating revenuesdeclined slightly, the net overall effect was an increase in total own source funds. Interms of transfers the FCA and FIIL grants accounted for nearly 50 percent of totalrevenues, with the FCA grants accounting for 34 percent. APIE and other capital fundsaccounted for less than ten percent.

50. Focusing exclusively on Maputo provides for some contrast (Appendices 5 and6). Maputo generates fewer revenues than the other cities as a percentage of totalrevenues. Own source revenues represented 32 percent of total revenues, leavingtransfers to account for slightly more than two thirds of the total. One difference betweenMaputo and the others is that taxes were higher (fifteen percent) relative to fees andlicenses (seven percent) as a percentage of total revenues. Both taxes and fees andlicenses have been increasing, though other operating revenues has fallen precipitously,the net result of which has been a decrease in total own source revenues. Anotherdifference is that the FCA and FIIL grants component of total revenues was relativelysmaller, at nineteen percent (the FCA accounts for thirteen percent). Other capital fundsprovided 39 percent of total revenues in Maputo.

51. For the four cities (excluding Maputo) revenues from fees and licenses weregreater than tax revenues. Fees and license revenue was mostly from market fees andrelated activities, garbage collection fees, street vendor licenses, and charges for the useof public land. In Pemba's case the largest component of fees and licenses was the "useand improvement of public land," which was mostly market fees; "building licenses" alsoprovided a significant share of income. In Beira "publicity and neon signs" provided alarge share of own source revenue, while in Quelimane "fines and penalties" wasimportant. Tax revenues in Nampula were limited to the head tax. Maputo's "otheroperating revenues" included "receipts from municipal fixed assets," which the smallercities presumably do not have (Brockman and Wojtyla, 2000). In Maputo' s case, thetourism tax accounted for about half of tax revenues; the elimination of the tourism tax in2001 will have a disproportionate effect on Maputo's finances.

52. Presently, then, tax administration seems to be just as much of a problem formunicipalities as for districts. Most municipalities do not have specialized tax units. It is

34 Data on Maputo may be particularly questionable, given its status as the capital and its previousstatus as a province. National, provincial, and municipal financial management seem to overlap.

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unclear when municipalities will begin to collect the taxes due them, given the technicalcomplexities of revenue administration. Nor is it clear how municipalities will addressthe problem of compliance with taxes, licenses, and fees. Though compliance data at themunicipal level are not available, anecdotal evidence suggests that non-compliance isconsiderable. It would seem then, under present conditions, that municipalities face aserious challenge in increasing their tax revenues. To the extent that municipal revenuesdo not increase considerably (assuming fiscal transfers will not increase greatly in theshort term), improvements in the quantity and quality of service delivery will becompromised. The risk for the municipal decentralization program is that limitedrevenue raising capacity will act as the binding constraint on the transfer ofresponsibilities from the central government to the autarquias, thus stalling the program.

53. Another concern, which is held by some high level Government officials, is thatmunicipalization has created inequalities vis-a-vis the districts (for example,municipalities are perceived to have received favored status at the local level). Criticsbelieve that the amounts of funding channeled to the municipalities through the FCA andFIIL are too high and that the districts have suffered in comparison. The equity problemis especially pronounced in the towns, as opposed to the large cities. In many rural areasthere are not many noticeable differences between towns and districts, except that theautarkic towns receive more funding, and have more control over it, than the districts.

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IV. Expenditures


54. Provinces, much the same as sectoral ministries, are assigned a portion of theannual national budget (OGE), including investment funds through the national PublicInvestment Program (PIP)3 5, which permits provinces to develop provincial PIPs.36 Theprovincial budget as such may be thought of as having two components: priority (PSI)and non-priority sectors. The priority sectors' budgets, both capital and recurrent, aredetermined by the sectoral ministries at the central level, thus provincial levelGovernment has limited input into the budget formulation process in these sectors(sectoral provincial directorates have some input into their parent ministries' budgetformulation process). The non-priority sector capital budget is formulated by theprovincial government, that is, the sectoral directorates in conjunction with the governor.The non-priority sector recurrent budget is largely determined by decisions about civilservice staffing levels made at the center, and in practice tends to be formulated in termsof an increment over the previous year's budget.

55. In the non-priority sectors the capital budget formulation process begins wheneach sectoral provincial directorate submits a proposal to the DPPF.37 At the same timethe MPF sets the aggregate provincial capital budget ceiling and sectoral ceilings for thePSI sectors. The residual, or difference between the provincial ceiling and the sum of thePSI sector ceilings, is allocated to the non-priority sectors. Based on the sectoralproposals and the total ceiling, the DPPF then prepares a proposal for the allocation offunds to the remaining sectors. The DPPF's recommendation is taken up by theprovincial council with the governor presiding. The council then makes a final decisionon non-priority sectoral allocations.

35 The first PIP, formerly known as the Triennial Public Investment Program (PTIP), was developedin 1993. The name was changed when the PTIP became part of the MTEF.36 The inter-provincial allocation decision is based on several general criteria, including regionalredistribution, provincial population, and the existing project portfolio.37 To the extent that district directorates participate in the budget formulation process it is by makingproject proposals to their provincial directorates.

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Table 5: Provincial and Non-Priority Capital Expenditures as a Percentage of the TotalCapital Budget

1995 1996 1997 1998 1999 2000 2001Provincial capital budgetas a percentage of totalcapital budget 2.3% 2.7% 6.1% 2.3% n/a 2.8% 8.6%Provincial capital budgetas a percentage of totalcapital budget(excluding donorfunding) 7.0% 8.1% 18.3% 6.9% n/a 8.4% 25.9%Non-PSI (discretionary)provincial capital budgetas a percentage of totalcapital budget 1.5% n/a 2.0% 2.0%Source: OGE for 1995-1998 and 2001, execution report for 2000, and World Bank staffestimates.Note: PSIs were introduced in 1998.

56. Discretionary capital spending by provinces in Mozambique remains very low,reflecting the highly centralized nature of the Mozambican state. 8 Table 5 shows thatdiscretionary provincial spending averaged 3.7 percent over the pre-PSI period, 1995-1997, and 1.8 percent during the post-PSI period, 1998-2001 (excluding 1999).39 That is,discretionary provincial spending, which was quite low, shrunk even further. The datasupports the argument that the PSIs in the priority sectors had the effect ofreconcentrating authority at the central level by diminishing the percentage of budgetfunds allocated at the provincial level. In fact, the PSIs led to an average reduction indiscretionary provincial spending (as a percentage of total spending) of nearly 50percent. 40 The table also shows that the non-priority sectors are not benefiting (in relativeterms) from the large increase in provincial-level spending programmed for 2001. In realterms, however, the non-priority sectoral allocation grew by 53 percent from 1998 to2000 and by an additional 27 percent from 2000 to 2001. The growth spurt in 2001reflects the government's intention to increase allocations to the provincial level as partof its "decentralization" program. In addition, the increase reflects the use of additionalHIPC funds in the priority sectors at the provincial level. Thus, in real terms, the amountof the discretionary capital budget allocated to the provinces has increased. The relativeamount, however, as a percentage of the total capital budget, has fallen over the period,resulting in a recentralization of the budget process.

38 Discretionary spending is defined as the amount allocated by the provincial level govermmentduring budget formulation.39 If one excludes donor funding from the calculation, the average discretionary share rises to 5.2%over the period 1995-2001 (excluding 1999).40 At the same time, it seems that in some provinces and in some priority sectors there is somedeconcentration of decision making to the territorial level of government. The real impact of thisdeconcentration, in terms of the control of resources, is unknown.

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57. These figures, however, should be interpreted with caution. Given the seriousproblem of budget coverage in Mozambique (see section on off-budget funds), ananalysis of data from the budget will be incomplete. For example, as the off-budgetsection notes, while the aggregate investment amount indicated in the capital budgetmight be between three-quarters and four-fifths of actual total investments, the data at theprovincial level are less accurate than the aggregate amounts, due to the fact that donorsoften do not specify the geographical allocation of their funding with any precision ordetail. While it is true that the government has been able to capture more and more donorfunding in the budget at the aggregate level over the past few years, the same cannot besaid for the provincial level. Thus the result that discretionary provincial capitalexpenditure is decreasing could be spurious (given improvements in accuracy at theaggregate level but not at the provincial level). At the same time, there is a great deal ofdonor funding at the provincial level that has never been captured in the capital budget.Moreover, given that only one budget execution report has been produced, the budgetfigures must be taken as indicative only.

Figure 1. Provincial Recurrent Expenditures as a Percentageof the National Recurrent Budget

80% -70%

60/' =_ 50%

40%Z_ 30%

20%10%

!0% -1995 1996 1997 1998 1999 2000 2001

-|--Provincial Wages as a % of National Wages |-- Provincial Non-wage Recurrent as a Percentage of National Non-wage Recurrent|

58. Provincial recurrent spending has averaged 38 percent of total national recurrentspending (see Figure 1) over the period 1995 to 2001 (not including 1999), though it hasranged from 27 percent to 46 percent. A steep decrease in the ratio of provincialrecurrent expenditures to total national recurrent expenditures occurred in 1998, thoughthe ratio has inched up since then. Figure 1 shows that from 1995 to 1997 provincialspending on wages accounted for a hefty two-thirds of the total national wage bill. Dueto a massive increase in the central government wage bill in 199841, the provincial sharedropped to 47 percent on average over the period 1998 to 2001 (see Appendix 7). Asimilar trend is evident in non-wage provincial recurrent expenditures. One maindifference that persists over the period is the ratio of the wage bill to total recurrent

41 A 280 percent increase in real terms (see Appendix 7).

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expenditures at the central and provincial levels. Spending on wages averages 62 percentof total provincial recurrent spending, whereas it only accounts for 33 percent of totalcentral recurrent spending over the period 1995-2001. Recurrent spending at theprovincial level is largely devoted to personnel costs, which are programmed accordingto civil service complements at the central level. Furthermore, once the PSI sectors areremoved from total non-wage recurrent expenditures (the health, education, agriculture,and public works sectors accounted for 58 percent of total provincial recurrent spendingin 2000, for example), only a small percentage is left for allocation at the provincial level.

59. In addition to the minor level of deconcentration that exists in budget formulation,there is also some deconcentration to the provincial level in other aspects of public sectorfinancial management. Provincial sectoral directorates are responsible for managingsome projects funded by sectoral ministries, especially in the education sector, in whichprovincially managed projects account for about 25 percent of the total number ofsectoral projects, as well as for managing projects in the provincial PIP.

60. Within the sectors, budget management is also somewhat deconcentrated. In thehealth sector, for example, the Provincial Directorates of Health (DPS) play a significantrole in the allocation of resources at the district level. In fact, the DPSs determine theintra-provincial allocation for each of the districts and major health facilities (rural andprovincial hospitals). Provincial govermments also play a role in budget execution,though it appears to vary by sector, province, and district, as well as by source of funds(OGE or donors). According to a recent report (Lindelow and Dehn, 2001), theresponsibilities of the DPPFs, the DPSs, and the district health directorates are not clearlydefined; uniform regulations are lacking. Based on calculations by the DPPF, which areinformed by the provincial budget and district tabelas de despesa, the relevant treasuryoffice advances funds to the province. In some provinces, funds are transferred directlyto the provincial directorate, while in other more deconcentrated provinces funds aretransferred to the district directorate. Subsequent monthly transfers are contingent on theexecuting agency's submission of an accounts report (presta,co de contas) by the tenthof the following month to the DPPF. In cases in which the district directorate is the directrecipient of funds, it must render accounts to the provincial directorate, which then passesthe consolidated accounts on to the DPPF. Accounts must be supported by control,balance, and bank reconciliation documentation (as regulated by the DNPO). The DPPFexamines accounts for compliance with the provincial budget. However, given thatdistrict budgets have no legal standing, the DPPF only verifies accounts at the level of theprovince. The responsibility for verification at the district level seems to rest with thesectoral provincial directorate. The DPPF then authorizes the next advance (reposi,cao),once the previous accounts are approved. At present no new funds are released untilprevious accounts have been approved (this control measure was only recently instituted).If the agency spent more than approved in the previous period, or if funds were notavailable, the replenishment might be reduced.

61. In practice, however, the system of inter-governmental transfers does not operatequite so smoothly. There are three main problems. First, the operation of the systemdepends on available resources. Due to a chronological mismatch between revenuecollection and expenditure needs, liquidity problems are common, especially at the

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beginning of the fiscal year. Second, the process of submitting accounts, in which theDPPF must approve of submitted accounts before releasing more resources, often causesdelays. It is not clear whether this bottleneck is due more to the DPPFs or the provincialand district directorates (it is in this context that own source revenues are used to someextent by the collecting agencies to bridge unanticipated shortfalls). This problem iscompounded by the duodecimo system, which does not permit agencies to make up forpast shortfalls.

Table 6. Per Capita Provincial Expenditures (Recurrent and Capital), 1998 and 2000(Meticais; cur ent prices)

1998 2000Cidade Maputo 169,717 Cidade Maputo 274,954Sofala 11 5,509 Maputo 266,444Maputo 90,686 Sofala 258,793Niassa 89,273 Niassa 248,561Manica 84,383 Manica 230,981Inhambane 83,152 Tete 210,484C. Delgado 82,701 Gaza 209,127Average 78,348 Average 188,410Tete 78,219 C. Delgado 183,492Gaza 74,643 Inhambane 177,018Nampula 57,597 Nampula 138,027Zambezia 43,661 Zambezia 118,408Source: OGE and INE.

62. The process by which the Government allocates expenditures to the provinciallevel is not transparent. There does not seem to be a clear set of technical criteria used tomake these allocational decisions. As Table 6 shows, per capita expenditures varyenormously. Over the two years examined, Maputo, Sofala, and Niassa were consistentlythe most favored, while Nampula and Zambezia consistently received the least in percapita terms. The question of inter-provincial allocation merits further attention,especially if the Government intends for its deconcentration reforms to have aredistributional impact.

63. Recurrent expenditures allocated to districts are determined both centrally andlocally (legally, the district budget has no legal standing). The civil service personnelcomponent of district recurrent expenditures is determined centrally by the civil servicesystem (districts may also use their own revenues plus any subsidy available to hiretemporary contract workers, which most districts do). On the other hand districtsthemselves are responsible for developing the goods and services component of theirrecurrent budgets, such as they are, mainly because they are responsible for financingtheir own non-wage recurrent expenditures. In the 2001 budget for Mandlakazi, forexample, the subsidy from the provincial budget was equal to expenditures on salaries,including temporary contract workers (note that the subsidy does not cover training ortravel costs). The provincial subsidy may exceed the annual salary cost of civil servicepersonnel. Districts thus have some discretion over how to spend the subsidy (if itexceeds permanent staff costs) and their own source revenues. Still, some districts reportshortages of basic items, including supplies and electricity, due to budgetary

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inadequacies. In addition, some districts report problems with transfers from theprovincial budget. Liquidity problems, stemming from inadequacies in the duodecimossystem, seem somewhat frequent. Erratic disbursements from the provincial budgetcoupled with seasonality in own-source revenue collections make the district recurrentbudget quite uncertain on a monthly basis. One district, for example, had a very highvariance in its monthly expenditures for these reasons. The implications for planning areserious.

Box 3: Salaries at the District Level in Mandlakazi

The district administration in Mandlakazi consists of 30 permanent civil servants and 15temporary contract workers. The district administrator and his adjunct earn, respectively, Mts. 39,960,000and 33,744,000 (about US$ 2,220 and US$ 1,875). Each of the six chefes de posto earns Mts. 21,312,000(US$ 1,185). The district employs nine technical assistants (Grelho 6, classes B and C) with averageannual salaries of Mts. 11,367,000 (US$ 632). The contract workers are paid about US$ 400 per year.

Source: "Proyecto de Orcamento de Funcionamento para o Ano Econ6mico 2001," Mandlakazi District.

64. Districts' recurrent budgets are reported in their statements of revenues andexpenditures, though these statements are rudimentary and non-standardized. Onedistrict, for example, reports its expenditures only by month; there is no furtherclassification. Another reports expenditures according to an economic classification.

65. The other important financial management component is the district developmentbudget. Each year as part of the annual budget process, the district administrationsubmits capital expenditure proposals to the DPPF. As part of the deliberations about theprovincial budget, district development allocations are determined. Districts are theninformed of the approved projects and their allocations (one district complained ofsubmitting its proposal in June and not being informed of a decision until the followingJanuary). Some districts do not actually administer their allocated funds; rather, fundingis transferred to the implementing agency. Due to the lack of a legislative framework,however, there is no uniform process at the district level.

Box 4: District Development Budgets in Mandlakazi and Mabalane in Gaza Province

The 2001 capital budget in Mandlakazi consisted of three projects: construction of anadministrative post building in Chalala (Mts. 450,000,000), construction of a residence for the chefe deposto of Chalala (Mts. 400,000,000), and acquisition of furniture and equipment (Mts. 100,000,000), for atotal value of about US$ 53,000. In Mandlakazi the proposed budget for 2001 included three projects: theexpansion of the district office, construction of a new office in Tlavene, and furnishing of the districtadministrator's palacio, for a total of Mts. 750,000,000 or roughly US$ 42,000. The capital budgets fromthese two districts suggest two hypotheses that merit further attention: (1) that districts prefer to spend theirscarce capital resources on building construction projects; and (2) that districts spend large percentages oftheir capital budgets on residences and furnishings for the district administrators and post chiefs.

Source: District documents.

66. District budget management capacity is thus quite limited. Districts neithermanage the capital budget nor the civil service component of the recurrent budget.

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Districts, for the most part, manage their own source revenues for the acquisition ofgoods and services, though they also have some control over the hiring of contractworkers.

67. A recent pilot project, jointly managed by the UNCDF and the DPPF of Nampula,is changing the way district-level financial management operates. The joint DistrictPlanning and Financing Project provides funding for the planning and implementation ofsmall-scale infrastructure projects at the district level. The District Development Fund(DDF) is used as a mechanism for channeling donor funding through the provincialtreasury of Nampula to the participating districts. Unlike many other donor-fundedprojects, the pilot makes use of the existing budget and treasury systems in an attempt tostrengthen them at both the provincial and district levels.

68. The pilot is being conducted under the auspices of the government's NationalDecentralized Planning Program, which is responsible for a number of decentralizing anddeconcentrating reforms over the past several years, including the creation of thedecentralized municipalities. In addition, a new district decentralization anteproyecto iscurrently under consideration. 42 While the details of the reform have not been madeavailable, it is believed that the Nampula pilot is used as the model for reform at thedistrict level. The reform may also go farther than the pilot by giving the district a realrole in sectoral decision making. Though the details are not clear, the reform proposalwould strengthen the technical and decision making capacity of the district administrationvis-a-vis the sectors. Moreover, the reform intends to establish district developmentcouncils to increase civil society participation in the planning process.

69. The project is predicated on districts' producing their own medium-termdevelopment plans (DDPs). The districts would then use their DDPs, as well as theprovincial socio-economic plans (PESs) to develop their annual capital budgets, whichwould then be approved by the provinces and incorporated into the provincial PIP.District capital budgets would have to be consistent with the provincial PESs, whichmeans that districts could not set policy priorities; rather, they would complement them.Once the district budget were agreed upon, the DPPF would make donor funding,complemented by government counterparts funds, available to the district. In addition toproviding sorely needed infrastructure, the project also aims to develop administrativecapacity at the provincial and district levels and to foment the participation of civilsociety, through consultative councils, in the district planning process.

70. The project, which intends to disburse US$ 2.8 million over three years, hashelped thirteen of Nampula's twenty one districts, through their executive councils,produce district development plans according to the national guidelines promulgated bythe MPF and MAE.43 In terms of financing, the provincial government has committedinitially to providing the district development fund with five percent of the provincial PIPin counterpart funds, rising to ten percent by 2002. To follow up on the Nampula pilot,

42 Anteprojecto de Orgdos Locais de Estado (OLE).43 A small, non-random sample indicates that districts involved in the pilot project produce muchmore sophisticated plans than districts not participating.

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the Bank is preparing a Local Management and Development Program to establishdistrict-level participatory planning systems, including DDFs, initially in the districts oftwo provinces. The DDFs would finance public infrastructure and public services. TheBank project would also support training for district officials and staff.

B. Municipalities

71. Municipalities are required to adhere to the national public accounting system(including the national chart of accounts). Though a computerized accounting packagewas developed for the five selected municipalities under the auspices of a Bank project,the system has not been used. Instead, most cities use manual entry systems, often inExcel (Beira, which uses a DOS-based accounting system, developed with Swedishsupport, is the exception). The cash accounting system does not record accounts payableor receivable, so current reporting is incomplete; balance sheets, as such, do not exist.Most municipalities track their liabilities and assets, though none has a complete assetvaluation inventory (Brockman and Wojtyla, 2000).

72. Municipal accounting is to be further regulated by the Council of Ministers. Interms of oversight, annual municipal accounts are first reviewed by the MunicipalAssembly (by the end of March of the following fiscal year) and then sent to theAdministrative Court and the IGF (by June). The IGF is supposed to issue a formalopinion to the court, which would then review the accounts. Furthermore, thegovernment is charged with inspecting municipal financial and asset management at leasttwice per electoral term. As of July 2000, none of the cities had been audited since theirfounding in 1998. Between July 2000 and mid-2001, only seven municipalities haveactually been audited, though the IGF plans to complete audits of all municipalities bythe end of 2001.

73. Municipalities are required to prepare annual budgets according to the legislationgoverning the national state budget (OGE). Municipalities must use the same structureand classification system as used in the OGE. The intent of the MFL is to makemunicipal budgets compatible with the national budget and to generate uniform budgetdocuments and processes across municipalities. The MPF provides municipalities with abudget methodology guide as well as yearly templates; both the guide and templates mustbe followed by the municipalities.44 Some, however, go beyond the minimalrequirements. Nampula, for instance, prepares monthly departmental budgets as part ofthe budget process and Pemba, among others, issues monthly reports to its CouncilPresident. Expenses are paid by check, signed by the president and the financial officer.The cities' treasury system, which is independent of the national system, is operatedaccording to the caixa unica model.

44 See "Metodologia para a elabora,cao da proposta de orcamento do estado: Autarquias,"DNPO/MPF, May 2000. Note that the guide provides a four digit functional classification system as wellas a program-based classification system.

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74. Municipalities must present a draft budget to the MPF by July 31st of the previousfiscal year. The municipal council has until fifteen days before the last session of theyear to submit the budget, along with a plan of activities, to the municipal assembly. Theassembly may only approve or reject, but not alter, the budget (though it may reject withspecific suggestions). Budgets approved by the assembly must then be forwarded to theMPF for ratification. 45 In addition, three copies of the budget must be made available tothe public. Currently, the MPF limits its review to three criteria that autarkic budgetsmust follow: (1) the classification system must be used to the third digit; (2) the year-endbalances are used only for capital expenditures; (3) salaries must not exceed thirtypercent of own-source revenues. In addition, the MPF verifies that the budget wasapproved by the municipal assembly. The MPF may also approve budgets conditionally(in 2001 approximately forty percent were ratified conditionally). The MPF has taken aliberal approach to ratification thus far, on the belief that a legalistic approach wouldresult in failure rates of over fifty percent. 46 It is of the view that budget preparation willimprove gradually (in 1998 most autarquias did not present budgets). In fact, mostautarquias do not present the corresponding financial and administrative informnation thatthey are required to submit. This is partly because the government has yet to issue all theregulations that are required by the autarkic legislation, including regulations on territory,municipal debt, and socio-economic criteria for grant allocation. The MPF is presentlyimparting, for the first time, a three day training course for all municipalities.

75. Once a budget is approved by the assembly, no revenue or expenditure line itemsmay be added. All budget modifications must be approved by the MPF, with a maximumof three modifications per year. The MFL also, places restrictions on the use of funds:allocations for goods and services and for the capital expenditures may not be used forsalaries. 47 In addition, any remaining funds at the end of the year may only be used forcapital expenditures. If a municipality does not approve a budget by March 31 " of thefiscal year to which it applies, the Council of Ministers may remove municipal officialsor dissolve the municipal council and assembly. 48

76. In terms of the expenditures of the five largest autarquias, recurrent costsabsorbed about two thirds of total expenditures in 1999 and 2000 (see Appendices 1 and2). Personnel costs were 36 percent of the total, while goods and services accounted for27 percent. Though goods and services costs have remained steady in nominal terms,personnel costs have increased by 43 percent from 1999 to 2000, due, in large part, torecent civil service salary increases. Similarly, other operating expenditures haveincreased by over 300 percent (in nominal terms) from 1999 to 2000. There is little

45 In addition, the following must also be approved by both the municipal assembly and the MPF:the municipal development plan, the territorial organization plan, the personnel chart, and long term loanobligations.46 This may be due, in part, to the fact that the MPF has limited to capacity to manage autarkicbudgets, which are handled by the same unit that oversees the provincial budget process. Creation of a newautarkic budget unit is under consideration.47 Neither government transfers nor municipal own-source revenues are earmnarked by the centralgovernment, which is appropriate given the mandate of the municipalities to program expenditures basedon the preferences of the voters as expressed through municipal elected officials.48 Removal from office and dissolution of the council and assembly can also occur in other cases ofillegal activity or negligence, including excessive borrowing and unauthorized personnel expenses.

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information on capital expenditures, except that they were made on municipal projects,the costs of which increased by 42 percent from 1999 to 2000. Donor funded projectsaccounted for less than one percent of total expenditures, according to the available data.In all likelihood, however, donor funding at the municipal level accounted for a largershare.

77. Given Maputo's special status, it is also useful to examine the subset of the otherfour cities separately (Appendices 3 and 4). In terms of expenditures recurrent costsaccount for 76 percent of the total, with personnel costs alone accounting for 41 percentof that. Personnel costs grew by about 39 percent between 1999 and 2000 whilespending on goods and services declined by a small amount. Capital expenditures grewby fifteen percent. These cities also have positive year-end balances, which are on theorder of eight percent of total expenditures.

78. Maputo's recurrent expenditures represent 61 percent of total expenditures,leaving about 40 percent for capital investments (Appendices 5 and 6). Personnel costsincreased by 46 percent, slightly higher than in the other cities, while spending on goodsand services decreased slightly. Other operating expenditures also grew sharply in 2000.Capital spending on municipal projects also grew steeply (by 61 percent) in 2000.Maputo has high, positive year-end balances in both 1999 and 2000, averaging 81 percentof total expenditures for the two years.

79. In terms of capital investment programs, municipalities and the government arerequired to coordinate, though the division of responsibility is unclear. What is clear isthat the government has reserved final authority to itself, even with respect to individualinvestment projects within one municipality. Public works contracts are regulated by theCouncil of Ministers, down to the level of pricing. Concessions, in which themunicipality may transfer assets temporarily to a third party, are also regulated by thegovernment. Whether the government exercises its authority on a continuous basis, orreserves it for special cases, remains to be seen.

80. The Bank is presently preparing a project to support a number of the decentralizedmunicipalities, starting with the five largest. The project aims to assist the government indeveloping the legal, institutional, and fiscal framework for municipal governance, totrain municipal officials and staff, and to pilot a Municipal Grants Fund for capitalexpenditures.

V. Reform Agenda: Conclusions and Recommendations

81. The Mozambican government's reform program can indeed be described as oneof gradualismo. The program has been pursued both in terms of devolution in the urbanzones and deconcentration in the rural zones. Both strategies are characterized by greaterlocal participation. At the municipal level the president and assembly are elected, whileat the district level pilot projects have stressed the development of representative district

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consultative councils. 49 Given that local participation is one of the key ingredients forsuccessful decentralization (see Box 5), the Government has clearly adopted the rightstrategy by coupling participation with decentralizing reforms, and should continue tolink the two, especially at the district level. The strategies also stress integrated planningas both municipalization and the district-level pilot projects aim to integrate sectoralplanning with territorial planning. The reforms are oriented toward fostering greaterurban devolution and rural deconcentration in Mozambique.

Box 5: Popular participation is a critical ingredient to successful decentralization

Decentralization is typically regarded as a means to make the public sector more responsiveto citizens' needs. However, decentralization will only make the public sector moreresponsive if it allows citizens to hold public servants accountable and provides for broadparticipation in the local development process. The quality of public services increaseswhen elected officials and administrators are held more accountable to their localconstituents and clients than to their hierarchical superiors.Moving programs closer to users and allowing them to participate in program design andimplementation has many potential benefits. For example, a study in South Africa foundthat grassroots participation improved the cost-effectiveness of transferring resources to thelocal poor. Another study in Nicaragua found that schools with greater local autonomyperformed better on test scores than schools with little or no autonomy.

International experience suggests that in order to maximize the potential benefit ofdecentralization, participation should not be limited to election time. In Bolivia and thePhilippines grassroots associations play a formal (legally-mandated) role in policy makingand administration. In Porto Alegre, Brazil a participatory budget-making process hasenhanced the effectiveness of municipal resource allocation for local development.At the same time the central government has an important support role to play in thedecentralization process. Central government support is necessary to ensure compliancewith national policies and safeguards, especially in the area of financial management, and tocoordinate activities between levels of government. Moreover, central authorities shouldplay a major role in providing the training necessary to foment local administrative capacity,which is the sine qua non of successful decentralization.

Source: World Development Report, 2000over the short to medium term. ''he districts' revenue-raising capacity is also limited adunlikely to improve over the medium term. Moreover, fiscal constraints limit thedevelopment of district and municipal administrative capacity. The risk is that fiscalbottlenecks will constrain service delivery at the local level. Furthermore, there isanother risk that poor revenue performance will lead to bailouts from the centralgovernment, which would exert increased pressure on the nation's fiscal balance andraise concerns about the fiscal sustainability of the decentralization program. Thefollowing recommendations, supported by international good practice, are intended toaddress these concerns.

Provinces and Districts: Recommendations

49 Local councils (conselhos de localidade), which would promote democracy at the sub-districtlevel, are also presently under consideration.

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Recommendation: The functional roles of the provincial and district administrationsneed to be redefined vis-ai-vis the sectors in the context of reform of the "dupla tutela"systenm

83. Thus far, in many cases the territorial provincial goverrnent (i.e., the provincialgovernor) has played a very limited role in the deconcentration program, though in someprovinces and in some sectors territorial planning has played a more important role thanin others. The role of the territorial provincial government, which is limited by thenational constitution, seems to have been further reduced, perhaps unintentionally, as aresult of the PSIs. However, the reform program will have to rethink the role of theprovinces vis-a-vis the districts. One option would be for the provinces to take on thedirect oversight of the districts. For example, the provinces could be charged withholding districts accountable for good administrative and financial management practices.Provinces could also provide technical support at the district level. Provinces could alsotake on responsibilities for coordinating district and municipal development initiatives.Given the status of both the municipal and district level reforms, the moment isopportune for a reconsideration of the role of the provinces vis-A-vis both the central andlocal governments.

84. The role of the provinces will depend, in part, on the role of the districtadministrations. Although reform of the districts is proceeding apace with discussions ofdistrict assemblies and budgets, there is a fundamental question that has beensidestepped: the functional role of the district administration. Given the structure of thedupla tutela, even if districts are given assemblies and budgets, they will still besubordinated to the sectoral ministries. Thus, districts should first be assigned functionalroles. Once functions were devolved, appropriate areas of expenditure could then beestablished; revenue needs could then be assessed based on expenditure assignments.50

To some extent the Government is putting the cart before the horse by reforming theapparatus of the district without reforming the functional division of responsibilitiesimplied by the dupla tutela. There thus has to be a fundamental rethinking of the duplatutela, and with it, the functional role of the district administrations.

85. Central to this point is the definition of the responsibilities of the districtadministrations (i.e., the district administrator) vis-,a-vis the district sector directorates.The Government has two basic choices: devolution or deconcentration. The fiscalanalysis shows that devolution at this time is seriously constrained by the small size ofthe average district tax base and low administrative capacity to raise revenues at thedistrict level. The present fiscal constraint thus limits the extent of decentralization thatcan be undertaken. From the fiscal perspective deconcentration would seem to bepreferred to devolution at the district level.

Recommendation: District revenue administration needs to be overhauled.

86. Presently, districts are authorized to collect a myriad of taxes and fees. Somehave very low yields and are costly to collect. Others, like the market fee, have a high

50 Transferring revenues before functions raises the specter of unfunded mandates.

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yield, though they are undermined by low rates of compliance. In some cases the legalbasis for collecting these fees is unclear. Therefore, the legal foundation of districtrevenue collection needs to be updated and harmonized across all districts. Moreover,district tax administration needs to be strengthened. Specialized collection personnelneed to be trained and deployed, standardized forms need to be produced anddisseminated, and the central Government needs to provide the districts with the legalauthority necessary to enforce compliance. It would seem that developing this complexadministrative capacity across all of rural Mozambique would be a daunting challengecharacterized by high administrative costs. For this reason, two considerations should bekept in mind. First, the district tax and fee structure should be simplified as much aspossible: taxes and rates should be few and exemptions should be scarce. Second,district revenues should focus more on fees for services and less on direct taxation, giventhat the tax base of most districts is likely to be quite small (and the informal sector quitelarge), especially in light of the municipalization reform. A study on the district tax basemay be necessary to determine the extent that districts should also rely on taxes onimmobile factors, such as property. Moreover, to the extent that taxpayers perceive theyare getting something in return for their contributions, compliance will be easier topromote. Given these considerations, the Government should consider establishing adistrict tax administration agency. The role of the agency would depend on the needs ofthe Government, but it could range considerably. At a minimum the agency couldprovide standardized forms and manuals for tax collectors and taxpayers and imparttraining courses for district administrators. Or, the agency could take on actual taxcollections for the districts, which would each contribute a percentage of their taxcollections to its operations. Either option should reduce the total administrative costs ofdistrict taxation. Whatever the decision, urgent action needs to be taken.5 1

Recommendation: District personnel andfinancial management capacity, especially inthe areas of accounting and budget management, should be strengthened.

87. Districts need to readjust the ratio of technical to support staff, not only byincreasing expenditures for technical personnel but also by reducing expenditures foradministrative personnel (especially those who act as the personal staff of theadministrator). The districts also need technical assistance in developing sound financialmanagement practices. In many, if not most, districts financial management isrudimentary. District financial management, including revenue collection andexpenditure, needs to be standardized. A guidebook along the lines of the budgetingguide developed for the municipalities should be developed and promulgated by theMPF. Strengthening public expenditure management at the district level would be aidedby granting the district budget legal status and integrating it fully into the national andprovincial budget process.

5 I Centralizing tax administration would also eliminate the need to rely on tax farming practices, ill-regarded in the literature, at the local level.

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Municipalities: Recommendations

Recommendation: Municipal revenue administration needs to be overhauled,especially if municipalities are going to assume additionalfunctional responsibilitiesand improve municipal service delivery.

88. Currently, municipal revenue collections are quite low and there is no evidencethat municipalities, especially the smaller ones, are ready to assume additional taxresponsibilities. In order to mitigate these problems, it is imperative that the Governmenthelp improve revenue raising capacity at the municipal level. Though the Governmenthas provided the municipalities with ample regulations, it has not provide the materialsand tools necessary to develop administrative capacity in this area. Presently, the DPPFsare assuming municipal tax collection responsibilities, which makes sense in the currentcontext. DPPFs should continue to collect municipal taxes until the municipalities areready to assume them. However, there are legitimate concerns about whether the smallermunicipalities will develop the necessary expertise in the short to medium term. Giventhat municipalities will have to collect a wide range of personal, corporate, and propertytaxes, administration will be costly and complicated. Creating thirty three municipal taxadministrations, many of which would have to be established in very small towns, doesnot seem the best way forward. It might make more sense, in terms of capacity andadministrative costs, for the DPPFs to collect municipal revenues indefinitely. 2

Alternatively, a municipal tax administration agency could be established to handleselected aspects municipal tax administration. The responsibilities of the municipal taxagency could range from producing common publications (forms and guides) toproviding data processing and property valuation services to outright tax collection (theagency could be funded by a percentage of its collections). Several countries followvariations of this model. In China there is a tax agency responsible for all localcollections. In Peru other municipalities contract out collections for a fee to the Limamunicipal tax agency. The Government thus has a number of specific options to considerfor improving municipal tax collections.

Recommendation: The Government should comply with the funding and legalrequirements of the fiscal transfer system and should consider increasing transfers asthe municipalities assume newfunctions.

89. Presently, fiscal transfers from the central Government account for the majorshare of municipal income (for the five major cities), which is consistent with the ratio oftransfers to own source revenues experienced by sub-national governments in mostdeveloping countries. In addition, the sum of transfers plus own source revenues isgreater than the amount of recurrent expenditures, which is again consistent withinternational experience. The appearance of the current financial situation is, however,clouded by the fact that municipalities have yet to become responsible for manyfunctions. Once social service functions are transferred to the autarkies, the financialpicture will look more worrisome. As more substantive functions are transferred to the

52 This option would look more appealing if the national internal revenue administration were toundergo a major reform in the near future.

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autarkies, considerably more resources will be required. Transferring additionalfunctions heavy in personnel costs, such as education and health, might also lead to animbalance in the amount of recurrent expenditures as compared to revenues. Even givensubstantial improvement in revenue collections, additional transfers might be required inorder to match revenues to expenditures. Currently, funding for the FCA is below theminimum 1.5 percent of national tax revenues required by law and funds are transferredonly according to population, in spite of provisions in the law for transfers based onadditional factors (such as socio-economic status). As the Government transfers moreresponsibilities to the municipalities, especially for major social functions, it should alsomove forward with its plans to allocate fiscal transfers according to redistributive criteria,in order to introduce an equity-enhancing component to its decentralization program.The MPF should be able to develop a simple decision rule based on the available data.

Recommendation: Municipalpublic expenditure management should be strengthened,especially in the areas of accounting, budgetformulation, and auditing.5

90. Fiscal management is also inadequate at the municipal level. There is widespreadconcem that many, if not all, municipalities are not following the law in this area. Thereis a clear need for a program of training and auditing. The MPF recently launched a threeday program in this area at the municipal level. This is a welcome start, but much moreis needed. The MPF should develop a follow-up program immediately after thecompletion of the training program. In addition, the World Bank-funded municipalproject should play a role in identifying and addressing specific financial managementdeficiencies. Initial needs identified include: accounting practices, budget classification(for both revenues and expenditures), and sectoral planning. The MPF, together with theTribunal Administrativo, should also launch a high-profile program of municipalauditing. Audits would initially need to be corrective, but could shift to a sanctioningmode after an initial trial period.

Recommendation: The transfer of revenue and expenditure powers to themunicipalities should be rationalized and regulated.

91. The assumption of revenue and expenditure responsibilities by the autarkies hasbeen left completely to the autarkies themselves, according to the law. The Governmentshould ensure, however, that as the decentralization program goes forward, autarkiesmatch revenues with their expenditure responsibilities. The Government might establishsome idea of a timetable for progress. The Government should clarify the requirementsfor the transfer of functions and responsibilities. There should be clear, transparent,technical criteria by which the appropriateness of responsibility transfers to the municipallevel could be judged. Without some sense of a timetable with technical criteria, thereform could flounder unnecessarily.

53 For further details see World Bank Country Financial Accountability Assessment, 2001.

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Recommendation: Municipalities should be empowered to manage their ownpersonnel according to a set of municipal civil service regulations developed bv thecentral government.

92. Another important constraint on municipal decentralization concerns centralGovermment control over municipal civil servants. Autarkies inherited civil servantcomplements without any regard for the match with their functions, expenditures, andrevenues. Given that the central Government effectively controls staff complements, andthat municipal employees are subject to the same civil service system as central civilservants, municipalities do not have control over their own staffs. This means that, forexample, if civil service wages increase, municipal wages increase as well, even thoughthe considerations that support central civil service wage increases may not coincide withthe situation at the level of the municipalities. Since the municipal wage bill accounts forthe majority share of recurrent expenditures, municipalities have no control over theirsingle largest expenditure item. Effectively this means that the central Government hasan undue influence in municipal expenditure management. For the decentralizationreforn to gain some depth, municipalities should be given full control over theirpersonnel, subject to a basic regulatory framework established by the central government.International experience on this question varies: some countries have separate civilservices for subnational governments, while in other countries subnational publicemployees are part of the national civil service system. The particularities of theMozambican case merit serious consideration of a subnational civil service system.

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Appendix 1Page 1 of 1

Appendix 1: Revenue and Expenditures: Beira, Maputo, Nampula, Pemba, and Quelimane(Millions of Meticais)

Actual Projection1998 1999 2000

Revenue:

Own SourceTaxes 12,996 24,888 32,699Fees and Licenses 14,502 33,583 38,253Other Operating Revenues 71,766 34,321 13,201Sub-total (Own Source) 99,265 92,792 84,153

Fiscal TransfersMunicipal Compensation Fund (FCA) 5,993 46,548 53,992Counterpart APIE 4,125 23,298 22,568Local Investment Fund (FIIL) - 21,559 22,637Other Capital Funds 661 57,441 90,322Donor Funds for Capital Projects 256 - 1,891Sub-total (Central Transfers) 11,035 148,847 191,411

Total Revenues 110,300 241,639 275,564

Expenditure:

Operating ExpensesPersonnel 27,738 52,095 74,438Goods and Services 43,460 46,985 44,758Other Operating Expenditures 423 2,636 11,749Sub-total (Operating Expenses) 71,621 101,716 130,944

Capital Expenditures - - -Municipal Projects 1,418 46,622 66,085Central Government Projects 434 - -

Donor Funded Projects 256 - 1,891Sub-total (Capital Expenditures) 2,108 46,622 67,976

Total Expenditure 73,729 148,337 198,920

Year-end Balance 36,570 93,302 76,644

Source: Brockman and Wojtyla, 2000.Note 1: The FCA began disbursing in late 1998, so the annual disbursement only covered a few

months of the year.Note 2: Data for 2000 are based on annualized data for the first six months, except for Beira,which is based on budget data, and Maputo, in which budget data is used for expenses.

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Appendix 2Page 1 of 1

Appendix 2: Revenue and Expenditures (Percentage Terms): Beira, Maputo,Nampula, Pemba, and Quelimane

Actual Projections1998 1999 2000

Revenue:

Own SourceTaxes 12% 10% 12%Fees and Licenses 13% 14% 14%Other Operating Revenues 65% 14% 5%Sub-total 90% 38% 31%

Fiscal TransfersMunicipal Compensation Fund (FCA) 5% 19% 20%Counterpart APIE 4% 10% 8%Local Investment Fund (FIIL) 0% 9% 8%Other Capital Funds 1% 24% 33%Donor Funds for Capital Projects 0% 0% 1%Sub-total 10% 62% 69%

Total Revenues 100% 100% 100%

Expenditure:

Operating ExpensesPersonnel 38% 35% 37%Goods and Services 59% 32% 23%Other Operating Expenditures 1% 2% 6%Sub-total 97% 69% 66%

Capital ExpendituresMunicipal Projects 2% 31% 33%Central Govemment Projects 1% 0% 0%Donor Funded Projects 0% 0% 1%Sub-total 3% 31% 34%

Total Expenditure 100% 100% 100%

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Appendix 3: Revenue and Expenditures: Beira, Nampula, Pemba, and Quelimane(Millions of Meticais)

Actual Projection1998 1999 2000

Revenue:

Own SourceTaxes 147 544 2,443Fees and Licenses 13,539 22,072 24,105Other Operating Revenues 3,438 6,068 5,662Sub-total (Own Source) 17,125 28,684 32,209

Fiscal TransfersMunicipal Compensation Fund (FCA) 5,993 24,080 27,977Counterpart APIE 4,125 4,438 4,634Local Investment Fund (FIIL) - 11,153 11,711Other Capital Funds 661 1,963 3,371Donor Funds for Capital Projects 256 - 1,891Sub-total (Central Transfers) 11,035 41,635 49,582

Total Revenues 28,160 70,318 81,792

Expenditure:

Operating ExpensesPersonnel 12,048 24,294 33,713Goods and Services 11,713 21,597 20,437Other Operating Expenditures 423 2,636 4,641Sub-total (Operating Expenses) 24,184 48,527 58,791

Capital ExpendituresMunicipal Projects 1,418 15,440 15,903Central Government Projects 434 - -MGF Projects - 0DonorFunded Projects 256 - 1,891Sub-total (Capital Expenditures) 2,108 15,440 17,794


Year-end Balance 1,868 6,351 5,207

Source: Brockman and Wojtyla, 2000.

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Appendix 4: Revenue and Expenditures (Percentage Terms): Beira, Nampula, Pemba, and Quelimane(Millions of Meticais)

Estimates Projections Averages1998 1999 2000 1999-2000

Revenue:

Own SourceTaxes 1% 1% 3% 2%Fees and Licenses 48% 31% 29% 30%Other Operating Revenues 12% 9% 7% 8%Sub-total (Own Source) 61% 41% 39% 40%

Fiscal Transfers 0% 0% 0% 0%Municipal Compensation Fund (FCA) 21% 34% 34% 34%Counterpart APIE 15% 6% 6% 6%Local Investment Fund (FIIL) 0% 16% 14% 15%Other Capital Funds 2% 3% 4% 3%Donor Funds for Capital Projects 1% 0% 2% 1%Sub-total (Central Transfers) 39% 59% 61% 60%

Total Revenues 100% 100% 100% 100%

Expenditure:

Operating ExpensesPersonnel 46% 38% 44% 41%Goods and Services 45% 34% 27% 30%Other Operating Expenditures 2% 4% 6% 5%Sub-total (Operating Expenses) 92% 76% 77% 76%

Capital ExpendituresMunicipal Projects 5% 24% 21% 22%Central Government Projects 2% 0% 0% 0%MGF Projects 0% 0% 0% 0%Donor Funded Projects 1% 0% 2% 1%Sub-total (Capital Expenditures) 8% 24% 23% 24%

Total Expenditure 100% 100% 100% 100%

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Appendix 5: Revenue and Expenditures: Maputo(Millions of Meticais)

Actual Projection / Budget1998 1999 2000

Revenue:

Own SourceTaxes 12,849 24,344 30,256Fees and Licenses 963 11,511 14,148Other Operating Revenues 68,328 28,253 7,540Sub-total (Own Source) 82,140 64,108 51,944

Fiscal TransfersMunicipal Compensation Fund (FCA) - 22,468 26,016Counterpart APIE - 18,860 17,935Local Investment Fund (FIIL) - 10,406 10,927Other Capital Funds - 55,478 86,951Donor Funds for Capital Projects - - -Sub-total (Central Transfers) - 107,212 141,828

Total Revenues 82,140 171,321 193,772

Expenditure:

Operating ExpensesPersonnel 15,690 27,801 40,724Goods and Services 31,747 25,388 24,321Other Operating Expenditures - - 7,108Sub-total (Operating Expenses) 47,437 53,189 72,153

Capital ExpendituresMunicipal Projects - 31,181 50,182Central Government ProjectsMGF ProjectsDonor Funded ProjectsSub-total (Capital Expenditures) - 31,181 50,182


Year-end Balance 34,703 86,951 71,437

Source: Brockman and Wojtyla, 2000.

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Appendix 6: Revenue and Expenditures (Percentages): Maputo(Millions of Meticais)

Actual Projection I Budget Average1998 1999 2000 1999-2000

Revenue:

Own SourceTaxes 16% 14% 16% 15%Fees and Licenses 1% 7% 7% 7%Other Operating Revenues 83% 16% 4% 10%Sub-total (Own Source) 100% 37% 27% 32%

Fiscal TransfersMunicipal Compensation Fund (FCA) 0% 13% 13% 13%Counterpart APIE 0% 11% 9% 10%Local Investment Fund (FIIL) 0% 6% 6% 6%Other Capital Funds 0% 32% 45% 39%Donor Funds for Capital Projects 0% 0% 0% 0%Sub-total (Central Transfers) 0% 63% 73% 68%

Total Revenues 100% 100% 100% 100%

Expenditure:

Operating ExpensesPersonnel 33% 33% 33% 33%Goods and Services 67% 30% 20% 25%Other Operating Expenditures 0% 0% 6% 3%Sub-total (Operating Expenses) 100% 63% 59% 61%

Capital ExpendituresMunicipal Projects 0% 37% 41% 39%Central Government Projects 0% 0% 0% 0%Donor Funded Projects 0% 0% 0% 0%Sub-total (Capital Expenditures) 0% 37% 41% 39%

Total Expenditure 100% 100% 100% 100%

Year-end Balance 73% 103% 58% 81%

Annex 3Appendix 7Page 1 of 1

Appendix 7: Recurrent Expenditure by Province: Wage and Non-wage Recurrent ExpendituresMillions of Meticais

OE OE OE OE OE Execution OE1995 1996 1997 1998 1999 2000 2001

Niassa 17,100 31,629 49,926 70,318 106,078 202,423 228,950C. Delgado 26,413 48,336 66,179 111,678 148,025 257,815 266,995Nampula 48,708 93,341 130,710 173,013 219,095 429,564 469,598Zambezia 49,053 80,714 109,198 128,317 206,834 372,473 406,036Tete 28,204 47,601 65,105 94,195 120,992 259,673 248,876Manica 21,463 35,853 48,437 88,635 125,171 253,574 253,189Sofala 41,054 77,753 111,756 156,152 204,526 354,851 362,085Inhambane 24,678 42,629 58,360 95,364 124,679 215,310 244,132Gaza 24,875 38,533 53,518 79,411 133,361 234,039 262,452Maputo 25,063 41,189 56,172 76,485 117,939 231,647 239,836Cidade Maputo 64,878 88,017 127,734 162,130 186,446 250,799 278,739

Total Provincial Recurrent 371,489 625,595 877,095 1,235,709 1,693,145 3,062,168 3,260,888Wage expenditures 236,584 402,259 583,104 770,584 1,042,340 1,738,274 1,920,278Non-wage expenditures 134,905 223,336 293,991 465,125 650,805 1,323,894 1,340,611

Total National Recurrent 826,000 1,511,000 1,962,000 4,634,661 5,699,272 6,688,983 9,213,467Provincial as % of Total National Recurrent 45% 41% 45% 27% 30% 46% 35%

Total Central Recurrent 454,511 662,480 821,995 3,414,574 4,006,127 3,626,817 5,952,579Central wage expenditures 139,416 188,931 242,595 930,543 1,246,802 1,677,837 2,169,335Central non-wage expenditures 315,095 473,549 579,400 2,484,031 2,759,325 1,948,980 3,783,244% Spent on Salaries at Prov. Level 64% 64% 66% 62% 62% 57% 59%% Spent on Salaries at Central Level 31% 29% 30% 27% 31% 46% 36%

Notes:Non-wage recurrent expenditures include goods and services, transfers, and other recurrent expenditures.1995 at constant 1994 prices1996 at constant 1995 prices1997 at constant 1996 prices1998-2001 in nominal terns

Annex 3Appendix 8Page 1 of 1

Appendix 8: Capital Expenditure by ProvinceIn Millions of Meticais

Execution1995 1996 1997 1998 1999 2000 2001

Niassa 6,363 7,398 Data 13,960 84,577C. Delgado 7,070 9,523 not 11,100 69,025Nampula 14,717 15,090 available 21,211 71,348Zambezia 142,948 16,493 20,250 131,107Tete 6,716 9,046 18,146 113,020Manica 92,163 7,346 9,155 51,908Sofala 65,130 11,790 21,416 38,876Inhambane 6,335 9,087 7,049 113,165Gaza 12,723 10,406 17,602 31,592Maputo 6,080 8,211 17,199 29,424Cidade Maputo 8,130 10,801 29,362 30,497Provincial Total 72,283 98,831 368,375 115,190 186,449 764,537

National Total 3,079,248 3,646,865 6,043,321 4,997,867 6,650,033 8,843,662Prov. as % of National 2.3% 2.7% 6.1% 2.3% 2.8% 8.6%*2000: For total national capital budget, executed amount of internal financing (1,212,033) was added to extemal financing in revised OGE (5,438,000).

*1997: Provincial breakdown is based on percentages from author's summation of provincial projects but actual amounts based on provincial total given in OGE

(since the two are not equal).

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ANNEX 4

THE PROCESS OF BUDGET FORMULATION

1. Until the application of the Lei de Enquadramento Or,amental (or BudgetFramework Law) in 1998, the budget preparation process in Mozambique was differentfor the recurrent and investment budgets, driven in part by the different fiscal yearsapplicable to the two budgets. Under the current law, a unified budget proposal,including current and capital expenditures, needs to be discussed and approved by theNational Assembly by December 31 st. Following approval, the budget executioncommences in January on the basis of a fiscal year that runs from January throughDecember, and a detailed budget document is supposed to be prepared and published inthe first quarter of the calendar year.

2. The budget cycle starts with the preparation of the first draft of a Medium TermFiscal Framework (Cenario Fiscal de Medio Prazo, or CFMP) that sets the aggregateexpenditure limits , broken down by priority sectors, based on projections of the overallresource envelope. Expenditure limits are subsequently communicated by circular to allministries and State institutions participating in the budgetary process by May 31 5t 1 InJune and July sector ministries and provinces generally organize sectoral meetings wherediscussions are held with all key officials, including provincial level representatives.These lead to the submission of the budget proposal by the ministry -- including bothrecurrent and investment expenditure estimates -- to the budget department in theMinistry of Planning and Finance, Direc,do Nacional do Plano e Or,amento (DNPO),not later than July 31 St,

3. Elaboration of the final budget, or Or,amento do Estado (OE), is the soleresponsibility of the MPF, on the basis of the proposals received from line ministries.Although negotiations may in some cases take place, much of the discretionary power forresource allocation rests with the Minister of Planning and Finance who submits thebudget for approval to the Council of Ministers.

4. The OE is complemented with the preparation of two important companioninstruments: the Plano Trienal do Investimento Pzublico (PTIP) and the PlanoEcon6mico e Social (PES). The Three Year Investment Plan (PTIP), produced since1990, has been the primary tool for investment programming and management. The PTIPis presented to the National Assembly, but has in itself no legal basis. Programmed

I Mozambique's budgetary institutional framework is organized into central and provincialadministrations. These include ministries -- most of which are represented in the 11 provinces byprovincial sector directorates -- services and autonomous institutions, totaling 67 units, of which 30are at the central level. Each one of these institutions constitutes a budget and accounting entity.

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expenditures under the first year of the PTIP are the samne as the investment component inthe national budget. The PTIP offers a relatively comprehensive view of total investmentexpenditures projected for the year, the majority of which - an estimated 66 percent in2000 and 69 percent in 2001 -- are externally financed.

5. To complement and support the budget document, the government also preparesits Economic and Social Plan (PES), which is presented to the National Assembly prior toapproval of the budget. The PES makes a presentation of the state of the economy overthe past year and lays out the principle priorities of government policy for the next year.It discusses the evolution of general macroeconomic indicators, and discusses socialsector priorities more specifically. Quarterly PES updates over the course of the year,moreover, are used as an instrument to inform the National Assembly as to the state ofthe economy, although in practice they are hardly put to any use.

6. Annual budgets are approved and published in real terms, based on previous yearprices. During execution, the MPF adjusts budget allocations by decree, adjusting forprojected average inflation (in the case of internally financed expenditures) and expectedaverage exchange rate depreciation (for externally financed outlays, mainly investment).The modified limits are communicated to spending agencies but are not published. Thisfact makes it difficult to compare budget allocations (published in constant prices) andactual expenditures (recorded in current prices) and therefore reduces transparency. Thisis aggravated by the fact that adjustments are not uniform and may vary widely betweenbudgetary categories. For example, in 1998 the allocation for the Office of the PrimeMinister was adjusted upwards by 85 percent, while that for the Ministry of ForeignAffairs was increased by only 0.4 percent (although in aggregate terms the totaladjustment remained close to projected annual inflation).

7. The budget proposal is discussed and approved by the National Assembly.However, the planning and budget commission, in charge of the technical analysis of thebudget document, lacks the resources and the capacity to effectively perform its role.

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ANNEX 5

THE PROCESS OF BUDGET EXECUTION

1. Budget execution and accounting for central government is the responsibility ofthe Directorate of Public Accounting (Direcqdo Nacional da Comptabilidade Publica,DNCP), while the Provincial Directorates of Finance (Direcqdo ProvinVal do Plano eFinan as, DPPF) undertake provincial level budget execution and accounting. Theexecution process follows a strict cash basis budgetary system that ensures a rigorouscontrol of resources, but which may be too stringent and cumbersome, especially giventhat most of the operations are performed manually.

2. In the case of non-salary recurrent expenditures, as well as all expenditures in theinvestment budget, the financial execution system entails, first, an advance of funds to thespending agencies (line ministries and autonomous institutions); second, a reporting bythese agencies on incurred expenditures; and, third, a reimbursement of spent funds bythe Ministry of Planning and Finance to the spending agencies. At the beginning of theyear, the Ministry of Planning and Finance holds back a reserve for each the recurrentand the investment budgets'. Net of these reserves, funds are then transferred to spendingagencies on the basis of one -twelfth (duodecimo) of their respective budgetary allocationeach month, except in the beginning of the year when a transfer of two-twelfths takesplace2. These funds are deposited in special bank accounts - two per spending agency,one for recurrent and another for investment expenditures - that agencies are required toopen each fiscal year.

3. Regarding the provinces, funds are advanced to the DPPFs to finance thoseexpenditures executed at the provincial level. These advances are meant to cover theprojected shortfall between the revenue from central government taxes and non-taxes

I In the case of the recurrent budget, the MPF holds 10 percent of the annual sectoral provision for eachline item of goods and services as an "execution" reserve, including the covering of eventualoverspending by a sector for any given month. A separate recurrent budget emergency reserve is heldby MPF to cover unforeseen expenditures (such as expenses for epidemics, floods, etc.). In the caseof the investment budget as well, a reserve, which was close to 20 percent of the total investmentbudget in 1998, is administered by DNPO and used for contingencies, for new projects approvedduring the course of the year, and for supplementing (reforco) the budgets of projects as requiredduring the year.

2 Certain legal exemptions exist to this duodecimos system in cases, such as road rehabilitation, wherelarge, discrete expenditures are programmed for specific (dry season) months during the year.

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collected by the province - which the provinces are allowed to retain - and the provincialgovernment expenditure provided in the budget3.

4. Before the 1 O"h of each month, spending agencies (the Department forAdministration and Finance [DAF] in the case of the central ministries; DPPFs in thecase of provincial governments) must justify expenses incurred during the previousmonth by submitting to DNCP a summary (balancete) listing each type of expenditure --current and investment -- according to the economic classification, and accompanied bystatements for each bank account. After reviewing this information and ensuring thateach expenditure is properly justified, the following tranche, matching the exact amountof expenditures justified and up to one-twelfth of the budgetary allocation, is liberated byDNCP, after verification of the availability of funds by the treasury. As this wholeprocess is expected to take close to a month, the "second" twelfth of the budget paid outin January acts as a rolling buffer throughout the year and is settled at the closing of theyear.

5. Salary expenditures aren't subject to the rule of duod&cimos4. Instead, themonthly salary bill is paid to each spending institution according to programmed salaryexpenditures based on sectoralfolhas de salarios. In the case of central ministries, thesesalary bills are usually paid into each Ministry's bank account (usually at the Bank ofMozambique). In the case of provincial level salaries, the payments are made through theDPPFs at the provincial level to the sectoral ministries' DAF in the province. At theprovincial level, given the absence of Bank of Mozambique branches in most provincialcapitals, DPPFs and sector Ministry DAFs usually have their accounts with BancoComercial de Mocambique (BCM), a private bank with minority governmentshareholding. The actual timely payment of salaries in the provinces continues toundergo difficulties, however, especially in areas of the country where there are no banks.The salary payment system is computerized at a central level.

6. With respect to the investment budget, the payment process depends on whether agiven project is centrally or provincially administered. Projects managed centrally by thesector ministries in Maputo have their investment budget payments executed through thecentral ministry. In the case of provincially administered projects, the payments aremade through the provincial DPPF.

7. Spending agencies are supposed to follow several steps in the execution ofexpenditures, but these are unclear and not specified in the legislation. The first step isthe verification that a sufficient budget allocation is available (cabimento); the second isliquidacdo, or the estimation of the exact amount to be paid; and the last is the actualpayment. However there seems to be an additional stage, commitment, before

3 As provinces tend to systematically underestimate the collection of taxes and no downwardadjustment is done of the advances during the execution of the budget, provincial Governments havein recent years been able to mobilize resources above the level they would normally be entitled to.

4 Other outlays exempted from this rule are debt service, transfers to abroad, subsidies, other currentexpenditures, customs duties and operations during the complementary period.

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liquidaqdo, but which is not explicitly mentioned in the Budget Framework Law nor inthe implementation regulations.

8. It is at this point that decisions are also made about nominal salary adjustments tobe taken during the year. For mid-year reallocation of budgetary resources from onebudget line to another within sector ministries, the ministry would require permissionfrom MPF. As mentioned above, the government also uses the fractions held as reserve(budgeted under a line entitled "provisionary allocation") to supplement ministerialallocations. The government is however obliged not to exceed the limits set in the budgetdocument under the economic classification, and would need to obtain the authorizationof the National Assembly to surpass either these ceilings or the aggregate budget limit.

9. Spending agencies benefit from a complementary period after December 31(periodo complementar) for payment of expenditures. The complementary period coversthe period January-February for expenditures administered at the provincial level andJanuary-March for those administered at the central level. No new expenditures can inprinciple be incurred during this period, which can only be used for the payment ofexpenditures already committed before the end of the fiscal year. In practice however,agencies use this period to continue incurring new expenditures they were unable tocommit before the end of the year simply by backdating supporting documents, henceundermining fiscal discipline.

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ANNEX 6

TOWARDS AN INTEGRATED FINANCIAL MANAGEMENT SYSTEM INMOZAMBIQUE-KEYS TO TIE SUCCESSFUL IMPLEMENTATION OF THE

SISTAFE

Overview

1. The new Law on the Financial Administration of the State (Lei da AdministracdoFinanceira do Estado) creates the basis for the introduction of an integrated financialmanagement system (IFMIS), or Sistema de Administracdo Financeira do Estado(SISTAFE, as it is known in Mozambique) that integrates more closely the differentfunctions of the fiscal process-budgeting, accounting, cash and asset management,reporting, and auditing. This is an important step in the right direction. The effectiveintroduction of such systems is, however, a very demanding exercise and experience inSub-Saharan Africa calls for extreme caution in their implementation. Basically, a strongand sustained commitment at the political and technical levels, coupled with a gradualistapproach that takes into account capacity constraints and avoids costly technologicalsolutions, are key to the successful introduction of IFMIS. Above all, the basic problemsaffecting the current system, especially in the areas of budget coverage, accounting cashmanagement and auditing, must be addressed first in order to create a sound basis for theeffective introduction of the SISTAFE.

Critical ingredients for success

2. The following are critical ingredients of a successful IFMIS:

> Strong political commitment and effective technical coordination and leadership.Fiscal management reform demands a strong and sustained commitment andleadership at the political level, supported by a small but efficient technical unit thatensures coordination of all services involved, monitors implementation of an actionplan and provides technical guidance. This is a complex and demanding task. IfUTRAFE is to play this role, it must be able to mobilize the required expertise. Itwill need to ensure the services of a small team of qualified experts with experienceon IFMIS in Africa.

> The IT component must not be an end in itself While the IT component is at thecore of the development of an IFMIS, it should not be an end in itself, nor the drivingforce behind the reform process. It must support whatever organizational changes arenecessary to make the system work, and its success will be measured not by thesuccessful introduction of an IT package, but by its successful use by civil servants,i.e. the timeliness and accuracy of the inputs and outputs of the system.

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> The solutions adopted must be aligned with broader reforms in public service. Thedesign of the IFMIS, and the technical choices adopted, must be in line with andsupport a broader public sector reform process that addresses institutional,organizational and behavioral weaknesses. In the specific case of Mozambique, thiswill require a very close coordination between UTRAFE and UTRESP to ensurecoherence between the civil service reform process and the gradual introduction ofthe SISTAFE.

Sequencing

3. The development of a specific and time-bound action plan for implementation ofthe SISTAFE should be consistent with the following broad steps.

> "Getting the basics right". The improvement of the current budget managementsystem is a necessary condition for the effective implementation of the SISTAFE.The following areas are among those that require urgent attention: (i) reducing thenumber and rationalizing the operational procedures of bank accounts operated byspending units; (ii) including in the budget all revenues, earmarked or not, andrelated expenditures; (iii) revising the chart of accounts in line with the new budgetfunctional classification and (iv) improving the information in the budget executionreports, in particular by including data on donor-financed sectoral expenditures.

> Concentrate first on improving the inputs of the system. Implementation of theSISTAFE should focus first on the areas of accounting and cash management(treasury) and only later be extended to the other sub-systems or modules (budgetformulation, auditing, physical assets, etc). Accounting is important because it is theprimary source of financial information linked to the operations of the government.As such, the quality and timeliness of accounting information is critical for theefficient finctioning of all the other components of the system. As far as the treasuryis concerned, it is responsible for saving the government money through the cost-effective use of resources, it is the link with the monetary program and is key toensuring the smooth implementation of the budget. A roll-out strategy, directing thegradual extension of the system into the other areas, should be devised up-front.

> Adopt a modular, step-by-step approach and "think smafl"' As in other countries,but particularly in Mozambique, an incremental approach will be determinant tosuccess. Whatever the decision taken on the scope of the project, the SISTAFEshould be conceived around self-contained modules and should concentrate first on asmall core of functions considered key. Experience in several other countries, e.g. inGhana, shows that overly-complex projects inevitably run into considerabledifficulties and are likely to fail.

> Build capacity and retain qualifled staff Experience indicates that the capacitybuilding demands are substantial as modern FMS require skills which are not readilyavailable in the public sector. This refers in particular to professional accountingskills as well as the IT skills to effectively use and operate the new system. InMozambique, one of the most urgent needs is to train staff on double-entry

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accounting and modified accrual accounting. Although the future introduction of acomputerized accounting system will tend to simplify the tasks required from staff,and hence reduce the need for a deep knowledge of accounting techniques, this willtake time and will continue to require that staff be familiar with the basic concepts.

Implementation

4. The following guidelines should be taken into account for the implementation ofthe SISTAFE:

> Develop an action plan. The first step must be the preparation of a realistic actionplan describing both the final objective (the scope and main components of theSISTAFE) and the specific steps to get there. It must be accompanied by a timetableand clearly identify those responsible for each of the tasks.

> Project implementation needs to be organized around clearly identiflable resultsand achievements. To maintain the enthusiasm and the momentum for reform duringthe implementation phase, is a critical success factor. To ensure continuous supportfor the reform process clear benchmarks and demonstrable results must be identifiedthat would enable to measure implementation progress. These performance criteriashould be part of the project implementation plan. Too often, performance indicatorsfocus on technical achievements rather than demonstrable results. Improvements inbudget coverage, in the quality of accounting reporting and in treasury control ofbank accounts-all mentioned in the latest report of the Administrative Tribunal andin the PER report-are among the obvious performance criteria that could be used.

> A risk management strategy is importantfor the implementation of a new IFMIS.Typical elements of such a strategy are (i) an identification of potential problems thatmight endanger the implementation of project components and sub-components, (ii)an assessment of the likelihood for these problems to occur, and (iii) the developmentof options to overcome the problems including the implications for the project. Basedon the experience in other countries, the main risks are associated with difficulties inthe effective introduction of the IT component and with resistance from users to thenew system.

> An active information campaign is criticaL The introduction of the SISTAFE, to besuccessful, needs to be supported and understood by end-users and stakeholders at alllevels. An information campaign needs to be put in place at the outset. Capacity-building activities need to include general information on the purpose and rationale ofthe exercise. End-users need to be informed of the changes that this introduction willbring to their work and what specific benefits it will generate (in particular how it willhelp them doing their jobs better). Mechanisms must be put into place to ensure thatpeople have no choice but to use the new system. Managers, anxious of loosing thepower linked to their privileged access to information, must be brought in early intothe process. Implementation must be accompanied by a change in the incentivesstructure, hence the importance of linking the introduction of the SISTAFE with thecivil service reform.

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