JAR 2007 - OPERATIONAL REVIEW 2008 EC ─ MOZAMBIQUE JOINT ANNUAL REPORT on 2007 For the Operational Review 2008 1 Chapter 1. Executive Summary The present document is the Joint Annual Report corresponding to implementation year 2007 that the Government of Mozambique and the European Commission have agreed on in 2008, as stipulated in the Cotonou Agreement, Annex IV, Article 5. This report analyses for the year the situation in the country; describes an overview of past and current EC cooperation in Mozambique; makes an assessment on policy coherence issues; identifies actions foreseen in the 10th EDF in accordance with the priority actions of EU- Africa Action Plan agreed in December 2007 and describes dialogue in the country with the NAO and the Non State Actors. It also presents an update of the existing general donor coordination and harmonization framework, and the main conclusions on the implementation of the 9th EDF CSP. The performance of the EC cooperation can be assessed in terms of financial absorption of the available envelope; sectoral and macro-economic performance in the sectors of intervention in relation to agreed targets aligned on the PARPA II objectives and quality of dialogue. In Mozambique for the period under consideration, those three elements can be considered as globally positive. However, improvements can be made in some specific areas. The evaluation of the current CSP (9th EDF) found that EC development cooperation in Mozambique is of high quality. The effectiveness of the EC Delegation as a partner of government supporting national poverty reduction policies has improved significantly during the period 2001-2007. Also, the EC has continued the move towards increased proportions of general budget support and sector budget support, as recommended. The rate of disbursement has been considered impressive. As to results in focal sectors, overall level of performance against the 2007 PAF targets is mixed. Good progress was achieved in a number of areas, namely macroeconomic support – solid growth having been showed - and overall reforms in PFM. However, inequality seems to be growing, particularly in urban areas. Therefore there are questions on the poverty reduction effects of the high growth rates experienced by Mozambique. It is expected that the househould survey, which will take place in 2008 would shed light on this matter. In the Road sector, there were significant improvements, as the new sector policy and strategy, functional organization and the move towards sector budget support were consolidated. The Road Fund revenues continued to improve but the performance on routine maintenance still has to be improved. The delivery of core services in agriculture was, in some cases, below the targets but some progress in the indicators was considered encouraging. Although the expansion of service delivery in health and education continued to be good, the spread of HIV/AIDS is also an enormous threat to future growth and poverty reduction. A series of challenges also remain in the area of governance. Demonstrating a positive performance of the EC-Mozambique cooperation, it was formally decided at the beginning of 2007 to increase the 9th EDF envelope by 50 M€ (as a result of the 2006 End-of-Term review). Those additional funds were concretized through the signature in October 2007 of an extension of the general budget support programme 2006-2007. This allowed to avoid any gap in the EC’s support in this area and in Mozambique’s national budget during 2008, transition year between the 9th and the 10th EDF. 2 Chapter 2 . Update on political, economic and social environment 2.1 Political situation Mozambique is a competitive electoral democracy but the challenge to improve the conduct and administration of the next electoral processes remains. The November 2007 consensus of the two main parties to amend the Constitution in order to allow the postponement of the first provincial assemblies´ elections, that were scheduled for 2007, was welcomed as it provided the time for a more comprehensive voters´ registration exercise and for a proper planning and preparation of the up-coming elections (which also includes municipal, parliamentary and presidential elections). The independence of high-level institutions that check on executive and legislative powers has been up-held significantly with far-reaching decisions of the Constitutional Council and also from the Administrative Court that were duly respected and implemented. These developments clearly indicate that the consolidation process of the rule of law at top level is progressing. The Government completed half of its mandate and while there has been sustained macroeconomic stability, economic growth and broad policy continuity, there was also recognition that the results of the reform process and of some policies defined in the PRSP were not meeting expectations. Corrective measures were taken and changes were made in some important positions and institutions. A wave of violent and localized crime that hit mostly Maputo and its surroundings in the beginning of the year 2008 exposed the weaknesses of the police force. Efforts to counter administrative corruption continued but the effectiveness of the national anti-corruption strategy will only be assessed in a medium and long term perspective. The implementation of the APRM process in Mozambique continued with the establishment of a national forum to undertake the country self-assessment and to draft a programme of action. The forum contracted three organisations to carry out surveys and broad publicity was given to the overall process. In what regards regional integration, Mozambique has a particular interest in promoting regional initiatives which strengthen inter-country transport, energy markets, and the use of international water and ports, making the international transit through Beira, Nacala and Maputo corridors competitive. 2.2 Economic Situation Despite extensive flooding and cyclone Favio which caused serious damages in the country, Mozambique's macroeconomic performance continued to be positive during 2007. According to the National Institute for Statistics, in the third quarter of 2007 GDP growth was 7.3% and the average inflation rate was 8.2% that is above the programmed 2007 target of 5.9%, but decreasing compared to December 2006 when it amounted to 13.6%. In its fight against inflation, the Central Bank is trying to reduce liquidity in the economy through the issuing of Treasury bills and the sale of foreign exchange. Macroeconomic stability is facilitating the economic expansion of Mozambique. A second generation of mega-projects, such as the Moatize coal mine, a doubling of gas exports through the Sasol pipeline and the construction of a second fuel pipeline to South Africa is expected to take place over 2008-2009. The PRGF programme supported by the IMF expired in July 2007. It has been replaced by a new Policy Support Instrument that aims to ensure macroeconomic stability while improving social service delivery and boosting economic growth. The three IMF missions in 2007 all confirmed that Mozambique's economy continues to perform well. Macroeconomic stability is consolidated through the pursuit of prudent monetary and fiscal policies in the context of a flexible exchange rate regime. 3 In 2007, revenues were higher than programmed due to better collection of direct domestic taxes, reaching an amount of 16.4% of the GDP. In the medium term, the revenue effort as percentage of GDP is increasing. The IMF is confident that the Government of Mozambique will continue to increase domestic revenue by 0.5% of the GDP per year as presented in the Medium Term Fiscal Framework (MTFF). However, it is crucial that mega-projects start contributing more to tax revenue. The government is reviewing the package of fiscal exemptions offered to companies investing in Mozambique and is expected to introduce new fiscal regimes for the mining and petroleum sectors. In terms of the Mozambican Government's budget, around two-third of the 2008 budget was allocated to priority sectors, and as a result it is expected that high spending on poverty alleviation projects will continue in 2008-2009, in line with the PARPA II, with a focus on meeting the MDGs. A second PEFA Assessment started at the end of 2007 to verify progress achieved until the end of 2006. It must be noted that Mozambique is one of the first few countries that have conducted two PEFA assessments and therefore developing a robust basis for verification of reform progress over time. According to the study, significant improvements in the quality of PFM systems and processes have been achieved between 2004 and 2006. The most important improvements have come in cash management, payroll, procurement and internal controls, revenue collection and management and donor practices. Credibility of the budget, available information on resources received by primary service delivery units, Medium Term expenditure Framework (MTEF) and coordination between central management and sector level management, as well as internal and external audit capacity and consolidation of SISTAFE are areas that need to be further developed and improved. The business environment is expected to improve gradually, in particular through the newly established fast track procedures aimed at reducing the period for enterprising licensing, and the introduction of a new labour law. However, constraints as the limited access to the sources of financing and the high costs of financial services