Mozambique: A Soft Landing in 2016 — Tiago Dionisio, Chief Economist

Mozambique’s long-term economic outlook remains upbeat 
Economic activity in Mozambique slowed in 2015. The latest data released by the National Statistics Bureau (INE) showed that real GDP expanded at a more modest 5.9% YoY in 2Q15. This is well below the growth rates seen in the previous four quarters, which averaged 7.4%. The mining and construction sectors remained the main growth drivers of the economy, improving 17.9% and 13.1%, respectively, from the same period of 2014. Although mining still accounts for a small share of the country’s GDP structure (3.7%), it has been responsible for a significant part of the foreign direct investment (FDI) that has entered Mozambique in recent years. Large investments have initially been made in the coal sector, but more recently attentions have turned to the vast natural gas reserves in the Rovuma basin, in the north of the country. This has boosted other sectors such as construction, utilities, and real estate. All in all, Mozambique is currently a more diversified economy, but it remains highly dependent on the agriculture sector, which still accounts for nearly a third of its GDP. 

Mozambique’s long-term economic outlook remains upbeat though largely as a result of the natural gas projects expected to come on-stream later this decade. Local officials reportedly expect more than US$30 billion will be invested initially in this sector to build capacity to produce 20 million tons per year of liquefied natural gas (LNG), with first exports due to start no sooner than in 2020. This is huge for a country whose GDP currently stands at more than half of that amount. However, Mozambique currently faces several headwinds that will most likely prevent it from expanding at the rates witnessed of the last decade. These include (1) a significant drop in commodity prices, namely aluminum and coal (its main exports) and (2) a deceleration in FDI in the country. We believe both the prices of these two commodities, which together account for about 40% of Mozambique’s exports, and FDI is not expected to see a material recovery in the foreseeable future. 

Overall, we estimate real GDP growth of around 6-6.5% this year and next (down from 7.2% in 2014) and for economic activity to accelerate thereafter. This means that growth could pick-up to an average of nearly 8% in 2017-20 on the back of the anticipated investments in the natural gas projects in the Rovuma basin. Mozambique could benefit from international loans like the ones recently agreed with the IMF (US$ 286 million over an 18-month period) to help bring some stability to the economy following the sharp drop in commodity prices and the European Union (US$ 740 million over the next five years) to support several development projects. However, we believe that short-term risks remain skewed to the downside, as persistently low commodity prices and a weaker global economic outlook could put additional pressure on economic activity in the country.  

Inflation and Monetary Policy 
The latest consumer price data released by the INE showed that inflation is gradually picking up after recording a constant downward trend in recent years. This has been mostly felt in the food and non-alcoholic beverages segment, with prices in other items going up very modestly in 2015. The inflation rate surged to 6.27% YoY in November while the 12-month average stood at 2.83%. This compares with 1.93% and 2.56%, respectively, at end-2014.

Consumer prices are expected to remain under pressure in the short-term and going into 2016. We currently expect average annual inflation to increase to 8% in 2016 from an expected 3% in the previous year. A large part of this has to do with the significant depreciation of the metical against other currencies such as the US dollar and the South African rand (nearly 50% and 29%, respectively, as of mid-December).

On the other hand, foreign reserves have fallen markedly in the last months, standing at about US$ 1.95 billion in November and representing about three months of imports. This is down from US$ 2.9 billion at the end of 2014. International reserves were under pressure in 2015 due to (1) higher external public debt payments, (2) the absence of capital gains in transactions in the extractive industry (we note that Mozambique netted around US$1.3 billion in capital gains in the period 2012-14), (3) lower disbursements from foreign donors and (4) a deterioration in the country’s external accounts (the current account deficit is expected to reach 41% of GDP in 2015 vs. 33.9% in the previous year). 

Meanwhile, the Central Bank tightened monetary policy in its last three monthly meetings (October, November, and December) by raising interest rates and increasing reserve requirements. These combined moves lifted (1) the overnight lending interest rate to 9.75% (+225bps), (2) the deposit standing facility interest rate to 3.75% (+250bps) and (3) the reserve requirements to 10.5% (+250bps). We believe this shift in monetary policy is likely to continue going forward bearing in mind the need to protect international reserves and limit the exchange rate depreciation.

The Central Bank also introduced several measures aimed at ensuring that the foreign exchange market functions in a smooth manner and, at the same time, to contain the depreciation of the metical. These measures state that:

– The conversion of import proceeds and offshore investment earnings by banks that were not involved as intermediary banks are strictly forbidden;

– Export proceeds of goods/services and offshore investment earnings shall only be transferred between local bank accounts for the sole purpose of amortizing foreign currency denominated loans within the local banking system;

– Entities authorized to import funds in the form of foreign direct investment or external loans are allowed to keep them in foreign currency in their accounts with intermediary banks;

– The foreign exchange funds mentioned above can only be transacted at the exchange rate of the respective bank;

– Entities authorized to import capital have to specify the commercial bank that will intermediate and assist in the application process for the approval of the Central Bank.

Moreover, the Banco de Moçambique announced that it was limiting the use of international cards (that can be used both domestically and internationally) for overseas payments to MZM 700,000 (or about US$ 13,500 at the current exchange rate). This limit is assigned to each card holder regardless of the number of contracts signed with one or more issuers. Exceptions to this limit can occur, but they will need to be evaluated by the card issuers and are subject to the approval from the Central Bank. This measure is effective as of January 1st, 2016.  

Budget Proposal 2016 
The budget proposal for 2016 approved in the country’s Parliament suggests that the government plans to center its fiscal policy for this upcoming year on (1) increasing and diversifying revenue sources, (2) controlling public spending levels (including wages by only hiring new workers in the education, health and police sectors), (3) concluding ongoing public works, (4) continuing to provide basic social services, (5) prioritizing debt service payments, (6) improving human capital development and (7) promoting a business environment that will foster the development of local enterprises and attract investment. The document also includes the following macro assumptions for 2016: (1) a real GDP growth rate of 7% and (2) an inflation rate of 5.6%. The government expects economic activity to be boosted by several sectors namely agriculture, the extractive industry, manufacturing, electricity, retail and transports and communication. 

According to the 2016 budget proposal, the government foresees total revenues (ex-grants) reaching MZM 176,409 million and total expenditures MZM 246,070 million. This is roughly US$ 3,615 million and US$ 5,040 million, respectively, at the current exchange rate. It also leads to a projected budget deficit (ex-grants) of MZM 69,661 million or 10.2% of GDP. If we include the projected grants of MZM 24,800 million (about US$ 500 million) for 2016, the budget deficit is forecasted at 6.6% of GDP.

Total revenues are projected to see a 10% improvement from the 2015 budget proposal and account for 25.9% of GDP, a slight drop when compared with the 26.7% in 2015. Tax revenues, including income and goods & services taxes, are forecasted to increase 14% and represent 86% of total receipts. Most of this improvement is likely to come from higher goods & services taxes, namely VAT. The government also foresees the amount of grants improving 21% YoY and accounting for 3.6% of GDP (roughly the same as in 2015). 

Regarding expenditures, the local authorities expect to spend 8.7% more than in 2015. Still, total spending is forecasted to represent 36.2% of GDP, which is lower than the 37.6% in the 2015 budget. Current expenditures should see a strong increase as the government expects to (1) hire new public sector employees in strategic sectors (like education, health, and defense) and (2) significantly increase debt payments (namely interest on domestic debt instruments and interest on external debt related to infrastructure investments). They are expected to account for nearly 55% of the government’s total expenditures.

Meanwhile, the government stated that it was allocating MZM 138,116 million (or about US$ 2,830 million) to the economic and social sectors next year. This figure is 12.4% higher than the one allocated in 2015. It also represents 66.6% of total expenditures (excluding interests and net lending) planned for next year (vs. 62.5% this year). Education gets a third of the total spending by sector while the infrastructure sector gets nearly 30% of this allocated amount, with most of this going to spending on roads.

The government is planning to finance three-fourths of its expenditures with domestic receipts such as tax revenues, which is roughly the same as in 2015. However, it also expects to borrow both in the domestic and international debt markets. Indeed, it is worth noting that public debt levels are expected to remain significantly above the levels seen in recent years. In particular, external debt is projected to increase from US$ 7 billion at the end of 2014 to an estimated US$ 7.4 billion in 2015 and US$ 7.75 billion in 2016. This means that, after taking into account the exchange rate effect, Mozambique’s external debt as a percentage of GDP is expected to surge from 41.6% in 2014 to 65.7% in 2015 and 58.3% in 2016.

Increasing concerns about the sustainability of the country’s external debt position have led to downgrades in the country’s rating by the main agencies during 2015. In July, Standard & Poor’s downgraded Mozambique’s credit rating from “B” to “B-“, questioning the governance model in the country and the government’s management of public sector debt. This followed the announcement that the government was planning to restructure the state-backed US$ 850 million loan issued back in 2013 to Ematum, a domestic tuna company. The local authorities ended up confirming that the state was responsible for US$ 500 million out of the total issued amount, with the remaining staying with Ematum. S&P’s also placed Mozambique on “credit watch”, suggesting that it could downgrade its rating further. 

The following month, it was Moody’s turn to lower the country’s rating to “B2” from “B1” and change its outlook to negative. The rating agency stated that the key driver behind this decision was the underperformance of the country’s fiscal and debt metrics relatively to its peers, which is something that is expected to continue in the medium-term. The negative outlook reflected uncertainties over the local authorities’ strategy for covering its increasing external debt payments in foreign currency.

More recently, in October 2015, Fitch lowered Mozambique’s rating to “B” from “B+”, with a stable outlook. It stated that the country’s fiscal profile deteriorated significantly over the past year, reflecting (1) high budget deficits, (2) a rapid rise in public debt, (3) volatile government revenue and (4) a widening wage bill. The rating agency added that the new government is making efforts to control capital expenditures, but fiscal consolidation is expected to be gradual, evidencing in part difficulties in increasing the tax base.